Document of The World Bank Report No. 75750-BR INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN IN THE AMOUNT OF US$550 MILLION TO THE STATE OF PERNAMBUCO WITH THE GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL FOR A PERNAMBUCO EQUITY AND INCLUSIVE GROWTH DEVELOPMENT POLICY OPERATION May 23, 2013 Human Development Department Brazil Country Management Unit Latin America and the Caribbean Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank's policy on Access to Information. Brazil - GOVERNMENT FISCAL YEAR January 1-December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 20, 2013) Currency Unit Real (R$) US$1.00 R$ 2.04 Weights and Measures Metric System ABBREVIATION AND ACRONYMS AD DIPER State Development Agency (Agncia de Desenvolvimento Econmico de Pernambuco) APEVISA Pernambuco Health Surveillance Agency (Agncia Pernambucana de Vigilncia Sanitria) ATS Automatic Transfer System BCB Central Bank of Brazil (Banco Central do Brasil) BNDES National Bank of Economics and Social Development (Banco Nacional de Desenvolvimento Econmico e Social) CAF Andean Development Corporation CEBRID Brazilian Center of Information on Drugs (Centro Brasileiro de Informaes sobre Drogas) CBMPE Pernambucan Fire Services (Corpo de Bombeiros Militar de Pernambuco) CFAA Country Financial Accountability Assessment CIB State and Municipal Health Committee CIDE Contribution on Household Budget Intervention (Contribuio de Interveno no Domicilio Econmico) CPI Consumer Price Index (indice de preo ao consumidor IPCA in Brazil) CPRH State Environmental Agency CPS Country Partnership Strategy CVLI Violent Lethal Intentional Crimes (Crimes Violentos Letais Intencionais) DPL Development Policy Loan ESW Economic and Sector Work FDI Foreign Direct Investment FEAS State Fund of Social Assistance FGC Credit Guarantee Fund FMAS Municipal Funds for Social Assistance (Fundos Municipais de Assistncia Social) FPE Project Structure Plan (Fundo de Estruturao de Projetos) FRL Fiscal Responsibility Law FUNDEB Development Fund for Basic Education (Fundo de Desenvolvimento da Educao Bsica) GAP Gender Action Plan GBV Gender-based violence GDP Gross Domestic Product GFS Government Finance Statistics GOP Government of Pernambuco ii GSDP Gross State Domestic Product IBRD International Bank for Reconstruction and Development ICMS Taxes on Goods and Services (Impostos sobre Circulagio de Mercadorias e Prestay5o de Serviyos) IDA International Development Association IDB Inter-American Development Bank IFC International Finance Corporation IFPES Federal Technological Institutes of Pernambuco ILOS Institute of Logistics and Supply Chains IGP General Price Index (indice Geral de Preyos) IMF International Monetary Fund IOF Taxes on financial transactions (Imposto sobre Operay6es Financeiras) IPCA Consumer Price Index IPEA Institute for Economic Analysis (Instituto de Pesquisa Econdmica Aplicada) IPI Tax on Industrial Goods (Imposto sobre Produtos Industrializados) IR Income tax (Imposto de Renda) JUCEPE Board of Commerce of Pernambuco (Junta Comercial de Pernambuco) LDO Law of Budget Guidelines (Lei de Diretrizes Oryamentarias) LOA Annual Budget Law (Lei de Oryamento Annual) LRF Fiscal Responsibility Law (Lei de Responsabilidade Fiscal) M&E Monitoring and Evaluation MAR Metropolitan Area of Recife MDGs Millennium Development Goals MOH Ministry of Health NCD Non-communicable disease NCR Net Current Revenue NLTA Non-lending Technical Assistance NPL Non Preforming Loan OECD Organisation for Economic Co-operation and Development PAF Fiscal Adjustment Program PB Pernambuco no Batente PDCA Plan-Do-Check-Act PEFA Public Expenditure Financial Accountability PFM Public Financial Management PICs Productive Inclusion Centers PNAD National Research by Domestic Sample (Pesquisa Nacional por Amostra de Domicilio) PPA Multi-year Action Plan (Plano Plurianual de A do) PPE Education Convenant (Pacto pela Educaqio) PPV Pact for Life (Pacto Pela Vida) PRODETUR Programa de Desenvolvimento do Turismo PROINFRA State Industrial Infrastructure Development Program PRONATEC Programa Nacional de Acesso ao Ensino T6cnico PSIA Poverty and Social Impact Assessment REDESIM Rede Nacional para a Simplificaqio do Registro e da LegalizaTo de Empresas e Neg6cios SDS Secretariat for Social Defense SDSDH Social Development Secretary and Human Rights SECGE Secretaria Especial da Controladoria Geral do Estado SECMULHER Secretaria da Mulher SEDSDH Social Development Secretary and Human Rights iii SEE State Secretary of Education SEFAZ State Secretariat of Finance SELIC Sistema Especial de Liquidagdo e Custodia SEM State Economic Memorandum SENAI Servigo Nacional de Aprendizagem Industrial SENAR Serviqo Nacional de Aprendizagem Rural SENARC Serviqo Nacional de Aprendizagem Comercial SEPLAG Secretariat of Planning and Management of the State of Pernambuco SIM/SEVS Sistema de Informagdo sobre Mortalidade STN National Treasury Secretariat (Secretaria do Tesouro Nacional) STQE Secretary of Labor, Qualification and Employment SUS Unified Health System (Sistema Unico de Safide) SWAp Sector Wide Approach TA Technical Assistance TCE Court of Accounts of the State (Tribunal de Contas do Estado) TVET Technical and Vocational Education and Training UPA-E Urgent and Specialized Care Centers UPP Pacification Police Units VAT Value Added Tax WB World Bank Vice President: Hasan A. Tuluy Country Director: Deborah L.Wetzel Sector Manager: Mansoora Rashid Sector Manager: Louise Cord Task Team Leader: Magnus Lindelow Co-Task Team Leader: Aude-Sophie Rodella iv BRAZIL PERNAMBUCO EQUITY AND INCLUSIVE GROWTHDPL TABLE OF CONTENTS I. INTRODUCTION....................................................................................................1 II. COUNTRY CONTEXT....................................................................................... 3 RECENT ECONOMIC DEVELOPMENTS IN BRAZIL ..............3 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ........4 RECENT EVOLUTION OF FISCAL AND DEBT INDICATORS FOR THE STATE OF PERNAMBUCO ................................6 POVERTY AND SOCIAL DEVELOPMENT ....................8 III. GOVERNMENT PROGRAM AND PARTICIPATORY PROCESSES.....12 THE GOVERNMENT PROGRAM ...........................12 IV. BANK SUPPORT TO THE GOVERNMENT'S PROGRAM........................14 RATIONALE FOR BANK INVOLVEMENT AND LINK TO THE CPS.. 14 COLLABORATION WITH THE IMF AND OTHER DONORS............15 RELATIONSHIP TO OTHER BANK OPERATIONS ..............15 CHOICE OF INSTRUMENT ................................17 LESSONS LEARNED................................ .....18 ANALYTICAL UNDERPINNINGS ............l.........21 V. THE PROPOSED OPERATION: PERNAMBUCO EQUITY AND INCLUSIVE GROW TH DPL .................................................................................................................... 24 OPERATION DESCRIPTION ...............................24 POLICY AREAS ...........................................24 VI. OPERATION IMPLEMENTATION ...............................................................40 POVERTY AND SOCIAL IMPACTS ................... ......40 ENVIRONMENTAL ASPECTS .............................43 IMPLEMENTATION, MONITORING AND FIDUCIARY ENVIRONMENT ...... ...............................................43 FOREIGN EXCHANGE CONTROL ENVIRONMENT ... .............46 DISBURSEMENT AND AUDITING.....................47 RISKS AND RISK MITIGATION ........................47 ANNEX 1: PERNAMBUCO LETTER OF DEVELOPMENT POLICY..................49 ANNEX 2: POLICY M ATRIX ....................................................................................... 58 ANNEX 3: DETAILED MACRO SECTION................................................................ 65 ANNEX 4: FISCAL AND DEBT SUSTAINABILITY ANALYSIS...........................75 ANNEX 5: STRATEGY MAP FOR THE ALL FOR PERNAMBUCO PROGRAM ....89 ANNEX 6: COUNTRY AT A GLANCE (includes country map)..............................90 v The Pernambuco Equity and Inclusive Growth DPL Loan was prepared by an IBRD team consisting of Magnus Lindelow (TTL and Sector Leader for Human Development, LCSHD) and Aude-Sophie Rodella (Economist, LCSPP and Co-TTL) Philip Schellekens (Senior Economist, LCSPE), Madalena Santos (Consultant, Education Specialist, LCSHD), Fabio Sola Bittar (Consultant, PREMPE), Ezau Pontes (Consultant, Health Specialist, LCSHH), Marcela Distrutti (Consultant, Health Specialist, LCSHH), Joana Silva (Senior Economist, LCSHS), Maria Concepcion Steta Gandara (Senior Social Protection Specialist, LCSHS), Thadeu Abicalil (Senior Water and Sanitation Specialist, LCSWS), Diego Dorado (Senior Public Sector Management Specialist, LCSPS), Rogerio Bianchi Santarrosa (Consultant, LCSPP), Flavia Carbonari (Consultant, LCSSO), Rodrigo Serrano-Berthet (Senior Development Specialist, LCSSO), Renata Mayer-Gukovas (JPA, LCSHD), Joaquin Toro (Senior Disaster Risk Management Specialist, LCSDU), Luis-Felipe Lopez-Calva (Lead Economist, LCSPP), Carolina Rend6n (Public Sector Specialist, LCSPS), Edith Kikoni (Economist, LCSPE), Miguel-Santiago da Silva Oliveira (Senior Finance Officer, CTRLN), Victor Ordonez (Senior Finance Officer, CTRLN), Joseph Kizito Mubiro (Senior Financial Management Specialist, LCSFM), Luiza Guaraciaba (Program Assistant, LCC5C), Roland Clarke (Lead Public Sector Management Specialist, LCSPS), Tom Kenyon (Senior Private Sector Development Specialist, FPD); Jessica Terry (Operations Analyst, LCSPP), Anita Fiori (Private Sector Development Specialist, IFC) and Angela Nieves Porto (LCSPS). The operation was undertaken under the general guidance of Deborah L. Wetzel (Country Director, LCC5C), Keith Hansen (Sector Director, LCSHD), Mansoora Rashid (Sector Manager, LCSHS) and Louise Cord (Sector Manager, LCSPP). Peer reviewers were Maria Beatriz Orland Bloom (Senior Social Development Specialist, SDV), Aline Coudouel (Lead Social Protection Specialist, LCSHS), Tania Dmytraczenko (Senior Economist, LCSHH), Ambar Narayan (Lead Economist, PRMPR), Bill Dorotinsky (Adviser, PRMPS), and Francisco Galrao Carniero (Lead Economist, ECSP1). Vi LOAN AND PROGRAM SUMMARY BRAZIL PERNAMBUCO EQUITY AND INCLUSIVE GROWTH DPL Borrower The State of Pernambuco, Brazil, with a Guarantee of the Federative Republic of Brazil Implementing Agency Secretariat of Planning and Management of the State of Pernambuco SEPLAG-PE Financing Data US$550 million with a sovereign guarantee from the Federative Republic of Brazil Operation Type Single tranche Development Policy Loan to be disbursed upon loan effectiveness Main Policy Areas Regional economic development, private sector development, technical and vocational education and training, productive inclusion, public sector management, crime and violence prevention, health Key Outcome The key outcome indicators are as follows: Indicators * An M&E system for PROINFRA is established and generates annual reports, which are expected to provide the basis for decisions about adjustments of the program. * Percentage of new business registrations completed within 72 hours in the 25 municipalities participating in REDESIM increases from 0% to 70%. * An M&E System for state's TVET programs has been implemented and data on key indicators on inputs, efficiency and results are available for decision making. * Number of municipalities that have signed adherence pacts with the state, thus benefitting from state financing for productive inclusion programs and committing to service delivery targets and performance reporting, increase from 0 to 51. * The state's Results Based Management model, based on the approaches used in Pacto pela Vida and including sectorial committees, is fully implemented in at least three sectors (security, health, and education), and key elements of the model established in other secretariats. * The number of beneficiaries of the "Programa Atitude" program, which is focused on rehabilitating crack users increases from 2000 to 6000, of which the number of women increases from 500 to 2000. * Implementation of a Monitoring and Evaluation (M&E) system to (i) register the occurrence cases of gender-based violence in the geographic areas of the PPV (AIS); (ii) evaluate the results of the actions taken to address violence against women; and (iii) provide inputs for decision-making regarding new interventions and the adjustment of existing policy/ programs as part of the PPV, under vii the auspices of the Technical Chamber to Combat Violence against Women. * Percentage of hypertensive patients that are under active management in primary care increases form 50.7% to 58%. * Percentage of diabetes patients that are under active management in primary care increases from 58% to 66%. * Percentage of specialist consultation (cardiology and endocrinology) referred through the state referral system, reflecting improvements in the functioning of the state referral system increase from 0% to 70%. Program Development The Development Objective of the proposed operation is to support Objective(s) and the Government of Pernambuco to strengthen the design, Contribution to CPS implementation, monitoring and evaluation of policies and programs aimed at promoting sustained growth and improved economic opportunities for the poor, consolidating public sector management innovations, preventing crime and violence, and reducing the burden associated with chronic disease. The Program is fully aligned with the priorities of the World Bank Group's Country Partnership Strategy 2012-2015 (Report #63731- BR), discussed by the Executive Directors on November 1, 2011. In accordance with the Country Partnership Strategy (CPS), the proposed operation aims at promoting a more equitable, sustainable and competitive Pernambuco, including through a strong gender focus. Risks and Risk The overall risk rating for the operation is moderate. Economic and Mitigation fiscal risks are related to prudent management of the state's fiscal position in an uncertain global environment. Social and economic impacts for the most vulnerable population are expected to be positive, but depend on effective implementation. Fiduciary risks are assessed as low given strong internal rules and controls. Institutional and implementation risks are moderate to low and relate to capacity constraints and the need for intersectoral and intergovernmental coordination to implement reforms and programs. Overall, risks are mitigated by a strong ownership of reforms by the Government of Pernambuco, as well as an established track record of coordinating I and implementing difficult reforms. Operation ID P132768 viii IBRD PROGRAM DOCUMENT FOR A PROPOSED PERNAMBUCO EQUITY AND INCLUSIVE GROWTH DPL TO THE STATE OF PERNAMBUCO WITH THE GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL I. INTRODUCTION 1. The proposed operation is a single tranche Development Policy Loan (DPL) to the State of Pernambuco, Brazil, in the amount of US$550 million. The program development objective of the proposed operation is to support the Government of Pernambuco (GoP) to strengthen the design, implementation, monitoring and evaluation of policies and programs aimed at promoting sustained growth and improved economic opportunities for the poor, consolidating public sector management innovations, preventing crime and violence, and reducing the burden associated with chronic disease. The multi-sectoral operation supports the implementation of the GoP strategy "All for Pernambuco" (Todos por Pernambuco), which aims to make the state a "better place to live and a better place to work." It builds on the Bank's long- term engagement with the state of Pernambuco and the recent Expanding Opportunities, Enhancing Equity in the State ofPernambuco Development Policy Loan (Report No. 62869-BR), approved in 2012. 2. Over the last decade, Brazil has made significant advances in terms of economic and public sector management, poverty reduction, and social indicators. Consecutive governments have maintained sound macroeconomic policies, achieving low inflation, robust economic growth, and significant job creation. Growth in employment and labor incomes, as well as the implementation of targeted social assistance programs, such as Bolsa Familia, have contributed to a reduction in the share of Brazilians living below the extreme poverty line of R$70 a month' from 10.5 percent at the start of the 2000s to 4.7 percent in 2011, as well as a reduction in inequality as reflected in a fall in the Gini coefficient from 0.59 to 0.53 over the same period. Brazil has also seen significant improvements in health and education outcomes resulting from public investments and sectoral reforms. 3. Similarly to the rest of Brazil, the State of Pernambuco has seen improvements in economic and social indicators over the last decade, but is still facing significant challenges. With over 9 million inhabitants, the State of Pernambuco is the second largest economy in northeast Brazil. However, like other states in the Northeast, it has long lagged behind the rest of Brazil. In 2010, gross domestic product (GDP) per capita was R$10,822, about half of the national average (R$19,766), and the share of the population living below the poverty line was twice that of Brazil as a whole. This pattern is apparent in other areas as well, with comparatively poor health and education outcomes, and high levels of crime and violence. Pernambuco also remains highly unequal, with significant disparities in human capital, economic opportunities and access to public services, including along spatial, racial and gender lines. 4. The State of Pernambuco has made significant advances in addressing its development challenges. Two consecutive Government programs (2008-2011 and 2012-2015), based on strong participatory processes, have emphasized the need for increased public investment, improvements in public services, reduction in crime and violence, and sustainable growth as key means to improve equity and living conditions in the state, including for the most vulnerable segments of the population. Equally important, the state has put in place an innovative Amount in 2010 constant prices; it corresponds to approximately USD40. 1 public sector management model based on systematic monitoring of performance and an institutionalized mechanism for policy coordination and accountability for results. 5. The proposed multi-sectoral operation seeks to further the Government's reform agenda by strengthening the design, implementation, monitoring and evaluation of priority policies and programs in the GoP strategy for 2012-15. Building on the prior engagement with the state and a dialogue on priorities, the proposed operation focuses on seven areas that correspond to priorities in the GoP strategy, including its overarching priority of addressing the needs of the most vulnerable segments of the population: (i) regional economic development, (ii) private sector development, (iii) technical and vocational education and training, (iv) productive inclusion, (v) public sector management, (vi) crime and violence prevention, and (vii) health. In each of these areas, the operation supports critical actions towards the institutionalization and expansion of key Government policies and programs, or the establishment of monitoring and evaluation systems that will provide the basis for evidence-based and performance-oriented policy making in the future. Taken together, the policy actions are expected to help promote sustained growth and improved economic opportunities for the poor, support the consolidation of public sector management innovations, prevention of crime and violence, and a reduction of the burden associated with chronic disease. 6. The proposed operation builds on the first DPL to the state, while also extending the engagement into new areas. The first DPL with the state focused on education, water resource management, disaster risk management, vocational training, gender mainstreaming, economic development, and public sector management. Building on the implementation progress from the first DPL, the current DPL maintains a focus on a number of strategic areas (economic development, technical and vocational training, gender, and public sector management), while also extending the policy dialogue into new areas (crime prevention, productive inclusion and health). Three areas covered in the first DPL (education, water resource management and natural disaster risk management) were dropped on the grounds that the Bank has other instruments for sustained engagement in these sectors. 7. The operation also complements the Bank's broader engagement with the State of Pernambuco. The Bank has a long-standing partnership with the state, with nearly US2 billion in lending since 1979 in the areas of rural development, water resource management, urban upgrading, and education. The policy areas covered in the first DPL and in the proposed operation were selected with a view to build on and complement other forms of engagement with the state, including by expanding support on policy development and implementation to new areas not covered by existing operations. Moreover, past and ongoing analytic work in Pernambuco and Brazil more broadly provide the main foundations for the proposed operation, as well as a means to follow up on the policy actions and provide technical support to the state in the future. 8. The Program is fully aligned with the priorities of the World Bank Group's Country Partnership Strategy 2012-2015 (Report #63731-BR), discussed by the Executive Directors on November 1, 2011. In accordance with the Country Partnership Strategy (CPS), the proposed operation aims at promoting a more equitable, sustainable and competitive Pernambuco, including through a strong gender focus. The program also facilitates the Bank's strategic engagement in key areas of the state's development plan. 2 II. COUNTRY CONTEXT RECENT ECONOMIC DEVELOPMENTS IN BRAZIL 9. The Brazilian economy slowed significantly over 2011 and 2012. Real GDP grew at a meager 0.9 percent in 2012 compared to 2.7 percent in 2011 (Table 1). With a growth trend estimated at around 4 percent, this growth slowdown represents a major weakening of economic performance. The slowdown was driven by both domestic and external factors. Tighter monetary and fiscal policies aimed at curbing earlier overheating pressures weakened domestic demand. External demand was dampened by protracted weakness and uncertainty in advanced economies and slowing growth in major emerging economies such as China. While the slowdown was felt across the board, industrial output and investment demand were affected disproportionately. Table 1: Brazil Selected Economic Indicators and Projections (2006-2016) Estimates Pmjections Indicator 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 National Accounts (annual mal percent change) Real GDP Gmwth 4.0 6.1 5.2 -0.3 7.5 2.7 0.9 3.1 3.7 3.5 3.7 (in percent of GDP) Gross domestic investment 16.8 18.3 20.7 17.8 20.2 19.7 17.6 20.8 21.2 21.5 21.9 External Sector (in US$billions, unless noted) Currnt account 13.6 1.6 -28.2 -24.3 -47.3 -52.5 -54.2 -62.9 -69.3 -82.7 -87.4 Merchandise trade balance 46.5 40.0 24.8 25.3 20.1 29.8 19.4 15.0 14.5 8.2 6.2 Exports (fob) 137.8 160.6 197.9 153.0 201.9 256.0 242.6 262.2 274.8 299.8 331.2 Imports (fob) 91.4 120.6 173.1 127.7 181.8 226.2 223.2 247.2 260.3 291.6 325.0 Nonfactor services, net -9.6 -13.2 -16.7 -19.2 -30.8 -37.9 -41.1 -41.9 -44.9 -45.9 -47.1 Income and current tmnsfers, net -23.2 -25.3 -36.3 -30.3 -36.6 -44.3 -32.6 -36.0 -38.9 -45.0 -46.5 Direct investment, net -9.4 27.5 24.6 36.0 36.9 67.7 68.1 60.0 60.0 60.8 62.9 Portfolio equity, net 1 6.8 24.8 -7.3 39.7 43.9 16.0 3.3 4.6 4.7 4.8 4.9 Gross international reserves 85.8 180.3 193.8 238.5 288.6 352.0 373.1 390.6 404.7 423.9 437.3 Currnt account (% of GDP) 1.3 0.1 -1.7 -1.5 -2.2 -2.1 -2.4 -2.4 -2.5 -2.8 -2.7 General Government (in percent of GDP) Total Revenues and Grants 34.6 34.3 35.0 33.9 35.4 35.0 35.0 35.3 35.4 35.5 35.5 Total Expenditum 38.1 36.9 36.3 36.9 38.1 37.6 38.1 38.2 38.3 38.3 38.2 Current Expenditure 36.1 35.1 34.0 34.7 34.1 35.4 35.6 35.7 35.7 35.7 35.5 ofwhich: Interest payments 6.8 6.1 5.4 5.2 5.2 5.7 5.4 5.2 5.1 5.0 4.9 Capital Expenditure 1.9 1.8 2.2 2.2 4.0 2.3 2.5 2.5 2.6 2.6 2.7 Primary Balance 3.3 3.5 4.1 2.2 2.5 3.1 2.4 2.3 2.2 2.2 2.2 Overall Balance -3.5 -2.6 -1.3 -3.0 -2.7 -2.6 -3.0 -2.9 -2.9 -2.8 -2.7 Gross Public Sector Debt 66.7 65.2 63.5 66.9 65.2 64.9 65.0 62.7 60.6 58.7 56.9 Prices (annual percent change) GDP Deflator 6.1 5.9 8.3 7.2 8.2 7.0 6.0 5.5 5.3 4.9 4.9 ConsumerPrice Index(eop) 3.1 4.5 5.9 4.3 5.9 6.5 5.8 5.7 5.5 5.3 4.9 Producer Prices (eop) 4.3 9.4 9.8 -4.1 13.8 4.1 11.1 5.2 5.0 4.7 4.7 Memorandum items: Nominal GDP (in R$billions) 2,369 2,661 3,032 3,239 3,770 4,143 4,403 5,294 5,768 6,273 6,809 Note 1: Porfolio equity does not include debt securities Source: IMF, BCB, IBGE, EfU, WB Calculation 2 Annex 3 contains more detailed description of recent economic developments and macro outlook. 3 10. Recent indicators provide tentative signs of the recovery gathering strength. Quarterly data point to improved investment demand towards end 2012, following four quarters of consecutive contraction. Late 2012 momentum also picked up in the service sector, while industrial output decelerated somewhat even though it continued to sustain a positive trend. Monthly data suggests good growth in industrial production in January (at 2.5 percent, compared to the previous month and adjusted for seasonality), which has been broadly shared by some 67 percent of industrial enterprises. Over the same interval, the production of capital goods started to expand strongly at 8.2 percent, following two months of decline. 11. The disappointing growth performance prompted various policy interventions. Monetary policy was eased aggressively with the policy rate reduced by an unprecedented 525 basis points to 7.25 percent in October 2012 - and recently put on hold. Fiscal policy became more expansionary on the back of cyclical revenue weakness and discretionary stimulus measures in the form of tax cuts and faster spending, which led to a primary surplus of 2.4 percent - well below the 3.1 percent target. Fiscal interventions aimed at reviving industry through payroll tax reductions, cheaper and more expansive funding through the development bank, tax cuts on selected consumer durables and reductions in energy costs. In an effort to curb foreign capital inflows, a financial transactions tax and enhanced foreign exchange intervention helped reverse real exchange rate appreciation, supporting the external competitiveness. . 12. The financial side of Brazil's economy has weathered the slowdown well so far. The banking system has remained sound and resilient. Despite rapid credit growth, lower interest rates have eased pressures on borrowers containing delinquencies and allowing asset quality indicators to broadly stabilize. Solvency and liquidity indicators have remained comfortable. The balance of payments saw the current account deficit at 2.4 percent by end-2012 on account of a deteriorated trade balance, but foreign direct investment remained more than sufficient to cover the deficit. Portfolio flows showed significant volatility however: buoyed by interest rate differentials, inflows were strong until global risk aversion rose, the policy rate was lowered and financial transaction taxes were imposed. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 13. Growth is expected to gradually strengthen over 2013, settling at 3.1 percent for the full year. Domestic demand is expected to drive forward momentum. As consumer confidence strengthens, consumption, which previously slowed but remained relatively resilient - should get a boost on the back of favorable fundamentals. Investment, which saw a major decline, should see a revival as sentiment improves and will be aided by the development of new offshore oil fields and the preparations for upcoming mega events. While the external environment is likely to stabilize if not improve, the contribution of external demand will likely remain dampened by structural factors affecting export competitiveness as well as the likely boost to import demand arising from domestic demand strength. 14. The inflation outlook remains a challenge. The negative output gap that resulted from the economy's recent underperformance did not prevent inflationary pressures from emerging, a trend which should be accentuated as the recovery takes a firmer hold. Given that inflationary risks have emerged on the back of accommodative fiscal and monetary policies as well as wage policies in the context of an already tight labor market, looking ahead, policymakers will need to walk a fine line between supporting the recovery and guarding against the resurgence of inflation. 15. Brazil's near-term outlook is subject to both domestic and external risks. Domestically, aside from the upward risks to inflation already noted, market participants have 4 been concerned about a heightened degree of policy uncertainty relating to factors such as fiscal interventions that have targeted certain sectors of the economy. Externally, a worsening of the global economy may translate into lower external demand for Brazil's export products as well as deterioration in the terms of trade. Brazil is also vulnerable to market sentiment affecting portfolio and foreign direct investment (FDI) inflows. This risk is mitigated by adequate foreign reserve levels, favorable external debt composition, a current account fully covered by FDI and an overall low degree of trade openness. 16. A prolonged slowdown would pose a risk to the fulfillment of fiscal targets. If the economy were to remain weak, fiscal outcomes are expected to deteriorate both as a result of weaker revenue growth and higher expenditures due to the cycle and the likelihood of additional fiscal and quasi-fiscal stimulus. Additional fiscal risks to be monitored stem from multiple sources, such as the January Additional fiscal risks to be monitored stem from multiple sources, such as the January 2013 minimum wage increase, tax relief for selected industries, the quasi- fiscal activities by the National Bank of Economics and Social Development (BNDES) as well as the possibility that real interest rates will adjust upward from their historically low levels. 17. Brazil's overall macroeconomic framework is deemed adequate and sustainable in the medium term. Brazil's policy framework (see Box 1 for more details on Brazilian Fiscal Federalism) has provided the authorities with sufficient leeway to respond to past and current crises with an array of fiscal, monetary, and external measures to stimulate demand. Gross public sector debt is expected to decline in the future, despite difficulties in maintaining fiscal balance in the face of large investment needs and pressures from current expenditure growth. Flexible exchange rates and relatively large foreign reserves provide additional comfort in meeting external contingencies, even if of late the exchange rate has been managed relatively heavily. 18. The overriding challenge for the medium term is for Brazil to tap into its unrealized growth potential. For per capita income to continue increasing, while at the same time ensuring that growth is both inclusive and sustainable, it will be important to take advantage of this unrealized potential by creating better conditions for growth. This will require not only tapping into Brazil's internal growth dynamic (which is linked to its large domestic market and rising middle class), but also deriving greater benefits from Brazil's ongoing integration into the world economy. 19. Energizing the underlying drivers of growth will require determined multi-year efforts in tackling long-standing structural bottlenecks. Key among these challenges is the need to accelerate and strengthen the quality of human capital formation to raise living standards and boost productivity growth. In addition, it is important to raise public and private investment, to address growing infrastructure bottlenecks and lay the foundations for innovation-led growth. Further key challenges relate to the importance of developing a private long-term capital market, a more flexible labor market, and a more agile business environment that promotes internal competition and external competitiveness. Box 1: Brazilian Fiscal Federalism and the Control of Sub-National Fiscal Performance The fiscal stance of Brazilian states has always been an important element in macroeconomic management in Brazil. Until the late 1990s, expansionary fiscal policies by the states and the lack of effective controls over their indebtedness resulted in frequent sub-national debt crises. On three different occasions (1989, 1993 and 1997) the Federal Government had to take on and reschedule the debts of the states. The largest operation occurred in 1997, under Law 9496, when the Federal Government restructured R$200 billion (12 percent of national GDP) of debt owed by the states. The controls on sub-national fiscal performance were further strengthened by the approval of the Fiscal 5 Responsibility Law (Lei de Responsabilidade Fiscal -FRL in 2000. The FRL institutionalized fiscal discipline at all levels of Government, incorporating hard budget constraints into a single unifying framework. It explicitly prohibits debt refinancing operations between different levels of Government, thereby addressing the moral hazard problem in intergovernmental fiscal relations caused by sequential bailouts. Complementary Senate resolutions also prohibit borrowing if: (i) the net consolidated debt exceeds twice net current revenue (NCR); (ii) new credit operations exceed 16 percent of NCR; and (iii) debt service exceeds 11.5 percent of NCR. Borrowing is also prohibited if it violates the debt reduction schedules set by the debt renegotiation contracts under Law 9496. Finally, emission of sub-national Government bonds is generally prohibited through 2016; however, states whose net debt is less than net current revenue can issue bonds after 2011, although even here the Federal Government retains the option to review the decision to issue bonds. This system of controls has resulted in repeated state and municipal surpluses-an adjustment that has continued through four federal administrations. In addition, this system has also favored the adoption of appropriate expenditure programs by sub-national governments. Besides the controls on indebtedness, FRL requirements improved transparency and strengthened budgetary practices. Transparency: budget outturns and compliance with the FRL-including a statement of corrective measures if the relevant provisions are breached-are reported on a regular basis. Municipalities and states are also required to report the fiscal outturns of the previous year to the Ministry of Finance. The legislative branch of each level of Government, aided by its respective Court of Accounts, monitors observance with fiscal targets and ceilings. Budget Institutions: the FRL introduces more stringent requirements on fiscal targets in the preparation of the Budget Guidelines Law (Lei de Diretrizes Orcamentdrias), strengthening its role in budget preparation and fiscal management in general. The LRF also calls for a detailed assessment of the Government's contingent liabilities and strengthens the link between the Annual Budget Law (Lei Orqamental Anual - LOA) and the Budget Guidelines Law. A complementary Fiscal Crime Law is applied to all levels of public administration, with the possibility of detention for those public officials not complying with the FRL. RECENT EVOLUTION OF FISCAL AND DEBT INDICATORS FOR THE STATE OF PERNAMBUCO 20. Over the past decade, Pernambuco has achieved fiscal consolidation. The state's fiscal performance has been marked by rising operating balances that have allowed for a pronounced reduction in debt levels and debt stock as a share of GSDP from 12.5 percent in 2004 to 5 percent in 20103. Higher operating surpluses have created fiscal space for investment spending resulting in a significant increase in the public investment rate from 8 percent of Net Current Revenue (NCR) in 2004 to 15 percent in 2012. 21. Pernambuco has met all requirements of the Fiscal Responsibility Law (FRL) and has also achieved most of the targets of the Fiscal Adjustment Program4 (PAF) agreed with the National Treasury Secretariat. As a percentage of net current revenue, net consolidated debt fell from 104 percent in 2004 to 46 percent in 2012. Personnel expenses as a share of net current revenue fell from 55 percent in 2004 to 51 percent in 2011 before increasing to 54 3 Currently, state GDP figures for 2011 and 2012 have not been released. 4 Under the Debt Restructuring Program 25 state government have each agreed to a PAF, which is for a period of three years but renewed annually. The PAR is the principal tool used by the Federal Government to reinforce fiscal discipline for sub-national governments: The achievement of the targets enables state to engage in new borrowing. 6 percent in 2012, below the FRL ceiling of 60 percent. Debt service obligations over this period have been reduced to 6 percent of state NCR (below the FRL limit of 11.5 percent), down from 12 percent in 2004. In addition, the ratio of new credit operations to NCR has remained below the FRL limit of 16 percent, averaging at 4 percent between 2004 and 2012 despite the sharp increase to 15 percent in 2012 to finance the state's investment program. 22. Consistent fiscal adjustment has been an important factor in reaching Pernambuco's improved fiscal position. Following the period of strong fiscal adjustment between 1996 and 2004, the state has sustained implementation of fiscal reform measures focused on (i) strengthening revenue mobilization through improvements in tax collection efficiency; and (ii) reducing debt levels through restrictions on new credit operations. Overall, these measures have been successful. Combined with the increase in economic activity, they have resulted in robust revenue growth. Between 2004 and 2012, Pernambuco registered a strong increase in internally generated revenues and transfers alike owing to the favorable economic environment in the state and nationally, as well as significant improvements in tax collection efforts. Tax revenues, grew at an average real rate of 8.7 percent over this period, one of the highest rates among Brazilian states, while federal transfers grew at 7.7 percent. On the expenditure side, fiscal savings from the adoption of these measures have been used to increase investment, resulting in improvement in the composition of the budget. Over this period, the share of current expenditures in total expenditures has declined from 95 to 89 percent. Notwithstanding this positive trend, however, growth in current expenditures has matched the growth in current revenues, driven by personnel expenditures and equally, expenditures on goods and services, in line with rising investment levels. 23. Pernambuco's fiscal accounts and public debt are projected to remain sustainable in the medium-term. Baseline projections for the period 2013-2020 depict a sustainable trajectory of the main fiscal indicators. Debt levels are forecast to rise significantly in the medium term but remain well below the FRL limit of 200 percent of NCR, while annual operating balances increase. Uncertainties of this baseline outlook arise primarily from a prolonged growth slowdown, pressures on personnel expenditures and ongoing reforms to Brazil's intergovernmental fiscal framework. Revenue sharing rules for FPE (Fundo de Participaqdo dos Estados) transfers, the main transfer mechanism through which the Federal Government redistributes to states a proportion of income tax and industrial production tax, are due to be revised end June 2013. These transfers represented 27 percent of Pernambuco's net current revenue in 2012. Nevertheless other reforms to the institutional framework are expected to benefit Pernambuco, offsetting potential revenue losses from changes to the FPE sharing rules. Specifically, proposals being discussed to reform the main state tax, ICMS (Imposto Sobre Circulaqdo de Mercadorias e Serviqos) would work to Pernambuco's advantage, providing for higher ICMS revenues. In addition, proposed changes to reduce interest rates on subnational debt owed to the Federal Government (under Law 9.496/97 and Provisional Decree MP 2.185- 35) would improve debt sustainability of subnational governments.5 Risk analysis was undertake to assess the potential impact of fluctuations in macro-fiscal variables and FPE reform on Pernambuco's finances and concluded that under any plausible set of external conditions, the debt and deficit dynamics are sustainable and consistent with the Fiscal Responsibility Law. The proposed changes to reduce interest rates from IGP-DI + 6% or 9% to the lowest rate between SELIC or IPCA + 4% are contained in a recent draft law sent by the Federal Government to Congress on December, 28th 2012 7 Table 2: Evolution of GFS Fiscal Accounts, State of Pernambuco 2012 R$ Billions 2004 2005 2006 2007 2008 2009 2010 2011 2012 I. REVENUE 12.8 14.5 15.8 16.9 19.4 20.0 23.4 24.4 25.2 Taxes 6.2 7.0 7.6 8.1 8.9 9.3 10.7 11.8 12.1 Social Contributions 1.9 2.1 2.4 2.4 2.6 2.4 2.8 2.8 3.1 Transfers 4.2 5.0 5.3 5.9 7.2 7.5 9.1 8.6 8.8 Other Current Revenues 0.5 0.5 0.5 0.5 0.8 0.8 0.8 1.2 1.1 II. EXPENSE 11.8 13.1 14.1 15.2 17.2 18.7 20.6 22.2 23.5 Compensation of Employees 4.4 4.9 5.2 5.7 6.4 6.9 7.6 7.9 8.5 Pensions 1.9 2.0 2.2 2.3 2.4 2.5 2.6 2.8 3.0 Interest Payments 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.4 Transfers 2.6 2.9 3.1 3.6 4.1 4.4 5.0 5.5 5.5 Goods and Services 2.5 2.9 3.2 3.3 4.0 4.5 5.0 5.7 6.1 III. GROSS OPERATING BALANCE (I - II) 1.0 1.4 1.7 1.7 2.2 1.3 2.8 2.2 1.8 (as % ofNCR) 12.5% 15.9% 16.6% 15.8% 17.6% 10.5% 20.0% 14.3% 11.3% IV. TRANSACTIONS IN NON-FINANCIAL ASSETS 0.7 0.7 1.0 0.9 1.4 2.3 2.7 2.6 3.0 Net acquisition ofnon-financialassets 0.6 0.7 0.9 0.6 0.9 1.3 2.1 2.0 2.3 (as % of NCR) 7.7% 7.3% 8.6% 5.8% 7.4% 10.5% 14.6% 13.3% 14.7% Other investments in assets 0.05 0.09 0.11 0.26 0.43 0.91 0.63 0.56 0.68 V. NET LENDING / BORROWING (III - IV) 0.33 0.68 0.70 0.84 0.84 -0.91 0.13 -0.40 -1.20 (as % of NCR) 4.2% 7.6% 6.9% 7.6% 6.7% -7.2% 0.9% -2.6% -7.7% VI. PRIMARY BALANCE (V + Interest Payments) 0.7 1.1 1.1 1.2 1.2 -0.6 0.4 -0.1 -0.8 (as % of NCR) 9.2% 12.0% 10.7% 10.9% 9.3% -4.9% 3.1% -0.5% -5.4% VII. TRANSACTIONS IN FIN. ASSETS AND LIABILITIES -0.4 -0.5 -0.5 -0.4 -0.3 0.7 0.4 0.1 1.8 New Loans 0.1 0.1 0.1 0.1 0.3 1.3 0.7 0.5 2.3 Amortizations, net -0.5 -0.6 -0.6 -0.5 -0.6 -0.6 -0.4 -0.4 -0.5 Asset sales 0.00 0.01 0.07 0.00 0.00 0.02 0.00 0.00 0.01 VIII. TOTAL BALANCE (V + VII) -0.1 0.2 0.3 0.4 0.5 -0.2 0.5 -0.3 0.6 IX. GROSS FINANCING NEEDS (Amortizations - V) 0.2 -0.1 -0.1 -0.3 -0.2 1.5 0.3 0.8 1.7 Memo: Net Consolidated Debt / NCR 104% 83% 67% 53% 42% 43% 39% 38% 46% Source: SEFAZ WB Calculations POVERTY AND SOCIAL DEVELOPMENT 24. Economic growth and expansion of social assistance programs have contributed to reductions in inequality and poverty in Pernambuco over the past decade. Inequality in Pernambuco has been declining since 2001, roughly at the same pace as the rest of the country. After a stagnant period during the 1990s, extreme poverty has fallen steadily from 33 percent to 17 between 2003 and 2009. (Figure 1).6 6 The extreme poverty line is defined as the costs of basic food basket that supply the minimum individual caloric intake. The extreme poverty line varies between regions, states, urban, rural and metropolitan areas. Poverty lines account for these differences. Poverty line is twice the extreme poverty line. 8 Figure 1: Poverty Headcount and inequality, Pernambuco and Brazil - 1992-2009 reains Extreme poverty rate a nt CI-2CI 70-0 0-610 400A QMQ 4 40AV 0-570:33 0520A 050 Cn n Source: Institute for Economic Analysis 25. Notwithstanding this progress, poverty and inequality challenges in Pernambuco remain significant. The incidence of extreme poverty in Pernambuco remains among the highest in Brazil (Figure 2). The 2010 census data shows that extreme and moderate poverty rates were lowest in the Recife Metropolitan Area (12.4 percent and 35.4 percent, respectively) and highest in the Sertdo do Araripe (34.8 percent and 60.9 percent). Metropolitan Recife is the only region which ranks below the average poverty and extreme poverty lines for the state. 26. High rates of poverty and inequality are partly due to the geographic concentration of economic activity in the state. More than 70 percent of the state's GDP is produced in the coastal area while household per capita income in the interior of the state was half that of the Metropolitan Area of Recife in 2009. Moreover, certain groups in the state are systematically disadvantaged, with race and gender, interacting with geographic factors to aggravate inequality. For instance, poverty incidence among afro-descendent and indigenous groups in the interior of the state is four times higher that of the white population in the MAR, and economic opportunities for women are more limited than those for men. The average income gap between male and female employees is about 20 percent after controlling for hours worked and individual characteristics of the workers. 7 The number of families receiving the Bolsa Familia in Pernambuco as of December 2011 accounted for 16.3 percent of those benefited in the Northeast. 9 Figure 2: The incidence of extreme poverty across states in Brazil (2011) 16% 14% 12% 10% 8% 6% 4% 2% 0% "j V- 0I V 0V~a ~ ) 0c 'C Z 0 S e rld Bn Ca E C 0 V~ 0I o 0 0 ;U P4 -oP Source: World Bank Staff Calculation using Ipeadata 27. Labor market participation is increasing, but Pernambuco still lags behind the rest of Brazil. Over the past decade, Pernambuco experienced growth in labor force participation and an important decline in unemployment and informality, but most of this progress was concentrated in the Metropolitan Area of Recife. Since 2000, labor market participation has grown at a 1.6 percent annual rate. Due to employment creation at a faster rate, unemployment rate fell in the Recife Metropolitan area and the share of the labor force employed informally decreased (to from 64 to 60 percent between 2001 and 2009). In 2011, there were 112.3 thousands more formal jobs in the state than in 2010. Importantly, the average income from the main job increased at a 2 percent annual rate over the last decade bringing increasing living standards along with employment creation. Nonetheless, the state continues to have the second lowest employment rate in Brazil, and many lagging areas of the state are persistently characterized by low employability and private sector opportunities, compounded by weak education foundations. According to the 2010 Census, 11.1 percent of the economically active population of the state was out of work, which is significantly above the 7.7 percent national average. Among women this share is even higher (around 17 percent), in a state where female labor force participation hovers at 45.7 percent. 28. Weak skills foundations in the interior of the state posed an important constraint for growth, and also help explain patterns of poverty and inequality. Pernambuco lags behind other states in Brazil with respect to educational outcomes of the population. According to the 2010 population census, among those 10 years or older, 57.8 percent have a schooling level below primary school while the national average is 50.2 percent, and the share of the population who completed a college degree is 5.7 percent while the national average is 8.3 percent. Importantly, skill gaps are even larger in interior states. The previous specialization pattern of the interior of the state (agriculture and tourism) is in strong contrast to the MAR, and therefore the skill profile of the existing workforce imposes a constraint for their access to the benefits of the expanding sectors and for firms' growth potential. New investments can, through job creation, transform lagging areas and promote regional development. However, business 10 viability, and therefore private sector willingness to invest, depends to a great extent on the quantity and quality of human resources available. 29. Citizen security comprises another important challenge for the state, constraining further gains in terms of equity and inclusive growth. First, despite Brazil's socioeconomic achievements over the last decade, drug related crime and violence remain high, even increasing in some areas, with young afro-descendant males of peri-urban areas being particularly affected. While other factors such as the consolidation of drug markets, a lingering culture of impunity and inefficient public security policies are known to be key factors in the persistence of violence, poverty and inequality are also important determinants (Sapori, 2013). In Pernambuco, the Government estimates that approximately 40 percent of the intentional lethal violent crimes (CVLI) in the state are related to crack use.9 A 2012 survey showed that more than 100,000 people had used crack at least once; an upcoming study from Fiocruz points to 200 "cracolandias" ("cracklands", concentrated areas of intense use and trafficking) in the state. 10 Crack has become such an issue nationwide that in 2011 the Federal Government declared it a "national epidemic" and launched the National Program against Crack (Vencer o Crack e Possivel). Another key challenge further heightened by the crack epidemic and that receiving increased attention from the GoP is violence against women. In 2010, for instance, there were 249 female homicides in the state, making it the tenth in Brazil with the highest number of women being killed. During the last decade the rate of female homicides of women aged 15 to 49 has also been rising, from 5.7 per 100,000 in 2000 to 8.2 per in 2010. Although female homicides are an imperfect proxy for domestic violence, it is well established that intimate partners commit a high fraction of female homicides.12 Additionally, as it is based on death records, this measure does not suffer from the same reporting bias as indicators based on self- reporting of violent events. 30. Finally, rising mortality from non-communicable disease constitutes another pressing challenge to Pernambuco's sustaining and improving its equity gains for all Pernambucans. While the state has seen significant improvements in maternal and child health, chronic non-communicable diseases are gaining importance and are now accounting for the single largest share of deaths in the state. The growing burden associated with chronic disease, which reflects a process of aging and changing lifestyles, are putting increase strains on the 8 This situation is sometimes referred to as "the Brazilian paradox" 9 Related to conflict over debts with drug traffickers, dispute over territories for trafficking, or violent users 10 Data from the Brazilian Center of Information on Drugs shows that, in 2012, 1.5 percent of Northeast's population consumed crack, against 0.7 percent in 2005. 1 Waiselfisz, Julio Jacobo. (2012). Mapa da Viol6ncia 2012: Caderno Complementar: Homicidios de Mulheres no Brasil. 2012. SAo Paulo: Instituto Sangari. 12 UN Office on Drugs and Crime (2011) estimates that 70 percent of female homicides in South Africa, Israel, Canada and the US is due to domestic violence. Similar estimates are not available for Brazil; however, 70 percent of women who sought hospitalization due to aggression in Brazil reported that the aggressor was a family member; and 40 percent of all female homicide took place in home residence, compared to 14.7 percent of male homicides (Waiselfisz, 2012). 1 Between 1996 and 2010, mortality from infectious and parasitic diseases decreased 17 percent, while mortality from cardiovascular diseases increased 53 percent (MS/SIM). In 2010, the main causes of mortality in the state were cardiovascular diseases (29.6 percent), external causes (accidents and violence) (13.6 percent), and cancer (12.8 percent) (PES 2012-15). There are however important gender differences: cardiovascular diseases represent 33 percent of all deaths in women, followed by cancer (14.9 percent) and respiratory illnesses (11.6 percent); in men, cardiovascular diseases (26.9 percent) are followed by external causes (20.4 percent) and cancer (11.2 percent). In the period 2000-2010 the risk of dying from cerebrovascular diseases in Pernambuco is 19.2 percent higher than in the Northeast and 7.7 percent higher than in Brazil. Similarly, the risk of dying from an infarction is much higher than in the Northeast (63.4 percent) and the overall country (33.7 percent). 11 health system and is an emerging health challenge for the state. Contrary to what is sometimes believed, chronic diseases (and associated risk factors) are equally prevalent among the poor as better-off individuals.14 However, given lower likelihood of having private health plans, as well a,s geographic and other barriers to accessing services in the national health system (Sistema Unico de Sadde), low income households are disadvantaged in terms of access to preventive and curative health services. III. GOVERNMENT PROGRAM AND PARTICIPATORY PROCESSES THE GOVERNMENT PROGRAM 31. The proposed operation is fully aligned with the GoP program for the period 2012- 2015. Since assuming office in 2007, the administration of Governor Eduardo Campos has centered its priorities on promoting balanced development in Pernambuco, and focusing on active results management and improving service delivery. In 2010, the Governor was re-elected, receiving 82 percent of the popular vote. The new administration developed a Strategy Map for the Allfor Pernambuco program (2012-2015), which highlights the needs of the most vulnerable segments of the population, consolidation of progress, and development of the interior of the state as overarching priorities (see Annex 5). 32. The All for Pernambuco strategy is based on a comprehensive consultation process. Building on the consultative process for the 2008-2011 Government program, an expanded series of regional seminars was carried out between February and May, 2011 and included a gender focus. These seminars aimed at fostering dialogue between the population and key sectoral secretariats, including Health, Education, Economic Development, Social Development, Infrastructure, and Security. As part of the process, questionnaires were distributed to gather suggestions from the population, with a high response rate among participants. Women's participation was encouraged and extensively discussed in the thematic sessions that took place in all 12 development regions of the state during the 2011 process. Out of the total 13,498 participants to those seminars, 41 percent were women. 33. The A11 for Pernambuco strategy map outlines three broad components: i. New Economy - Opportunities For All Pernambucans. This policy area is focused on promoting sustainable and inclusive growth though a dynamic private sector, creation of employment opportunities and investment in infrastructure. ii. Action-Driven State - Capacity To Generate Results. This policy area is focused on establishing conditions for improved public administration, service delivery and public investment, by establishing processes and routines focused on results and problem solving. iii. Quality of Life - A Better Life For All Pernambucans. This policy area is focused on improving the quality of life of the citizens of Pernambuco by improving public services, with a focus on education, health, and citizen security, but also including water and sanitation, sports and leisure, and urban mobility. 34. Within the broad component of the Strategy Map, it identifies a set of sub-goals, representing key pillars or programs of the GoP strategy. Specifically, the GoP goals in the 14 For instance, self-reported prevalence of diabetes and hypertension is similar in the top and bottom income quintiles, even though under-reporting is likely to be significantly higher among low-income households. 12 area of health, education, and citizen security are being pursued through a series of Pactos (covenants) based on explicit targets and results (Pacto pela Educaqjo, Pacto pela Saude and Pacto pela Vida). The Pacto pela Vida, which is focused on citizen security, is the oldest of these pactos, and the most mature in terms of indicators and management instruments, while the covenants in health and education are more recent. Table 3 shows how the proposed operation is directly linked to these respective pactos, as well as to a number of other pillars in the three broad policy areas of the Strategy Map. Table 3: DPL policy areas and the GoP Strategy Map DPL Policy Area Link with Government Strategy Map Regional economic The operation supports reduction of administrative barriers to firm entry development and strengthening of the state's Industrial Infrastructure Program. The prior action support the consolidation of progress and development of interior, identified as one of the overarching priorities of Strategy Map. Economic development, generation of employment and promotion of Private sector innovation is also included as a pillar in the New Economy policy area of development the Strategy Map. Technical and The operation supports strengthening of TVET programs in the state. vocational Improvements in basic education and professional training are a key focus education and of the Government's Pacto pela Educaqdo (Education Covenant), which training is one of the pillars of the Quality of Life policy area. The pact incorporates a set of policies aimed at strengthening partnerships with municipalities, improving monitoring and transparency, improved teacher development and management, improved school management and accountability, and expansion of technical and vocational education and training. It is also linked to the goal of employment and income generation in the New Economy policy area. Productive The operation supports strengthening and expansion of the state's inclusion productive inclusion program, which includes training and technical assistance to low-income individuals. The prior action is related to the Pacto pela Educaqdo, and to the overarching priority of the Strategy Map to address the needs of the most vulnerable segments of the population. Public sector The operation supports strengthening and extension of the Results Based management Management model of the state. This model is included as one of the premises of the Strategy Map, and consolidation of the model is a key element of the Action-Driven State policy area of the Strategy Map. Crime and violence The operation supports strengthening of programs in the area of prevention rehabilitation of crack users and gender-based violence. These are key aspects of the state's Pacto pela Vida (PPV) program under the Quality of Life policy area of the strategy map. The PPV program combines control and prevention interventions across six key areas: crime control, institutional improvement, education and training, information and knowledge management, social prevention, and democratic management. The PPV has brought together key entities such as the police, the judiciary, the prosecutor's office, and agencies at the state, municipal and federal governments. Health The operation supports policies, programs, and approaches aimed at attending the needs of patients with chronic diseases. Improving the population's health by enhancing the performance of public health services is the focus of the Pacto pela Sadde, one of the pillars of the 13 Quality of Life policy area of the Strategy Map. The Pacto pela Saude,is focused on reducing mortality and morbidity rates from preventable causes and improving the overall state health indicators. 35. Implementation and monitoring of the pactos and, to a lesser extent, other sectoral programs, is based on an innovative, Results Based Management Model. The management model involves participatory planning, a close link between planning and budgeting, intensive data collection and monitoring of results, and institutionalized mechanisms for coordination and accountability. It relies on strong leadership of the Governor and an active engagement of the Planning Secretariat (SEPLAG) (Box 2). Box 2: Pernambuco's Management Model The two main elements of Pernambuco's management model are: (i) an active participatory process in defining priorities, involving consultations in each of the twelve regions of the state; and (ii) high level monitoring meetings (usually chaired by the Governor), in which senior officials report on progress and are held accountable for results, but which are also forums for active problem-solving and inter-sectoral coordination. The model began to be implemented in 2008, but it was only in 2009 that Law 141/2009 provided an abbreviated legal framework and mandated a systemic organization of the functions related to the state's formal planning instruments (the Multiannual Planning or PPA, the Annual Budget Guidelines and the Annual Budget Law) and management tools adopted by the state's public administration. The participatory process defines the strategic priorities for a four-year period, which are formalized in the PPA document. These priorities feed into the budget formulation of individual institutions on an annual basis through the Annual Budget Guidelines. Budget formulation following priorities is then reflected in allocations in the Annual Budget Law. During budget execution, the state monitors expenditures and physical progress related to strategic priorities in real time to ensure expenditures are executed towards these objectives. Finally, for priority areas, performance relative to targets is monitored on a quarterly basis through the Social Management Report, closing the management model cycle and feeding into discussions for revising the PPA. Law 141/2009 established a Core Management Group, reporting directly to the Governor's Office, for the coordination of the management model. IV. BANK SUPPORT TO THE GOVERNMENT'S PROGRAM RATIONALE FOR BANK INVOLVEMENT AND LINK TO THE CPS 36. The Bank's engagement in Brazil is focused on second-generation development problems that require innovative solutions in terms of improving national policy frameworks and finding ways to implement programs with sub-national governments. The overarching goal of the 2012-2015 Country Partnership Strategy15 is to contribute to faster, more inclusive and more environmentally sustainable growth, with macroeconomic stability. To achieve this goal, the strategy highlights four strategic objectives: (i) increasing the efficiency of public and private investments; (ii) improving the quality and expanding the provision of public services for low income households; (iii) promoting regional economic development through improved policies, strategic infrastructure investments, and support for the private sector in 15 CPS FY2012-2015 (Report No. 63731-BR) discussed by the Executive Directors on November 1, 2011. 14 frontier areas; and (iv) improving sustainable natural resource management and enhance climatic resilience while contributing to local economic development and helping to meet rising global food demand. 37. The proposed multi-sectoral operation is fully consistent with the overarching goal of the CPS and with many of its strategic objectives. The operation is expected to help promote sustained growth and improved economic opportunities for the poor, consolidation of public sector management innovations, prevention of crime and violence, and a reduction of the burden associated with chronic disease in the state. The program development objective and the policy focus of the operation are hence closely aligned with the strategic objectives of increasing the efficiency of public and private investments, improving the quality and expanding the provision of public services for low income households, and promoting regional economic development. Moreover, the operation is consistent with the expansion of lending to state and municipal levels through multisectoral operation envisaged in the CPS. COLLABORATION WITH THE IMF AND OTHER DONORS 38. As the International Monetary Fund (IMF) does not work directly with sub-national governments, no direct collaboration with the IMF is expected on the proposed DPL. This DPL does, however, comply with the guidelines for coordinating with the IMF on development policy lending set forth in the Joint Management Action Plan as relevant to national DPL collaboration. 39. The Inter-American Development Bank (IDB) is actively implementing five investment loans within the State of Pernambuco. This includes the development of the National Tourism Program (PRODETUR, US$75 million); Modernization and Transparency of Fiscal Management (PROFISCO-Pernambuco, US$15 million); Innovation and Dissemination Local Cluster Competitiveness (US$10 million); the Northeast Brazil Small Business Fund (US$1.5 million), and an environmental sanitation project in the Ipojuca basin (US$200 million). In addition, the state is in the process of preparing a US$400 million Program Based Loan with IDB, primarily focused on fiscal and public expenditure management. As part of the process of preparing the operation, the Bank team has met with the IDB team working on the PBL and also discussed links between the IDB operation and the proposed DPL with the state counterparts. 40. The Andean Development Corporation (CAF) is a regional development bank that has ongoing programs in Brazil. Their recent lending in Brazil has focused heavily on supporting productive sectors, international trade, and infrastructure lending to both the public and private sectors. In 2011, CAF approved a lending portfolio of US$1.797 billion, of which 71 percent (US$ 1.278 billion) came from non-sovereign risk operations and 29 percent (US$ 520 million) sovereign risk operations. Their current lending portfolio does not include investments directly with the State of Pernambuco.17 RELATIONSHIP TO OTHER BANK OPERATIONS 41. Currently, the Bank has four active operations in the State of Pernambuco. These include three investment loans in the areas of water resource management, education, and rural 16 Guidance on Coordinating with the IMF on Development Policy Lending (2010) and Enhancing Collaboration: Joint Management Action Plan (Follow-Up to the Report of the External Review Committee on World Bank-IMF Collaboration) (2007) 17 See. http://www.caf.com/ 15 economic inclusion, as well as a DPL (Expanding Opportunities, Enhancing Equity Development Policy Loan) approved in 2012. 42. The Pernambuco Sustainable Water Project (P108654) is focused on improving sustainable water supply and sanitation services for the population residing in the Capibaribe river basin. The project, which closes in 2015, supports strengthening the institutional and regulatory frameworks in the water sector, improving efficiency in the provision of water supply and sanitation services, and expanding water supply and sanitation services expansion. The first DPL with the state included prior actions linked to water resource management. The proposed operation supports the objectives of the Sustainable Water Project primarily through the expansion of improved public sector management practices across Government, including in the water and sanitation sectors. 43. The Pernambuco Education Results and Accountability SWAp (Sector Wide Approach) (P106208) aims to improve the quality, efficiency and equity of education and strengthen management. The proposed DPL complements this Bank investment by supporting policies to improve the quality and relevance of technical and vocational education, particularly for vulnerable population. It also supports the consolidation of public sector management, which is consistent with the aims of the second component of the Education SWAp. 44. The objective of the Pernambuco Rural Economic Inclusion Project (P120139) is to promote rural business initiatives and expansion of rural access to water and other complementary infrastructure. The project seeks to achieve these goals by supporting infrastructure development and enhancing capacity and conditions for rural producers. The proposed DPL complements this Bank investment by supporting strengthening of the state's regional development program, expansion and enhancement of technical and vocational education and training programs, and the improvement of public sector management practices. 45. The proposed operation builds on the first DPL to the state (P106753), while also extending the engagement into new areas. The operation maintains the engagement in key strategic areas, including economic development, technical and vocational education and training, gender, economic development and public sector management. In these areas, the policy actions in the second DPL build on and complement those covered in the first DPL. The second DPL also extends the policy dialogue into new areas based on priorities indicated by the state, with a particular focus on crime prevention and health. Three areas covered in the first DPL (education, water resource management and natural disaster risk management) were dropped in the second DPL on the grounds that the Bank has other instruments for sustaining an engagement in these sectors. Table 4 provides an overview of the links between the first and second DPLs, and with other instruments for engagement. Table 4: Links between DPL1, DPL2 & Other Instruments for Engagement with the State Sector DPL1 DPL2 Comments DPL 1 supported expansion of full-day schools in the state; Education Education SWAp provides basis for complementary support, including teacher training and development of management capacity. Water resource DPL 1 supported institutional reform to strengthen water m m management; continued engagement and assistance is provided through the Pemambuco Sustainable Water Project. Disaster Risk DPL 1 supported institutional reforms to strengthen disaster risk Management management; continued engagement and complementary TA is 16 Sector DPL1 DPL2 Comments provided through the Pernambuco Sustainable Water Project. Technical and DPL1 supported expansion of technical schools; DPL2 is vocational supporting complementary reform to strengthen M&E systems to education and strengthen management and performance of full range of TVET training programs; as well as establishment of state financing for municipal training programs focused on the poor. DPL1 supported establishment of permanent Women's Gender Equity Secretariat; DPL2 focuses on strengthening M&E systems and policy coordination related to gender-based violence - a priority issue for the Women's Secretariat. DPL 1 supported establishment of an agency responsible for Economic promoting micro and small enterprises and rural producers; DPL2 Development/ supports complementary reforms focused on business registration Private Sector and the institutionalization of M&E in the state's industrial Development infrastructure development program that is intended to stimulate economic development in the interior. DPL 1 supported improvements in tax and budget management; Public Sector DPL2 supports consolidation and expansion of a public sector Management management model, which is intended to enhance efficiency and effectiveness of Government spending. Citizen Security / Citizen security is a long-standing priority of the state, and was Crime and violence included in the DPL2 at the request of the state. Prevention Health Health is one of the three pactos in the GoP strategy map; the sector was included at the request of the state. 46. The proposed operation is complementary to the International Finance Corporation's (IFC) engagement in Pernambuco. Currently, the IFC is discussing potential investments in the following sectors: banking, private education, micro finance. IFC has also invested in a private chain of universities in Pernambuco in previous years. Moreover, on the advisory side, the IFC supported Brazil's investment attraction and exports promotion agency to create an investment attraction strategy for Pernambuco, focusing on targeted sectors (e.g. agribusiness and renewable energy), development of customized investment attraction tools (e.g. a system for handling inquiries and a process and protocols for investor site visits), and training of agency staff in the provision of high-quality information and services to investors. CHOICE OF INSTRUMENT 47. DPL vs. Investment Lending. The GoP has a clear and coherent Government program based on a robust participatory planning process. The program is focused on economic development, improvement in quality of life, and enhanced public sector management, with responsiveness to the needs of the poorest segments of the population as an overarching priority. Over the last five years, the state has demonstrated clear political leadership and strong implementation capacity. However, in order to achieve the objectives of the Government program and lay the foundations for sustained progress over the medium term, the state faces significant financing needs. Moreover, the Government is trying to continually improve Government policies and programs, and strengthen its capacity to monitor performance and 17 manage for results. In this context, development policy lending, which provides rapidly disbursing policy-based financing to help the state address actual or anticipated development financing requirements is the most appropriate instrument to support the state. The operation will complement support to the state through other instruments, including investment loans. 48. One-tranche DPL vs. two-tranche DPL. A single-tranche DPL was deemed suitable as it would allow for fast disbursement of funds to address the financing needs of the state. The proposed operation, however, follows on the first DPL with the state. Given significant continuity with the policy areas covered in the first DPL, the two operations are similar in nature to a two-series or programmatic DPL. The loan amount represents approximately 5 percent of state Government expenditures. The experience from the first DPL has demonstrated the state's capacity to make effective use of the resources within a short time period after disbursement. Moreover, possible ways to sustain an engagement with the state in priority areas beyond the DPL are being discussed, thus mitigating the risk that the momentum of reform will not be sustained. LESSONS LEARNED 49. The Bank has a long-standing partnership with the State of Pernambuco. Since 1979, the Bank has provided nearly US$2 billion of financing to the state (Figure 3). This includes a series of projects in the areas of rural development, water resource management, urban upgrading, and education. Most of these projects have been with the state, but also include projects with the Recife Municipality. 18 Figure 3: Overview of Bank Support to Pernambuco PE Rur. Dev. Project NE Rural Development PE Rur. Poverty (SIL) Project (SIL) Alleviation (SIL) PE Rur. Poverty PE Rur. Econ. Inc. Reduction (SIL) (SIL) Recife Urban Upgrading (SIL) vl Recife Integrated Urban Recife Urban Dev. (SIL) and Social Inc. (SIL) PE Sustainable Water (SIL) PE Eclu. Qual. Impr (SIL) PE Education Results (SWAp) Recife Edu. and PSM (SWAp) DPL1 * Nearly US$1.8B lending since 1979 (incl. pipeline) Mostly SIL, but two DPLs (US$500M each) DPL2 US$180 million lending to Recife municipality 50. Investment lending in rural development, water resource management, urban upgrading and education have proved to be appropriate instruments for supporting specific investments needs. These operations have supported investment in priority areas such as rural infrastructure, establishment of producer associations, slum upgrading, water and sanitation infrastructure, the school network, and teacher training. They have provided a platform for a medium term engagement, financing of both infrastructure and TA, and intensive implementation support. However, in some cases, effective investment or action in a specific sector is constrained by the higher-level policy and institutional framework. This issue has been apparent in some of the sectoral engagements in the state. For instance, effective water resource management practices depend on policies and institutions for coordination between the state and municipalities, and returns to investments in schools and teacher training are contingent on broader reform of the education system. 51. The first DPL with the state (Expanding Opportunities, Enhancing Equity DPL) supported key policy and institutional reforms, and helped develop new areas of engagement with the state. Implementation capacity in the state has been growing steadily over the last decade. Moreover, the last two mandates have been characterized by clear policy frameworks focused on poverty reduction and inclusiveness, as well as significant advances in public sector management. In this context, the first DPL comprised an effective instrument for advancing key policy and institutional reforms in sectors where the Bank also has other forms of engagement, such as rural development, water resource management, and education, while also providing an opportunity to develop an engagement with the state in new areas, including private sector development, gender and public sector management. Throughout preparation and implementation of the project, the state has demonstrated strong ownership, and there have been significant progress on the indicators identified in the operation. The implementation of the 19 operation has been rated as satisfactory in all areas and highly satisfactory in the area of public sector management, with progress in all areas (Table 5). The proposed operation builds on this approach and experience, extending the engagement in strategic sector while also supporting policy development and institutional reform in new priority areas for the state. Table 5: Overview of implementation and results of the first DPL with the state Focus of Prior Action and Result Indicator Results to Date 1.1. Provide quality education. Increased proportion of Increase in the number of students students enrolled receiving greater academic training through enrolled in 40 hour schools by expanded school hours and increased number of secondary 30,922 (total of students by Feb school students enrolled in integral and semi-integral schools 2013- 53,515); increase the number outside of the MAR. of students enrolled in 30 hour schools by 17,470 (total of students by Feb 2013- 48,780) ; increase in the number of students enrolled in integral and semi-integral schools outside MAR by 34,341 (total of students 67,714) 1.2 Improve water security and increase reliability of water The two indicators related to water supply. (i) Issuance of water rights for both groundwater and rights (APAC) are already met and surface water by APAC; (ii) Creation of reservoir management exceeded, while the indicators committee for water basins in the interior of the State; (ii) related to the creation of reservoir Establishment of water users cadastre for the water basins of management committee and the Ipanema, Pajedt and Moxot6. water users cadaster are underway. 1.3 Disaster and Risk Management. (i) State protocol All indicators related to this formalizing procedures and responsibilities for the flood risk component were met. This early warning system established;(ii) Population covered by the component also helped engage the monitoring alert system of APAC; (iii) Communication strategy state in a more structured approach developed and implemented to disseminate hydro- to DRM. meteorological information produced by APA 2.1. Promote job creation through the development of Additional 8,320 students for (i) human capital. (i) Secondary school students enrolled in and additional 5,879 for (ii) professional education schools which offer courses meeting In both cases the targets were local job demand and vocation; (ii) Secondary school students surpassed (Feb.2013) outside of the MAR in professional education schools, 2.2 Increase opportunities through greater gender equity. The indicators were successfully The Women's Secretariat (SccMulher) is elevated to a completed as (i) 2,230 professionals permanent secretariat, with results including (i) increase in were trained; and (ii) 12 regional number of public employees who have received training on coordinations were created ( Feb. gender issues; and (ii) creation of regional gender coordinators 2013) are established in the 12 development regions of the state. 2.3 Promote economic development through support to The indicator is nearly met, with an SMEs and rural producers. Number of productive projects of increase of project supported from 3 several segments among the development regions of the state to 17 (with a target of 19). supported by AGEFEPE through financing or training. 3.1 Improve ICMS tax revenues without increasing tax The state increased ICMS revenue to burden on firms and citizens, to expand fiscal space for 12.6%, exceeding the agreed target; investment and promote private sector development. (i) the second indicator related to the Increase of ICMS Revenues as % of State's GDP by reducing real growth of ICMS was partially 20 tax evasion, without increasing tax burden; (ii) Real growth of met to date. ICMS revenues. 3.2 Improve efficiency of allocation and execution of PPA Execution has increased from 64.10% and budget to make sure public expenditures reflect to 100.5%, significantly exceeding Pernambuco's strategic priorities. (i) Approved budget the target of 75%. versus executed budget for strategic priorities; (ii) Number of budgetary revisions approved during the year of execution 3.3. Improve capacity to plan and implement public policies Three management reports prepared through institutionalization of Pernambuco's management and published online in 2012. model. State management report produced and published online every four months. 52. The proposed operation is also consistent with lessons learnt from experience with sub-national DPLs in other parts of Brazil. Over the last few years, the Bank has supported a significant number of DPLs at both state and municipal level. The preparation and implementation of these operations have highlighted the importance of focusing on policy areas that reflect the Government's reform agenda; stimulating cross-government dialogue and coordination; supporting innovation and links with engagements in other states and with federal Government; and creating opportunities for the Bank to sustain a dialogue and technical work with the client on the policy issues covered by the operation. The proposed operation is consistent with these principles. It is closely aligned with the Government's strategy map, has strengthened dialogue both across sector secretariats and between sector secretariat and the state planning secretariat, and has supported innovations that in some cases have already shaped dialogue in other states and at federal level (e.g. M&E systems for TVET programs). In terms of future engagement, the investment projects mentioned above provide a basis for sustained engagement in some areas; in other areas, ongoing analytic work through the State Economic Memorandum and other AAA pieces will permit a continued policy dialogue. Moreover, the team is discussing possible future reimbursable technical assistance and other forms of support with the state. ANALYTICAL UNDERPINNINGS 53. The proposed operation builds on a sustained dialogue with the GoP through the first DPL and the ongoing process of preparing the second DPL. This dialogue has been informed by previous and ongoing analytic work in the Brazil country program, regional and global Bank studies, as well as the broader research literature. Moreover, to complement the policy dialogue in the context of the proposed operation, the Bank is preparing a State Economic Memorandum, which will provide the basis for a deepened partnership with the state on key strategic issues covered in the operation. Finally, the operation is informed by on-going engagements at federal level and with other sub-national governments. The analytical underpinnings of the operation are summarized in Table 6. Table 6: Analytical Underpinnings of DPL Economic * Extensive dialogue with a range of public sector agencies, private sector development associations, and Brazilian researchers since the DPLI. and poverty * Research and studies concerning the conditions for inclusive growth (World Bank, 2006; Bourguignon, et al., 2007; Levy and Walton, 2008) * On the effect of business registration simplification, the component is informed by Bruhn (2010) on Mexico and Bruhn (2012) on Minas Gerais; * On poverty dynamics in Brazil, empirical findings in Molinas-Vega et al. (2010), as well as on the finding of Santarrosa et al. (World Bank, 2012), 21 showing that that the disparity of initial conditions for individuals, which tend to be linked to socioeconomic background and other group-specific circumstances, are a key determinant of future income. The absence of interventions to "level the playing field" or equalize the initial conditions for all can reinforce intergenerational poverty traps and perpetuate inequality. This message is further echoed by the findings of the Economic Mobility and the Rise of the Middle Class in Latin America (World Bank, 2013) which shows that despite substantial upward income movements within generations, intergenerational mobility remains limited in Brazil, as in the rest of Latin America. Productive * Productive inclusion programs often range from training to self-employment inclusion assistance. International evidence shows that the design of these programs needs to be adjusted to insure program effectiveness among the poor and vulnerable (World Bank, 2003). * Experience has demonstrated the positive value of decentralized implementation by municipalities (by strengthening tights to local labor markets and referral systems) and focus on results through better monitoring on programs' performance (World Bank, 2010). * The work is being informed by the ongoing World Bank Brasil Sem Miseria non-lending technical assistance (NLTA) and the Brazil Skills and Jobs study (ESW), which are analyzing the different experiences on productive inclusion in Brazil and promoting north-south knowledge exchanges to build capacity and systems. Technical * Studies have showed potential positive impacts of TVET programs, but these and impacts are by no means guaranteed (see Card, Kluve and Weber, 2010). Vocational Impact evaluations show that interventions do not always improve Training employability of participants, nor are they always cost-effective. Better results (TVET) were found for programs that involved employers or otherwise had explicit links to the private sector and local labor markets. * International experience has shown the importance of coordination across TVET programs, which are often fragmented, and implementing robust and shared approaches for tracking programs' results on employability (see Almeida et al. 2012). Public sector * The relevance of engagement on public sector management at the state level management has been confirmed by the Independent Evaluation Group's 2010 review of World Bank engagement at the state level (World Bank, 2010b) and by "The World Bank's Approach to Public Sector Management 2011-2020: "Better Results from Public Sector Institutions" (World Bank, 2012). * The sub-component on public sector management builds on the engagement on tax administration and public sector management in the first DPL. It also builds on a long-standing engagement on public sector management in Minas Gerais and other states (World Bank P121590; and "Minas Gerais-Word Bank Partnership: Building on a Strong Foundation and Leading to Next Steps" Report No. 40036-BR, June 2007; and Estado para Resultados, Government of Minas Gerais, 2010). * The work is also informed by the state's own analyses of its public sector management reform experience (see for example Revisjo PPA 2013, Anexo I, Government of Pernambuco, 2013, for an analysis of the management approach in Pernambuco). The relevance of engagement on public sector management at the state level has been confirmed by the Independent Evaluation Group's 2010 review of World Bank engagement at the state level. (World Bank, 2010b). Crime and * The report "Making Brazilians Safer: Analyzing the Dynamics of Violent 22 violence Crime", concluded in 2011, details the role of schooling and social cohesion in reducing violence. It highlights the promise of the PPV in Pernambuco, noting its comprehensive and integrated approach, strong Results Based Management Culture, and emphasize on combining control and prevention measures. The DPL is also informed by studies on youth at risk (2008) and on crime and violence (2008) in Brazil also provided inputs of trends and good practices in the country. * Evidence from the relation between drug and violence (WHO, 2009) confirms the relevance of tackling through integrated policies. Studies on the relationship between drug use and intimate partner violence were also reviewed (El Bassel et. Al. 2005; Gilbert et al. 2012). * Lessons from the evaluations of crack related violence and the rehabilitation of crack addicts informed the operation and the decision to include an integrated crack rehabilitation program (Ribeiro et al. 2010a, Duailibili et al.2008, Ribeiro et al. 2010b, INPAD 2010, Lins et al. 2010, Becker 2012) to address the specificities of crack users (including gender wise), as well as the public health and socio-economic implications of an addiction known for its devastative long-term effects. Gender- * The 2012 World Development report on gender equality (WDR 2012) based recognizes the vital role that governments can play in achieving greater violence gender equality through the influence of gender-sensitive programs and policies. * The Bank has supported several studies informing the proposed operation as part of the Gender Action Plan (GAP), including: Orlando et al. (2012) on Women's Economic Empowerment in Latin America and the Caribbean, Chioda (2011) on Work and Family, and Azevedo et al. (2012) on the effect of Women's Economic Power in Latin America and the Caribbean. * Recent analytic work on domestic violence in Brazil (Perova et al., 2012) has demonstrated the high costs associated with domestic violence and the importance of public discourse on and policies against domestic violence, crystallized in the Maria da Penha law (2006). The work highlighted a number of barriers to a smooth implementation of domestic violence legislation and reducing gender-based violence, including lack of information on the respective legal provisions, social norms, and low levels of empowerment. Health * A Bank study on aging in Brazil showed how the demographic and epidemiological transition under way in Brazil, with a growing share of the burden of disease due to non-communicable diseases, will impact on the health system (World Bank 2011). * "Brazil's Sistema Unico de SaCide After 20 Years: Achievements, Challenges, and Unresolved Issues" (Gragnolati et al., forthcoming), confirms that Brazil's Unified Health System has contributed to better coverage, health status and financial protection, while also noting significant problems in access to specialist care and diagnostic services, poor quality of health services, and a lack of integration between different elements of the health system. * The Bank is currently undertaking new analytic work on chronic disease and the health system in Brazil. 18 Law 11,340, also known as the Maria da Penha law, creates mechanisms to prevent and restrain domestic violence in accordance to the Constitution, the convention of Belem do Pard and CEDAW, introduces special courts on domestic and familiar violence, and establishes assistance and protection measures for victims. 23 V. THE PROPOSED OPERATION: PERNAMBUCO EQUITY AND INCLUSIVE GROWTH DPL OPERATION DESCRIPTION The proposed operation is a single tranche Development Policy Loan (DPL) to the State of Pernambuco, Brazil, in the amount of US$550 million. The Development Objective of the proposed operation is to support the Government of Pernambuco to strengthen the design, implementation, monitoring and evaluation of policies and programs aimed at promoting sustained growth and improved economic opportunities for the poor, consolidating public sector management innovations, preventing crime and violence, and reducing the burden associated with chronic disease. POLICY AREAS 54. The operation is aligned with the three main components of the State Government's Strategy A11 for Pernambuco. These components are: (i) New Economy - Opportunities For All Pernambucans; (ii) Action-Driven State - Capacity To Generate Results; and (iii) Quality Of Life - A Better Life For All Pernambucans. Within the broad strategy of the state, the Development Policy Operation supports the following policy areas: Regional economic development, private sector development, technical and vocational education and training, productive inclusion, public sector management, crime and violence prevention, and health. In each of these areas, which correspond to sub-components in the policy matrix, the operation supports critical actions towards the institutionalization and expansion of key Government policies and programs, or the establishment of monitoring and evaluation systems that will provide the basis for evidence-based and performance oriented policy making in the future. Taken together, the policy actions are expected to help promote sustained growth and improved economic opportunities for the poor, consolidation of public sector management innovations, prevention crime and violence, and a reduction of the burden associated with chronic disease. The following sections describe each policy area, while Annex 2 presents the broader policy matrix, including the specific legislation or other documentation linked to the policy actions. COMPONENT 1: NEW ECONOMY - OPPORTUNITIES FOR ALL PERNAMBUCANS Sub-component 1.1. Regional economic development: To strengthen the state's Industrial Infrastructure Development Program (PROINFRA) through the development of a monitoring and evaluation system that will provide information for evidence-based policy making. Description and Challenges 55. To accelerate regional development, Pernambuco will need to reinforce efforts to develop competitive growth poles across the state, making sure that lagging areas are well connected with existing and emerging opportunities. Despite recent socio-economic progress, a key development challenge remains for interior areas to participate more inclusively in the growth process of the state. In order for this to happen, the state's regional development strategy will need to: (i) promote the development of competitive and sustainable growth poles in both the interior and the coastal areas of the state, in line with the comparative advantage of respective areas, (ii) articulate the importance of geographic concentration of economic activity, recognizing that the resulting productivity gains of agglomeration may result in faster growth than if economic activity were to be diluted throughout the state, and (iii) enhance good 24 connectivity with existing and emerging growth poles so that those in lagging regions can avail themselves more effectively of the economic opportunities being generated elsewhere. 56. A key strategy of the GoP to stimulate inclusive growth has been the use of taxes and other incentives. This approach has yet to demonstrate that the gains accruing as a result of the incentive (typically measured in terms of Government revenues and job creation) exceed the sum of the gains lost as a result of the investment not having taken place elsewhere and the administrative costs of implementing it. This is more likely to be the case if it provides benefits that potential investors consider significant (as determined by an analysis of their expressed preferences or past investment decisions) and if the policy itself or the private investment it triggers then generates additional social benefits (e.g. a public good). At present this type of cost-benefit or demand analysis is rarely if ever undertaken in Brazil. Even more rarely does it contribute to the reformulation of an incentive policy. The GoP use of taxes and other incentives to attract private investment would benefit from an institutional mechanism allowing for the evaluation of the impact of regional development programs that provide incentives for private investment. 57. One of the key incentive programs, PROINFRA, constitutes a prime candidate for the establishment of such monitoring and evaluation and would help the GoP improve the effectiveness and sustainability of its regional development program. The PROINFRA program, which has backing of the federal Government and has been adopted by several other Brazilian states, was introduced in 2011 and will run until 2017. It works by partially or fully subsidizing the cost of small infrastructure projects - typically of around BRL 5-10 million, such as electricity connections and feeder roads - that, it is assumed, are required to trigger investments by private firms. The instrument of the subsidy varies by agreement between the potential investor and the Government. Either the Government finances the works directly, or the investor can choose to expedite the process by financing them itself and reclaiming the outlay from future tax receipts (up to a maximum of 10 percent of its ICMS liability). 58. The program has so far contributed to triggering three investments in the interior of the state for a total of BRL 573 million and the creation of 1,150 jobs. A further two investments are under discussion and are expected to generate an additional BRL 50 million in outlays and an additional 400 jobs. In each case the program financed a combination of access roads and other earthworks. The criteria used for allocating the subsidy have been: (i) the socio- economic characteristics of the municipality; (ii) the availability of transport and particularly road links; (iii) the pre-existence of other firms or an industrial district; (iv) the presence of other infrastructure (e.g. proximity to grid, water supply); and (v) the level of support from municipal Government. The evaluation system supported under the project will give the GoP a clearer picture of the degree to which these investments and other can be attributed to the program and enable them to measure the social returns they have generated. Specific policy actions supported by the operation and expected results Prior Action 1.1.1: The state has created the legal basis for the establishment of a monitoring and evaluation system for the PROINFRA Program that will provide information for evidence- based policy making. 59. The establishment of the M&E system will require the approval of a decree that introduces a requirement that the program be routinely evaluated (Decree No 38.971), and a subsequent Portaria that specifies the principles and approaches to be used in these evaluations. The system will consist of the production and public dissemination of an economic analysis of the program. The analysis is expected to measure the social and private benefits of 25 public investment in infrastructure and the additional social and private benefits of the provision that allows firms to recoup infrastructure outlays against future tax receipts. The detailed methodology will be defined by AD DIPER, but is expected to involve an ex-post comparison between: (i) those municipalities not receiving any investment; (ii) those receiving investment funded wholly or partially via public expenditure, and (iii) those receiving investments funded wholly through the tax credit. This policy action is expected to help the GoP evaluate the impact of regional development programs that work by providing incentives for private investment and adjust its strategy accordingly. As the objective of the M&E system is to ensure that information about the effectiveness of incentives is taken into account into further rounds of policy design. AD DIPER will communicate the results of the evaluation via its website and through meetings with the public. Over time, the M&E system is expected to make PROINFRA, and Government policy more broadly, more effective in achieving sustainable economic development in the interior of the state, which will disproportionately benefit the poorer segments of the population and reduce spatial inequalities. Sub-component 1.2. Private sector development: To reduce administrative barriers to firm entry and ensure that firms can complete the state registration process within 72 hours. Description and Challenges 60. For Pernambuco to sustain rapid economic growth into the medium term, continued improvements will be needed in the investment climate to stimulate private sector initiative. The perpetuation of Pernambuco's good fortunes of recent years cannot be taken for granted once the catch-up industrialization process from initially low levels slows down and the importance of investment as a driver of growth diminishes. To ensure that a healthy pace of investment is sustained, it will be essential that the catalytic efforts of the state in providing strategic infrastructure inputs will be increasingly complemented and eventually replaced by private sector-driven activity. But for this to take place the state will need to strengthen the enabling environment for private sector dynamism, and this will require further efforts to improve the investment climate. 61. Lengthy bureaucratic processes have historically limited firm registration in Pernambuco, constraining the attraction and retention of firms in the state. In the past three years around 50,000 new businesses have registered annually, of which 30,000 have chosen to do so under the Federal Lei do Microempreendedor Individual (an option open only to micro- enterprises in low risk activities with yearly sales of up to BRL 60,000) and the remaining 20,000 under the REDESIM network. Of these new registrations, 57 percent were located in the Metropolitan Region of Recife, 18 percent in the Agreste and the rest in the Zona da Mata and Sertdo. But survey evidence suggests that there may a large reservoir of informal businesses in Pernambuco - around 570,000 in urban areas alone, according to the most recent Pesquisa da Econ6mica Informal Urbana in 2003 - which would benefit from the simplification of registration procedures. Of those informal enterprises surveyed in 2003, approximately 55,000 or 10 percent employed two people or more and would therefore stand to benefit from the reform supported under this operation. 62. According to the IFC's Municipal Scorecard, in 2009 it took around 60 days to register a business in Pernambuco. In order for a company to be registered, it must: (i) get registered and get a tax ID number at the federal level (CNPJ); (ii) get registered and get a tax ID number at the State level (Inscriqdo Estadual); and (iii) get registered and get a tax ID number and operations license at the Municipal level (Inscriqdo Municipal and Alvarca de Funcionamento). While this situation is not uncommon in Brazil, the GoP has made a priority of simplifying this process to improve the overall registration time, using REDESIM. At its core, 26 REDESIM can be understood as an information system that collects data from Juntas Comerciais (State Commercial registries), aggregate them and simultaneously issues State, Municipal and Federal registrations and tax ID numbers. Specific measures supported by the operation and expected results Prior Action 1.2.1: The State Business Registration Agency (Junta Comercial de Pernambuco - JUCEPE) has signed agreements with concerned Borrower's agencies and municipalities to implement REDESIM/PE and establish a "single window" for the Borrower's business registration process, thus reducing administrative barriers to firm entry. 63. The DPL will support the reduction of administrative barriers to firm registration through REDESIM, ensuring that enterprises can complete the state registration process within 72 hours. 19 The process would require integrating registration processes with: (i) the commercial registry at the state level (JUCEPE), (ii) the social security administration at the federal level, and (iii) the fiscal administrations at the state or municipal levels (depending on the type of economic activity), which through REDESIM would reduce the overall registration time to 72 hours. In addition, the state aims to include into the REDESIM process the licensing requirements with agencies at the state and/or municipal levels providing sanitary (CPRH), environmental (APEVISA), fire safety (CBMPE) and other licenses related to urban planning. The policy action supported by the DPL is to have 25 municipalities joining and implementing the system (representing 80 percent of all business registration activity) through agreements between JUCEPE and the municipalities and responsible agencies (CPRH, APEVISA, CBMPE). Throughout the implementation period the state is providing training to the municipalities concerned. 64. Streamlining business registration is expected to produce tangible results for a number of reasons. Bureaucratic procedures at the federal, state and municipal levels combine to greatly delay the speed with which potential entrants can establish or close companies in response to volatile market circumstances. These barriers also constrain the growth of small enterprises by discouraging their graduation from micro-entrepreneurial status, restrict the extent of internal competition and thereby dampen an important source of productivity growth. Insofar as the cumbersome procedures also affect the state's image as a business-friendly investment destination, they may also act to deter the much-needed investment that is needed to connect to existing and emergent clusters, such as the industrial complex around the port of Suape. It is important to note that streamlining procedures does not imply any watering down of oversight on the part of regulatory agencies. Rather it involves the introduction of a risk-based system according to which only those activities considered of high potential negative environmental or social impact are screened out for further assessment. Sub-component 1.3. Technical Vocational Education and Training: To strengthen Technical Vocational Education and Training (TVET) programs through the development of a monitoring and evaluation system (M&E) that will support policy development and program management and, over time, enhance employment outcomes for the target populations of the programs. Description and Challenges 19 Experience from other Brazilian states suggests that this is a realistic goal: Ceard, for example, increased the proportion of businesses registered in under 72 hours from 29 percent to 80 percent between 2009 and 2011. 27 65. In order to stimulate inclusive economic growth, the state has also made efforts to address skills gaps through TVET. Pemambuco is a fast growing economy with rising demand for skills. The GoP has identified the promotion of skills and workers' employability a key element of the strategy to support private sector development. To this end, the state is aggressively expanding TVET programs (from 18,490 vacancies in 2011 to 93,380 in 2012).20 These programs are of two main types: technical vocational education (TEC) and vocational training (FIC). TEC programs are long duration programs (minimum of 800 hours) directed at school age population. These courses are under the auspice of the State Secretary of Education (SEE). FIC programs are shorter duration trainings (between 160 and 400 hours) directed at the existing workforce. These courses are under the auspice of the Labor and Vocational Training and Entrepreneurship Secretary (STQE). TVET expansion in Permambuco has been done by expanding the state's own programs (in number of programs and coverage), increasing number of state technical schools, and the implementation of the Federal Program PRONATEC.21 Table 7 below lists the main TVET programs in the state and the respective number of vacancies. Table 7: TVET programs in Pernambuco and some key characteristics Vacancies in I Vacancies in 2011 12012 TEC SEE Technical Courses at the State Technical 10,069 13,474 Schools SEE Technical Courses in the Long Distance 0 4,473 Learning Modality PRONATEC-TEC 1,686 4,386 FIC Novos Talentos 5,125 13,957 Projovem-Trabalhador 0 12,000 Qualipetro - instructors 0 76 Qualipetro - Students 0 1,520 Automotivo Pole (civil construction, basic 0 7,730 qualifications, tecnical courses, QUALIAUTO) Naval Pole 0 3,000 Planteg and Plansey 1,610 1,483 PRONATEC-FIC-MDS 0 27,642 PRONATEC-FIC-MTE 0 3,639 TOTAL 18,490 93,380 66. The fast expansion of TVET and the diversity of actors involved impose important new challenges. TVET system in Pernambuco involves several distinct providers. The TEC programs "SEE technical courses" are offered at the State Technical Schools ("Escolas Tenicas Estaduais") and through long distance training centers, and, in both cases, are funded by the state. Currently, 52 percent of these programs students are women. These courses are complemented by PRONATEC-TEC which is offered by the Federal Institutes of Technical 20 TEC provides "concomitant" technical and vocational education along with a general secondary curriculum designed to develop strong math, literacy, foreign language and critical thinking skills. Upon completion of TEC in the modality integrated secondary education (Ensino Mddio Integrado), students receive a diploma and can either enter university or labor markets. 2 PRONATEC has a dual system with PRONATEC-TEC long duration courses (800 hours) for high school students and PRONATEC-FIC short duration course (160 to 400 hours) for existing workforce. The Federal administration predicts the creation of eight million vacancies in short courses and vocational programs until 2014 in Brazil. 28 Education of Pernambuco (IFPEs) and "S" system,22 and is funded by Federal funds. The "S" system is also the main provider of FIC programs.23 FIC system includes a very heterogeneous set of programs, targeted at a more diverse set of population and skills. They can be grouped in three main types. First, trainings geared at complementing the professional preparation of youth through short vocational courses developed in partnership with either the "S" or the Federal Institutes of Technology (e.g. Projovem for school dropouts and Novos Talentos for high-school students). Second, locally provided trainings that are linked to skill gaps in expanding sectors and aimed at promoting skills supply in those sectors (e.g. Qualipetro, Automotive and Naval Poles). Third, trainings offered to vulnerable population (e.g. PRONATEC-MDS). This diversity raises difficulties of coordination, data collection for monitoring and program management. 67. While the state administration embraced a new public sector management model focused on results, information collected on TVET programs remains focused on inputs of individual programs, rather than on the performance of the overall system. TVET expansion has not been accompanied by the setting up of corresponding Monitoring and Evaluation (M&E) systems to properly track the quality and efficiency of the programs, ensuring their relevance to evolving labor markets needs and thus the employability of the beneficiaries of those programs. Currently, monitoring is done for each individual program, information is collected for each of the various institutions and no integrated system exists. Moreover, indicators focus on inputs and processes rather than outcomes, such as the number of people enrolled who find jobs and who remain in employment after some time. Information is lacking at 3 main levels: (i) Placement rate in employment of TVET beneficiaries; (ii) effectiveness of the curriculum and courses offered to support the economic development of the state; and (iii) extent to which current vocational-technical policies at the various levels are contributing to the development of students' skills aligned with personal aspirations and business needs. An integrated M&E system for labor policies could be instrumental for the state's efforts to promote an integrated employment and skills strategy, avoid overlapping of programs, foster coordination between programs and increase employability among TVET beneficiaries. Specific measures supported by the operation and expected results Prior action 1.3.1: The state has created the legal basis for the establishment of a monitoring and evaluation system for the TVET Programs in the state that will support policy development and program management. 68. The DPL will support the development of an integrated M&E System for TVET programs implemented in the state, adopted by SEE and STQE, and make key indicators on inputs, efficiency and results available for decision making.24 The M&E will generate system- 22 "S" system includes a network of publicly-funded training centers. It has 3 main groups: "Serviqo Nacional de Aprendizagem Industrial" (SENAI) which is managed by the national confederation of industry (CNI), "Serviqo Nacional de Aprendizagem Comercial" (SENAC) which is managed by the national confederation of services, and "Serviqo Nacional de Apredizagem Rural" (SENAR) which is managed by the national consortia of workers in rural areas and focuses on agriculture. Given its direct links to industry, the system is known by the relevance and quality of the training offered. 23 Most training in Pernambuco is provided by Sistema S (a quasi-state institution) and public schools. In some programs, such as PROJOVEM, private providers are contracted in short-term basis. PRONATEC is currently in the process of accrediting other providers besides the "S" system, so the role of the private sector my expand over time. 24 An "integrated" system means there will be a single system for both labor and education programs, and the system will collect and consolidate comparable data on relating to different stages of the respective programs (application, registration, completion and labor market insertion). 29 wide data (collecting and integrating information across SEE and STQE programs) to inform program management and policy development in a rapidly growing and complicated system. This system will permit, for each program, routine monitoring of what participants are being trained in, enrolment, completion and employment outcomes by demographic characteristics of beneficiaries (e.g, gender, age) and geographical areas, which could help re-design programs in the future. The policy action in this area includes two key steps in establishing the system. First, a state decree will institutionalize an integrated TVET program, serving as an umbrella for all initiatives and defining the coordination mechanisms between the different secretariats involved, making program goals explicit, creating inter-sectorial committee (led by the STQE, in partnership with SEE), responsible for monitoring and managing the program, and establishing responsibilities and modalities of annual evaluation reports on program results to support next years' activity planning. As such, the institutional structure of the M&E system will include clear roles and coordination mechanisms between the various secretaries involved in TVET, and establish links between the information provided and program expansion through the requirement of producing and publishing an annual evaluation report to be discussed by the committee in a dedicated meeting and considered for vacancies planning. Second, the State will institute the M&E system, define the guidelines for its implementation and the use of M&E data produced to help program management and provide information for evidence based policy making. The annual evaluation report will be come publicly available to potential trainees who will become more informed, and adjust demand between programs becoming more exigent on state-provided training opportunities. 69. Through these measures, consolidated data on quality and efficiency of programs, beneficiaries' employability and client satisfaction will become routinely available. This will enable not only analysis of efficiency and performance at the program level, but also of participant-level outcomes and how they relate to gender, education level, location and so forth. The system will be implemented jointly by the STQE and SEE (with STQE having primary responsibility for implementation and hosting) and will allow for monitoring of the effectiveness of TVET programs and decrease fragmentation. It is expected that improved information on performance will be used in program planning and in that way enhance the quality and relevance of TVET programs in the state. Given that much of the expansion of TVET vacancies is in programs specifically targeted towards the poor or disadvantaged groups (e.g. Projovem Trabalhador and PRONATEC-MDS), overall improvements in TVET policies and programs are expected to disproportionately benefit the poor. Through the new M&E system, Pernambuco can also advance in the agenda of promoting equity in access to services and programs in this area for afro-descendent and indigenous populations by consolidating information on coverage and results of the programs among this population. This objective of promoting equity will be included in the text of the decree that launches the system. The information provided by the system can then be used as an input for discussions with the State committee for the promotion of equity (Comit6 Estadual de Promoqjo de Igualdade Etnoracial - CEPIR), in charge of this policy in the State. Sub-component 1.4. Productive inclusion: To strengthen and expand the state's productive inclusion program, Pernambuco no Batente, that promotes employability and/or income earning opportunities for the poorest segments of the population. Description and Challenges 70. Despite recent economic growth in Pernambuco, opportunities for "graduating" out of poverty through productive employment remain limited among the extreme poor. The inability of a large share of the population, currently reliant on social assistance programs, to 30 move out of poverty by obtaining productive employment has been a key obstacle to more inclusive growth in the state. Low skills and skill gaps among the poor are important factors behind this challenge. While strengthening professional education to offer large-scale, high quality, long duration curses at school for current students might be an important step to foster opportunities to all, it might not be sufficient to ensure the poorest participate in growth through enhanced employment and/or income earning opportunities. Complementary programs targeted at the poor, in particular interventions that are tailored to their needs, skill levels and abilities and integrate elements of training through shorter duration courses outside school for the existing workforce and technical assistance, are key. 71. The state has created the productive inclusion program, "Pernambuco no Batente" (PB) targeting poor and vulnerable families registered as extremely poor (less than R$70 per capita) in the national targeting registry of poor households, the "Cadastro Unico". PB offers training and technical assistance for business development to the target population, and supports the construction and operationalization of the Productive Inclusion Centers (PICs). Calls for applications are done locally through advertisement in community radio, bikes with speakerphones, pamphlets and other outlets, and selection is made on first come first served basis. The goal of the program is to support low income families graduating out of poverty through employment by developing technical and business competencies linked to local labor markets and productive chains. As part of this effort, the State has sought to expand coverage and outreach of their productive inclusion program among Afro-Brazilian and indigenous populations. Specifically, in an effort linked with the municipal social assistance centers (CRAS) in the context of the Brasil sem Miseria Plan, social assistance agents have applied the new national tools to register this populations in the national targeting system of social assistance (cadastro finico), which is the point of entry to all the existing programs. 72. Despite the positive results, Pernambuco no Batente remains small and relies on ad- hoc funding. The program currently has 8,200 beneficiaries and an annual budget of around US$ 5 million (about 9% of the state total Social Assistance budget). It is being implemented in 41 municipalities, with a total of 62,543 families under extreme poverty. Among registered participants, 87 percent are women. Beyond providing training the program supported the construction of 6 PICs, where group sessions focused on skills and practices related to local production or market needs are provided based on preferences by beneficiaries. PICs also offer technical assistance for the development of beneficiaries' existing businesses and social enterprises ("cooperativas"). Among program beneficiaries, 61 percent were absorbed by local labor market as either workers (40 percent) or self-employed (21 percent). During 2012, the Government made significant efforts to strengthen the program, including (i) providing support to the social assistance team in the active search and registration of extreme poor households in the "Cadastro Unico," (ii) establishing partnerships with private sector firms, and (iii) promoting activities linked to agro-industry in collaboration with the Secretary of Agriculture. To avoid duplication of efforts with the ministry of agriculture, the productive inclusion program operates in different geographical from those covered by Agriculture. The program is further coordinated with the Secretary of Labor, Qualification and Employment, including in the preparation of the 25 The program is complemented by the Federal productive inclusion program PRONATEC-MDS. PB and PRONATEC-MDS differ on geographical coverage, minimum schooling requirements (inexistent in the case of PB), targeted group (all in CadastroUnico for PRONATEC and extreme poor in PB, which represent 67 percent of all in CadastroUnico) and types of benefits offered. In addition to PB and PRONATED-MDS, the State of Pernambuco implements two other programs which are targeted at specific groups: "Chapeu de Palha" for workers of the sugar cane providing supplementary income through temporary jobs during the off season, and "Mae Coruja" for pregnant and lactating women aimed at decreasing mortality child through civic education and awareness. 31 training programs (curriculum) and in the allocation of the PRONATEC-MDS vacancies.26 Despite good results and citizen demand for PE, state funding has been provided on case by case basis. This process limits investment in implementation capacity and the scope for expansion Moreover, in the absence of regular and institutionalized funding, results monitoring and oversight by the state has been weak, with a focus primarily on process indicators. Specific measures supported by the operation and expected results Prior action 1.4.1: The state has created a financing mechanism for the implementation of the Productive Inclusion Program by municipalities within the state, linked to Results Based Management agreements that establish results monitoring arrangements and annual targets on service provision 73. The DPL will support the creation by the State of a financing mechanism for the implementation of Pernambuco no Batente by municipalities, linked to Results Based Agreements that establish results monitoring arrangements and annual targets on service provision. The policy action in this area establishes an Automatic Transfer System (ATS) for the State Productive Inclusion Program transferring resources from the State Fund for Social Assistance ("Sistema de Transferdncia Automctica e Regular de Recursos Financeiros do Fundo Estadual de Assistincia Social" (FEAS) to the Municipal Funds for Social Assistance ("Fundos Municipais de Assist8ncia Social (FMAS)." The possibility of municipalities to access this line will be regulated by: (i) a Resolution of the Bipartite Management Commission ("Comissdo Intergestora Bipartite (CIB)") (approved by the State Council of Social Assistance) which establishes the criteria the for regular and automatic transfer of funds using the ATS in the productive inclusion program and establishes that the amount to be transferred will be linked to each municipalities' existing productive chains ("cadeias produtivas locais"), and (ii) a Portaria establishing the criteria for eligibility of municipalities to the ATS, regulating the use of funds and establishing the monitoring requirements by municipalities, including annual report on process indicators. Municipalities will access the ATS through the signature of a results based agreement (Adherence Pact (Termo de Adesdo) that establish annual requirements on service provision and results monitoring. As part of the prior actions, the state published a Resolution, which includes a draft of the Adherence Pact to be signed by municipalities, including the annual targets for service provision and the details the evaluation report to be completed by municipalities with results indicators. The target number of municipalities expected to sign signed adherence pacts is 51. This action is expected to expand coverage among the poor using the national registry (Cadastro Unico), as well as upgrade productive inclusion programs by strengthening role of the state's municipalities, ensuring stability of funding for sustainable policy implementation and increasing the focus on results. COMPONENT 2 -ACTION DRIVEN STATE - CAPACITY TO GENERATE RESULTS 26 The program is complemented by the Federal productive inclusion program PRONATEC-MDS. PB and PRONATEC-MDS differ on geographical coverage, minimum schooling requirements (inexistent in the case of PB), targeted group (all in CadastroCnico for PRONATEC and extreme poor in PB) and types of benefits offered. In addition to PB and PRONATED-MDS, the State of Pernambuco implements two other programs which are targeted at specific groups: "Chapeu de Palha" for workers of the sugar cane providing supplementary income through temporary jobs during the off season, and "Me Coruja" for pregnant and lactating women aimed at decreasing mortality child through civic education and awareness. 32 Sub-component 2.1. Public sector management: To strengthen and extend the Results Based Management model of the state by adopting the approaches used in the Pacto pela Vida in the Secretariats ofHealth and Education and progressively in other Secretariats. Description and Challenges 74. Since 2007, the State of Pernambuco has developed a Results Based Management (RBM) model to promote efficient public administration and service delivery. Although the model covers all areas of state Government, it been developed most deeply in the area of public security (in the form of the Pacto pela Vida) and somewhat less in the areas of health and education (Pacto pela Sadde and Pacto pela Educaqjo).27 The approach has contributed to improved outcomes in at least the areas of public security and education, and has also helped focusing the efforts of officials on performance and results. Nevertheless, the model is currently very dependent on the leadership of the current governor and his team, and has been implemented without much formal institutionalization. One of the main challenges for the Government will be to formalize and extend the model so that it is workable for the whole of the public sector in Pernambuco. 75. One of the main characteristics of the RBM model is the integration of all stages of the public policy cycle, including planning, budgeting, monitoring, evaluation and accountability. The model is based upon an integration of the planning and budgetary processes which ensures that resources are in fact allocated to policy priorities. It also incorporates elements of quality control practices, routines and tools, derived from the private sector, including in particular the use of the PDCA (Plan-Do-Check-Act) framework to incorporate a problem solving framework into administrative processes. 76. The RBM model is based upon two central pillars. The first is an active participatory process in defining priorities, involving consultations in each of the twelve development regions of the state, in the years 2007 and 2011 (to prepare the PPA). The second major pillar is the adoption of high level monitoring meetings (usually chaired by the Governor), weekly in the case of the Public Security and fortnightly in the case of health and education. In these meetings senior officials are personally accountable for the achievement of targets. The meetings also serve to identify problems and to allow for interventions by the Governor and his team to remove obstacles to the achievement of targets. Finally, the model includes public reports on progress achieved every four months, with the annual report (Relat6rio de Aqdo de Governo) presented also to the legislative assembly. 77. Despite its success the model also has potential problems of sustainability. Firstly, the legal and regulatory framework for the model is currently minimal, and most of the key processes have been introduced through executive decisions, and could easily be rescinded. The Government has begun to institutionalize the management model, principally through the approval of the State Law 141 from September 3 of 2009 that provides a basic legal framework 27 "Pacto pela Vida" (PPV) includes additional operational and management practices that complement the management model. The PPV is an integrated strategy to improve citizen security and reduce Crime, requiring the coordination across 12 State Secretariats, the Prosecutor's Office and Local governments. For this purpose, the Government created an Executive Committee led by the Governor that meets every two months to monitor progress, and five (5) sectorial committees (Camaras Tecnicas) oriented to solve problems and executed direct actions related to public security (e.g. social protection, combatting crack and prison administration). These committees report directly to the executive committee. In addition, a system of salary bonuses linked to performance on specific indicators has been introduced in the Social Development and Human Rights Secretariat, which leads the PPV. 33 by introducing the integration of the accountability, planning, budgeting, administrative and control systems as key of the integrated management model of Pernambuco, and creating the Performance Management Council to monitor advances and produce quarterly reports to the State Assembly. Nevertheless, the law itself does little more than establish a very general outline of management processes. Other actions taken recently include the creation of a specific civil service regime for public management specialists (State Law 118 of 2008) and, the establishment of the Public Management Institute of Pernambuco (Decree No.37.846 of 2012) with the aim of promoting permanent capacity building of all public servants on results based management. However for the model to be extended and institutionalized it will be necessary to formalize operational procedures and routines, like those developed by Pacto pela Vida and replicated partially for the Pacto pela Saude and Pacto pela Educaqdo. It will also be necessary to address two further key questions. The first is whether the current systems are focusing on the correct data and are able to prioritize data requirements, since there is a potential risk of the monitoring systems being overwhelmed by data, particularly as the system is extended. Secondly, while the current system has been apparently successful, it has consumed considerable time and energy of the political leadership of the state, including that of the Governor, raising concerns about sustainability if the application of the model is extended. Specific measures supported by the operation and expected results Prior action 2.1.1: The state has established the legal basis for the Results based Management model and extended its application throughout the state's executive branch. 78. The operation will support the development of a legal framework for the Results Based Management Model, and measures to increase its sustainability. This will extend the model and lead to the adoption of the management and operational practices of the Pacto pela Vida in the Pacto pela Saude and Pacto pela Educaqdo within the next year. In addition, in order to increase the sustainability to the management model all state secretariats will be required to adopt the result based management methodology as an integral part of their planning and HR tools, implying that, for example, results indicators used to calculate bonus payments will have to be aligned with the Secretariats performance measures. It is expected that by 2014 at least 50 percent of the line secretaries will have adopted these measures. In addition to this decree, the Government is developing regulations for the adaptation of the institutional planning tools for results based management, and is expected that within six months these will have been adopted. COMPONENT 3: QUALITY OF LIFE - A BETTER LIFE FOR ALL PERNAMBUCANS Sub-component 3.1. Crime and violence prevention: To strengthen violence prevention programs in the state with a focus on rehabilitation of crack users, gender-based violence and monitoring capacity. Description and Challenges 79. As part of its broader program to improve citizen security, GoP has launched a program to reduce crime associated with the trafficking and use of crack. Over the past five years, the state's citizen security policies (Pacto pela Vida), have led to a substantial reductions in crime and violence. However, rates of homicide and other violent acts remain high; with drug related crime (particularly crack) being one of the main drivers. Launched in September 2011, Programa Atitude is an innovative program aimed at providing integrated support to crack users 34 and their families.28 The main objective of the program is to reduce the number of CVLIs related to crack use by protecting and treating those most at risk. The program, which is managed by the Social Development Secretary and Human Rights (SESDH) in coordination with the Prosecutor's Office and 12 state secretariats, promotes a close articulation between the state health and security sectors at all levels. It combines a pro-active approach of outreach to users and their families (in particular those that are known to be at risk of victimization) with the more traditional type of psychological and social support provided in specialized centers. It also includes centers for intensive care and a temporary financial assistance for graduates of the program to support them in the process of social and economic reintegration.29 In one community where the program has been operating more intensively (Arco Verde) a reduction of 67 percent of cases of violence and crime involving crack users has been observed since the official launch of the program. In its first year of operation, the program has treated approximately 2,200 people. 80. The first year of implementation of Programa Atitude has shown that there is an urgent need for expanded services and more qualified professionals. While crack use is not limited to the poor, it is more prevalent among socio-economically vulnerable populations and particularly afro-descendants ('blacks' and 'pardos') populations, who present both a higher risk to be exposed to crack and more limited options to seek treatment and rehabilitation services.30 The demand for support from users at risk of victimization, who sometimes have to leave their communities, has proven much greater than expected exceeding the program capacity in its pilot stage, and there is a need for more centers and more qualified professionals to attend this demand. There is also a need reach other territories outside the capital. According to the Government, drug trafficking and crack use is spreading to the interior of the state, and as of now, all Atitude centers are concentrated in the capital. Finally, it is crucial for the program to be able to provide separate/ more specialized treatment for youth and women, including pregnant women, who present specific types of vulnerability to crack addiction (including biological) and its consequences in public health, social and economic terms. 81. The lack of institutionalization of the program has constrained the Government in its capacity to expand the Programa Atitude services to respond to the increasing demand. This expansion has been ad hoc and not as integrated to the strategic and monitoring focus at the heart of the PPV which is needed to ensure the adaptability and sustainability of the program. As of September 2012, Programa Atitude had 15 teams of Street Agents, with the capacity of 28 Programa Atitude is the key focus of the State Policy on Drugs, instituted in 2011 by Law 14561. 29 Programa Atitude's comprehensive approach to treat and protect crack users at risk of victimization follows a four stage process that goes from outreach to users and families to income support in the reinsertion of "graduates" into society. The first stage, Abordagem Social, is the outreach phase of the program, in which "street agents" go to the areas where most users stay and reach out to offer support to them and their families and bring them to treatment. Those that accept help are then sent to Support Centers (Casas de Apoio), a 24/7 day service that provides psychological and social support to users and their families, working with groups, offering first care, professional courses, and connecting beneficiaries to other social programs. Users that hear about the program can also come voluntarily and stay up to 6 nights in the support centers. When the Support Centers are not able to attend all the demand, users are sent to the specialized centers (CAPSs) administered by the municipal government. Those who seek longer treatment after passing through the support centers can sign up for Intensive Care Centers (Casas de Tratamento Intensivo), the third stage of the program, where users can stay from one to six months. For those who conclude the treatment and "graduate" from the program, having gone through the previous two stages, a temporary income support is provided directly against the payment of rent ("Social Rent," Aluguel Social - R$ 400 per month/ approximately USD 200) to support them in their reintegration process. 30 Afro-descendant (black and 'pardos') represent over 66% of the population currently attended by the Atitude program. While the program does not specifically have a racial inclusion focus, afro-descendants are likely to benefit disproportionately given the higher prevalence of crack addiction in poorer communities. 35 reaching out to 50 users/families per month each. In addition, there are 5 Support Centers in the state, with capacity for 30 people each, and 10 places for those who need to spend the night; and 5 Intensive Care Centers with capacity for 30 users in each. The program is expected to expanding to the municipalities of Recife, Olinda, Carpina and Petrolina chosen on the basis of their high prevalence of CVLI and indications from the PPV data that homicides in those municipalities were particularly connected to crack. To respond to the need for more qualified professionals, the Government has started to discuss with the University of Pernambuco the development of a specific academic course to prepare specialized workers for the program. 82. Gender-based violence is also a salient concern in Pernambuco. While systematic data on gender-based violence in Brazil is sparse, existing data and research place Pernambuco in the top three states with the highest rate of female homicides in 2010.31 Pernambuco is also among the states with the highest incidence of homicides of women of African-descent.32 In response to the lack of legislation or strong institutional agencies specifically targeting violence against women in Pernambuco, the first DPL with the state supported the GoP in establishing the Secretariat of Women's Affairs (SecMulher). The Secretariat's work has been considered one of the most successful in the promotion of gender equality in Brazil. However, so far, the Secretariat has focused mostly on capacity building in rural areas, notably through the establishment of regional coordinators (12) to facilitate the articulation of policies and programs with a gender perspective. 83. In order to address gender-based violence and strengthen the Secretariat's work to prevent violence against women, the Government has decided to create the Technical Chamber on Violence against Women as part of its successful Pacto Pela Vida program.33 The Chamber is part of one of the six technical chambers that supervises all PPV's interventions. It brings together the secretariats of Women's Affairs, Judiciary, Public Defense, Health and Education with a view to strengthen actions focused on the prevention of violence against women, and the monitoring of these actions. As part of the PPV, this technical chamber signals the political commitment of the GoP to tackle GBV and presents an opportunity to mainstream gender into the sub-programs but also to develop a better M&E system on gender-based violence for the state. 84. The Technical Chamber will also be important for supporting the work of the Secretariat of Women's Affairs (SecMulher) and its new focus on urban violence against women. The work of the Secretariat is increasingly moving towards a more integrated and territorially-based approach to violence against women, more focused on urban violence (50 percent of women live in urban areas in the state), and bringing together different secretariats, the judiciary and civil society.34 31 Waiselfisz, Julio Jacobo. (2012). Mapa da Viol6ncia 2012: Caderno Complementar: Homicidios de Mulheres no Brasil. 2012. SAo Paulo: Instituto Sangari. 32 Ibid. The other States are: Alagoas, Paraiba, the Federal District, Para and Espirito Santo. In 2010, for every white female killed as a result of gender-based violence, two women of African-descent succumbed to the same homicide cause. 3 Cimara Tecnica do Pacto pela Vida para o Enfrentamento A Viol6ncia de G6nero contra a Mulher. The Technical Chamber was created on August 27, 2012, by the Decree No 38.576. 34 The idea is to "regionalize" its work within the metropolitan region, offering "one stop shop" type of services in a centralized manner. One-Stop-Shop have been proven to be more effective in urban settings (Perova et al., 2012) and a law has already been approved to create these integrated centers in each of the municipalities of the metropolitan region. Urban violence against women and the metropolitan approach require a different type of intervention than those implemented in rural areas, and therefore adjusting the Secretary's modus operandi for this new context will be challenging. Violence against women in urban areas is, for instance, commonly linked with drug trafficking. 36 Specific measures supported by the operation and expected results Prior action: 3.1.1: The state has created the operational framework for the expansion of the "Programa Atitude" as a form of social prevention to combat drug-related violence and rehabilitate drug users. 85. The proposed operation will support the creation of the conditions for the expansion of the Programa Atitude as a form of social prevention to combat drug related violence and rehabilitate drug users. Specifically, a new Decree will formally establish the Programa Atitude as part of the Pacto pela Vida program and define the objectives and operational framework for the program. This will provide the basis for expansion of the program, including through sustained financing and systematic monitoring of performance under the PPV monitoring framework. The expansion and strengthening of the program is expected to and enhance the capacity of the Government to respond to the demand from crack users at risk of victimization, and to the program's overall goal of reducing the number of homicides related to crack use. Prior action: 3.1.2: The state has established institutional mechanisms for addressing violence against women 86. The DPL will further support the establishment a Technical Chamber on Violence against Women and the strengthening of the M&E capacity of the GoP on issues related to GBV. The policy action includes the approval of a decree that creates the Technical Chamber on Violence against Women, but also it operationalization, notably in supporting the cooperation between SecMulher and other Secretariat on data sharing and monitoring issues related to gender-based violence, towards the establishment of an M&E system capable of informing the GoP on the state of GBV in Pernambuco, as well as on all actions related to violence against women being carried out. The policy action will contribute to strengthen PPV interventions focused on the prevention of violence against women, in providing much needed data and cross- sectoral cooperation through the Technical Chamber, which due to its visibility as part of the PPV system and monitoring framework, offers an unprecedented opportunity to address this issue beyond being simply a discussion forum. The collected data will feed into the PPV monitoring system and sessions. It will also contribute to the improvement of the definition, collection and monitoring of data, building upon the PPV existing M&E system to allow for the monitoring of this issue along with other priorities of this flagship Program. Sub-component 3.2. Health: To strengthen policies, programs and approaches in the state aimed at attending to the needs of patients with chronic conditions, with an emphasis on diabetes and hypertension. 87. Demographic and socioeconomic changes in Brazil are contributing to a growing problem of chronic non-communicable disease.35 According to Ministry of Health data, 60 percent of all deaths in Brazil in 2010 were attributable to three conditions: circulatory disease (31 percent), cancers (16 percent) and chronic respiratory disease (13 percent). Available data suggest that mortality from several chronic conditions is high in Brazil compared to other Latin American countries and several OECD countries. The growing chronic disease challenge is associated with urbanization and lifestyle changes, which in turn are linked to risk factors such as smoking, alcohol consumption, poor diet, insufficient physical activity, and obesity. While the " Chronic diseases are generally defined as diseases of long duration and generally slow progression. They include heart disease, stroke, cancer, chronic respiratory diseases and diabetes. 37 last couple of decades have seen progress on some of these risk factors (e.g. smoking), problems have worsened in other areas (e.g. alcohol consumption among youth, physical activity and obesity). 88. Despite lagging behind the rest of Brazil in terms of economic development, Pernambuco and the rest of the Northeast face similar chronic disease challenges as the rest of Brazil. The prevalence of diabetes and hypertension in the Northeast (9.1 and 22 percent respectively in 2010) is similar to the prevalence in Brazil as a whole (9.9 and 23.3 percent). The Northeast is also similar to the rest of Brazil in terms of many risk factors, as well as the mortality rate from diabetes, heart disease, and many cancers. In Pernambuco, as in others Brazilian states, indigenous and afrodescendant populations tend to be disadvantaged in terms of communicable disease, reflecting higher incidence of poverty, poor sanitation and access to water, and other factors. Patterns in respect to the prevalence of chronic disease and associated risk factors are less clear, with little evidence to suggest that indigenous and afrodescendant groups are systematically disadvantaged. However, on account of location and socioeconomic conditions, these groups tend to have worse access to the health services to diagnose, treat and manage chronic condition. 89. At the federal level, the Ministry of Health (MOH) has prepared a national strategy for addressing chronic disease, but challenges remain in tailoring the national strategy to local conditions and ensuring effective implementation. The MOH strategy on chronic disease outlines key actions relating to both prevention and health services. However, the strategy needs to be adapted to local conditions in terms of the epidemiological status, funding capacity, and the organization of the health system. Moreover, the implementation of the strategy will depend on the development of tools and instruments for effecting change in how health care providers and other actors operate on a day-to-day basis. This will include improving primary care services by integrating secondary prevention of chronic disease, enhancing quality of care, and increasing the number of health care workers with expertise in NCDs through expanded training programs. In addition, it will be essential to improve surveillance of risk factors and the evaluation of key health system reforms. 90. In recent years, Pernambuco has made considerable progress in improving the performance of the health system. Key measures have included: (i) approval and implementation of the State Policy to Strengthen Primary Health Care (2007) that introduced state financing, technical standards, monitoring indicators and financial incentives for municipalities to expand the number of family health team and improve their performance; (ii) implementation of the complementary federal program to improve access and quality in primary care (Programa Nacional de Melhoria do Acesso e da Qualidade da Atenqjo Bcisica); and (iii) expansion of new Urgent and Specialized Care Centers (UPA-E) to provide intermediate specialized services in coordination with the primary and tertiary levels of care. 91. Important challenges remain in strengthening the capacity of the state's health system to effectively address the growing burden of chronic disease. Effective management of chronic diseases depends on continuous and coordinated care by many different providers to diagnose conditions, to contain the progression of the disease or onset of symptoms (secondary prevention), and to provide treatment and palliative care. To meet these demands, a strong primary care system and adequate capacity of diagnostic and specialist services are critical, as are referral systems and patient records to manage access and the flow of patients and information. However, despite progress in recent years, many parts of Pernambuco's health system are still characterized by poor quality services, fragmentation across different types of providers and levels of the health system, long waiting times, poor access to medications and 38 diagnostic tests, and limited data on performance. These problems all contribute to poor outcomes for patients with chronic conditions. Specific measures supported by the operation and expected results 92. The proposed operation will support two complementary prior actions focused on strengthening the state's capacity to attend to the needs of patients with chronic conditions. Prior action 3.2.1: The state has approved the plan to address chronic non-communicable disease and establishment of measures to support its implementation 93. The first prior action supports the adoption and implementation of a State Plan to Tackle Non-communicable Diseases. The State Plan to Tackle Non-communicable Diseases provides the policy and technical framework for improving prevention, treatment and monitoring of chronic disease in the state. The plan includes a focus on the contextual determinants of health, ad on interventions and inter-sectoral initiatives aimed at improving access to services and outcomes among the indigenous and afrodescendant population. Although the implementation of the plan will inevitably take time, the alignment of the plan with the municipal health systems and with the organization of primary care comprises a critical step towards implementation. To this end, the first prior action also includes: (i) a Decision of the Municipal Secretariats of Health Council to incorporate municipal activities, as well as a revised monitoring framework in the State Plan, and (ii) the formal establishment of a working group to revise the State Policy to Strengthen Primary Care based on the State Plan to Tackle Non- communicable Disease. Taken together, the policy actions, complemented by state initiatives to expand training of health professionals on chronic disease management, are expected to contribute to expanding the percentage of patients with diabetes and hypertension that are diagnosed and managed in by primary care providers in the state. Prior action 3.2.2: The state has approved new clinical protocols and simplified clinical pathways focused on chronic non-communicable diseases. 94. The second prior action supports the approval of clinical protocols and simplified clinical pathways that are expected to contribute to improve the organization and coordination of health services in the state, and enhance quality. The clinical protocols and pathways are documents (and potentially computerized tools) to support appropriate clinical decision-making, both regarding diagnostic and treatment procedures (protocols) and referral and counter-referral of patients to specialized or diagnostic providers based on clinical criteria (pathways).36 The clinical protocols and pathways hence comprise important foundations for improving the performance of the health system, both in terms of the quality and safety of care, and management of the flow of patients through a strengthened referral and counter-referral system. The prior action further includes the formation of a working group to revise the State Policy to Strengthen Primary Care (same as for the first prior action) with a view to incorporate the systematic use of clinical protocols and pathways in primary care throughout the state. The expected outcome of the prior action is that a larger share of specialized services will be 36 Modern clinical guidelines identify, summarize and assess evidence about prevention, diagnosis, prognosis, therapy, including dosage of medications, risk/benefit and cost-effectiveness for different conditions, and, based on this information, they define the most important questions related to clinical practice and identify all possible decision options and their expected outcomes. Some guidelines contain decision algorithms to be followed. Clinical pathways, also known as care pathways, integrated care pathways, or care maps, are one of the main tools used to manage the quality in healthcare concerning the standardization of care processes, including the role of different providers in providing care for a patient with a particular condition. 39 provided based on referrals from primary care, and that the quality of care at different levels of the system is improved. Progress in this area is important as it ensures that scarce capacity is used to address patients with priority needs (relative to a situation based on patient-led self- referral), and improvements in quality of care will eventually contribute to improved patient outcomes. Moreover, an organized referral system provides critical (currently missing) information on actual demand for services, referral patterns of different providers, and waiting times, which is essential for effective management of the health system. Given that low-income households are more likely to use the national health system than higher-income households, the benefits of the prior action are expected to disproportionately benefit the poor. VI. OPERATION IMPLEMENTATION POVERTY AND SOCIAL IMPACTS 95. The policy actions supported by the proposed operation are intended to contribute to reductions in poverty and inequality. The operation will support policy changes that: (i) support the effectiveness of policies aimed at stimulating inclusive growth and private sector development; (ii) strengthen TVET policy; (iii) expand and strengthen the state's productive inclusion program that promotes employability and/or income earning opportunities for the poorest segments of the population; (iv) strengthen and extend the Results Based Management model of the state; (v) strengthen violence prevention programs in the state with a focus on rehabilitation of crack users, gender inclusion and monitoring capacity; and (vi) strengthen policies, programs and approaches in the state aimed at attending the needs of patients with chronic conditions, with an emphasis on diabetes and hypertension. A first assessment of the potential distributive effects of this policy changes on society and poverty relied on secondary data and interviews with key stakeholders was undertaken as part of the preparation of the operation.37 96. An analysis of the baseline context in the state was undertaken as part of the PSIA. The analysis confirms that: (i) social condition in Pernambuco remains worse than national averages, in spite of notable improvement over the past years; (ii) there are important inequalities within the state. The PSIA notes that Pernambuco's heritage as a slave economy based on sugar cane plantations resulted in a highly stratified society where wage income was limited and land ownership heavily concentrated, especially in the coastal areas where sugar plantations were located. The interior was settled by cattle raisers whose activity also demanded large pieces of land. The state is emblematic of the Brazilian social formation, evolving with many differences across race, gender, social groups and regions, with strong implication of the poverty pattern and dynamics in modem Pernambuco. Under this scenario, the social and economic impacts of the policies supported by this operation are expected to be positive for the most vulnerable populations. 97. The PSIA explores different dimensions of the state's challenges to improving outcomes in inequality and poverty reduction, including racial disparities. The afro- indigenous population, comprising black, "pardo" (mixed-origin) and indigenous groups, represents over 62% of the Pernambuco's population.38 The indigenous population tends to live 37 These interviews were carried out during the month of January to February 2013. Stakeholders interviewed comprised: (i) policy makers; (ii) policy executioners; (iii) project's managers; (iv) NGO representatives; (v) scholars; (vi) members of state's councils; and (vii) community leaders 38 The tribes Xukuru Pankararu, Trukd Atikum , Fulni-6 comprise 72% of this population, while the KambiwA, Kapinawa, Pankaiukd, Pankard, PipipA, and TuxA represent smaller tribes. 40 on lands that are often remote, severely affected by drought, and with limited investments in terms of water and sanitation. Reflecting this situation, the indigenous population faces significant socioeconomic vulnerabilities linked to pressures on land and land conflict, water shortages, inappropriate agricultural techniques, and lack of access to credit and agricultural inputs. The policies supported by the proposed DPL, which aim to address barriers to reducing poverty and inequality, complement Pernambuco's 2010-2015 Indigenous Action Plan. Afro- descendants and pardos also face poorer opportunities and outcomes in terms of skills, economic opportunities and education which are determinants of labor income. For instance, in the interior of Pernambuco 30% of afro-descendent or indigenous individuals aged 18 to 24 years have completed eleven years of schooling whereas 70% of the white individuals living in Metropolitan Recife were able to do so. According to the latest census, afro-indigenous households represent over 70% of household living with less than R$70 (IBGE). The poverty headcount is slightly higher for the black and pardo population (14.4 and 16.8% respectively) relative to the white population (12.3%), and significantly higher for the indigenous population (27.5%). In part, this reflects higher unemployment rates among the afro-indigenous population, both in the case of men (34.6% vs. 10.9% for non-afro-indigenous men) and women (40.6% vs. 13.8%) (DIEESE, 2011). 98. The policy action supporting the establishment of an M&E system for the Industrial Infrastructure Development Program (PROINFRA) is expected to have positive distributional impacts. Specifically, the M&E system will provide the basis for assessing the efficiency and effectiveness of the program, not only to meet its objectives but also to improve the targeting of the program to poorer areas presenting untapped or under-developed potential. Furthermore, with land becoming increasingly scarce in the Metropolitan Area of Recife, the PROINFRA program tend to benefit more the interior of the state where investment is most needed to provide job opportunities and increase income. Thus, this program benefits the areas of state that are more disadvantaged, contributing to a more equitable distribution of productive activities across the state's territory. 99. The reduction of administrative barriers to firm registration (REDESIM) will help improve the business climate, with positive spill-overs for poor and vulnerable groups. Simplified business registration processes, combined with other measures to stimulate private sector development, are expected to contribute to an expansion and increased formalization of the private sector in the state. This will have benefits in terms of overall employment creation, but also through the improved employment conditions associated with formal employment and increased tax revenues for the state. The distributional impact of the policy action will depend on how impact varies with geographic location, sector, and size of firms. Experience from federal programs suggests large responses of micro and small enterprises to simplified registration processes.39 However, the team will work with the state to monitor these impacts during implementation. 100. Policy reforms related to the strengthening TVET policy and programs and the productive inclusion program Pernambuco no Batente are progressive and pro-poor. The monitoring and evaluation system is expected to decrease program fragmentation, as focus is 39 The 2009 Lei do Microempreendedor Individual offered micro and individual businesses (single proprietors with annual turnover of up to BRL 60,000 whose activities are not considered high risk) to register online at the Federal level and complete the process in less than 48 hours. This led to a large increase in registrations among individual micro-entrepreneurs. The 2009 Lei do Microempreendedor Individual offered micro and individual businesses (single proprietors with annual turnover of up to BRL 60,000 whose activities are not considered high risk) to register online at the Federal level and complete the process in less than 48 hours. This led to a large increase in registrations among individual micro-entrepreneurs. 41 moved from inputs of individual programs towards focus on efficiency of the overall system. This enhances the quality and relevance of TVET programs, which, given the overall emphasis of the state on productive inclusion and the expansion of economic opportunities for the poorer segments of the population, is likely to benefit disadvantaged candidates. Further, disclosing information on monitoring and evaluation to stakeholders, especially of the TVET on employment outcomes will help to increase program coordination and to match the supply of labor with the required labor market skills placed by the local economy. Given that much of the expansion of TVET vacancies are in programs focused on the poor and disadvantaged population, the distributional impacts of the policy action are expected to be positive. The M&E system will further provide the basis for assessing how outcomes of TVET program beneficiaries relate to gender, level of education, and geographic location, thus providing a basis for continuously assessing the poverty and equity dimensions. TVET programs are complemented by the productive inclusion program Pernambuco no Batente, which is explicitly targeted on households identified as extreme poor in the Cadastro Unico. 101. The strengthening of Pernambuco's result-based management model will contribute to effectiveness of Government policy across the board, but particularly in the areas of citizen security, health, and education. Given the explicit priority to attending the needs of the most vulnerable segments of the population and stimulating economic development and enhancements in the quality of life in the interior of the state in the GoP Strategy Map, improvements in public sector management and in the implementation of pactos on citizen security, health and education, are expected to have a positive impact on the poor. 102. The expansion of the Atitude Program for crack prevention, treatment and rehabilitation will primarily benefit the poor. The prevalence of addiction to crack is higher among the poorer quintiles of the population, with devastating effects on communities and families. With a majority of crack users being young afro-descendant males between the age of 15-24, living in urban territories presenting a high social vulnerability, the expansion of the Atitude Program has a clear pro-poor focus. Additionally, while female users represent a smaller number of crack users, with again a predominance of users with lower educational and socio- economic background, the public health and socio-economic consequences of their addition are both greater, longer lasting and requiring specific attention. 103. The policy supporting the creation of the Technical Chamber on Violence against Women and the strengthening of M&E capacity on issues related to GBV is likely to disproportionately benefit the poorer segments of the population. While violence against women is not a phenomenon limited to the poorer segments of the population, poorer women, either due to unemployment or lower income, tend to present a higher dependence to their male partner which places them higher risk of being victimized. Additionally, the strengthening of the gender focus of the PPV can be expected to benefit young poor males which tends to be at higher risk of being involved or victim of violence, through (i) the improvement of the understanding of the dynamics and patterns at plays in GBV through the strengthening of the M&E capacity, (ii) the adjustment of programs/projects aimed at the reduction of CVLIs to address gender dimensions currently unaccounted for. 104. Policies tackling chronic conditions in the state will benefit poor families. While the Federal Constitution of 1988 incorporated the universality of coverage and selectivity to reach the most vulnerable, challenges remains in the implementation of this right. The policy actions supported by the operation are focused on improving quality and access of preventive and curative services for patients with chronic disease. The approval of a state plan for to address chronic disease, as well as clinical protocols and pathways, complement ongoing efforts to expand primary care (Family Health Teams) and access to urgent and specialized care in the 42 state. Taken together, these measures will improve access and quality of services - and eventually outcomes - in communities that benefit from the expansion of the system (under- served areas in the interior and poor urban areas) and the segments of the population that rely exclusively or primarily on the national health system (which are concentrated in the lower quintiles of the income distributions). 105. The PSIA concluded that the policies supported by the DPL operation are expected to have potential positive, progressive and pro-poor impacts, thus promoting more equitable growth as a result of its effects across regions and social groups. However, the analysis underlined a general concern regarding the effectiveness of horizontal and vertical coordination within and between governments to implement them. ENVIRONMENTAL ASPECTS 106. The analysis of the specific policies supported by the operation indicates that they are not likely to cause significant effects on the country's environment, forests, and other natural resources. Given that the policies supported aim to strengthen of the capacity of the State of Pernambuco to manage and improve its results in the different sectors that are part of this operation, with a notable focus on monitoring and evaluation, no significant direct or indirect impact could be identified during the preparation of this operation. IMPLEMENTATION, MONITORING AND FIDUCIARY ENVIRONMENT 107. The State Secretariat of Planning and Management (SEPLAG) has led the preparation of this multi-sectoral operation and will be responsible for its overall implementation. Given its nature, the operation will be implemented by seven different state secretariats, namely for Policy area 1: the State Business Registration Agency of the State Secretariat of Economic Development, the Pernambuco Development Agency (Ag6ncia de Desenvolvimento de Pernambuco), the Secretariat for Labor, Qualification and Employment (STQE), the Secretariat for Education (SEE), the Secretariat for Social Development and Human Rights (SEDSDH); for Policy Area 2: SEPLAG; for Policy Area 3: the Secretariat for Social Development and Human Rights (SEDSDH), the Secretariat for Women's Affairs (SecMulher), the Secretariat for Social Defense (SDS), the State's Health Secretariat (SES). 108. SEPLAG has instituted an elaborate monitoring and evaluation system for its strategic priorities. The Governor convenes a meeting of the secretaries of all the state secretariats to assess progress on strategic objectives, analyze advances towards reaching outcome and results indicators, and identify obstacles to progress and budgetary implications. As the proposed operation is fully aligned with the state's strategic map, the progress of the indicators defined under this program will be monitored as part of this process. This will facilitate regular updates of program implementation and allow for necessary adjustments. 109. The Bank's knowledge of the public financial management system in Pernambuco is based on a Public Expenditure Financial Accountability Assessment (PEFA), finalized in 2009, and on subsequent and more recent analysis undertaken in the preparation and supervision of Bank lending operations, including the Pernambuco Education SWAP, as well as other publications that assess Brazil's overall performance of the PFM systems. 110. A centerpiece of Government's All for Pernambuco strategy is the commitment to increasing the capacity and efficiency of public administration, including strengthening public financial management. The strategy recognizes transparency, accountability and the increased efficiency of public expenditures as key elements necessary to ensure equitable 43 economic growth in the state. To achieve these, the Government has undertaken a number of reforms to enhance efficiency, transparency, and accountability in the use of public funds. These reforms have been aimed at strengthening linkages between strategic planning and the budget preparation process, increasing capacity for the accounting and internal audit functions, and upgrading information systems. 111. The Constitution of the Federative Republic of Brazil underpins the management of public finances at all levels of Government throughout the country. More detailed requirements and guidelines relating to public financial management (PFM) procedures to be adopted at all levels of Government are contained in a well-developed legal framework. This framework was developed through the introduction of legal and institutional reforms to help strengthen accountability and transparency in the management of public finances in Brazil. A public accountability law (Lei 4.320 of 1964) regulates financial controls, budgeting and reporting at the federal, state and municipal levels. The Law of Fiscal Responsibility (LRF) of 2000 established particular requirements for macroeconomic and fiscal discipline. The federal Government is leading an initiative to adopt international public sector accounting standards that will improve financial reporting and accountability at all levels in Brazil. These reforms have been implemented in an environment characterized by increased demand for accountability in the use of public resources. 112. The PFM system consists of strong internal rules and controls. These clearly define the roles of the different institutions involved in the management of public funds and allocate responsibilities between them. The legislature is responsible for approving the budget and for oversight of its execution. SEPLAG is responsible for the preparation of the budget while SEFAZ undertakes budget execution duties. The budget classification system is governed by federal rules that are consistent with international standards. These rules require the publication of comprehensive information in the budget documents. Brazil scores high on the 2012 Open Budget Index, indicating that significant information is provided to the public in budget documents.40 Accounting rules and regulations are generally respected and there is a high level of transparency with respect to financial information on the state's transactions. This is due to a number of factors, including the clarity with which relevant laws describe obligations in relation to the preparation of these financial statements, and the diligence with which they are applied. 113. The budget preparation process is orderly, and is guided by well-defined budget preparation procedures and calendar. These establish proper sequencing and allow sufficient time for budget preparation activities. The state has consistently met the deadlines for the preparation of the key budget documents (the Plano Plurianual de Aqdo (PPA), the Lei de Diretrizes Orgamentarias (LDO) and the Lei Orgamentaria Annual (LOA), and for their submission to the legislature for their consideration and approval. The process is designed in such a way as to promote participation by all key stakeholders and sectoral agencies. The PPA provides a reasonable foundation for a multi-year perspective in fiscal planning, upon which further linkages to the annual budgeting process can be built. It covers a period of four years, the latest being 2012 to 2015. 114. Despite this fairly robust multi-year planning framework, there are remaining inconsistencies between the program objectives, costs and targets listed in the PPA, and those reflected in the work plans of budget agencies, and the execution reports prepared by 40 The Open Budget Survey assesses whether the central government in each country surveyed makes eight key budget documents available to the public, as well as whether the data contained in the document is comprehensive, timely and useful. Brazil rank #12 out of over 100 countries ranked by the Open Budget Survey; With a score of 73 out of 100, Brazil has an openness ranked as 'substantial' substantially above neighboring countries (the nearest neighboring country, Chile has a score of 66). See http://www.intemationalbudget.or/files/OBI2010-Brazil.pdf. 44 them. This weakens the linkage between multi-year planning and the annual budgeting process. The definition of program objectives, costs and targets in the PPA is at times inconsistent with that in the LOA. Also, PPAs do not sufficiently reflect the lifecycle costs of investment programs. The Government is committed to improving the medium-term outlook in its planning and budgeting process, through better coordination between planning agencies and the sector and financial units in individual secretariats. 115. Pernambuco's E-Fisco financial management information system contains an accounting module that is used to link the approved budget with accounting and budget execution data. For a number of years, Pernambuco used the Integrated System for State Financial Management as its integrated financial management information system. The PEFA review noted weaknesses resulting from the outdated architecture upon which it was based, which limited its usefulness as a management tool. The new system also enables the real time capture of transaction data, making budget execution data instantly available for the preparation of financial reports. These are prepared in conformity with federal laws and regulations. In addition, the system is used to provide citizens of Pernambuco access to budget execution data, thus promoting transparency in the use of public funds. 116. Pernambuco is undertaking a number of reforms to prepare for the implementation of the new accounting requirements, including the adoption of a plan of accounts and training of staff. Brazil has established a timetable for the adoption of international public sector accounting standards in all federal entities by 2013. Upgrading the information system will also facilitate the implementation of the new accounting procedures. 117. Weaknesses in the internal audit function of the state were noted during the PEFA assessment. Since then, the state established the Secretaria Especial da Controladoria Geral do Estado (SECGE) to undertake internal audits. The head of the SECGE reports directly to the Governor, thus enhancing its independence. The department has sufficient access to other Government departments to enable it to undertake its audits, and its recommendations are generally implemented. The Government continues to strengthen the SECGE through the creation of a specific career path designed to increase the professionalism of staff in the department. It has also undertaken a recruitment drive and training program for staff aimed at increasing their knowledge and skills. 118. The responsibility for external audit of the accounts of the Government and its agencies is exercised by the Tribunal de Contas do Estado (TCE) of Pernambuco (TCE). The TCE enjoys operational independence and its staffing is considered sufficient for it to carry out its duties. In addition to compliance and financial audits, the TCE has recently embarked on performance audits in a bid to help enhance efficiency in the use of public funds. The recommendations of the TCE are generally implemented, partly due to an effective system it uses to monitor its previous recommendations. 119. A specific committee, whose recommendations are submitted to the legislature plenary session for approval, carries out legislative scrutiny of the budget. Rules for budget amendments during the budget execution cycle are clear and these establish limits to which the administration adheres. The above assessment indicates that the PFM environment in Pernambuco meets the Bank's requirements and is adequate to support the proposed operation. In addition, through the preparation of Pernambuco's development strategy and actions undertaken subsequently to implement related reforms, the Government's commitment to a strong PFM environment is satisfactory. 120. Procurement in the State of Pernambuco is made in accordance with Federal and State legislation, and except for small adaptations follows the same system as other states in 45 the federation. Overall, the procurement system in Pernambuco is acceptable, executing a budget of approximately US$16 billion in FY 2013. The state is working to address a number of challenges, including the quality of bidding documents, lack of coordination between the technical and operational staff, cost estimation methods (to avoid tendency for over-estimation of costs by firms), and bottlenecks in the procurement workflow. The state is also facing similar fraud and corruption issues as other states in Brazil related to limited competition and weak control of interactions between procurement staff and bidders. Over the last few years, the state has established new control policies and enhanced the efficiency of procurement processes, including investment in new systems and mechanisms for processes control, standardization of processes of the State General Attorney (Procurador Geral do Estado) to enhance workflow, and the use of e-procurement systems is expanding participation of interested parties. There is still a need to enhance training of staff, equipment, monitoring and control systems, and investigation of fraud and corruption cases.41 121. As a result of the sound PFM environment presented above, as well as appropriate foreign exchange control and disbursement arrangement described in the following sections, the fiduciary arrangements in the State of Pernambuco are adequate to support the proposed operation. In addition, the Government's development strategy and actions undertaken to implement reform actions in these areas are a satisfactory reflection of its commitment to improving the PFM environment. FOREIGN EXCHANGE CONTROL ENVIRONMENT 122. The Central Bank's foreign exchange control environment has been assessed as adequate based on a review of recent audit reports and earlier IMF Safeguards Assessments. The IMF undertook its assessment in October 2002 and updated in March 2004. It concluded that the Central Bank does not present widespread vulnerabilities that could compromise the safeguarding of Fund resources. To update these assessments, the Bank also undertook a review of the financial statements of the Central Bank to assess the extent to which the foreign exchange control environment remained adequate. As part of this review, the Bank examined the financial statements for the years ending December 31, 2006 to 2011. These included Explanatory Notes to the financial statements and a report of the independent audit carried out by an international firm of auditors. The latter contained an unqualified opinion on the financial statements for all years. The Explanatory Notes, an integral part of the financial statements, provide an extensive explanation of the Central Bank's risk management policies, including those related to financial instruments held to manage the international reserves. 123. In relation to operational risks, the Explanatory Notes state that the Central Bank "uses internal control systems, which are considered adequate for its activities." The Bank's conclusion based on the review of the financial statements was that the control environment governing the Central Bank's operations, within which the loan's foreign exchange would flow, continued to be adequate. 41 At Federal level, the main rules of procurement are: (i) Lei Federal 8.666/93 (Lei de Licitaq6es e Contratos), (ii) Lei Federal 10.520/2002 (Lei do Preg5o), (iii) Decreto Federal 5.450/2005 (PregAo Eletr6nico), and (iv) Lei Federal 12.462/2011 (Regime Diferenciado de Contrataq6es - RDC). At state level, the main rules are: (i) Lei Estadual 11.424/1997, and (ii) Lei Estadual 12.794/2005. Pernambuco has a procurement portal with information on opportunities with the state and orientation to interested parties, including manuals and standard bidding documents. 46 DISBURSEMENT AND AUDITING 124. The proposed loan will follow the Bank's disbursement procedures for development policy lending loans. The funds will be disbursed against satisfactory implementation of the development policy program and will not be tied to any specific purchases. Once the loan is approved by the Board and becomes effective, the Bank will deposit the proceeds of the loan in an account designated by the Borrower and acceptable to the Bank at the Banco do Brasil S.A. This commercial bank is an acceptable financial institution for the Bank as it is: (a) financially sound; (b) authorized to maintain the account in the currency agreed between the Bank and the Borrower; (c) is audited regularly, and has received satisfactory audit reports (reviewed December 31, 2010 Financial Statements audited by KPMG); (d) able to execute a large number of transactions promptly; (e) is able to perform a wide range of banking services satisfactorily; (f) is able to provide a detailed statement of the account; (g) is part of a satisfactory correspondent banking network; and (h) charges reasonable fees for its services. 125. This account at the Banco do Brasil S.A is denominated in local currency and does not form part of the country's official foreign exchange reserves. The state will provide a confirmation to the Bank the respective amount was accounted for in the state's budget management system. Such confirmation will be sent to the Bank within 30 days after payment. If the proceeds of the loan are used for ineligible purposes as defined in the Development Loan Agreement, the Bank would require the state to refund the amount. Due to the conclusions related to the adequacy of the state's public financial management environment, no additional fiduciary arrangements will be put in place for the operation. RISKS AND RISK MITIGATION 126. Country, state and sector factors. Moderate to low risk. As described in the country and state context, despite external risks and internal policy challenges, the Government of Brazil's overall macroeconomic framework is considered sustainable in the medium term. At the state level, economic and fiscal risks are related to prudent management of the state's fiscal position in an uncertain global environment. Even though the state has a strong fiscal stance, ICMS tax revenues remain vulnerable to macroeconomic fluctuations in Brazil and partner countries. In addition to the fundamental factors affecting demand, the economy of Pernambuco is also vulnerable to the nature of the policy response to continued economic weakness, where a higher tolerance for inflation and a lower primary surplus at the federal level may lead to higher risk premiums and therefore a higher cost of finance. 127. Social factors. Moderate. A poverty and social impact analysis was carried out, including secondary data analysis and focus group interviews with key stakeholders. The analysis concluded that the combined social and economic impacts for the most vulnerable population are expected to be positive. The social-related risks associated with the operation are moderate and refer to concerns regarding the effectiveness of horizontal and vertical coordination within and between governments to implement them. 128. Fiduciary factors. Low. PFM procedures are well developed in Brazil and adopted by all levels of government. A sound legal framework was developed over a number of years to help strengthen accountability and transparency in the management of public finances in the country. Pernambuco's PFM system features strong internal rules and controls, with clear definition of responsibilities and institutional arrangements for the management of public finances. Existing weaknesses are being addressed by the state through a number of reforms, which would mitigate the financial management risks. 47 129. Institutional and implementation factors. Moderate to low risk. Risk analysis ranges from moderate to low risk for institutional and implementation factors. The main risk concerns the effective implementation and eventual impact of the policies and reforms that are the focus of the operation. It is recognized that there are a number of potential bottlenecks related to technical capacity to develop and implement new M&E systems and other reforms in the concerned secretariats, the need for inter-sectoral coordination, and the shared responsibility between state and municipal governments for many activities. These risks are however mitigated by a strong sense of ownership of the reforms by the state Government and relevant secretariats and agencies, strong leadership and management capacity by SEPLAG, a strong track record of implementing difficult reforms. Moreover, the Bank is committed to provide technical as needed. In part, this will be done through the supervision of the proposed operation, as well as through the supervision and dialogue related to other operations. In addition, ongoing analytic work, such as the Pernambuco State Economic Memorandum and the study on Skills and Jobs in Brazil provide a basis for follow-up work with the state on specific issues. Finally, the Bank and the state are pursuing other forms of technical cooperation in a number of areas of the operation, both based on trust fund resources and a potential reimbursable technical assistance arrangement. 130. The overall risk rating for the proposed operation is moderate. 48 ANNEXES ANNEX 1: PERNAMBUCO LETTER OF DEVELOPMENT POLICY PERNAMBUCO Gabinete do Governador Sode Provis6 ridaldoz ieaI C o de C onene de Pernamohuco Pa-i do d., P, ... A,. Governador Agamenon MagalbOes. & 200 N., d Republicd, s (Acesso pea Rua Alemnanha) 11 10-70) Salad,nh, Oli d/PE Tefnc:(81)311-2100/Fax:(81)31q1-2322 Oficio no 159/2013 GG/PE Recife, 27 de marco de 2013 Mr. JIM YONG KIM President The World Bank Washington, DC This letter presents Pernambuco's commitment to the Pernambuco Equity and Inclusive Growth Operation with the World Bank, within the scope of the 2011-2014 Government Plan. This operation is aimed specifically at Economic Development, Education, Public Health, Crime Prevention, Gender and Public Sector Management Policies Areas. 1) The "Todos Per Pernambuco" model - history, actions and main achievements Since assuming the Executive Branch of the State of Pernambuco, in 2007, the Government reinforced its commitment to improve the quality of life in Pernambuco through the Government's Plan for 2011-2014. The goal of the plan is to overcome social deficits in education, health and sanitation and to mobilize all political resources, institutions and financial provisions in the State in order to break the shackles that have bound a significant portion of the citizens of Pernambuco in underdevelopment. In early 2007 the Government created the "Todos por Pernambuco" Program which represented a significant change in the way of governing, in particular modifying the way in which priority policies, programs and projects are selected and executed by the Government. With this new model, the foundations for a democratic planning process were established in order to ensure that the actions of the Government are aligned with citizen interests. Broadeitizen consultations regarding public policy have been regularly organized at the state and regional level to ensure active citizen participation in decision-making. This reflects a clear commitment of the Government towards inclusion of all, building on the rich diversity of the State of Pernambuco. 49 PERNMBUCO Gabinete do Governador Sede Provis6r[a: d, T N'1 1k l. Centre de. Convenrcaes d,. PernambucoPaiido a;p bIhnes Av. G,vernd,r Apamenon Magalbores, n 200 si, d kobi I, IP (Acesso pLb Rua Alemanhl) 50 01) 920 Sante Art6u Roe PE 53,110 7 [0 Salgadinho - Olinda/PE Telele:{8 ([ 3101 2L0/ ,a: (81)311-232n The "Todos por Pernambuco" strategy has provided an opportunity to structure the interrelated dimensions of State planning, recognizing it as a process with both political and technical dimensions. The political dimension is reflected in the spaces created to accommodate specific institutional manifestations of society's desire to influence the formation of public policy at the state and regional levels. The technical dimension is reflected in the State's commitment to re-structure itself to meet these challenges. The 2012-2015 PPA (Multi-Year Plan), like the 2008-2011 PPA, was built from the second round of Regional Seminars where the questionnaires were distributed to more than 10,000 citizens. The high return rate (43%) has provided the government with important information to inform its mandate. Thematic discussion groups were conducted at the seminars held in the 12 regions, with more than 13,000 participants, representing a 154% increase in participation in comparison to the first PPA. The second PPA showcases a broad range of programs for each region and provides for societal monitoring of Government actions. Following the renewed Government mandate, a new Strategy Map was completed, using the same methodology as the previous map. The new map consolidates three pillars of action and twelve strategic objectives, which represent a renewed vision of the future with a larger primary focus on planning and monitoring Government action. The focus on results brought by the strategic objectives will support the integration between the different secretariats represented in the new administration structure. Guided by one public policy, they will assure the alignment between the Government actions in order to improve future results. Monitoring and evaluation has been key to the implementation of the Strategy Map since 2008. The elements of the Government Program have been organized around keystrategic objectives that have been implemented in coordination to achieve the Government's vision of the future. The achievement of strategic objectives allowed the progress in achieving the following pillars: i. New Economy - Opportunities For All Pernambucanos. This policy area is focused on promoting sustainable and inclusive growth though a dynamic private 50 PERNAMBUCO Gabinete do Governador Sede P'rovLkbria: E,ee'OtL! Ceo d Convenes d Pamc (po d t--, A,. Governador Agamenon MagalbAs, a200 Pm,d Rok,Cn (Aco pe.a Ra- M- n 50010 -9A m Santho a.1lflP 5311r-710 Sagadinho OliodaFE TeefoRe: (1 3181-2100: Fan: (801 3101-2322 sector, creation of employment opportunities and investment in infrastructure, including in the perspective of the 2014 World Cup and promoting environmental sustainability. ii. Action-Driven State - Capacity To Generate Results. This policy area is focused on establishing conditions for improved public administration, service delivery and public investment, by establishing processes and routines fociused on results and problem solving. iii, Quality of Life - A Better Life For All Pernambucanos. This policy area is focused on improving the quality of life of the citizens of Pernambuco by improving public services, with a focus on education (Pact for Education), health (Pact for Health), and citizen security (Pact for Life), but also including the promotion of citizenship, the fight against social inequality, the improvement of water and sanitation, sports and leisure, and urban mobility. With the Strategy Map agreed to by all departments, the Government highlighted three main axis of work: the most vulnerable strata of the population; the consolidation of the foundations for a new economic development cycle; and the interiorization of the State's development and actions. At the same time, the Government has put a priority on combatting the differences and disparities between segments of the population and between regions of the State. This innovative fonn of management has gained momentum for the implementation of a public policy that consolidated the performance of the regionalized administration, and could be developed further at all levels of the State. In order to achieve its goals, the Strategy Map has a focus on results and highlights the following tools to adjust the necessary conditions for Pernambuco's development: responsibility; transparency, social accountability: citizen participation; and an integral cycle of management. The results of the implementation of the Management Model "Todos por Pernambuco" have been confirmed through measurable indicators, defined for each pillar. This innovative management model has thus laid the foundations of all the Government actions over the past 6 years. The vision focused on making "Pernambuco, a better place to work and a better place to live" has given direction to the efforts of all departments in their 51 PERNAMBUCO Gabincte do Governador Enderego Oficial: Sede Provisifri; Palac, do Campo ds Prmeesas Centr de Convenq6es de Pemambuc Pr da Repdbhca, s A, . overnador Agoinenon Magalhcs, n" 200 50.r010 -9d - Sant o AnIMio - Rclfe VE (Acsso pela Rua Alemanha) 53.110-710- Slgadinho. Olinda'P[ Telefon: (81)3181-2100/Fax I (81)3191- 22 daily actions, allowing the creation and implementation of the territorial approach. The Strategy Map was distributed to all the administrative structure of the Government and presented by the Governor to all public servants - managers and leaders - along with the results of the past Government as part of the strategy of transparency promoted by the State. The consolidation of this new way of governing contributed to the following results across the State: V Increase of water supply, removing more than 1,5 million people from the rationing V Three metropolitan hospitals have been constructed and with emergency departments expanded to add 1.307 new beds to the State Health network; V Creation of 147 new Secondary Schools of Reference and 13 new Technical Schools, reflecting the expansion of investments in Education; / Creation of the Pact For the Life program - the largest program of Public Safety in the history of Pernambuco - which has contributed to the reduction of violence in the State since 2007; V Highways construction, giving access to municipal districts, before isolated, integrating development poles and reinforcing the Pernambuco connection with the neighboring states; V Large investments in Federal Government attracted new companies which contributed to new employments opportunities, year after year at the capital and in the Interior; V Large investment in the Suape Port Industrial Complex, twice the equivalent and stocking of the past 30 year-old investments sum, with a growth of 52% in the number of industries attracted to the area. The results with the management model All for Pernambuco has made of the State a place with more opportunities and development, this fact is evident in their communities and lives. The positive results of the new public administration have been recognized not only by Pernambuco's population, but have also been highlighted by the national and international media. Although recognized by the population and national media, the Management Model structure required formalization within the law to ensure continuity. Thus formal measures were 52 PERNAMBUCO Gabinete do Go,ernador S,de Provis6ria: Erdereo Ofo Ceuro de (nvenefes de Pernambucs, P.i'm d Cm.. do, P--, A'. Governador Agamenon Mgalhesbk00 , . (Acesso peta Rua Alnanha 50,0 10 -028 S-toAntnnin Rec&F 53110-710 Salgadinhl, OlindaPE Telefo : (81) 3181-2100 /,Fx: (81) 3181-2322 adopted under Complemental Law 141 in September 2009. This measure instituted the Executive Power Integrated Management Model, which is composed of four systems: (i) Social Control, (ii) Planning and Management; (iii) Administrative Management; and (iv) Internal Control. Additionally, in 2010 the following positions became competitively filled: Planning Analysts, Budget and Management Analysts (APOG), Administrative Management Analysts (AGAD) and Internal Control Analysts. The citizens of Pernambuco confirmed their support in this new director for Pernambuco when the Government was reelected in October 2010 with more than 82% of the vote, making the Governor the most highly supported governor in Brazil. The Pernambucanos confirmed trust in the Management Model "Todos por Pernambuco" allowed for consolidation and adjustments and adaptations, which were made within the administrative structure of the Government's team, in order to enhance performance. At this time, the Instituto de Gestho - PE was also created, which addressed areas of improvement for Pernambuco's Public Administration, including the support of knowledge production. Across Pernambuco, from the coast to the interior, important programs contributing to improved quality of life for all Pernambucanos have been introduced, which are in line with the Government's Plan for 2011-2014 to transform Pernambuco into a "better place to work and a better place to live". In order to achieve the goals set forth in the Government's Plan, a new proposal has been introduced which includes methods for measuring and monitoring of these interventions by both the Government and society. Three strategic areas of focus: V The first area of strategic focus is related to the enlarged concept of quality of life, where interventions are aimed at guaranteeing the quality of public goods and services for all from Pernambuco and committing to prioritizing actions with high impact on people's reality. V The second area of strategic focus is related to the configuration of the Development Management Model, which is currently being implemented. Priority is given to generating opportunities with productive inclusion and income distribution in order to increase the productivity patterns and competitiveness of Pernambuco's economy. 53 PERNAMBUCO Gabinete do Governador Sede Pro1isria: entr de Conneng0es de Pnambucot U aas I s An. G(overnador Agamnenasn Magathiles. it? SWPa(Ko1tptlco / (Ace pela 1W Alemoanha) i010 928 SolitoAnteniu Mife,VE 53.110-110 Salgadinho Olinda/M Telcfone: (81 3181-2100 F : (81) 3181-2322 v The third area of strategic focus is related to the State's Public Management structure and professionalization. Efforts are underway through the Fiscal Responsibility Law and Integrated Administration Model to increase capacity to generate results for society through the effective delivery of public goods and services by improvement management of available resources. In each strategic area, the intervention axes synthesize the main action lines and the proposals that showcase the continuity of the executed work and lay the groundwork for new platforms of performance. The Government is promoting continued development in four areas: V Territorial approach of the development; V Transverse treatment of the environmental questions; V Social agenda; V Technological innovation as element of value aggregator. Promotion in these areas will ensure that the future agenda is compatible and sustainable under the current development model, which allows for adjustments in order to correct existing development deficits and establish new targets. Accordingly, the Strategy Map was restructured, following the same methodology and logic adopted in the original construction. The new map has three pillars of actions and twelve organized strategic objectives. With a renewed vision of the future, the priority focuses have been enlarged along guiding premises to establish a monitoring and evaluation system of the Government's Plan. The new Strategy Map aims to integrate several organs of the administrative structure to promote alignment of the Govemment's actions in order to increase effectiveness of results. 2) Policies to be supported by the DPL I In order to achieve the goals proposed by the Strategy Map which was developed with the Government's Plan for 2011-2014, the State of Pernambuco seeks assistance from the World Bank in three key policy areas: (1) Life Quality - A better life for all Pernambucanos; (2) 54 PERNAMBUCO Gabinete do Governador Sede Provisoria:rdeeoOiit C-ntrode Conv'ne-s d, Perambuct,aoNl- d, Cae,, do Prin..... A,. Govrr,ador Agamno-n M,Agales. n 00 ' & Rbi, (Acesso pela Rua AlIcnanhal 50.010 9 8 Sat Atcnio- eife/PL 53.1170 1 Salgadrh OindaPI, Telone' ( ) t181 2100 1/ a: (M1) 31H]-2322 New Economy - Opportunity for all Pemambucanos; (3) Action driven state - Capacity to generate results to all Pernambucanos. This support would allow the State to keep its high investment rates along the next years, bringing continuous development and equity for all the Pernambucanos. The policies involved are: Component I -Life Quality - A better life for all pernambucanos Subcomponent 1.1 - To strengthen the S/ate s Industrial Infrastructure Development Program (PROIXFRA) through the development of a monitoring and evaluation system that will provide information for evidence-based policy making. / The State has created the legal basis for the establishment of a monitoring and evaluation system for the PROINFRA program that will provide information for evidence-based policy making. Subcomponent 1.2. - To reduce administrative barriers to firm enty and ensure that firms can complete the State registration process within 72 hours. V The State Business Registration Agency (Junta Comercial de Pernambuco -- JUCEPE) has signed agreements with concerned State agencies and municipalities to implement the State Network to Simplify Business Registration (REDESIM/PE) and establish a "single window" for the State business registration process, thus reducing administrative barriers to furn entry. Subcomponent L3. - To strengthen Technical Vocational Education and Training (TVET) policy and programs through the development of a monitoring and evaluation system (M&E) that will support policy development and program management and, over time, enhance employment outcome.for the target populations of the programs V The State has created the legal basis for the establishment of an M&E system for TVET programs in the state that will support policy development and program management. Subcomponent 1.4. - To strengthen and expand the State s Productive Inclusion Program that promotes employability and/or income earning opportunities for the poorest segments of the population. 55 PERNAMBUCO s avIIR I 00 OSTali Gabinete do Governador Sede Provisoria: ldro iiil Centro do Convenge0s do Pernambuco Plcs oCas o Tnca A,. Govenaldor Agamnons Magalhies, n 200 P., b Rube s,n (Acesso pela Rua Alemanha) 50,0l1-928 Sn to R-if.Pi 53.110-710 Salgadinho Olinda/PE Telefane:(81)3181-2100/Fax:(81)31s1-2322 V The State has created a financing mechanism for the implementation of the productive inclusion program by municipalities, linked to results-based agreements that establish results monitoring arrangements and annual targets on service provision. Component 2 New Economy Opportunityfor all pernambucanos Subcomponent 2.1. - To strengthen and extend the Results Based Management model of the State by adopting the approaches used in the PactoPela Vida in the Secretarials of Health and Education and progressively in other Secretarials. V The State has establishedthe legal basis for the results-based management model and extended its application throughout the State Government; Component 3 - Action Driven State - Capacity to generate results to all pernambucanos Subcomponent 3.1 - To strengthen violence prevention programs in the State with a focus on rehabilitation of crack users, gender inclusion and monitoring capacity V The State has created conditions for expansion of the "Programa Atitude" (Integrated Attention for Crack Users and their Families) as a form of social prevention to combat drug-related violence and rehabilitate drug users; V The State has established institutional mechanisms for addressing violence against women; Subcomponent 3.2 - To strengthen policies, programs and approaches in the State aimed at attending the needs of patients with chronic conditions. with an emphasis on diabetes and hypertension. / The state has approved a State plan to address chronic non-communicable disease and establishes measures to support its implementation. V The State has approved new clinical protocols and simplified clinical pathways focused on chronic non-communicable diseases 3) Request for financial assistance The Government of the State of Pernambuco believes that the set policies described above constitutes a coherent and sustainable effort to support our economic and social development, promoting economic growth and enhancing equity in the State. The Government of the State 56 PERNAMBUCO scorooa 00 FsrAon Gabinete do Governador Sede Provioria: Edrc Iiil 1Cro de Convenqe d Pernambucol d A, Goverador Agamenon Magalites i 200 Pm I Rcp&blia. s!n (Acesso pel Rut Alemnanha) 50010-928 SntAntn-R.lAP 53.110-710 - Salgadinho -Olinda/PE ITlefone:(81)3181-2100/Fau:(81)3181-2322 of Pernambuco is deeply committed to its development program and to the specific policies supported by the Operation. With this letter, the Government would like to request financial assistance from the World Bank in the form of a single tranche Development Policy Loan, aimed at supporting a set of measures to accelerate and consolidate the efforts of the Government to solidify the concept and practice of an innovative form of government in line with the new development cycle, towards increased equity and inclusive growth in Pernambuco. Yours sincerely, EDUAR HENRIQUE ACCIOLY CAMPOS Governor of the State of Pernambuco 57 ANNEX 2: POLICY MATRIX OBJECTIVES POLICY ACTIONS RESULTS INDICATORS COMPONENT 1 - NEW ECONOMY - OPPORTUNITIES FOR All PERNAMBUCANS Sub-component 1.1: 1.1.1 The state has created the legal basis for the establishment of a An M&E system for PROINFRA is Regional economic monitoring and evaluation system for the PROINFRA Program that established and generates annual reports, development will provide information for evidence-based policy making, as which are expected to provide the basis evidenced by: for decisions about adjustments of the To strengthen the state's program. Industrial Infrastructure (i) The State Decree N0 38.971, dated December 19, 2012, published Development Program in the State's Official Gazette on December 20, 2012 , establishing the Baseline: No data available on the effects (PROINFRA) through the requirement for monitoring and evaluation of the effects of of the program. development of a PROINFRA program on participating municipalities; Tanzet 2014: Evaluation system is monitoring and evaluation operational and afirst annual report system(Secretaria de Desenvolvimento Econ6mico), dated March 9, 2013, Gve n p information for evidence- published in the state's Official Gazette on April 11, 2013, specifying website. based policy making. the details of the monitoring and evaluation system, including an outline of the evaluation approach, a list of indicators, the implementation schedule, data collection and management procedures, and mandatory issuance and public disclosure of annual reports. Responsibility: Pernambuco Development Agency (Ag ncia de Desenvolvimento de Pernambuco) 58 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS Sub-component 1.2: 1.2.1. The State Business Registration Agency (Junta Comercial de Percentage of new business registrations Private sector Pernambuco - JUCEPE) has signed agreements with concerned completed within 72 hours in the 25 development Borrower's agencies and municipalities to implement REDESIM/PE municipalities participating in REDESIM. and establish a "single window" for the Borrower's business To reduce administrative registration process, thus reducing administrative barriers to firm Baseline 2012: 00 barriers to firm entry and entry, as evidenced by: Target 2014: 70% ensure that firms can complete the state (i) Agreement between JUCEPE and the State Environment Agency registration process within (Agncia Estadual de Meio Ambiente), dated June 29, 2012; 72 hours. (ii) Agreement between JUCEPE and the State Agency of Health Surveillance (Agincia Pernambucana de Vigildncia Sanitaria - APEVISA), dated December 3, 2012; (iii) Agreement between JUCEPE and the State Fire Protection Agency (Corpo de Bombeiros Militar de Pernambuco - CBMPE), dated December 26, 2012; (iv) Agreement between JUCEPE and the State Finance Secretariat (Secretaria da Fazenda), dated July 1, 2012; (v) Agreement between JUCEPE and the State Secretariat of Federal Revenue (Secretaria da Receita Federal do Brasil), dated September 29, 2011; and (vi) Separate Agreement between JUCEPE and each of the Borrower's Participating Municipalities. Responsibility: State Business Registration Agency of the State Secretariat of Economic Development. Sub-component 1.3: 1.3.1 The state has created the legal basis for the establishment of a An M&E System for state's TVET Technical and vocational monitoring and evaluation system for the TVET Programs in the state programs has been implemented and data education and training that will support policy development and program management, as on key indicators on inputs, efficiency and evidenced by: results are available for decision making. 59 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS To strengthen Technical (i) State Decree 38.086, dated April 18, 2012, published in the state's Vocational Education and Official Gazette on April 19, 2012, that creates the TVET Programs Baseline: No data available on quality and Training (TVET) programs and details its goals, creates inter-sectorial committees for its efficiency of programs, beneficiaries' programs through the implementation and management, and establishes the responsibilities employability and satisfaction. development of a and modalities for preparation of annual evaluation reports of program monitoring and evaluation results to support next years' activity planning; Target 2014: Information on quality, system (M&E) that will (ii) State Decree No. 38.426, dated July 11, 2012, published in the efficiency and results of the TVET support policy development suportpolcy eveopmntstate's Official Gazette on July 12, 2012, which includes the State program consolidated in the M&E system and program management Secretary of Education in the scope of the TVET Programs; and and disseminated to stakeholders through and, over time, enhance the publication of report covering key employment outcomes for (iii) State Decree No. 39.299, dated April 15, 2013, published in the indicators for each program. the target populations of the state's Official Gazette on April 16, 2013, that modifies Decree 38.086 programs. of April 18, 2012, to define the guidelines for the implementation of the monitoring and evaluation system and for the use of monitoring and evaluation data produced by the system. Responsibility: Secretaria do Trabaiho, da Quaificang; e Emprego (STQE) and Secretaria da EducaqJ (SEE). Sub-component 1.4: 1.4.1. The state has created a financing mechanism for the Number of municipalities that have signed Productive inclusion implementation of the Productive Inclusion Program by municipalities adherence pacts with the state, thus within the state, linked to Results Based Management agreements benefitting from state financing for To strengthen and expand that establish results monitoring arrangements and annual targets on productive inclusion programs and the state's productive service provision, as evidenced by: committing to service delivery targets and inclusion program, performance reporting. Pernambuco no Batente, (i) State Decree 3 8.929, dated December 7, 2012, published in the that promotes employability state's Official Gazette on December 8, 2012, that establishes an Baseline: 0 municipalities signed the and/or income earning Automatic Transfer System (ATS) for the Productive Inclusion Adherence Pact opportunities for the poorest Program, transferring resources from the state's Fund for Social segments of the population. Assistance ("Sistema de Transferncia Automctica e Regular de Target 2014 51 municipalities signed Recursos Financeiros do Fundo Estadual de AssiNncia Social" adherence pacts (FEAS) to the Municipal Funds for Social Assistance ("Fundos Municieais de Assiadncia Social (FMAS)"); (ii) Resolution CIB No. 01, dated April 26 2013, published in the 60 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS state's Official Gazette on April 27, 2013, which approves the criteria for regular and automatic transfer of funds using the ATS in the Productive Inclusion Program, establishes the targets for service provision and amounts, and regulates the use of funds. (iii) Resolution No. 296 of the state's Social Assistance Council (Conselho Estadual de Assistncia Social), dated April 29, 2013 and published in the state's Official Gazette on May 3, 2013 that registers the approval of the Resolution CIB No.01 of April 26 2013; (iv) Portaria No. 58 from SEDSDH, of March 22, 2013, published in the state's Official Gazette on March 26, 2013, that establishes the administrative procedures for eligible municipalities to adhere to the ATS, which includes a draft of the Adherence Pact (Termo de Adesdo) to the ATS and Acceptance Pact (Termo de Aceite) of the targets and monitoring requirements specific to the productive inclusion programs to be signed by the eligible municipalities, including an annual report, the annual targets for service provision and the details of the evaluation report to be completed by the municipalities Responsibility: Secretaria de Desenvolvimento Social e Direitos Humanos (SDSDH) COMPONENT 2 - ACTION DRIVEN STATE - CAPACITY TO GENERATE RESULTS Sub-component 2.1: Public 2.1.1 The state has established the legal basis for the Results based The state's Results Based Management sector management Management model and extended its application throughout the state's model, based on the approaches used in executive branch, as evidenced by the State Decree No. 39.336, dated Pacto pela Vida and including sectorial To strengthen and extend April 25, 2013, published in the state's Official Gazette on April 26, committees, is fully implemented in at the Results Based 2013, that formalizes the Results Based Management model and least three sectors (security, health, and Management model of the requires the adoption of specific Results Based Management tools education), and key elements of the model state by adopting the and approaches in all state's secretariats. established in other secretariats. approaches used in the Pacto Pela Vida in the Responsibility: State Planning Secretariat (SEPLAG) Baseline 2012. Full implementation in the Secretariats of Health and area of public security (Pacto Pela Vida) Education and progressively and partial implementation in two others in other Secretariats. (health, and education). 61 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS Target 2014: 1) Results Based Management model implemented in three sectors (public security, health and education) 2) Detailed regulations for the adoption of RBM published and mandatory for the majority of secretariats. COMPONENT 3 - QUALITY OF LIFE - A BETTER LIFE FOR ALL PERNAMBUCANS Sub-component 3.1: Crime 3.1.1 The state has created the operational framework for the The number of beneficiaries of the and violence prevention expansion of the "Programa Atitude" as a form of social prevention to "Programa Atitude" program, which is combat drug-related violence and rehabilitate drug users, as evidenced focused on rehabilitating crack users. To strengthen violence by the State Decree 39.201 dated March 18, 2013, published in the prevention programs in the state's Official Gazette on March 19, 2013, which formally establishes Baseline 2012: 2000 beneficiaries, of state with a focus on "Programa Atitude" as part of Pacto pela Vida Program and defines which 500 are women (Pilot). rehabilitation of crack users, its objectives and operational framework. gender inclusion and Target 2014: At least 6000 beneficiaries, monitoring capacity. Responsibility: Social Development and Human Rights Secretary of which at least 2000 are women. (SESDH). 3.1.2 The state has established institutional mechanisms for Implementation of a Monitoring and addressing violence against women, as evidenced by: Evaluation (M&E) system to (i) register the occurrence cases of gender-based (i) State Decree No. 38.576 of August 27, 2012, published in the violence in the geographic areas of the state's Official Gazette on August 28, 2012, which creates the PPV (AIS); (ii) evaluate the results of the Technical Chamber to Combat Violence Against Women (Cdmara actions taken to address violence against para Enfrentamento da Violdncia de Ginero contra a Mulher) as a women; and (iii) to provide inputs for multisectoral forum for policy coordination and implementation of decision-making regarding new strategic actions to address violence against women as part of the interventions and the adjustment of broader Pacto pela Vida Program; and existing policy! programs as part of the (ii) the execution of a Technical Cooperation Agreement (Acordo de Chamber t at oence agait Cooperaqdo T&nica) between the Secretariat of Women's Affairs Wome. (Secretaria da Mulher) and the Secretariat of Social Defense o(Secretaria da Defesa Social), dated March 18, 2013, which 62 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS establishes the objectives and modalities for coordination and Baseline 2012: there is no systematic data collaboration between the two secretariats, including in the area of data on Gender-based violence (occurrence of sharing and joint monitoring and evaluation arrangements. GBV cases and measures taken to address GBV). Responsibility: Secretariat of Women's Affairs and Secretary of Social Defense (SDS). Target 2014: M&E system operational with reports available online, including (i) data on cases on cases of GBV in Pemambuco, and (ii) data on quality, efficiency and outcomes of actions to combat gender-based violence. Sub-component 3.2: 3.2.1 The state has approved the plan to address chronic non- Percentage of hypertensive patients that Health communicable disease and establishment of measures to support its are under active management in primary implementation, as evidenced by: care. To strengthen policies, programs and approaches in (i) CIB Resolution No. 2.212, dated February 18, 2013, published in Baseline 2012: 50.7% the state aimed at attending the state's Official Gazette on February 19, 2013, that approves the Target (2014): 58% the needs of patients with state's Plan to Address Chronic Non-communicable Disease. chronic conditions, with an (ii) Decision of the Municipal Secretariats of Health Council Percentage of diabetes patients that are emphasis on diabetes and (Conselho de Secretarias Municipais de Satie - COSEMS), dated under active management in primary care hypertension. March 25, 2013, that includes municipal activities and a revised Baseline 2012: 58%~ monitoring framework in the state's Plan to Address Chronic Non- Target (2014): 66% communicable Disease; and (iii) Portaria No. 157 of the State Secretariat of Health, published in the state's Official Gazette on March 28, 2013, and Portaria No. 256 of the State Secretariat of Health, dated May 7, 2013, published in the state's Official Gazette on May 8, 2013, that establishes a working group to revise the Borrower's Policy to Strengthen Primary Care based on the Borrower's Plan to Address Chronic Non-communicable Disease, thus taking concrete steps towards implementation of the Plan to Address Chronic Non-communicable Diseases. Responsibility: State Secretariat of Health. 63 OBJECTIVES POLICY ACTIONS RESULTS INDICATORS 3.2.2 The state has approved new clinical protocols and simplified Percentage of specialist consultation clinical pathways focused on chronic non-communicable diseases, as (cardiology and endocrinology) referred evidenced by: through the state referral system, reflecting improvements in the (i) CIB Resolution No. 2.213, dated February 18, 2013, published in functioning of the state referral system. the state's Official Gazette on February 19, 2013 that approves clinical protocols for chronic non-communicable diseases, with a particular Baseline 2012: 0% focus on hypertension and diabetes. Target 2014: 70% (ii) CIB Resolution No. 2.214, dated February 18, 2013,published in the state's Official Gazette on February 19, 2013 that approves simplified clinical guidelines for chronic non-communicable diseases; and (iii) Portaria No. 157 of the State Secretariat of Health, published in the state's Official Gazette on May 28, 2013 and Portaria No. 256 of the State Secretariat of Health, dated May 7, 2013, published in the state's Official Gazette on May 8, 2013, that establishes a working group to revise the state's Policy to Strengthen Primary Care based on the Borrower's Plan to Address Chronic Non-communicable Disease, with the aim of enhancing the organization of primary care and primary care interventions, including through the incorporation of new monitoring indicators and the introduction of clinical protocols and simplified clinical guidelines. Responsibility: State Secretariat of Health 64 ANNEX 3: DETAILED MACRO SECTION RECENT ECONOMIC DEVELOPMENTS IN BRAZIL 1. The Brazilian economy has slowed significantly over 2011 and 2012. Real GDP grew at a meager 0.9 percent in 2012, compared to 2.7 percent in 2011. With trend growth estimated at around 4 percent, Brazil's growth slowdown represents a major weakening of its economic performance. The slowdown was driven by both domestic and external factors. Tighter monetary and fiscal policies aimed at curbing earlier overheating pressures weakened domestic demand. External demand was dampened by protracted weakness and uncertainty in advanced economies and slowing growth in major emerging economies such as China. 2. While the slowdown was felt across the board, industrial output and investment demand were affected disproportionately (Figures 1 and 2). The all-important services sector cooled significantly but it was the industrial sector that slowed the most. This occurred on the back of weak demand conditions, a still relatively strong real exchange rate (despite recent depreciation) as well as long-standing structural impediments affecting external competitiveness (such as high real interest rates, infrastructure deficiencies, and human capital shortages). The poor performance of industry was also mirrored in the weaknesses of investment demand. With export demand stagnant and import demand weakening as a result of softer consumption, the contribution of external demand strengthened in recent quarters, even if it remained negative. Figure 1. Four-quarter growth contributions by sector 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% - -1.0% -2.0% -3.0% 07Q1 08Q1 09Q1 10Q1 iQ1 12Q1 MServices Industry mAgriculture --O-Value added at factor cost Source: IVGE and World Bank staff calculations Note: Rolling four-quarter year-on-year contributions to value added growth defined as growth rate of sum of value added of quarters t through t - 3 with respect to the sum of value added of quarters t-7 through t-4. Value added is measured at factor cost. 65 Figure 2. Four-quarter growth contributions by expenditure 12.0% 10.0% 8.0% 6.0% 2.0% ---------- --- - ---- - -- 0.0% -2.0% -4.0% -6.0% 07Q1 08Q1 09Q1 10Q1 iQ1 12Q1 Household Consumption :-:-:-:-:Government consumption Net Imports 'Z. Inventory investment Fixed Investment -0-GDP Source: IBGE and World Bank staff calculations Note: Rolling four-quarter year-on-year contributions to GDP growth defined as growth rate of sum of GDP of quarters t through t-3 with respect to the sum of GDP of quarters t-7 through t-4. 3. Tentative signs suggest that the business cycle may have finally started to gather forward momentum. Quarterly data suggest a number of improvements. Following four consecutive quarters of contraction, investment demand saw for the first time an expansion in the last quarter of 2012. The modest increase at 0.5 percent was helped by a sharp increase in BNDES loans. The service sector also registered improved momentum, at a solid 1.1 percent during the last quarter of 2012 compared to remaining flat during the previous quarter. However, the industrial sector decelerated from the previous quarter, even though it continued to sustain a positive trend (0.4 percent q-o-q s.a). Monthly indicators suggest that industrial production showed good growth in January (2.5 percent m-o-m s.a.), with nearly 67 percent of the industrial sector showing growth. Similarly, capital goods expanded strongly at 8.2 percent, following two months of decline. 4. Following a period of aggressive easing amidst mounting concerns about growth, the monetary policy stance has recently been put on hold. Central Bank of Brazil initiated a series of adjustments that lowered the policy rate to 7.25 percent by October 2012 - a cumulative reduction of 525 basis points since August 2011. These measures were accompanied by complementary efforts to raise the supply of credit and reduce bank spreads. The monetary policy stance has been put on hold in recent quarters reflecting a careful balancing act between, on the one hand, the need to protect growth amidst a still-weak economy and an uncertain global outlook and, on the other hand, the resurgence of inflationary pressures. Meanwhile, annualized inflation rose to 6.3 percent in February 2013, which is well above the 4.5 percent mid-point of the inflation target and may prompt future monetary policy action. 5. Cyclical revenue weakness combined with discretionary stimulus measures made fiscal policy more expansionary, but debt levels remain at moderate levels. Weak revenue growth as well as tax cuts and faster spending are estimated to have led to a primary surplus of 2.4 percent of GDP for 2012, which is well below the target of 3.1 percent. To counter this, the authorities tapped into the sovereign wealth fund, brought forward dividend payments from the BNDES development bank and deducted from the primary surplus target expenditures made on investment projects. Supported by underlying strengths such as a Government debt profile with 66 limited foreign currency exposure and a high level of international reserves, debt levels remain well controlled at around two-thirds of GDP. Projections indicate a continued decline in Brazil's public sector debt over the medium term. As of January 2013, the consolidated public sector posted a higher-than-expected R$30.3 billion primary surplus. On a twelve-month rolling basis, the consolidated public sector primary surplus rose to 2.46 percent. Table 1 Brazil: Selected Economic Indicators and Projections (2006 -2015) Estimates Projections Indicator 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 National Accounts (annual real percent change) Real GDP Growth 4.0 6.1 5.2 -0.3 7.5 2.7 0.9 3.1 3.7 3.5 3.7 (in percent of GDP) Gross domestic investment 16.8 18.3 20.7 17.8 20.2 19.7 17.6 20.8 21.2 21.5 21.9 External Sector (in US$ billions, unless noted) Current account 13.6 1.6 -28.2 -24.3 -47.3 -52.5 -54.2 -62.9 -69.3 -82.7 -87.4 Merchandise trade balance 46.5 40.0 24.8 25.3 20.1 29.8 19.4 15.0 14.5 8.2 6.2 Exports (fob) 137.8 160.6 197.9 153.0 201.9 256.0 242.6 262.2 274.8 299.8 331.2 Imports (fob) 91.4 120.6 173.1 127.7 181.8 226.2 223.2 247.2 260.3 291.6 325.0 Nonfactor services, net -9.6 -13.2 -16.7 -19.2 -30.8 -37.9 -41.1 -41.9 -44.9 -45.9 -47.1 Income and current transfers, net -23.2 -25.3 -36.3 -30.3 -36.6 -44.3 -32.6 -36.0 -38.9 -45.0 -46.5 Direct investment, net -9.4 27.5 24.6 36.0 36.9 67.7 68.1 60.0 60.0 60.8 62.9 Portfolio equity, net 1 6.8 24.8 -7.3 39.7 43.9 16.0 3.3 4.6 4.7 4.8 4.9 Gross international reserves 85.8 180.3 193.8 238.5 288.6 352.0 373.1 390.6 404.7 423.9 437.3 Current account (% of GDP) 1.3 0.1 -1.7 -1.5 -2.2 -2.1 -2.4 -2.4 -2.5 -2.8 -2.7 General Government (in percent of GDP) Total Revenues and Grants 34.6 34.3 35.0 33.9 35.4 35.0 35.0 35.3 35.4 35.5 35.5 Total Expenditure 38.1 36.9 36.3 36.9 38.1 37.6 38.1 38.2 38.3 38.3 38.2 Current Expenditure 36.1 35.1 34.0 34.7 34.1 35.4 35.6 35.7 35.7 35.7 35.5 ofwhich: Interest payments 6.8 6.1 5.4 5.2 5.2 5.7 5.4 5.2 5.1 5.0 4.9 Capital Expenditure 1.9 1.8 2.2 2.2 4.0 2.3 2.5 2.5 2.6 2.6 2.7 Primary Balance 3.3 3.5 4.1 2.2 2.5 3.1 2.4 2.3 2.2 2.2 2.2 Overall Balance -3.5 -2.6 -1.3 -3.0 -2.7 -2.6 -3.0 -2.9 -2.9 -2.8 -2.7 Gross Public Sector Debt 66.7 65.2 63.5 66.9 65.2 64.9 65.0 62.7 60.6 58.7 56.9 Prices (annual percent change) GDP Deflator 6.1 5.9 8.3 7.2 8.2 7.0 6.0 5.5 5.3 4.9 4.9 ConsumerPricelndex(eop) 3.1 4.5 5.9 4.3 5.9 6.5 5.8 5.7 5.5 5.3 4.9 Producer Prices (eop) 4.3 9.4 9.8 -4.1 13.8 4.1 11.1 5.2 5.0 4.7 4.7 Memorandum items: Nominal GDP (in R$ billions) 2,369 2,661 3,032 3,239 3,770 4,143 4,403 5,294 5,768 6,273 6,809 Note 1: Porfolio equity does not include debt securities Source: IMF, BCB, IBGE, EIU, WB Calculation 6. Recent fiscal interventions focused on boosting the performance of industry. A first stimulus package was launched April 2012: payroll taxes were reduced for industries hardest hit by the slowdown, additional funding to the BNDES development bank was provided and selected taxes on sales of durable consumer goods were cut. A second stimulus effort in June 2012 saw a lowering of the BNDES lending rate by 50 basis points to promote investment, complementing earlier measures to support consumption. In response to disappointing third- quarter GDP results, the authorities announced further measures in December 2012: a payroll tax reduction in civil construction, a Program to Sustain Investments, a further 50 basis points-cut in 67 the BNDES lending rate (bringing the rate to 5 percent). Efforts are also underway to reduce energy costs for companies and households.42 7. Following rapid capital inflows, efforts were made to curb exchange rate appreciation. In response to a significant currency appreciation, the authorities attempted to curb capital inflows through a financial transactions tax and enhanced foreign exchange intervention by the central bank. Against a backdrop of looser monetary policy and heightened risk aversion due to a weak global economy, these actions helped dampen short-term capital inflows and led to a real effective exchange rate depreciation of 35 percent between July 2011 and December 2012. To avoid further depreciation and its attendant effects on inflation, the central bank relaxed early December some of the restrictions by exempting loans with maturity over a year from the financial transactions tax. As a result, the REER appreciated almost 3 percent in January 2013. Continued appreciation pressures could lead to new interventions in the FX market in order to protect industry competitiveness. 8. As Brazil navigated through global turbulence, its financial system remained sound and resilient. Following a period of rapid credit growth (with credit outstanding to the private sector reaching half of GDP), asset quality indicators have broadly stabilized. As of January 2013, around 8 percent of consumer loans and 3.7 percent of corporate loans were classified as nonperforming (overdue for more than 90 days). Lower interest rates have eased pressures on borrowers, keeping delinquencies at thus far manageable levels. The banking system appears to be well-cushioned to withstand losses, with loan loss provision coverage at 160 percent of nonperforming loans and solvency ratios at 16.4 percent as of June 2012. While the rapid growth of home lending has fueled concerns about a bubble, these loans still represent only 13 percent of total private sector credit and their delinquency rates have recently fallen thanks to improvements in mortgage foreclosure processes. 9. The current account deficit was fully covered by foreign direct investment in 2012. The weaker external environment dampened the volume of trade and led to a deterioration of Brazil's terms of trade, which both acted to sharply reduce the trade balance leading to a current account deficit of 2.4 percent. At 2.9 percent of GDP, Brazil was the fourth largest destination of Foreign direct investment in 2012. Foreign portfolio flows, however, have shown less stability. Buoyed by interest rate differentials, portfolio inflows were initially strong, boosting the exchange rate and leading to financial transaction tax measures. The latter, alongside increased global risk aversion, led to a significant cooling of portfolio flows. This was compounded further by the lowering of the policy rate, which helped reduce interest rate differentials. MACROECONOMIC OUTLOOK 10. Growth is expected to gradually strengthen over 2013, settling at 3.1 percent for the full year. Domestic demand is expected to drive forward momentum. As consumer confidence strengthens, consumption, which previously slowed but remained relatively resilient - should get a boost on the back of favorable fundamentals. Investment, which saw a major decline, should see a revival as sentiment improves and will be aided by the development of new offshore oil fields and the preparations for upcoming mega events. While the external environment is likely to stabilize if not improve, the contribution of external demand will likely remain dampened by structural factors affecting export competitiveness as well as the likely boost to import demand arising from domestic demand strength. 42 Fiscal stimulus measures are estimated to entail an overall tax cost of R$40 billion for 2012, with a significant share accounted for by the temporary reduction of IPI tax on cars, consumer appliances and furniture (R$8.5 billion) and the reduction of capital goods taxes (R$7.6 billion). Other measures included the reduction of payroll taxes and of electricity prices. In addition, CIDE fuel taxes were reduced to compensate for fuel hikes (R$6.8 billion tax). 68 11. The inflation outlook remains a challenge. The negative output gap that resulted from the economy's recent underperformance did not prevent inflationary pressures from emerging, a trend which should be further accentuated as the recovery takes a firmer hold. Inflationary risks have emerged on the back of rapid wage growth (in excess of productivity growth) partly due to a tight labor market, with wage increases particularly affecting services prices. Price pressures are also related to external factors such as the severe drought in America's Midwest. After reaching 4.9 percent in June, 12-month inflation accelerated to 6.3 percent by the February 2013. Price pressures have furthermore resulted from earlier accommodative demand management policies as well as wage policies. Despite two years of weak growth, inertial inflationary forces are still strong and are contributing to keep inflation high. This has prompted the central bank to put monetary policy on hold. 12. Looking ahead, policymakers will need to walk a fine line to effectively support the baseline scenario of a continued recovery amidst an uncertain inflation outlook. Even if being actively used to support the recovery, fiscal policy is expected to maintain a prudent stance, which is considered appropriate given the need to build on past credibility. The implementation and impact lags of fiscal policy may also render it a less suitable instrument of demand management policy, particularly in an uncertain environment that requires agility in the policy response. With monetary policy expected to bear the brunt of countercyclical adjustment, policymakers will however need to walk a fine line. On the one hand, to manage inflationary expectations, the strength and nature of incipient price pressures will need to be monitored closely and contained should they become more entrenched. On the other hand, the recovery is still tepid and the external environment remains complex, which highlights the need to exercise caution so as not to choke off growth momentum before it becomes more broad-based. 13. Brazil's near-term outlook is subject to a number of domestic and external risks. Domestically, asides from the upward risks to inflation already noted, market participants have been concerned about a heightened degree of policy uncertainty. This uncertainty has been fueled by the authorities' fiscal interventions targeting particular sectors of the economy as well as the perception that the structural reform agenda needs to be tackled more. Externally, a worsening of the global economy caused by a possible U.S. and/or Chinese slowdown, coupled to a worsening of the fiscal situation of some countries in the euro zone, may translate into lower external demand for Brazil's exports, given the composition of its export markets.43 External vulnerabilities also arise from the growing share of commodity exports, estimated to have exceeded 58 percent in the first half of 2012, driven largely by reversible price increases of the main export commodities in recent years. Brazil is also vulnerable to market sentiment affecting both portfolio and FDI inflows. This risk is however mitigated by Brazil's high reserve levels, the favorable external debt composition, the disproportionate role of foreign direct investment in the financing of the current account, the relatively low degree of trade openness compared to other emerging markets and the low share of Government debt held by non-residents. 14. Notwithstanding its currently stable position, the banking sector remains vulnerable to a prolonged global and domestic slowdown. Small and medium sized banks, currently holding 8 percent and 12 percent respectively of the Banking system's assets, are exposed to liquidity risk given their reliance on more volatile sources of domestic financing, while the larger banks, with greater access to external financing could face difficulties in rolling over external debt. Indeed, rising private sector external debt levels, largely reflecting increased issuance of 43 In the first half of 2011, exports to the US, Europe, and China represented 50 percent of total exports, with China accounting for 18 percent, the EU-25 for 20 percent and the US 12 percent.Staff simulations suggest that a 1-percent decline in China's GDP growth would lead to a decline of Brazilian exports to China of 0.97 percent for all merchandise goods and 0.68 percent for just commodities. Brazilian exports to the EU or the US would be more resilient, declining for both destinations by about 0.91 percent for all merchandise exports and 0.60 percent for just commodities. 69 bonds by corporates and banks, have raised concerns about the capacity of some companies to carry their debt. However, most traditional capital structure metrics suggest that the level and composition44 of private sector external debt pose no particular risks to stability of the financial sector at this stage. Overall, system-wide assessment of banks indicates that risks are well managed. Brazil's banking system currently has solid liquidity levels, adequate capital cushions and the system's direct exposure in foreign currency is limited: 7.2 percent of liabilities and 4 percent of assets. 15. A further worsening of the global economic environment poses a risk to the fulfillment of fiscal targets. The achievement of primary surplus targets may be affected by the deceleration of economic activity, as federal revenues tend to decline and social protection expenditures tend to increase. Moreover, as record low interest rates and rising have limited the room for further monetary easing, the spotlight has shifted onto fiscal and quasi-fiscal instruments to stimulate the economy. Additional fiscal risks to be monitored stem from multiple sources, such as the January 2013 minimum wage increase, tax relief for selected industries, the quasi-fiscal activities by BNDES as well as the possibility that real interest rates will adjust upward from their historically low levels. 16. In spite of these risks and challenges, Brazil's overall macroeconomic framework is deemed adequate and sustainable in the medium term. Brazil's policy framework (see Box 1 for more details on Brazilian Fiscal Federalism) has provided the Government with the flexibility to successfully respond to the 2008/09 global financial crisis as well as to the ongoing worsening of the external environment driven by the European fiscal crisis with an array of fiscal, monetary, and external measures to stimulate domestic demand. Gross public sector debt is expected to decline in the future, despite difficulties in maintaining fiscal balance in the face of large investment needs and pressures from current expenditure growth. Moreover, flexible exchange rates and relatively large foreign reserves should help Brazil address the consequences of a potential external crisis, including a possible abrupt shift in market perceptions and an associated tum-around in capital flows. 17. Brazil's medium- to longer-term outlook will critically depend on its ability to tap into a large unrealized growth potential. While from a historical perspective the Brazilian economy has clearly experienced a period of accelerated growth over the last decade, the counterfactual perspective is that growth could have been significantly stronger given the country's vast unrealized potential. For Brazil to continue its ascent up the per capita income ladder, while at the same time ensuring that growth is both inclusive and sustainable, it will need to take advantage of this unrealized potential by creating better conditions for growth. This will require not only tapping into Brazil's internal growth dynamic (which is tethered to its large domestic market and rising middle class) but also deriving greater benefits from Brazil's ongoing integration into the world economy. 18. Energizing the underlying drivers of growth will require determined multi-year efforts in tackling long-standing structural bottlenecks. Key among these challenges is the need to accelerate and strengthen the quality of human capital formation to raise living standards and boost productivity growth. In addition, there is the need to raise public and private investment, to address growing infrastructure bottlenecks and lay the foundations for innovation- led growth. Further key challenges relate to the importance of developing a private long-term capital market, a more flexible labor market, and a more agile business environment that promotes internal competition and external competitiveness. 19. The authorities have launched various efforts in this respect. The Plano Brasil Maior (2011-2014) of the Ministry of Development, Industry and Trade (MDIC) aims to boost the 4 Short term private sector external debt levels remain relatively low, despite some increase since 2007. It should be noted though that of late the exchange rate has become more heavily managed. 70 competitiveness of the Brazilian economy by tackling cross-cutting bottlenecks as well as providing sector-specific support. The plan foresees to reduce business costs, accelerate productivity growth and strengthen Brazil's external competitiveness in the global marketplace. In addition, recent initiatives were launched to stimulate private investment in infrastructure and to reduce electricity costs. While the newly announced infrastructure investments are not small in absolute terms (about US$66 billion for roads and railroads), they amount to only 0.3% of Brazil's GDP, to be spread over 25 years. However, the plan has an important signaling value, showing the Government's increased emphasis on (i) boosting investment (in addition to consumption) as a means for accelerating the economic recovery, (ii) strengthening the foundations for sustained medium-term growth (not just the short term recovery) and (iii) enhancing private sector participation in infrastructure development, complemented its limited fiscal space for rapidly expanding public investment. RECENT SOCIO-ECONOMIC DEVELOPMENTS IN THE STATE OF PERNAMBUCO Economic developments 20. Pernambuco's development journey was marked by two decades of solid growth (1960s and 1970s) followed by two decades of relative stagnation (1980s and 1990s). The earlier period resulted in growth approximating national levels, in part thanks to tax and other incentives that helped attract significant investments. This enabled the expansion and diversification of the state's industrial base, even if most remained localized in the metropolitan area of Recife with the interior remaining mostly dependent on primary activities. Partly as a result of the reduction in these incentives and in line with the overall performance of the national economy, the two decades that followed were marked by lackluster growth. 21. Much like the rest of Brazil and its northeastern region, the Pernambucana economy saw growth accelerate in the 2000s (Figure 1). Growth accelerated from initially modest rates of 2.4 percent during the period of 1996-2006 to 5.5 percent over the last five years. The acceleration of growth helped propel per capita income growth, even though -at least as of the 2010 data - the relative gap with the rest of Brazil remains pronounced. Indeed, like other northeastern states, Pernambuco continued to lag the rest of the country in terms of socioeconomic development. Even though the economy of Pernambuco was in 2010 the second- largest in the region and tenth-largest in the country (at 2.5 percent of national GDP), the per capita income for its population of 9 million was at R$10,821, about half the national average. Figure 1: Pernambuco's Growth Acceleration in Regional Perspective Annual GDP Growth Rate GDP per capita 9.0% 10,000 8.0% 7.0% 9,000 6.0% 8,000 5.0% 7,000 4.0% ' * I ......................... .. ............................... 3.0% 16 6,000*.. -2.0% ~ ,.~ * 5,000 1.0%I 4,000 0.0% oe ' 3,000 -1.0% 2,000 1996 1998 2000 2002 2004 2006 2008 2010 1985 1988 1991 1994 1997 2000 2003 2006 2009 .***** Brazil --- Northeast - Pernambuco ****** Brazil - - Northeast - Pernambuco 71 Retail Sales Index Industial Production Index 180 130 160 120 v 140 _ __ 10- 120 1001! ' J~L1jj - 100 9 0 80 80 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 May-12 * .**** Brazil - - Ceara - Pernambuco Bahia ****** Brazil - - Ceard - Pernam buco Bahia Source: IBGE/Ipeadata Note: The Industrial Production Index is a monthly composite estimate based on the real output of the extractive and transformation industries. The index is available at both the national and subnational level. Figure 2. Despite Industry's Strength, Services Continued to Dominate the Economy Composition of output per sector: Brazil Composition of output per sector: Pernambuco I IA 62 1613 II 1613 16M WME f fMA M21ME f KIM l EU 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 m Agriculture mIndustry m Services n Agriculture industry o Services 0.02% 0.61% 2.39% 0.52% 0.11% 3.23% 0.26% 0.64% 2.79% 0.49% 0.89% 3.34% 0.27% 1.46% 4.09% 0.15% 1.51% 3.38% 0.37% 1.14% 3.26% 0.19% 0.89% 3.83% -0.18% -1.50% 1.43% 0.49% 0.60% 1.69% 0.34% 2.93% 3.66% 0.02% 2.93% 4.04% *contribution in percentage points *contribution in percentage points Source: IBGE 22. However, what distinguished Pernambuco from the rest of Brazil was the pattern of its growth expansion. Consumption demand played a major role supported by a solid expansion of credit and per capita income growth and aided by Government social transfers to the poorest population. But as the evolution of retail sales suggests (Figure 1), the strength of consumption demand was not unique to Pernambuco. What stood out in Pemambuco was the sustained strength of investment demand, reflected by an increased capacity to invest in physical and social infrastructure, the selective provision of fiscal incentives and improvements to the business environment. These investments centered on the Suape port area (Box 1). 23. Unlike the rest of Brazil, Pernambuco's industrial sector registered a strong performance. Over the last five years, industry grew by an average of 6.1 percent, which is a major pick-up compared to the average growth rate of 0.6percent during the previous 10 years. Pernambuco's industrial sector outperformed the rest of the country, even during years affected by economic turmoil: by mid-2012, industrial output was 20 percent higher than early 2007 in 72 Pernambuco (compared to 6.3 percent for Brazil, 0.6 percent for Bahia and -3.4 percent for Ceard). 24. Given the relatively low level of industrialization in Pernambuco, the services sector remained a key driver of growth. The pick-up in industrialization momentum meant that Pernambuco - unlike the rest of Brazil - was able to sustain the share of industry in GDP (Figure 2). Yet, the level of industrialization remains below the average of the country's, at 22 percent in 2010 (compared to 28 percent for Brazil), with the services sector being more pronounced at 73 percent (compared to 67 percent for Brazil). This meant that services growth, which is closely related to consumption demand, remained the key contributor to overall GDP growth. 73 Box 1: Port of Suape At a distance of 40km from Recife, the Port of Suape occupies an area of 140 square kilometers. Some 13.5 thousand are allocated to Port, Industrial, Administrative, Ecological Preservation and Cultural Preservation zones. More than 100 companies are currently in operation and the Suape Complex is estimated to have contributed more than 25,000 direct jobs. In 2010, the Institute of Logistics and Supply Chains (ILOS) considered the public Port of Suape as having the best and most modem infrastructure in Brazil. With deep waters (from - 15m to -20m) and a strategic location in relation to major shipping routes, it is connected to more than 160 ports throughout all continents. Suape is also being linked up with all productive segments of the Northeast via Transnordestina railway, currently under construction and expected to reach completion by end 2014. In addition, infrastructure projects are in progress to build roads and port infrastructure. Four new terminals will be installed, for bulk gods, sugar, container and grains. Suape is also slanted to play a role in the exploration of the Pre-Salt oil fields. Suape has attracted major private investments, which have by now surpassed the R$40 billion mark. These investments have benefited from a differentiated policy of tax incentives for new businesses (reduction of federal and state taxes up to 75 percent, along with other municipal incentives). The Suape Complex is expected to receive additional govermment investment of R$10 billion through 2014. These investments include an oil refinery (the first built in Brazil in 30 years), a new petrochemical platform, a naval cluster, an industry support cluster to the oil and gas Pre-Salt production complex, and a new industry chain for the wind energy production cluster. Investments in the Port of Suape are already reflected in the volume of cargo annually handled. From 2005 to 2011, containers handling increased by an average of 13.5 percent annually. The govermment of Permambuco projects that handling would reach 1 million by 2016 (an increase of 130 percent), and 2 million by 2030. The widening of the Panama Canal, which should be concluded in 2014, represents a unique opportunity for the State to achieve this goal and increase the presence of the Port of Suape in global trade networks, leveraging as well on the growing trade between Asia and Brazil. Containers (TEU) 500 .450 400 3S0 300 250 20 150 100 2005 2006 2007 2008 2009 2010 2011 74 ANNEX 4: FISCAL AND DEBT SUSTAINABILITY ANALYSIS PERNAMBUCO FISCAL SITUATION: 2004-2011 Evolution of Fiscal Balances, 2004-2011 1. Over the past decade, the fiscal situation of Pernambuco has improved markedly. Operating balances have risen to substantially higher levels, in what marked a period of consistent fiscal adjustment measures and high growth. In particular, operating surpluses increased from 12 percent of net current revenue in 2004 to 20 percent in 2010, providing fiscal space to considerably expand investment and reduce debt ratios. This positive trend was however reversed in 2009, and again during 2011 and 2012, when the size of the surpluses narrowed in line with performance of the economy. Table A5.1: Evolution of GFS Fiscal Accounts, Pernambuco State 2012 R$ Billions 2004 2005 2006 2007 2008 2009 2010 2011 2012 I. REVENUE 12.8 14.5 15.8 16.9 19.4 20.0 23.4 24.4 25.2 Taxes 6.2 7.0 7.6 8.1 8.9 9.3 10.7 11.8 12.1 Social Contributions 1.9 2.1 2.4 2.4 2.6 2.4 2.8 2.8 3.1 Transfers 4.2 5.0 5.3 5.9 7.2 7.5 9.1 8.6 8.8 Other Current Revenues 0.5 0.5 0.5 0.5 0.8 0.8 0.8 1.2 1.1 II. EXPENSE 11.8 13.1 14.1 15.2 17.2 18.7 20.6 22.2 23.5 Compensation of Employees 4.4 4.9 5.2 5.7 6.4 6.9 7.6 7.9 8.5 Pensions 1.9 2.0 2.2 2.3 2.4 2.5 2.6 2.8 3.0 Interest Payments 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.4 Transfers 2.6 2.9 3.1 3.6 4.1 4.4 5.0 5.5 5.5 Goods and Services 2.5 2.9 3.2 3.3 4.0 4.5 5.0 5.7 6.1 III. GROSS OPERATING BALANCE (I - II) 1.0 1.4 1.7 1.7 2.2 1.3 2.8 2.2 1.8 (as % ofNCR) 12.5% 15.9% 16.6% 15.8% 17.6% 10.5% 20.0% 14.3% 11.3% IV. TRANSACTIONS IN NON-FINANCIAL ASSETS 0.7 0.7 1.0 0.9 1.4 2.3 2.7 2.6 3.0 Net acquisition ofnon-financialassets 0.6 0.7 0.9 0.6 0.9 1.3 2.1 2.0 2.3 (as % of NCR) 7.7% 7.3% 8.6% 5.8% 7.4% 10.5% 14.6% 13.3% 14.7% Other investments in assets 0.05 0.09 0.11 0.26 0.43 0.91 0.63 0.56 0.68 V. NET LENDING / BORROWING (III - IV) 0.33 0.68 0.70 0.84 0.84 -0.91 0.13 -0.40 -1.20 (as % of NCR) 4.2% 7.6% 6.9% 7.6% 6.7% -7.2% 0.9% -2.6% -7.7% VI. PRIMARY BALANCE (V + Interest Payments) 0.7 1.1 1.1 1.2 1.2 -0.6 0.4 -0.1 -0.8 (as % of NCR) 9.2% 12.0% 10.7% 10.9% 9.3% -4.9% 3.1% -0.5% -5.4% VII. TRANSACTIONS IN FIN. ASSETS AND LIABILITIES -0.4 -0.5 -0.5 -0.4 -0.3 0.7 0.4 0.1 1.8 New Loans 0.1 0.1 0.1 0.1 0.3 1.3 0.7 0.5 2.3 Amortizations, net -0.5 -0.6 -0.6 -0.5 -0.6 -0.6 -0.4 -0.4 -0.5 Asset sales 0.00 0.01 0.07 0.00 0.00 0.02 0.00 0.00 0.01 VIII. TOTAL BALANCE (V + VII) -0.1 0.2 0.3 0.4 0.5 -0.2 0.5 -0.3 0.6 IX. GROSS FINANCING NEEDS (Amortizations - V) 0.2 -0.1 -0.1 -0.3 -0.2 1.5 0.3 0.8 1.7 Memo: Net Consolidated Debt / NCR 104% 83% 67% 53% 42% 43% 39% 38% 46% Source: SEFAZ, WB Calculations 75 Evolution of Fiscal Revenues, 2004-2012 2. Robust revenue growth has been an important factor in the achievement of the state's improved fiscal position. Between 2004 and 2012, total revenues grew at an annual average of 8.9 percent in real terms on account of strong performance of all the main revenue categories: taxes; transfers; social contributions; and other revenues. On the tax revenue side, ICMS (Imposto Sobre Circulaqdo de Mercadorias e Serviqos), the most important revenue item, grew at an average rate of 8.5 percent, notwithstanding its low growth in 2012 due to weak economic activity. Overall, the increase in ICMS has been driven by economic growth and measures to enhance tax collection efficiency, particularly the tax payer substitution system (Substituiqdo Tributdria)46 and adoption of the electronic fiscal note. As a result, ICMS revenue as a percent of GDP increased from 7 percent in 2000 to 9 percent in 2010, one of the most significant performances in the northeast (Table AX.2). According to data available for 2010, Pemambuco ranked 5th among Brazilian states in terms of ICMS revenue per state GDP, an improvement from its previous position of [17t] in 2000. Figure A5.1: Evolution of Revenue, Expenditure and Fiscal Balances, Pernambuco State 30 Revenues and Expenses (GFS Methodology) 3 Real Annual Growth in Revenue and Exenditure (%) S25 316% - 14% - 202 12% - % 6% 4% % 0 1 2004 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 =L RVENUE 11. EXPENSE - HL1 GROSS OPERATING BALANCE (1- II) - - - Current Revenue - Current Expenditure Source: SEFAZ, WB Calculations 3. Federal transfers have also grown robustly during this period. The increase was largely on the back of rising transfers from the redistributive fund for education resources (FUNDEB - Fundo de Desenvolvimento da Educagdo Basica), SUS (Sistema Unico de Sauide) and the State Participation Fund. The State Participation Fund (FPE - Fundo de Participaqdo dos Estados) remains the main component of federal transfers and has experienced annual growth above 7 percent each year; the exceptions being during the growth slowdowns in 2009/2010 and 2012. Likewise, revenues from SUS and FUNDEB have increased significantly (by an annual average of 11.7 and 16.3 percent respectively between 2004 and 2012). Altogether these transfers have contributed to the strong annual growth in transfers of 7.7 percent since 2004. 4. The good performance of state revenue also owes much to higher collection of social contributions, which account for 12.5 percent of revenues. The employers' contribution to the pension fund-FUNAFIN-reached 27 percent of payroll in December 2011 with employees contributing 14 percent. 46 Substituiqdo tributdria is a VAT tax collecting mechanism that puts the tax collection burden on the first firm of the production chain to avoid tax evasion. The Tax Substitution System has been in place since the 1980s for few products, but has recently seen a widespread expansion of its use by many states. In Pernambuco, implementation has been phased and in 2010, the State Government extended the coverage of the regime of tax substitution to selected products. 76 5. Overall, given stronger performance of tax revenues and other current revenues when compared to growth in federal transfers, the state's financial dependence on transferred resources has declined slightly. Between 2004 and 2008, federal transfers represented 41.7 percent of net current revenue while in 2012 they represented 36.7 percent. However, at 1.47 in 2011, the tax revenues to transfers ratio is still lower than the national average of 2.05 but remains higher than the regional average of 0.97 (Table A5.2). Figure A5.2: Revenue Composition, 2012 Table A5.2: Fiscal Indicators IcUS Northeast states Tax/Transfers (2011) ICMS/FPE (2011) ICMS/GDP (2010) 42% Other taxes 4~goas 77.4% 91.1% 8.3% 4% Bahia 139.9% 215.4% 7.2% Other C Cear6 126.9% 151.5% 7.8% Reve Maraio 66.7% 78.2% 6.5% 6% Paraba 88.5% 100.0% 8.1% Social Pernambuco 147.7% 234.6% 81% Contributions IPVA P1i 52.7% 60.8% 8.6% Transfers 13% 2% as% Rio Grande do Nofte 104.9% 127.5% 8.8% Sergpe 70.8% 80.4% 7.5% Source: SEFAZ, IBGE, WB Calculations Evolution of Expenditures, 2004-2012 6. Pernambuco's current expenditure and revenue growth have tended to move together. From 2004 to 2012, current expenditures excluding transfers grew at an average annual rate of 8.7 percent, slightly lower than the current revenue growth rate of 8.9 percent. Personnel expenditure, the largest expenditure category, had a real annual increase of 8.4 percent between 2004 and 2009, and this rate reduced to 6.6 percent between 2010 and 2012. Personnel expenditure includes wages and salaries for active personnel, social contributions, and pensions to retired personnel. Because growth in current expenditure has kept pace with that of current revenues, the Fiscal Responsibility Law indicator of personnel expenditure to Net current revenue has been reduced only slightly. The indicator declined from 54 percent in 2004 to 53 percent in 2012, still meeting the Fiscal Responsibility Law requirement. 7. The second most important component of current expenditures corresponds to operating expenses, which include purchases of goods and services, as well as operations and maintenance. Like personnel expenses, the growth of these expenditures has been high. The annual growth rate of this expenditure category increased from 9.8 percent between 2004 and 2007 to 13 percent since 2008, in part explained by increased investment, which has generated higher maintenance and operating costs. Annual growth of constitutional transfers to municipalities was also relatively high (8.7 percent from 2004 to 2012). The robust increase in transfers to municipalities reflects the good performance of state tax revenue, since transfer amounts to municipalities are defined by the Constitution as a fixed proportion of tax revenue (see Box A5.1 on Fiscal Arrangements). Interest payments on state debt declined by 7.1 percent between 2004 and 2012 in line with the downward debt trajectory. 77 8. With increased revenues, the ability to generate current savings has allowed the State Government of Pernambuco to finance the recovery of investment expenditures (275 percent growth between 2004 and 2012, corresponding to an annual rate of 17.9 percent). While the increase in investment is largely attributable to fiscal consolidation efforts by the state, since 2008, new credit operations have increasingly been used to finance investment spending. As a result, public investment has risen considerably from 7.7 percent of net current revenue in 2004 to 14.7 percent in 2012. According to data for 2011, Pernambuco's investment level is the 5th highest among Brazilian states, while the investment rate, as measured by the ratio of investment to NCR is the [13 h] highest. Evolution of Consolidated Debt, 2004-2012 9. Pernambuco's net consolidated debt has been falling in proportion to its revenue, and is comfortably within the limits set by the Fiscal Responsibility Law. As net current revenue doubled in real terms between 2004 and 2012, the Net Consolidated Debt-to-Net Current Revenue ratio fell steeply from over 104 percent to 46 percent in the same period (Table A5.3 and table A5.4). The strong revenue performance facilitated the payment of higher amortization amounts on state debt, particularly intra-limite debt47, as provided for in the debt repayment schedules set by the 1997 state debt renegotiation contracts. Debt service grew modestly, driven by higher amortization rather than interest payments. However, given increasing revenues, the debt service ratio has gradually fallen from 12 to 6 percent of NCR (Figure A5.3). Besides the good performance of revenues, the fall in Pernambuco's indebtedness is also explained by the low level of credit operations that amounted to about R$ 623.6 million between 2004 and 2008. More recently, however, the state has increased credit operations to finance its investment program, reflected in an increase in the ratio of credit operations to net current revenue in 2012. 10. In terms of its composition, contractual debt is the main component at R$ 8.1 billion, followed by Judicial debt (precat6rios)48 at R$ 0.4 billion. Most of its contractual debt (92 percent) is that owed to the National Treasury and other public institutions, while the remaining 8 percent is external. A large share of its public debt (32 percent) is indexed by inflation, specifically the wholesale prices indices IGP-DI and IGP-M, while approximately 21 percent of their debt is U.S. dollar denominated and 47 percent is indexed to other indices, mainly TR (Taxa Referencial) and TJLP, interest rates offered by BNDES. 47 Debt that is within the 1997 debt renegotiation agreement with the Federal Government. 48 Precat6rios is a term used in Brazilian legislation to refer to Judicial writs. They are legal requests for payment of a certain amount by the federal, state, or municipal treasuries. They cannot be appealed. At the end of judicial enforcement, a letter is submitted to the president of the court requiring payment of the debt. The requests received by the court until July 1 of each year are included in the budget proposal and should be paid in the following fiscal year. 78 Box A5.1 Intergovernmental Fiscal Arrangements in Brazil Brazil is a federative country made up of 26 states, plus the Federal District. There are also 5,564 municipalities. Each level of government is allowed to raise its own revenues through specific tax bases. The responsibility for collecting taxes is broadly consistent with economic principles that suggest that mobile tax bases need to be taxed by the central government while immobile bases should be taxed by sub-national governments. Broadly speaking, the federal government can levy taxes on personal income (IRPF) and corporate profits (IRPJ), industrial products (IPI), financial operations (IOF), fuels (CIDE), rural property (ITR), and imports (II). The federal government can also levy social contributions on corporate profits (CSLL), and payroll (social security contributions) and corporate revenues (PIS/COFINS). Social contributions are meant to finance health, social protection, and social security expenditures. Contrary to tax revenues, social contributions are not shared among subnational governments. The largest tax source for state governments is VAT (ICMS, value added tax on goods and services) receipts. In addition, they can also impose a tax on personal property such as motor vehicles (IPVA), and on donations and inheritances (ITCMD). Two of the three taxes collected by the state are shared with the municipalities, which receive 25 percent of ICMS and 50 percent of IPVA. The municipalities have the right to tax urban property (IPTU), services (ISS), and the transfer of property (ITBI). Tax Assignment and Intergovernmental Fiscal Transfers in Brazil Property Transaction Business Personal Miscellaneous Income PIS/COFINS socialsecurity IM ITR - i PI - CSLL -IRPF -CIDE - - IRPJ IPVAP- ICMS - ITCMD IPTU ISS ITR ITBI 79 Figure A5.3: Evolution of Debt and Debt Service during 2004-2012 300% Braziian States - Net Consolidated Debt NCR 14.0% Debt Service 700 12.0% 600 250% -X-Rio Grandedo . Sul 10.0% 500 200% .*-MinasGerais 8.0% 400 150% "4RiodeJaneiro 6.0% 300 104% 100% 0 8 53% + Saio Paulo 4.0% 200 42% 43% 38% 39% 2.0% 100 50% -Pernmbuco 0.0% - - - - - L - - 1 0 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 Interest Payments Amortization - Debt Service/NCR Source: SEFAZ, WB Calculations Table A5.3: Composition of Net Consolidated Debt during 2011-2012 2012 R$ Millions 2011 2012 Consolidated Debt (I) 7,161 8,969 Debt composition, 2012 Contractual Debt 6,149 8,077 Internal 5,572 6,392 National Treasury 3,233 3,060 Public Banks 2,338 3,332 Treasury External 577 1,685 I d Judicial Debt (Precatorios) 430 430 Deductions ofNet Financial Assets (II) 1,255 1,826 Net Consolidated Debt - NCD (I - 1) 5,905 7,143 Memo Items: Net Current Revenues - NCR 15,403 15,613 NCD/NCR 38% 46% Fiscal Responsibility Law ceiling: 200% Source: SEFAZ, WB Calculations Compliance with the Fiscal Responsibility Law Indicators, 2004-2012 11. Pernambuco has been complying with the prudential limits set out in the FRL. Over the past decade, fiscal indicators have improved and are within the prudential limits set in the LRF (Table A5.4). As a percentage of NCR, Net Consolidated Debt and debt service payments have fallen significantly. These ratios have been below the ceilings established under the FRL, respectively at 200 and 11.5 percent of net current revenues. Credit operations and guarantees have also remained below the legally imposed limits of 16 and 22 percent of net current revenue, respectively. However credit operations have since 2008 increased to reach 15 percent of NCR in 2012 due to additional financing from Caixa Econ6mica Federal, the Brazilian Development Bank (BNDES), the Inter-American Development Bank (IDB) and IBRD. In addition to its FRL performance, the state has met most of the fiscal targets defined in the rolling three year Fiscal 80 Adjustment Program-PAF-negotiated with the National Treasury Secretariat . Exceptions have been the targets on investment and own revenue collections for the years 2011 and 2012; the latter due to the weak growth performance of the past 2 years, as explained earlier. (Table A5.5). Table A5.4: Evolution of Fiscal Responsibility Law during 2004-2012 Current RS Billions 2004 2005 2006 2007 2008 2009 2010 2011 2012 Indicators o VALUE % VALUE % VALUE % VALUE % VALUE % VALUE % VALUE % VALUE % VALUE % NCR NCR NCR NCR NCR NCR NCR NCR NCR NCR Personnelexpenditures 60 2,853 54 3,316 53 3,780 51 4,203 51 4,987 50 5,664 53 6,438 52 7,305 50 8,307 53 Executive 49 2,356 44 2,729 43 3,122 42 3,455 42 4,173 42 4,763 45 5,428 44 6,199 43 7,054 45 Legislative 3 137 3 159 3 184 2 210 3 243 2 284 3 332 3 371 3 404 3 Judiciary 6 260 5 310 5 337 5 377 5 400 4 448 4 487 4 536 4 641 4 Public Prosecution 2 100 2 118 2 137 2 161 2 167 2 170 2 191 2 199 1 208 1 Net consolidated debt 200 5,506 104 5,231 83 4,920 67 4,404 53 4,249 42 4,563 43 4,799 39 5,580 38 7,143 46 Garantees Total 22 36 1 28 0 26 0 23 0 23 0 17 0 7 0 6 0 5 0 CrediOperations Revenues 16 71 1 64 1 66 1 80 1 213 2 1,111 10 664 5 517 4 2,310 15 Net7CrrentRewnues(NCR) 5,294 6,306 7,389 8,301 10,010 10,625 ___ 12,436 14,553_ 15,63 Source: SEFAZ Table A5.5: Fiscal Adjustment Program-Fiscal Targets and Observed Results TARGET 2006 2007 2008 2009 2010 2011 2012 Debt/NRR(%) Target 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Observed 0.8 0.7 0.6 0.6 0.5 0.6 0.7 Primary Balance (R$ million) Target 435 410 269 -137 -730 -588 -1128 Observed 599 686 535 -112 65 -369 -1099 Personnel/NCR (%) Target 60 60 60 60 60 60 60 Observed 54 55 53 56 54 52 56 Own Revenue Collection (R$ million) Target 5,091 5,748 6,666 7,652 7,652 10,969 12,112 Observed 5,304 5,927 6,811 7,682 9,867 10,785 11,642 Investment /NCR (%) Target 7.29 11.06 14.59 17.27 22.53 21.83 22.41 Observed 7.5 8.6 12.1 15.7 20.1 18.1 20.9 Source: SEFAZ MEDIUM-TERM FISCAL AND DEBT SUSTAINABILITY - BASELINE PROJECTIONS 12. The projected fiscal and debt paths for Pernambuco are deemed sustainable in the medium term. Baseline scenario projections indicate a sustainable path, despite a deterioration of the primary fiscal balance due to higher levels of public investment in the next three years. Pemambuco's operating balance is expected to record an increasing surplus over the projection period. Net Consolidated Debt is projected to increase from 46 percent of NCR in 2012 to 59 percent by 2015 before declining to 48 percent in 2020, as rising investments are financed from increasing operational savings and new credit operations. 13. In particular, baseline projections for the period 2013-2020 depict a fiscal framework marked by both revenue and expenditure growth. The principal drivers of revenue growth are taxes (primarily from ICMS, which is heavily dependent on economic growth) and current transfers from the federal Government (from FPE, FUNDEB and SUS). On the expenditure side, growth is being driven by capital expenditures, which rise in the short term 49 It is important to note here that the figures compiled by the state for the purposes of reporting on FRL compliance differ from the ones obtained directly from the fiscal accounts, as seen in our own estimates and those compiled by the federal government and presented in the PAF 81 to 15 percent of NCR. Current expenditures are rising largely on account of increases in goods and services (custeio), sub-national transfers to municipalities and to FUNDEB, as well as interest payments (Table A5.7). In line with higher debt levels, interest payments are projected to increase significantly from 2013 to 2016 before stabilizing at these higher levels. Overall, current expenditures as a share of total expenses are stable at around 89 percent from 2013 to 2020. 14. In the baseline scenario, the debt dynamics are sustainable and comply with the Fiscal Responsibility Law. Based on current financing plans and on data for scheduled amortizations and interest payments, net consolidated debt is projected to rise significantly in the medium term, as the state investment program is implemented, after which it is expected to decline slightly to stable levels until 2020 (Figure A5.4). However, given that Pernambuco's debt level as a percentage of NCR is well below the 200 percent limit set in the LRF, this should not affect its projected long-term fiscal sustainability. Net Consolidated Debt and debt service are projected to remain within the Fiscal Responsibility Law limits set by the federal Government. Debt service payments would remain below 10 percent of Net Current Revenue throughout the forecast period, peaking at about 10 percent in the medium term, and declining thereafter to 8 percent in 2020. Personnel costs are expected to stay below 53 percent of Net Current Revenue for the entire period of projection (Table A5.6). Table A5.6: Fiscal Responsibility Law Indicators Projections 2012-2020 Current Millions R$ LEGAL 2013 2014 2015 2016 2017 2018 2019 2020 LIMITE Indicators %NCR VALUE %NCR VALUE %NCR VALUE %NCR VALUE %NCR VALUE %NCR VALUE %NCR VALUE %NCR VALUE %NCR Personnelexpenditures 60 9,807 53 10,534 52 11,271 51 12,060 50 12,980 49 13,971 48 15,184 48 16,502 47 Net consolidated debt 200 10,812 59 11,838 58 12,687 57 13,328 55 13,879 52 14,182 49 15,184 48 16,136 46 Debt service 11.5 1,423 8 2,001 10 2,215 10 2,409 10 2,648 10 2,807 10 2,821 9 2,945 8 Net Current Revenues (NCR) 18,472 20,252 22,156 24,201 26,495 29,008 31,800 34,860 15. Data for the baseline year, 2012, were taken from the Secretariat of Finance (SEFAZ) and were reclassified according to the Government Finance Statistics (GFS) classification. According to the GFS classification methodology, Net Current Revenue includes capital transfer revenues (as reported by the Brazilian statistics), which are otherwise excluded in the National Treasury's definition of current revenues. The baseline fiscal projection results for 2013 to 2020 are presented in Table A5.7, while the assumptions used for the projection are found in Table A5.8 82 Table A5.7: Baseline Fiscal Projections 2012-2020 Billions 2012 R$ 2012 2013 2014 2015 2016 2017 2018 2019 2020 I. Revenue (I) 25.2 26.1 27.2 28.3 29.4 30.6 32.0 33.4 35.0 Taxes 12.1 12.6 13.1 13.7 14.3 14.9 15.6 16.3 17.1 Social Contributions 3.1 3.2 3.3 3.3 3.4 3.5 3.6 3.7 3.8 Transfers 8.8 9.2 9.6 10.0 10.4 10.8 11.4 11.9 12.5 Other Current Revenues 1.1 1.2 1.2 1.3 1.3 1.4 1.4 1.5 1.6 II. Expense (II) 23.5 24.2 25.1 26.1 26.9 27.8 28.9 30.0 31.2 Compensation of Employees 8.5 8.6 8.8 9.0 9.2 9.3 9.6 9.9 10.3 Pensions 3.0 3.1 3.1 3.2 3.3 3.3 3.4 3.5 3.7 Interest Payments 0.4 0.4 0.7 0.9 1.0 1.0 1.1 1.2 1.2 Transfers 5.5 5.7 5.9 6.1 6.4 6.6 6.9 7.1 7.4 Goods and Services 6.0 6.3 6.5 6.8 7.1 7.4 7.8 8.1 8.5 Precatorios 0.03 0.04 0.04 0.04 0.05 0.05 0.06 0.06 0.07 III. Gross Operating Balance (I - II) 1.8 2.0 2.1 2.2 2.5 2.8 3.1 3.5 3.8 Gross Operating Balance (% of NCR) 11.3% 12.4% 12.4% 12.5% 13.8% 15.0% 15.8% 16.9% 17.6% IV. Transactions in Non-Financial Assets 3.0 3.4 3.6 2.7 2.9 3.0 3.1 3.2 4.1 Investment 2.3 2.7 2.9 2.0 2.1 2.2 2.3 2.4 3.2 Investment (% of NCR) 14.7% 16.2% 15.4% 9.8% 9.4% 8.9% 8.5% 8.2% 10.2% Investment in Financial Assets 0.7 0.7 0.7 0.8 0.8 0.8 0.8 0.9 0.9 V. Net Lending / Borrowing (III - IV) -1.2 -1.5 -1.5 -0.6 -0.4 -0.2 0.0 0.2 -0.3 Net Lending/ Borrowing(% of NCR) -7.7% -9.2% -9.2% -3.4% -2.1% -0.8% 0.0% 1.1% -1.6% VI. Primary Balance (V + Interest Payment -0.8 -1.0 -0.8 0.3 0.6 0.9 1.1 1.4 0.8 Primary Balance (% of NCR) -5.4% -6.1% -4.6% 1.7% 2.8% 3.6% 4.3% 4.8% 2.7% VII. Debt 0.9 1.0 1.3 1.7 1.8 1.9 2.0 2.0 1.9 Interest Payments 0.4 0.4 0.7 0.9 1.0 1.0 1.1 1.2 1.2 Amortization Payments 0.5 0.6 0.6 0.8 0.8 0.8 0.8 0.8 0.7 Debt Service (% of NCR) 5.8% 6.6% 7.7% 9.9% 10.0% 10.0% 10.0% 9.7% 8.9% Net Consolidated Debt 7.1 8.6 9.7 10.1 10.3 10.3 10.3 10.1 10.3 Net Consolidated Debt (% of NCR) 45.8% 53.8% 58.5% 58.5% 57.3% 55.1% 52.4% 48.9% 47.7% VIII. Gross Financing Needs (VII - V) 1.7 2.1 2.1 1.4 1.2 1.0 0.8 0.6 1.1 Gross Financing Needs (% of NCR) 11.2% 13.1% 12.8% 7.9% 6.6% 5.2% 4.2% 2.8% 5.0% Source: SEFAZ, WB Calculations Figure A5.4: Net Consolidated Debt and Debt Service - Baseline Projections Net Consolidated Debt Debt Service 12000 - 70.0% 2500 10000 - 60.0% 50.0% 2000 .2 8000 - " 50.0% M 40.0% . 1500 30.0% 1000 4000 - 20.0% 0 -500 2000 - 10.0% 0 0 . .. . . . .0 0 0 Net Consolidated Debt - Interest Payments - Amortization Payments - Net Consolidated Debt (% of NCR) Debt Service 83 Gross Operating Balance Primary Balance 4000 - 20.0% 2000 -.- 6.0% 3500 - 18.0% 1500 3000 16.0% .-*** -16.0% 3000- 14.0% 1000 2.0% 2500 - - - 12.0% 500 2000 -10.0% 1500 .-8.0% 0 -2.0% 1000 -.- 6.0% - -0% - 4.0% 500.0% -1000 -6.0% 2.0%~ 0 0 l00O 0 o o . . . . . . . -0.%15 0 - -8.0% 0 =Gross Operating Balance - Gross Operating Balance / NCR llPrimary Balance - Primary Balance / NCR Source: SEFAZ, WB Projections Table A5.8: Pernambuco State Fiscal and Debt Baseline Projection Assumptions Assumptions Base year figures - 2012 REVENUES Tax Revenues ICMS Increase with IPCA inflation and GSDP growth. IPVA Increase with IPCA inflation and licensed vehicle growth. Other Tax Revenues Increase with IPCA inflation and GSDP growth. Social Contributions Increase with IPCA inflation and personnel growth. Current Transfers Federal Current Transfers Increase with IPCA inflation and GSDP growth Convenios Increase with IPCA inflation and GSDP growth. FUNDEB Increase with IPCA inflation and GSDP growth. Private Transfers Increase with IPCA inflation and GSDP growth. Capital Transfers Increase with IPCA inflation and GSDP growth. Other Current Revenue Increase with IPCA inflation and GSDP growth. Deductions to Revenue Increase with IPCA inflation and GSDP growth. Net Current Revenue (NCR) Current revenue minus deductions to revenue. EXPENDITURE Current Expenditure Wages and Salaries Increase with IPCA inflation and personnel growth. Pensions Increase with IPCA inflation and personnel growth. Social Contributions Increase with IPCA inflation and personnel growth. Interest Payments Calculated based on data from Debt Department of SEFAZ. Goods and Services Increase with IPCA inflation and GSDP growth. Precatorios Actual values provided by SEFAZ. Subnational Transfers Increase with GDP growth and IPCA inflation. Capital Expenditure Investment in Non-financial Assets Calculated based on data from the PAF Other Investments Increase with real GDP growth and IPCA inflation. Amortization Calculated based on data from Debt Department of SEFAZ. IBRD Loan US$550 million disbursed in one tranche in 2013 84 Table A5.9: Macroeconomic Assum tions for Fiscal Sustain bility Analysis Real IPCA IGP-DI Exchange Wage bill Year GSDP Inflation Inflation Rate Growth Growth (R$/US$) Baseline Baseline Baseline Baseline Baseline 2013 3.8% 5.7% 5.2% 2.00 2.0% 2014 4.4% 5.5% 5.0% 2.04 2.0% 2015 4.2% 5.3% 5.0% 2.09 2.0% 2016 4.4% 4.9% 5.0% 2.11 2.0% 2017 4.2% 4.9% 5.0% 2.11 2.0% 2018 4.8% 4.5% 5.0% 2.18 3.0% 2019 4.8% 4.5% 5.0% 2.25 3.0% 2020 4.8% 4.5% 5.0% 2.33 4.0% Source: EIU, BCB Focus, WB Staff Calculations MEDIUM-TERM FISCAL AND DEBT SUSTAINABILITY - RISK ANALYSIS 16. The risk analysis assesses the impact of uncertainty surrounding fundamental variables for Pernambuco's fiscal outlook. The main risks that could lead to deterioration in the state's fiscal balances are related to: (i) fluctuations in macroeconomic variables; and (ii) uncertainty surrounding FPE transfers stemming from ongoing reforms to Brazil's intergovernmental fiscal framework. The objective of the analysis is to establish whether any given shock would have a negative impact on revenues or increase expenditures and compromise fiscal and debt sustainability. Fluctuations in Macroeconomic Variables 17. The analysis examines the impact of fluctuations in key macroeconomic variables (the exchange rate, real GDP growth, Consumer Price Index (IPCA), General Price Index (IGP)) and personnel growth on projected fiscal and debt aggregates. Alternative pessimistic scenarios were modeled for each of the variables, the combined outcome of which produces the joint shock analyzed, painting a highly pessimistic view of the macroeconomic environment. To obtain the alternative values, simultaneous random shocks on the macroeconomic variables (real GDP growth, the exchange rate, IPCA and IGP) were simulated with Monte-Carlo simulations drawing shocks from a Gaussian distribution. The alternative personnel growth rate assumed one additional percentage point per year. 18. The projected debt trajectory is deemed sustainable in the scenario of joint adverse macroeconomic shocks. The analysis shows significant deterioration in all fiscal variables. Lower growth rates have large negative impacts on current revenues, which fall by more than current expenditures. The higher personnel growth rate is reflected in higher employee compensation expenses, and interest payments rise due to the deteriorating exchange rate. As a result of these adverse effects, the primary balance is negative during the projection period. However, even in this extreme situation, debt dynamics do not become unsustainable. The ratio of debt to Net Current Revenue increases to 95 percent of NCR by 2020, compared to 48 percent of NCR in the baseline. (Figure A5.5). 85 Figure A5.5: Risk Analysis of the Impact of Macroeconomic Variable Fluctuations 140% 25%. 120% 20% Z V E 100% 15 . 0 40%- 53 ____________ 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Time Time Probability Probability - 0.1 - 0.25 - 0.5 0.75 -0.9 -0-1 -025 - 0.5 0.75 - 0.9 63% 4% 62% 2% -6 - 60% . 0%. .... ....... ... ..... 5 9 % L; -2 % . ...................... .... ....... u 55 a. Z ~-4%- W 55% ( 54%-1 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Time Time Probability Probability - 0.1 - 0.25 - 05 0.75 - 0g - 0.1 - 0.25 - 0.5 - 0.75 - 0.9 Source: WB StaffEstimates Changes to the FPE sharing rules 19. This analysis models the risks associated with uncertain FPE transfers resulting from changes in the FPE sharing arrangements. The State Participation Fund (FPE) is one of the key components of Brazil's intergovernmental transfer system. It accounts for about 75 percent of all federal current transfers and is composed of 21.5 percent of the revenues collected by the Federal Government from income tax (Imposto de Renda - IR) and Tax on Industrialized Products (Imposto sobre Produtos Industrializados - IPI). FPE transfers are aimed mainly at reducing regional disparities and the sharing rules adopted in 1989 are based on fixed quotas. 20. However, new FPE sharing rules are currently being devised. Triggered by several Direct Actions of Unconstitutionality, which claimed that fixed quotas do not promote the funds' objective of socioeconomic rebalancing among states, the Supreme Court declared unconstitutional the current sharing rules and new rules must be formulated by end June 2013. 21. With an FPE coefficient of 7 percent, Pernambuco is currently the 4th largest recipient of FPE transfers. In 2012, FPE transfers represented 27 percent of Pernambuco's net 86 current revenue. But proposed changes in the FPE sharing rule under discussion in Congress have cast doubt on its future. An alternative scenario analyzed assuming a 20 percent reduction in the sharing rule percentage from the baseline level, applied in 2014 causes a permanent decline in Net current revenue. Lower transfers to Pernambuco are reflected in higher levels of debt, debt service and personnel expenses as a share of Net current revenue (Figure A5.6). However, these three indicators remain within the Fiscal Responsibility Law limits set by the Federal Government. In contrast, the primary balance will remain negative throughout the projection period on the back of lower permanent current revenues. 22. Nevertheless, losses under the FPE policy change might be offset by gains from forthcoming reforms on ICMS, the largest tax source for state governments. Following the Brazilian Supreme Court declaration that most of the state's tax incentives regarding ICMS are unconstitutional, ICMS rules will also be revised, affecting state Government revenues. A key component of the ICMS reform is the gradual unification of the interstate tax rate to 4 percent. The reform which will be conducted within a transition period of 12 years, starting in 2014, is expected to benefit state's that are net importers of ICMS-liable goods and services, including Pernambucoso. In addition, proposed changes to reduce interest rates on subnational debt owed to the Federal Government (under Law 9.496/97 and Provisional Decree MP 2.185-35) from IGP-DI + 6% or 9% to the lowest rate between SELIC or IPCA + 4% are expected to improve debt sustainability of subnational governments. Overall, the sustainability of the fiscal and debt trajectories over 2013-20 is expected to remain robust to these combined changes to the framework. 50 See AvaliagAo do impacto de mudangas nas aliquotas do ICMS nas transaq6es interestaduais, IDB 2011. 51 These changes are contained in a recent draft law sent by the Federal Government to Congress on December, 28th 2012. 87 Figure A5.6: Risk Analysis of the Impact of a change in the FPE sharing rule 90%- 14% Z 80% - 12%- - et10 a' 60% . - - - - - - - - - 40% .... j 6%.... ....... 2012 2013 2014 2015 2016 2017 2018 2019 2020 4 2012 2013 2014 2015 2016 2017 2018 2019 2020 Time Time Sharing rute - Baseline - Alternative Shatn rel -Aemtv 8% ~ 60% ----4 Zg 57% % z 55% - -- 51% , -0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Time Time Sharing rule - Baseline - lternative Baseline - Alternative 88 ANNEX 5: STRATEGY MAP FOR THE ALL FOR PERNAMBUCO PROGRAM ...... ....... VEW SION FOR [TE FUTUR Pe..n.t a..a. CtIkAL[TYCfLIFE-ABEUTER LIFEFEKRAllPERNAMBU ACM NIVEW ECNMR POT ES I FOLLPRABPRUM35 ANNEX 6: COUNTRY AT A GLANCE (includes country map) Brazil at a glance 3/5/13 Latin Upper Key Development Indicators America middle Brazil & Carib. income Age distribution, 2010 (2011) Male (.. Ferale (.) Population, mid-year (millions) 193.2 570 2,419 7579 Surface area (thousand sq. km) 8,515 20,394 59,328 60-54 Population growth (%) 0.9 1.2 0.7 Urban population (% of total population) 84 79 56 4549 30-34 GNI (Atlas method, US$ billions) 1,575.9 3,890 11,804 GNI per capita (Atlas method, US$) 8,150 6,831 4,880 1519 GNI per capita (PPP, international $) 10,230 10,442 9,014 0-4 GDP growth (%) -0.3 4.3 6.0 percent of total population GDP per capita growth (%) -1.2 3.1 5.3 (most recent estimate, 2005-2011) Poverty headcount ratio at $1.25 a day (PPP, %) 6 6 Under-5 mortality rate (per 1,000) Poverty headcount ratio at $2.00 a day (PPP, %) 11 12 Life expectancy at birth (years) 73 74 72 Infant mortality (per 1,000 live births) 16 20 18 70 Child malnutrition (% of children under 5) 2 .. 50 Adult literacy, male (% of ages 15 and older) 90 90 94 40 Adult literacy, female (% of ages 15 and older) 90 89 88 so Gross primary enrollment, male (% of age group) 141 118 111 20 Gross primary enrollment, female (% of age group) 132 114 111 lo 10 Access to an improved water source (% of population) 97 93 90 190 1995 2000 2010 Access to improved sanitation facilities (% of population) 78 77 67 .Brazil .#N/A Net Aid Flows 1980 1990 2000 2011 (US$ millions) Net ODA and official aid 85 151 231 460 Growth of GDP and GDP per capita (%) Top 3 donors (in 2010): n.a. 48 31 49 127 n.a. 0 1 2 6 s n.a. 9 19 24 41 4 Aid (% of GNI) 0.0 0.0 0.0 0.0 -2 Aid per capita (US$) 1 1 1 2 -4 -6 Long-Term Economic Trends -8 95 05 Consumer prices (annual % change) 95.6 1621.0 6.0 5.9 GDP implicit deflator (annual % change) 87.3 2,735.5 6.2 7.2 -- GDP - GDP per capita Exchange rate (annual average, local per US$) 0.0 0.0 1.8 2.0 Terms of trade index (2000 = 100) 147 164 100 125 1980-90 1990-2000 2000-11 (average annual growth %) Population, mid-year (millions) 121.7 149.7 174.4 193.2 2.1 1.5 1.1 GDP (US$ millions) 235,025 461,952 644,702 1,621,662 2.7 2.7 3.6 (% of GDP) Agriculture 11.0 8.1 5.6 5.6 2.8 3.6 3.8 Industry 43.8 38.7 27.7 26.8 2.0 2.4 2.8 Manufacturing 33.5 25.3 17.2 16.7 .. 2.0 2.5 Services 45.2 53.2 66.7 67.5 3.3 4.4 3.8 Household final consumption expenditure 69.7 59.3 64.3 61.1 0.7 3.7 3.7 General gov't final consumption expenditure 9.2 19.3 19.2 21.2 7.3 1.0 3.2 Gross capital formation 23.3 20.2 18.2 17.8 3.3 4.2 4.2 Exports of goods and services 9.1 8.2 10.0 11.0 7.5 5.9 7.2 Imports of goods and services 11.3 7.0 11.7 11.1 0.5 11.6 7.7 Gross savings Note: Figures in italics are for years other than those specified. 2011 data are preliminary. .. indicates data are not available. a. Aid data are for 2010. Development Economics, Development Data Group (DECDG). 90 Balance of Payments and Trade 2000 2011 a Governance indicators, 2000 and 2010 (US$ millions) Total merchandise exports (fob) 54,187 208,178 Total merchandise imports (cif) 55,783 172,782 Voice and accountablity Net trade in goods and services -7,860 6,044 Political stability Current account balance -24,225 -24,302 Regulatory quality as a % of GDP -3.8 -1.5 | Rule of law Workers' remittances and compensation of employees (receipts) 1,649 4,234 Control of corruption Reserves, including gold 33,011 273,123 0 25 50 75 10D Central Government Finance 200 Countrys percentile rank (0-100) Ceta oenetFnne02000 higher vaeuee irrily baterrtnagu (% of GDP) Current revenue (including grants) 0.0 0.0 Soome: Kaufmann-Kraay-/astrzzi, World Bank Tax revenue 0.0 0.0 Current expenditure 0.0 0.0 Technology and Infrastructure 2000 2010 Overall surplus/deficit 0.0 0.0 Paved roads (% of total) 5.5 - Highest marginal tax rate (%) Fixed line and mobile phone Individual .. 28 subscribers (per 100 people) 31 100 Corporate 37 34 High technology exports (% of manufactured exports) 18.7 11.E External Debt and Resource Flows Environment (US$ millions) Total debt outstanding and disbursed 242,512 281,651 Agricultural land (% of land area) 31 31 Total debt service 58,587 44,523 Forest area (% of land area) 64.5 62.7 Debt relief (HIPC, MDRI) - - Terrestrial protected areas (% of land area) 16.9 26.3 Total debt (% of GDP) 37.6 17.4 Freshwater resources per capita (cu. meters) 30,219 28,546 Total debt service (% of exports) 81.1 17.7 Freshwater withdrawal (billion cubic meters) .. -- Foreign direct investment (net inflows) ..C02 emissions per capita (mt) 1.9 2.1 Portfolio equity (net inflows) GDP per unit of energy use (2005 PPP $ per kg of oil equivalent) 7.3 7.4 Composition of total external debt, 2010 Energy use per capita (kg of oil equivalent) 1,084 1,298 Shant-,w ige&,160 65,49T6Bltr, 11,537 World Bank Group portfolio 2000 2010 (US$ millions) IBRD Total debt outstanding and disbursed 7,377 10.671 Disbursements 1,692 1,726 pr Principal repayments 887 812 241,037 Interest payments 464 498 US$ millions IDA Total debt outstanding and disbursed - - Disbursements Private Sector Development 2000 2010 Total debt service Time required to start a business (days) - 119 IFC (fiscal year) Cost to start a business (% of GNI per capita) - 6.9 Total disbursed and outstanding portfolio 2,146 3,049 Time required to register property (days) - 39 of which IFC own account 1,157 2,070 Disbursements for IFC own account 160 825 Ranked as a major constraint to business 2000 2010 Portfolio sales, prepayments and (% of managers surveyed who agreed) repayments for IFC own account 111 165 n.a. .. 84.5 n.a. .. 84.3 MIGA Gross exposure 706 249 Stock market capitalization (% of GDP) 35.1 35.7 New guarantees 315 33 Bank capital to asset ratio (%) 12.1 10.7 Note: Figures in italics are for years other than those specified. 2011 data are preliminary. 3/5/13 .. indicates data are not available. - indicates observation is not applicable. Development Economics, Development Data Group (DECDG). 91 Millennium Development Goals Brazil With selected targets to achieve between 1990 and 2015 (estimate closest to date shown, +/- 2 years) Brazil Goal 1: halve the rates for extreme poverty and malnutrition 1990 1995 2000 2010 Poverty headcount ratio at $1.25 a day (PPP, % of population) 17.2 12.3 11.8 6.0 Poverty headcount ratio at national poverty line (% of population) .. .. .. 22.6 Share of income or consumption to the poorest qunitile (%) 2.2 2.2 2.1 2.9 Prevalence of malnutrition (% of children under 5) 5.3 4.5 3.7 2.2 Goal 2: ensure that children are able to complete primary schooling Primary school enrollment (net, %) 92 94 Primary completion rate (% of relevant age group) 93 90 108 106 Secondary school enrollment (gross, %) 104 101 Youth literacy rate (% of people ages 15-24) .. .. 94 98 Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education (%) 103 103 Women employed in the nonagricultural sector (% of nonagricultural employment) 35 39 40 42 Proportion of seats held by women in national parliament (%) 5 7 6 9 Goal 4: reduce under-5 mortality by two-thirds Under-5 mortality rate (per 1,000) 58 48 36 20 Infant mortality rate (per 1,000 live births) 49 41 31 18 Measles immunization (proportion of one-year olds immunized, %) 78 87 99 99 Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio (modeled estimate, per 100,000 live births) 120 96 81 67 Births attended by skilled health staff (% of total) 70 88 96 97 Contraceptive prevalence (% of women ages 15-49) 59 77 .. 81 Goal 6: halt and begin to reverse the spread of HIVIAIDS and other major diseases Prevalence of HIV (% of population ages 15-49) Incidence of tuberculosis (per 100,000 people) 84 71 60 46 Tuberculosis case detection rate (%, all forms) Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source (% of population) 89 91 94 97 Access to improved sanitation facilities (% of population) 68 71 74 78 Forest area (% of land area) 68.0 .. 64.5 62.7 Terrestrial protected areas (% of land area) 9.0 11.1 16.9 26.3 C02 emissions (metric tons per capita) 1.4 1.7 1.9 2.1 GDP per unit of energy use (constant 2005 PPP $ per kg of oil equivalent) 7.7 7.8 7.3 7.4 Goal 8: develop a global partnership for development Telephone mainlines (per 100 people) 6.3 8.2 17.7 21.5 Mobile phone subscribers (per 100 people) 0.0 0.8 13.3 78.6 Internet users (per 100 people) 0.0 0.1 2.9 33.8 Computer users (per 100 people) Education indicators (%) Measles immunization (% of 1-year ICT indicators (per 100 people) olds) 125 1 1- 120 10D 7 - 19 - 75 80 50 50 60 25 40 0 2 0 20D2 20D5 25 20 - 1990 1995 20D0 2010 20)0 20D5 - Primary net enrollment ratio OFixed + mobile subscribers - Ratio of gids to boysin primary & wcondary DBrazil O#NIA * Internet usem educationI II II Note: Figures in italics are for years other than those specified. .. indicates data are not available. 3/11/13 Development Economics, Development Data Group (DECDG). 92 Pernambuco at a glance O Pernambuco, Age Distribution 2010 (percent of Key Development Indicators Pernambuco Brazil total population) 2010 75-79 Population, mid-year (millions) A 8.8 190.8 65-69 Surface area (thousand sq kM) A 98 8,503 Average population growth (2000-2010, %) A 1.07 1.18 55-59 Urban population (% of total population) A 80 84 45-49 35-39 2010 25-29 GDP (current prices, US$ billions) 2,B,C 541 2,143 GDP (current prices, R$ billions) c 95 3,770 15-19 GDP per capita (current prices, US$) 2.B.C,D 6,151 11,234 5-9 GDP per capita (current prices, BRL) c.o 10,822 19,766 Less than ayear 6 4 2 0 2 4 6 GDPgrowth(%)c 7.7 7.5 GDP per capita growth (%) 1 7.4 7.3 MMale Female o 2009 Extreme Poverty Headcount (% of the Poverty headcount ratio at $1.25 a day (PPP, %) E 12.3 6.1 population) - National poverty line (R$ 70) Poverty headcount ratio at $2.00 a day (PPP, %) E 20.7 10.8 0.25 2011 Extreme Foverty headcount (National poverty line) 10.1 4.7 Gini L 0.525 0.529 0.2 -k Life expectancy at birth (years) - 2010 G 69.4 73.4 0.15 Infant mortality (per 1,000 lives births) - 2010 4,H 17.0 16.0 Child malnutrition (% of children under 5) - 2006 G 2.2* 1.9 0.1 o- Adult literacy (% of ages 15 and older) - 2010 A 84.3 91.4 *Northeast region 0.05 2011 Net primary enrollment (% of age group) 1 98.1 98.2 Access to inproved water source (% of 82.4 84.6 2001 2004 2007 2011 Acces to improved sanitation facilities (% of 56.2 62.6 Brazil - Pernambuco Government Finance J Brazil 2010 2001 2010 Current Revenue (including grants) 17.9 22.2 23.6 Tax Revenue 8.7 7.0 7.5 Current Expenditure 17.1 24.5 23.5 Overall surplus/deficit (0.2) (3.9) (1.4) Primary Surplus 0.2 1.7 2.1 PE Consolidated Net Debt (DCL) and Net Current Revenue (RCL), 2000-2012 18.0 1.4 16.0 1.1 11 0 1.2 o 14.0 10 1.0 10.0 - 6 0.8 16 8.0 0.6 W 6.0 %wnC 4.0 2.0 -0.2 S0.0 7 70.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 DCL/RCL DCL RCL 93 Pernambuco Long-Term Economic Trends 1980-1991 1991-2000 2000-2010 1980 1991 2000 2010 (average annual growth %) Population, mid-year (millions) 1A Brazil 121.2 146.9 169.6 190.8 1.77 1.61 1.18 Pernambuco 6.2 7.1 7.9 8.8 1.20 1.17 1.06 1995-2000 2000-2005 2005-2010 1995 2000 2005 2010 (average annual growth %) GDP (constant price 1998, BRL million) 2,B,c Brazil 927,037 1,024,052 1,174,788 1,460,514 2.01 2.78 3.69 Pernambuco 21,298 23,406 27,313 36,875 2.65 3.94 4.33 GDP (constant price 1998, US$ million) 2,B,C Brazil 799,097 882,723 1,012,656 1,258,948 Pernambuco 18,359 20,176 23,544 31,786 Economic Sector c 1995 2000 2005 2010 1995-2000 2000-2005 2005-2010 (% of GDP) (average annual growth %) Agriculture Brazil 5.8 5.6 5.7 5.3 3.27 4.18 3.77 Pernambuco 5.1 4.4 5.1 4.5 1.30 5.36 5.26 Industry Brazil 27.5 27.7 29.3 28.1 1.08 2.50 3.14 Pernambuco 23.6 21.8 22.1 22.1 -0.32 1.57 6.15 Manufacturing Brazil 18.6 17.2 18.1 16.2 0.25 2.90 1.99 Pernambuco 14.4 11.2 10.9 10.9 -3.73 2.27 4.07 Extractive Brazil 0.8 1.6 2.5 3.0 3.06 6.36 4.26 Pernambuco 0.2 0.3 0.1 0.2 8.96 -1.52 10.56 Services Brazil 66.7 66.7 65.0 66.6 2.13 2.90 4.58 Pernambuco 71.3 73.8 72.8 73.4 2.16 2.80 4.45 GDP Growth GDP per Capita Growth 0.1 8% 0.08 6% 0.06 4% 0.04 2% MAI 0.02 0% 0-2 -0.02 -4% 1996 1998 2000 2002 2004 2006 2008 2010 1996 1998 2000 2002 2004 2006 2008 2010 .m Brasil -0- Pernambuco .. Brazil -01- Pernambuco Sources: A - Census 2010/IBGE; B - IMF WEO; C- Regional Accounts/IBGE; D- IBGE; E - WB; F- IPEA using PNAD/IBGE; G- Ministry of Health/Datasus; H- Ministry of Health/MS/SVS/DASIS/CGIAE; I- PNAD/IBGE; J- National Treasury; L-IETS using PNAD/IBGE Notes: 1 Per capita GDP is calculated using average estimated population growth between 2009 and 2011. 2 GDP and GDP per capita data for Brazil were taken from IMF WEO survey. The values for the State of Sergipe were estimated using share in total GDP (IBGE regional accounts) and population estimate for 2009, both from IBGE 3 70 reais poverty line in 2010 constant prices. 4Administrative data using Active Search (Busca Ativa) 'Access to water network supply per household (IBGE Tables) 'Access to sewage disposal system or to septic tank connected to disposal system per household (IBGE Tables) 94 70-W To Ciudad Guayana •90°W 50°W 40°W R.B. 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