Document of The World l3ank FO1R OIFIF'lCR[AL USE ONLY Report No. 2§129=CO MUEMOIRANDUM OF 1ITHIE PIRJESIDENT OF T1H1E IINTERNATlRIONAL 1BANK FOIR IRECONST]RUCT]ION AND DEVELOPMENT AND TH11E lNT]ERINATRONAL FIENANCE C IRPRATIJON TO THIE EXECUTJVE DRRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOIR THIE REPBLEC OF COLOM A December 24, 2002 (Colombia-Mexico-Venezuela Country Management Unit Latin America and the Caribbean Region Fi'his document has a restricted distribution and may be used by recipients only in the performance of their Iofficial duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EOUIVALENTS Currency Unit = Colombian Peso (Col$) US$ = 2,873.40 FISCAL YEAR January 1 to December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AML Anti-Money Laundering AUC United Self-Defense Forces of Colombia CAF The Andean Development Corporation CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CFT Combating the Financing of Terrorism CPAR Country Procurement Assessment Report CPPR Country Portfolio Performance Review ELN National Liberation Army FARC Revolutionary Armed Forces of Colombia FSAP Financial Sector Assessment Program GDP Gross domestic product GEF Global Environment Facility IBRD International Bank for Reconstruction and Development IDB The Inter-American Development Bank IFC International Finance Corporation IMF International Monetary Fund MDGs Millennium Development Goals IDP Internally Displaced Population MIGA Multilateral Investment Guarantee Agency PFMP Public Financial Management Project ODS Montreal Protocol on Ozone Depleting Substances RAF The Social Support Network SFAL Structural Fiscal Adjustment Loan SIIF Integrated Financial Management System SINERGIA National System for Evaluation of Public Sector Performance VAT Value added tax WBG World Bankl Group WBI World Bank Institute ICBRD Vice President David de Ferranti Chief Economist Guillermo Perry Country Director Isabel Guerrero Sector Leader Marcelo Giugale Task Manager Connie Luff Resident Representative Alberto Chueca-Mora Research Analyst Mario Cuevas Program Assistant Teresa Franco IFC Vice President Assaad Jabre Director, LAC Bernard Pasquier Manager Toshiya Masuoka Task Manager Dileep Wagle FOR OFICLAL USE ONLY COUNTRY ASSISTANCE STRATEGY FOR THE REPUBLIC OF COLOMBIA TABLE OF CONTENTS 1. Summary and Main Messages ........................................................1I II. The Country Context .........................................................2 Political Arena .........................................................2 Recent Economuc Developments and the External Environment .........................................................3 Colombia's Macroeconomic Prospects .........................................................4 Evolution of Poverty and Inequality-Voices of the Poor and Development Goals .................................6 III. Colombia's Main Development Challenges .........................................................9 Achieving Fast and Sustainable Growth ........................................................ 10 Sharing Growth with all Colombians ........................................................ 14 Building Efficient, Accountable and Transparent Governance ........................................................ 16 IV. Government's Agenda of Policies and Programs ......................................................... 17 V. World Bank Group's Partnership with Colombia ......................................................... 18 The Lessons of the Previous CAS ......................................................... 18 Procurement and Financial Management in Colombia's Portfolio ......................................................... 21 VI. World Bank Group Assistance Strategy ........................................................ 22 CAS Objective: Achieving Fast and Sustainable Growth ..................................... ................... 24 CAS Objective- Shanng the Fruits of Growth ........................................................ 29 CAS Objective: Building Efficient, Accountable and Transparent Governance ............................. ..... 32 Monitoring CAS Implementation ........................................................ 34 Exposure and Public Debt Sustainability Under the Proposed Strategy ........................... ...................... 34 VII. Coordination with Partners and Civil Society Participation ............................................. 36 Colombia CAS Consultation with Civil Society ........................................................ 37 VIII. The Risks of the Proposed Strategy ........................................................ 40 IX. Concluding Remarks ........................................................ 40 Table 1. Key Macroeconomic Indicators .6 Table 2. Poverty and Inequality Indicators 1978-2001 .7 Table 3. Vulnerability as Measured by Extreme Poverty and Poverty .7 for Population Subgroups in Urban Colombia 2001 Table 4. Millennimum Development Goals .8 Table 5. IFC Investments 1991-2002 ...........20... ........................................... ......... .. ........2...........0........................ 20 Table 6. Tnggers to Remain in High-Case. ......... ........ ........................................... 23 Table 7 Colombia-IBRD Lending Program For FY03-06 .31 Table 8. Colombia-Bank Knowledge Based Program for FY03-06 .33 Table 9. Core MDG/CAS Monitonng Benchmarks .34 Table 10. Partnerships in Colombia's Development Framework ..39 Figure 1. IBRD Exposure to Colombia ..35 Figure 2. Colombia-Ratio of IBRD to Preferred Creditor Debt Service . .35 Box 1. Colombia Voices of the Poor .8 ANNEXES Al Colombia at a Glance A2. Millennium Development Goals-Strategy and Indicators B2 Selected Indicators of Bank Portfolio Performance and Management B3 IBRD Program Summary B3. IFC & MIGA Program. FY 2000-2003 B4 Summary of Nonlendmng Services B5. Social Indicators B6. Key Economic Indicators B7. Key Exposure Indicators B8 Status of Bank Group Operations in Colombia Operations Portfolio B8. Statement of IFC's Held and Disbursed Portfolio B9. CAS Matrix FY03-05 Cl. Private Sector Strategy DI. Debt Management El. Voices of the Poor This doicument has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed withouit World Bank authorization. MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF COLOMBIA I. SUMMARY AND MAIN MESSAGES 1. There is no doubt that the long-standing armed conflict and violence driven by common criminal activities, especially drug related, are the most important issues facing Colombia as a nation, let alone as an economy. The cost of the violence is staggering. Since 1980, some 100,000 people have died directly as a result of the conflict, and two million displaced people haive lost their jobs, homes, and hope. Another million have left the country and most will not return. By some calculations, the conflict dampens GDP growth each year by two full percentage points-this means that if peace had come 20 years ago, the income of the average Colombian would now be 50 percent higher, and an estimated 2.5 million more children would be above the poverty line. The conflict has caused distortions in resource allocation: frightened by violence, private investment has, over the last 30 years, rarely surpassed one tenth of GDP, and just the lost revenue due to sabotaged oil pipelines (some US$500 million per year) would be enough to double the country's annual budget for social assistance. Behind these costs, lurks the loss of Colombia's social capital, that is, its citizens' hope for a better future and trust in the nalion's institutions. 2. In Colombia, stable economic growth rates have historically been instrumental to reduce poverty and increase public resources for social spending. During the second half of the 1990s, however, Colombia entered into a severe economic crisis, erasing over a decade of progress in po verty reduction and undermining Colombia's ambitious social agenda. Indeed, poverty increased 4 percentage points from 1995 to 1999, with the most recent data showing that poverty ha' continued to rise, despite modest rates of economic growth. The economic recession and pei,sistently high levels of violence have resulted in a marked deterioration in living conditions. 3. Economic prosperity alone will not be sufficient to stop the violence-but increased poverty could well inflame the situation further. Therefore, the overarching development objective of this strategy will be to support the government's efforts to achieve economic de,velopment as a necessary, but not sufficient, condition for peace. Sustainable economic development will underpin Colombia's efforts to build national reconciliation and lasting peace. The WBG's strategy will seek to support Colombia's quest for peace in three essential areas: (a) achieving fast and sustainable growth; (b) sharing the fruits of growth; and, (c) building efficient, acc:ountable and transparent governance. WBG will prepare periodic progress reports on the implementation of the planned strategy. 4. To support this strategy, the Bank lending program focuses on operations that would: (a) have the most tangible impact on poverty alleviation and help Colombia meet the targets for the Millennium Development Goals (MDGs); (b) achieve fast and sustainable growth while protecting the poor; (c) incorporate the lessons learned from Bank's operations, particularly from on-going Learning and Innovative Loans, and (d) pilot innovative interventions with important demonstration effects. 5.! The CAS envisages a maximum lending program for IBRD of about US$3.3 billion and a base-case scenario of US$2 to US$2.9 billion for the for the remainder of FY03 to FY06. This substantial increase in lending is justified by the ambitious program of the Uribe administration to build the foundation for lasting peace and to achieve poverty reduction. Colombia, which has traditionally had an excellent relationship with the World Bank Group, is now turning to it to help the country through this period of: (a) fiscal difficulties resulting from low economic growth, a drop in exports caused by the recession in countries that are Colombia's trading partners, declining petroleum production, historically low international coffee prices, and low private investment levels impacted by worsening intemal security conditions; and (b) restricted access of Colombia to international capital marlcets due to the country's loss of its investment grade credit rating and increased investor nisk aversion toward Latin America. IBRD would review the lending program and move to a low-case scenario of about US$900 million (US$225 million per year) or lower, with a focus on operations targeted to alleviate poverty and build social development, if the reform program were to completely stall or if the security situation were to substantially deteriorate. 6. As reflected in the WBG's Private Sector Strategy (Annex C1), IFC's increased activity will accompany IBRD's enhanced assistance, supporting private sector firms - large and small - and catalyzing a private-sector supply response that Colombia needs for achieving higher, sustained growth and the sharing of that growth. lFC's stepped-up activity, which has already been taking place in response to the deteriorated market conditions and the administration's request, is expected to continue during the CAS period. IFC's contributions will also support the strategic areas of corporate governance, envircnmental and social sustainability, and low- income and micro financing. 7. This CAS faces serious risks-of deepening conflict and violence with a resulting escalated loss of local and foreign investor confidence. Nevertheless, these risks are worth taking, given the rewards of helping to build a foundation for lasting peace and contributing to poverty reduction, equality enhancement and the promotion of sustainable development. The government's program is ambitious, but it has broad support-both within Colombia and internationally. The risk to Colombia of not implementing this long overdue reform program is great and the Bank's support may well mitigate it. In implementing its strategy, WBG will continue its close collaboration with other partners, especially the IRF, 1DB and CAF, and will maintain a strong program of consultation with civil society. Hl THE COUNTRY CONTEXT Political Arena 8. On May 26h, 2002, Colombians elected Alvaro Uribe to succeed President Andres Pastrana, whose efforts to find a negotiated solution to the armed conflict proved unsuccessful. After almost four years of govemment peace efforts, which included the granting of a large demilitarized zone, little progress was made toward respect for international humanitarian law, a lasting cease-fire or viable negotiation agendas. Instead, the internal conflict has intensified and guerrilla warfare has increased: bombs have been set off in major urban areas, infrastructure has been destroyed and politicians have been threatened (the country's 500 mayors have received death threats, presidential candidate Ingrid Betancourt was kidnapped and President Uribe has suffered several assassination attempts). 9. In response, Colombia's electorate embraced Mr. Uribe's message of restoring the authority of government and enhancing law and order and he won the election with 53 percent of the vote. The high approval rating he has commanded since his inauguration on August 7k" will provide him the scope to implement his social, political and economic agenda. However, with 2 unemployment persistently high, poverty rising and the internal conflict expected to intensify, President Uribe will need to act quickly while he commands broad civil and political support to pass unpopular but essential reforms aimed at curbing violence, reducing common crime and 'improving socioeconomic conditions for the long term. 10. The violent situation that President Uribe is confronting is not new. Indeed, since Ibecoming a republic in 1819, Colombia has suffered intermnittent periods of violence. Power sharing agreements between the Liberal and Conservative Parties reduced the violence in the t-arly 1960's, but excluded other political forces and led to the emergence of guerrilla groups. Guerrilla movements and crime have been encouraged by an ineffective legal system, deep social idisparities, and a weak state presence in rural areas. The current conflict has pitted the country ,against two well-armed guerrilla organizations, FARC and ELN, and fast growing paramilitary Forces. The FARC and the paramilitary forces produce much of the world's cocaine and the ELN is responsible for many of the roughly 4,000 kidnappings committed every year in 'Colombia. 11. Despite internal conflict and violence, Colombia has shown remarkable stability in its democratic institutions, and since the mid-eighties major efforts have been made to increase the iscope of these institutions. Key driving forces behind the changes in the political system have 'been the new Constitution of 1991 (expanding the scope of human rights, promoting civil society participation in govemance, increasing the evaluation of public sector performance, strengthening the independence of the judiciary, and enhancing government accountability), the reform of the electoral system (making the process more transparent and fair), and the process of territorial decentralization (including popular elections of mayors since 1988 and of governors since 1991). Nevertheless, Colombia continues to face the problems of an inefficient judicial system that provides services of poor quality and insufficient quantity, a high degree of corruption and state capture, and local governments that do not offer quality public services and or maintain fiscal discipline. The government is hence handicapped by the gradual loss of credibility and weak presence in wide areas of the country. The success of Mr. Uribe's government program will largely depend on the implementation of the proposed State reform program. Recent Economic Developments and the External Environment 12. Over the past half-decade, Colombia has run into fiscal problems, including significant deficits and large future fiscal liabilities. The rapid expansion of the public sector over the previous decade, from spending one fourth of GDP in 1990 to over one third of GDP today, combined with growing liabilities, particularly with pensions, have led to large structural deficits. Private GDP has grown little since the mid-1990s, and private investment has deteriorated from its peak of near 12 percent of GDP in 1994 to under eight percent today. Total investment is now about 15 percent of GDP. While government consumption grew by two thirds between 1994 and 2001, that of households remained basically unchanged. As public spending rapidly outstripped the sector's revenue generating capacity, much of the fiscal deficit was financed with debt, both domestic and external. Today, net public sector debt in Colombia stands at about 45 percent of GDP. 13. Despite Colombia's long tradition of prudent and successful macroeconomic management, including good debt management, Colombia's economic performance has continued to disappoint, with GDP growth reaching only 1.4 percent in 2001. Moreover, growth forecasts for 2002 are also close to 1.5 percent. Major obstacles to a more robust recovery include weak domestic demand associated with high unemployment, currently at almost 18 percent in urban areas, and historically low private investment levels. Moreover, exports, which 3 had led the recovery in 2000, languished over the past year due to a combination of domestic and international factors. This has in turn affected the performance of manufacturing, much of whose production is directed towards exports as a result of weak demand at home. Weak domestic demand and worsening internal security conditions are reflected in continued weak private investment. On the fiscal front, the projected deficit for 2002 is 4 percent of GDP, largely due to election year spending, higher military outlays, and a weakening of social security institutions. On security spending alone, the administration estimates that it willl need an additional 1 percent of GDP per year. Nevertheless, the Uribe administration has stressed its commitment to continue the fiscal adjustment efforts of the previous administration. Lwo key structural reformns have already been presented to Congress: a strengthened pension reform to address the looming deficits of the social security sector, Colombia's most pressing future fiscal liability, and a labor reform proposal intended to increase flexibility in Colombia's rigid labor market. 14. As a result of declining petroleum production and historically low international coffee prices, Colombia's traditional exports are experiencing a decline, having fallen over 9 percent during the first half of 2002 as compared to a year earlier, alleviated somewhat by the current high world price for oil. Traditional exports had already declined by 22 percent in 2001. While the country's non-traditional exports, mainly manufactured goods and cut flowers, had performed well in 2001, the appreciated peso earlier in 2002 and the economic slowdown in the United States, Venezuela and other Andean countries affected them negatively this year. Declining imports have, however, helped maintain a surplus in the trade balance. The external current account deficit is projected to be around 2 percent of GDP this year. 15. Inflation has continued its decline, assisted by sluggish demand, and today stands close to 6 percent-the target for the year. This has allowed the Central Bank to reduce interest rates, which, along with enhanced prudential regulation, has helped the financial sector to rebound from the significant crisis of 1999. 16. Colombia's vulnerability to external shocks has risen in recent months as a result of several factors: increased violence domestically and uncertainty as regards the future path of the internal conflict; the sharp deterioration in sovereign debt spreads; the recent worsening of market sentiment towards Latin America; problems in Venezuela, the largest market for Colombia's non-traditional exports; and an uncertain outlook for the US economy, Colombia's main trading partner. That said, Colombia is relatively well-equipped to deal with moderate external shocks, given its floating exchange rate, falling inflation, adequate international reserve levels, as well as the potential for further fiscal adjustment and reforms. 17. Colombia's sovereign spreads and currency had, until recently, been relatively unaffected by regional events, partly the result of the pre-financing by the government of more than three quarters of its external market financing needs for 2002. Pre-financing was undertaken in 2C01 in order to avoid accessing the markets in the run-up to the presidential election. Colombian bond spreads fell throughout 2001 and in early 2002, but increased somewhat in April after Colombia's sovereign rating was downgraded by Fitch and its outlook changed to negative by Moody's, both citing growing public debt and an uncertain outlook for reforms and fiscal results. Despite this, in June 2002 the government obtained fresh funds in the international bond market for US$195 million and an additional US$500 million in December 2002. Colombia's Macroeconomic Prospects 18. Colombia's macroeconomic performance is expected to continue improving in the next two to three years, but it will take longer before the country is able to achieve its full economic potential. Following a mild recovery of economic activity in 2002, GDP growth is expected to 4 accelerate to about 2.5 percent in 2003 mainly due to a recovery of the export sector and slightly better prospects for aggregate private investment. Growth will rise in 2004 to levels around 3 percent, reaching 3.5 percent by 2006. 19. Exports will be aided by a projected recovery of international trade growth and prices of some of Colombia's key export products. A shift in trade patterns is also expected, as the share of trade with neighboring countries will likely shrink due to the weak economic recovery of some regional partners (especially Venezuela). The prospective economic recovery in the U.S. and Europe suggests that Colombian exporters will shift their attention to these regions, with the impact of economic recovery in those markets further amplified by a possible weakening of the US$ relative to other major currencies. Colombia's exchange rate is projected to depreciate mildly in real terms over the next three years, as continued low domestic inflation and a flexible exchange rate policy facilitate a smooth adjustment of the tradable sector. In this connection, inflation is expected to continue on a downward path and stabilize at levels close to 4 percent by 2005 (from 6 percent in 2002). Inflationary expectations will continue to be anchored through credible management of monetary policy and Central Bank independence. 20. The projected GDP growth and exchange rate paths are consistent with a stable external current account balance, which is projected to fluctuate at levels close to 3 percent of GDP. Moreover, official foreign exchange reserves are expected to keep rising in line with the expansion of the country's external obligations, including imports and debt service, thus ensuring that future external liquidity ratios do not deteriorate. With improved macroeconomic prospects, other sources of external financing, such as foreign direct investment, are expected to recover close to their historical levels. In synthesis, the viability of Colombia's current account will in part be achieved through the adoption of a flexible exchange rate policy, while the capital account will be underpinned by increased reliance on official sources of funding. 21. Thus while the current policy framework is expected to provide for a solid adjustment of the extemal sector, the key risk to the country's macroeconomic stability remains a large fiscal deficit and the high burden of public debt. Assuming a full implementation of the proposed reforms package, the overall public sector deficit is projected to fall from about 4 percent of GDP in 2002, to about 3 percent in 2003, and about 2.5 percent in 2004 and 2005 (Table 1). The projected overall fiscal balance is consistent with an improvement of the primary surplus from about 1.5 percent of GDP in 2001 to 4 percent by 2005. A primary surplus of 4 percent of GDP, if maintained on a permanent basis, would be consistent with stable public debt dynamics. However, due to the lag in the fiscal adjustment process as well as the relatively conservative economic growth prospects projected for the country, on a net basis total public debt is still projected to continue rising (although at diminishing rates) before stabilizing at levels close to 50 percent of GDP. Achieving these goals for the overall public sector and thus macroeconomic stability on a sustainable basis will require strong and deep adjustment at the level of the central govemment, especially on the expenditure side, for which the authorities are still developing a strategy. 5 Table 1. Key Macroeconomic Indicators Projections 1998 1999 2000 2001 2002 2003 2004 2005 Real GDP Growth 0.6 -4.1 2.6 1.4 2.0 2.5 3.5 3.5 Fiscal BalancetGDP -3.8 -5.5 -3 4 -3.2 -4.0 -3.0 -2.5 -2 5 Curent Account/GDP -5.3 0.4 0.4 -2.2 -2.9 -3.2 -3.1 -2 9 Inflation 16.7 9.2 8.7 7.6 6 2 6.0 5.0 4.0 Evolution of Poverty and Inequality-Voices of the Poor and Development Goals 22. Economic Recession and the Reversal of Two Decades of Poverty Reduction. From 1978 to 1995, stable economic growth rates averaging over 4 percent annually were instrumental to substantial poverty reduction: the percentage of Colombians living below the poverty line fell by almost a quarter (from 80 to 60 percent) and extreme poverty declined by more than half (from 45 to 21 percent), as illustrated in Table 2. Growth also allowed for an increase of public allocation of resources to social spending and for substantial social progress, particularly in primary and secondary school completion, health insurance coverage, access to basic infrastructure, child labor, infant mortality, and life expectancy. However, rising income inequality during the 1990s limited the welfare gains made during Colombia's period of strong economic growth up to 1995. During the second half of the 1990s, the most severe economic crisis to hit Colombia since the 1930s erased over a decade of progress in poverty reduction, and undermined Colombia's ambitious social agenda. Indeed, poverty increased 4 percentage points from 1995 to 1999 and 3 more points up to 2001, exceeding by two points the poverty level of 1999. During that period, the poverty increase was more severe in urban than in rural areas. Macroeconomic performance deteriorated significantly, growth rates plummeted, and the unemployment rate doubled, reaching a historical high of over 20 percent. The most recent data show that despite modest rates of economic growth, poverty has continued to rise. Simultaneously, the continued increase in income inequality further aggravated already rising poverty rates. To bring poverty down to the level of 1995, Colombia will need to sustain economic growth rates of 4 percent over the next decade. The combined result of the economic recession, increased macroeconomic instability, and persistently high levels of violence, is a marked rise in the population's vulnerability to poverty. Most vulnerable are children, displaced populations, indigenous peoples, Afro-Colombian populations, and non-homeowners households with young, low-, mid-skilled, or unemployed heads. These groups are clearly worse off than pensioners, the college educated, the elderly, and non-recent migrants, and should consequently receive priority attention. (Table 3 and Box 1). 6 Table 2. Poverty and Inequality Indicators 1978-2001 1978 1988 1995 1999 2001 Poverty indicators Natwinal Poverty rate 80% 65% 60% 64% 67% Poverty Gap' 46% 32% 29% 34% 34% Exteme poverty rate 45% 29% 21% 23% 26% Meanincomepercapia' 131 213 251 245 230 Urban Poverty rate 70% 55% 48% 55% 59% Extreme poverty rate 27% 17% 10% 14% 17% Rural Poverty rate 94% 80% 79% 79% 80% Extreme poverty rate 68% 48% 37% 37% 42% National Giru Coefficient 0.53 0.54 0 56 0 57 0.58 Qwntiles(Top/Bottom) 172 17.6 17.2 202 224 Inequaliy Urban-Rural Decomwosuion (7hedl) Total 0.54 0 60 0.70 0 68 0.70 Within 0 42 0 50 0.59 0 58 0 61 Between 0.12 010 011 009 0.09 I Poverty rater Percentage of population under poverty hlie 2 The povery gap desenbes the average distance to the poverty line. 3 Tbousand 2001 pesos per moth. Source DANE, Encuesta Nacioral de Hogares, and Colombia Poverty Report (2C02). Table 3. Vulnerability as Measured by Extreme Poverty and Poverty for Population Subgroups in Urban Colombia 2001 Extreme Population Poverty Poverty share Urban Colombia (7 cities) 17% 59% 100% Households with non-homeowning, unemployed heads 50% 90% 4% Households with unemployed heads 39% 83% 8% Nor-homeowners 25% 70% 49% Children under 2 yrs. 28% 72% 4% From 2 to 6 yrs 27% 72% 11% From 7 to 13 yrs 24% 72% 14% From 14 to 17 yrs. 21% 69% 7% Households with female heads 20% 63% 25% Migranlts/just moved 19% 64% 1% Women 17% 59% 53% Disabled 10% 56% 1% Homeowners 10% 49% 44% Over 65 years old 8% 41% 5% Pensioners 2% 25% 3% * Refers to people who have lived less than 1% of their lives in the current city, 1999 data Source. DANE, Encuesta Nacional de Hogares, authors' calculations. Table 4. Millennium Development Goals Targets Position of the World Current Position of Colombia 1. Between 1990 and 2015, reduce by 20% of the world population live on less In 1998, 20% of Colombia's population half the proportion of people living in than US$1 a day (WBG estimate for lived on less than US$1 a day The extreme poverty and suffering from 2000). prevalence of malnutntion among hunger. chuldren under age 5 decreased from 10% in 1990 to 8% m 2000 2. Achieve universal completion of 90% of the world's elementary school- Net overall primary enrollment ratio in pnrmary education by 2015 for both boys age children (6-14) are enrolled (WBG Colombia in 1998 was 87%. and girls. estimate for 1997). 3. Eliminate gender disparities in Worldwide, there is a gender gap of The ratio of female to male enrollment in pnmary and secondary education by 7.6% in the primary education Gross primary and secondary schools is 101%. 2005, and for all levels by 2015. Enrollment Ratio (WBG estimate for 1996). 4. Reduce infant mortality rates by two Worldwide, the under-5 mortality rate The under-5 mortaity rate in Colombia thirds between 1990 and 2015. was 78 per 1,000 (WBG estimate for decreased from 40 per 1,000 in 1990, to 2000). 23 per 1,000 in 2000 5. Reduce matemal mortality rate by Worldwide, there are 400 matemal In Colombia, matemal mortality rate was three quarters between 1990 and 2015. deaths per 100,000 live births. 67.7 (per 100,000 live births) in 1999. 6. By 2015, halt and reverse the spread In 1999, the worldwide prevalence rate In 2001, the prevalence rate of of HIV/AIDS, malaria, and other of HIV/AIDS among adults was 1.05%. HIV/AIDS among adult population was diseases. 0.35%. 7. Ensure environmental sustainability. Worldwide, in 2000, approximately 80% In 2000, 91% of Colombia's population One indicator is access to an improved of the population had access to water. had access to an improved water source water source. A second indicator is ratio Likewise, in South America, percent of Likewise, in Colombia, land area in of land protected to maintain biological land area in protected areas averaged protected areas totaled 9% in 1999. diversity to surface area. 7.4% in 1999 Box 1. Colombia Voices Of The Poor The Colombia Voices of the Poor participatory poverty diagnoses focused on three themes: work and employment, education and capacities, and security and violence The key messages of the poor are the following: * Poverty has many dimensions in Colombia, including unemployment, lack of assets, inadequate social opportunities, and powerlessness. Colombia is particularly characterized by stigmatization linked to political and other forms of violence and the extreme vulnerability of youth and children, * Work was valued as an attrbute to achueve well-being, in most cases above education and health, * Poor people have an incredible versatility to find ways to make a living and adapt to adverse conditions, but this versatility and wilhngness to work hard are not rewarded by the market or government programs, * Poverty is experienced and confronted differently in different regions of Colombia, * Political violence deteriorates economic conditions of the poor and leads to increased common crime, increased violence in the home and violence at school. In addition, violence of all kinds is leading to more single mother homes, which in turn increases the vulnerability of children to more violence; * There is an increasing acceptance of illegal ways of making a living, such as through drugs, arned robbery, petty crime, and prostitution; * Police are absent from most of the 10 sites of the study and thus people find their own means to provide security and apply justice. Thus lack of state security results in less investment, more stigmatization, more youths caught up in gangs and irregular forces, and weakened communities that are victimized by armed groups; * The economic crisis has shown the shortcomings of formal education as a means to get a job. Poor families often send their children to school now for the food it provides rather than the learnng it may offer; * The femnization of work as a consequence of the economic crisis of 1995 has led to tensions in the family by the new demands on men to collaborate at home and has increased the vulnerability of children; * The increased vulnerability of children leads to abuse, abandonment and the loss of human capital. Children tend to reproduce the violence they have witnessed. 8 23. The govemment of Colombia is currently developing its strategy to attain the MDGs. Table 4 shows Colombia's current position in meeting these targets and Annex A2 outlines Colombia's strategy to improve its position. Studies conducted by the National Planning Department, the UN Development Program and other institutions indicate a widespread pattem of poverty, lower human development indices (especially in health and education), and a significant deficit in access to basic infrastructure services such as water and sanitation among both the indigenous and Afro-descendent populations. It is estimated that 10.5 million Colombians are of Afro-descendant origin, 1.2 million of whom live in the Pacific Region and southern Bolivar in the Caribbean coast. In addition, there are an estimated 800,000 indigenous peoples distributed in 82 ethnic groups. There are also significant enclaves of Afro-descendant persons living in urban slums, many of whom have been displaced by the armed conflict in rural areas and are often excluded from access to public services. 24. Given this situation, the government and the WBG will conduct a special pilot exercise which would disaggregate data from national household surveys and the national census, as well as other reports, to assess the status of Afro-descendent and indigenous populations in terms of the MDGs. Working in collaboration with the United Kingdom's Department for Intemational Development (DFID), a cross-sectoral team of Bank specialists will assist the govemment to develop a methodology for disaggregating poverty data regarding indigenous and Afro- descendant populations; designing a system for monitoring the impact of current education, health, social protection and rural/urban infrastructure programs on these traditionally excluded populations; and, developing new modes of social targeting and project evaluation which would more effectively include them in the country's poverty reduction programs. III. COLOMBIA'S DEVELOPMENT CHALLENGES-BUILDING THE ECONOMIC FOUNDATION OF PEACE' 25. Growth has been Colombia's best and most effective social safety net; on average, each percentage point increase in per capita GDP, reduces poverty by 0.6 percent (a quarter million people). Given the historical, geographical, and military fragmentation of the country, and the related weakness of the state, the possibility of eaming income within a growing economy has held the nation together. That order came to an end in 1999, wiping out within a year the previous decade of decline in poverty levels. 26. Furthermore the 27 million Colombians that live in poverty will need to be provided the tools to share in that growth. For most of them, better human capital formation mechanisms, and better markets in which to sell that capital, will be the answer. Both the public education and health systems need to be freed of the vested interests that now resist reform and accountability. In both systems, the govemment is paying too much, and getting poor and deteriorating quality. At the same time, the legal and regulatory framework of the labor market, where the poor should be able to exploit their human capital, is out of tune with a modem economy and effectively shuts out one in three workers. A comprehensive labor reform is overdue. But flexible labor markets and enhanced human capital will not be the answer for all Colombians-certainly not for those that cannot cope with systemic shocks, have been displaced by the conflict, or still face gender-based discrimination. 27. Finally, the govemment's capacity will be challenged by the breadth of the attendant policy agenda and a reform of the state is thus critical. This implies improving the way the state 1. This section is based on Policy Notes discussed with the authorities in July 2002. Marcelo Giugale, Olivier Lafourcade, and Connie Luff. Colombia-Policy Notes: The Economic Foundation of Peace. Washington, D.C.: The World Bank. 9 discharges its main functions-how it budgets, procures, audits, evaluates, regulates, supervises, and reports. Moreover, the context in which those functions are performed should be the subject of reform, on three fronts. First, the decentralization of responsibilities is on an unsustainable path, and a new incentive framework is necessary if departments and municipalities are to raise the quality of their public services and maintain fiscal discipline. Second, the mechanisms to fight corruption need strengthening. And, third, the judicial system delivers services of poor quality and insufficient quantity which a few critical reforms could improve. Achieving Fast and Sustainable Growth 28. Putting the economy back on a rapid, sustainable growth path requires action on six fronts: (a) achieving a sustainable macroeconomic framework by spending less, reducing debt accumulation, expanding the taxable base and improving tax collection; (b) completing the reform of the financial sector-both the conclusion of the bank-restructuring program and the fiscally all-important pension reform are pending; (c) improving the institutional, regulatory, and cross-subsidization arrangements in infrastructure provision to encourage private sector participation and extend service coverage to the poor; (d) achieving a strong supply response from the private sector through reactivation of its dynamism and a strengthening of the investment climate, (e) reorienting public policy to facilitate market signals to revive the rural economy, despite the armed conflict, the illegal crops, and the coffee crisis; and (f) exploiting the synergies between growth and environmental protection. 29. Maintaining Macro-Fiscal Adjustment. During the past four years, Colombia's macroeconomic policy had to focus on redressing the imbalance in the public purse. In this context, the growth of territorial transfers was delinked from the central government's revenues, fiscal discipline among subnational governments was fostered, public investment was further curtailed (to a mere 1 percent of GDP), civil servants' real wages were reduced (a measure later reversed by the Constitutional Court), the base of the value-added tax (VAT) was widened, and fuel taxes were increased. The Central Bank's independence was enhanced and its mandate to fight inflation was strengthened. However, these measures fell short of correcting the financial imbalance of the public sector-the deficit remains high and the country's sovereign debt position has deteriorated and is still on a non-sustainable path. 30. Colombia has faced an increasingly difficult situation with increased security requirements, lower-than-expected economic growth, and overspending by some public entities have led to a larger fiscal deficit than foreseen under the government program supported by a three-year IMF Extended Fund Facility and a Bank-SFAL. The fiscal slippage and the difficult security situation exposed the country to increased contagion from other countries in the region, and after mid-year the peso came under pressure. At the same time, the sovereign bond spread widened sharply, effectively closing the financial markets to Colombia. Faced with these challenges, the government took steps to rein in the fiscal imbalances, first by levying a one-off tax on net wealth to finance increased security, and by presenting to Congress a fiscal package of tax measures and key structural reforms. To further strengthen the public finances the authorities have advanced on a plan to downsize public institutions, and early next year a proposal for a two-year freeze on most current primary spending will be brought to a vote in a nationwide referendum. The government has sought support from the IMF and a key component of the program is to ensure that Colombia will gain firm control over its public debt dynamics, thus reducing the exposure to external shocks. 31. The main macroeconomic task of the new administration will therefore be to carry out fiscal adjustment and put the accumulation of public debt on a sustainable path. More specifically, even under optimistic assumptions in terms of growth, the new authorities will have 10 to reach and maintain a primary surplus in the nonfinancial public sector of at least four percent of GDP per year just to keep debt accumulation on a manageable trend and, at present, that surplus stands at only one percent of GDP. This requires action on three fronts-a major reduction in the size of the state, a growth-friendly tax reform, and better debt management. This poses a formidable challenge, especially when there is a strong demand for more public presence in the country. 32. Consolidating the Reform of the Financial Sector. Policy in the financial sector, the second key element in achieving fast and sustainable growth, will also be about completing and consolidating reforms. A systemic banking collapse was averted in 1999, through the "officialization" of affected public banks and a consolidation process that drastically reduced the number of players in the market; however, the fiscal liability arising from rescuing borrowers, depositors, and bankers was large, and is so far estimated at about 7 to 8 percent of GDP, depending on how much of the losses from non-performing loans of public sector banks are recovered via the ongoing disposition of the foreclosed assets. Specifically, there are still significant weaknesses in the housing finance sector where the nonperforming loan portfolios continue to loom large (especially in the state controlled entities) and risks associated with asset- liability mismatches have not yet been fully addressed. Reforms are also needed to improve the operation of public debt management, address critical governance and regulatory issues related to entities participating in the capital and debt markets, consolidation of state controlled second- tier banking entities, and regulation for bank resolution, bad-asset disposition and the insurance sector. Therefore, building on the financial sector reforms put in place during 1999-01, a second round of financial sector reforms will need to be implemented, while minimizing any further fiscal costs or interruptions in the flow of bank lending to the private sector. 33. Second, housing and rural finance merit a closer look. Restoring the housing finance industry to soundness is vital, as Colombia is estimated to have a deficit of one million new housing units, and two million in need of repair. The sector has experienced a sharply growing non-performing loans portfolio as a result of the weak performance of the economy, uncertain legal environment and deficient financial instruments related to indexation. Furthermore, it is unlikely that private banks will be attracted back into rural finance, especially for small and medium borrowers, as long as the armed conflict continues. Nevertheless, it is essential to establish an institutional base for a sustainable expansion of access to financial services in rural areas and other underserved segments, that does not rely upon continuous government subsidies. 34. Third, reform to the pension system also remains incomplete and poses a major contingent liability to the fiscal accounts. The consolidated pension system for public sector workers is technically insolvent, and the annual fiscal transfers required to cover its cash deficit is equivalent to the total health budget. This is a worrisome position for a country that is still demographically young and whose pension system only covers a third of the labor force. Contribution rates are already too high and discourage participation in the formal labor market. Until a transfer of all workers from the public pension system to the private sector can be achieved, further reforms should focus on a reduction of the benefits package and reform of the currently exempted regimes. 35. Moreover, banking and pension reforms go hand in hand with a strategy to create a deeper, more liquid capital market. Much activity is underway: the three stock exchanges have already been integrated and merged; a proposed draft capital market framework law that would reduce obstacles for private securities issuance is currently in Congress; a new mortgage securitization firm is now operating; market-making has been institutionalized for government bonds; and, an almost complete range of Treasury bill maturities are now available. Recent issues by multi-national entities have helped diversify somewhat the pool of fixed income 11 securities available in the market. However, access to the fixed-income market by non-sovereign issuers needs to be improved to reduce the crowding out of private financing. 36. Finally, a healthy and stable development of the domestic financial sector would require strengthening the legal and regulatory framework applicable to financial institutions, including the Anti-Money Laundering and Combating the Financing of Terrorism (AMLICFT) regime. The Ministry of Finance and Banking Superintendency have strengthened its AML/CFT system over the last two years, including the establishment of a monitoring unit to detect money laundering and white collar crime. The Bank stands ready to provide technical assistance and training in this area as needed, and/or to direct other TA providers to answer these requests. The FSAP program, in which Colombia participated in 1999, could be an efficient tool to provide an updated assessment of the country's financial sector vulnerabilities, including those in the AML/CFT regime. 37. Infrastructure - Making Private Participation Work for All. Adequate provision of physical infrastructure will be the third key element in retuming Colombia to a path of fast and sustainable growth. This is particularly relevant for a country where armed groups systematically target and destroy infrastructure and kidnap those that could help rebuild it. It is therefore not surprising that private investmnent has been very low. A main challenge is the existing major deficiencies in the access road network, water and sanitation facilities and basic urban services. This especially affects basic services to the poorest segments of the population such as those living in rural communities, urban squatter settlements and conflict areas. Moreover, unsatisfactory sanitation facilities have been shown to have direct health consequences which can be acute in the poorer neighborhoods-and absence of secondary roads severely limits access to schools and health care facilities. Efficient policies and procedures also need to be developed to anticipate, prevent and mitigate the effects of natural disasters which strike Colombia with regularity and disrupt basic infrastructure services, making as much use as possible of private initiative and insurance market instruments. 38. In the past, despite the difficult circumstances, Colombia has been fairly successful in attracting private participation into the provision of infrastructure services. The policy challenge is how to make private infrastructure investment more appealing in the context of the conflict, increase the coverage for those that cannot pay for infrastructure services, and protect the fiscal accounts. The remaining institutional and regulatory constraints that prevent further private participation should be removed; and, the stratification system for subsidization should be improved either by better means-detection and means-testing tools (not just housing quality); or a government-funded minimum level of service should be provided to all consumers, above which marginal tariffs grow steeply to recover the initial investment. 39. The problems with the various infrastructure sectors also have a common geographical point of convergence-urban centers. Two thirds of Colombians live in urban areas, of which more than half live in poverty and the armed conflict feeds the migration flow to cities. Those cities now operate within more binding budget constraints that limits their capacity to support the arriving poor. It is estimated that one fifth of all urban land developed each year is developed in informal settlements, where the subsequent provision of basic services is not only more expensive but also illegal. Local governments are compelled by law to produce nine-year land- development plans that are supposed to direct the new settlements toward efficient locations, but because of lack of resources, few municipalities do. 40. Facilitating a Private Sector Supply Response. If the private sector is to be able to realize its full potential, it will be essential for the investment climate, in the form of the legal and commercial framework for domestic and foreign enterprises, to be fully conducive. 12 Colombia has made a fair amount of progress towards establishing such a framework, both on the domestic and FDI fronts, through the introduction of a number of legislative enactments over the past decade. The challenge will now be. to consolidate all of these under a modem bankruptcy and commercial framework, while strengthening institutional capacities (such as the that of the Superintendency of Securities). Second, it will be essential for the major corporate entities, which are the backbone of the private sector in Colombia, to be able to strengthen their financial standing and competitiveness. To do this, they would need to improve access to finance through a strengthening of corporate govemance practices and adoption of socially sustainable business practices. Third, investment climate and access to financing for smaller firms will need to improve in order to achieve a broad-based private sector response. 41. Facilitating the Rebirth of the Rural Economy. Starting in 1991, the govemment embarked on a comprehensive reform program for the sector called la apertura. It essentially aimed at (a) trade liberalization and lower tariff reforms, (b) the promotion of market-oriented approaches, and (c) the reduction of state intervention in marketing and licensing activities. These reforms were meant to reinvigorate the agricultural sector and promote private sector involvement and access to the export markets that had remained underdeveloped as a result of import-substituting policies. It aimed at building on Colombia's comparative advantages to improve productivity and competitiveness. The apertura was immediately confronted with major exogenous challenges that occurred at the same time: (a) a significant exchange rate appreciation deriving from capital inflows associated to a favorable perception by foreign investors of the new liberal policies; (b) the inflow of financial resources from drug trade; (c) a drop of international prices for most agricultural commodities and consequent reduction of producers' real prices; (d) an increase of inflation rates generated by lax monetary policies and an expansion of government spending; and (e) one of the worst droughts in Colombian history in 1992. This led to a crisis in the agricultural sector which made further implementation of the reform agenda in the sector very difficult and important reforms were only partially implemented and for too short a period to have an impact. A decade later, the sector's productivity has not increased, coffee production is on the brink of collapse, the crops that are profitable are illegal and eighty percent of the rural population remains poor and subject to an armed conflict whose epicenter is the control of land. 42. The necessary diversification, and through it, the revival of the rural economy, calls for three main policy reforms. First, the sector needs to be put permanently on a path of open markets and private-sector-led efficiency, including the development of competitive rural financing systems and product diversification in line with the country's agro-ecological potential. Second, distortions to the land market should be removed as Colombia has one of the most concentrated land ownership structures in the world. Finally, the diversification of Colombia's rural economy will be spearheaded by the structural transformation of the coffee industry, guided by land redistribution and increased competitiveness. However, formidable external forces are changing the business of coffee: international prices are very low and are likely to continue to stay low; the concentration of international roasters, traders, and retailers has squeezed the share of earnings going to producers; and consumer preferences have shifted toward specialty coffees. 43. Mainstreaming the Environment in Key Sectors. Colombia is one of the most biodiversity-rich countries in the world, with unparalleled diversity at the genus, species, and ecosystem levels. However, much of this natural wealth is being rapidly destroyed, by two main factors. First, the arned conflict protects and fosters illicit crops that are grown in primary forests, leading to soil contamination, discharge of chemical residues from coca laboratories into important waterways, and forest clearing into virgin forest areas in response to fumigation efforts. Second, much of Colombia's growth and fiscal resources are increasingly dependent on 13 oil, gas, and coal which can, without the introduction of best environmental management practices and the transfer of international expertise, have a negative impact on the environment. The government will need to balance socioeconomic development with environmental protection. Policies which mainstream environmental considerations in key sectors can support existing government programs, improve coordination and strengthen consensus among key stakeholders, while supporting the development of appropriate fiscal instruments in support of environmental goals. Sharing Growth with all Colombians 44. Colombian society is highly unequal. While in the past three decades, sustained growth brought about marked reductions in poverty, inequality continued to increase. This not only affects the distribution of income but also of assets and of access to infrastructure-the two top deciles control 60 percent of income, while the bottom two accrue less than five percent; the measure of land concentration is one of the largest in the world (Gini 0.86); and the coverage of electricity, water, sewerage, and other public services often do not reach the fast-growing informal settlements where most of the urban poor live. Moreover, inequality seems resilient to public policy-it has not been significantly dented by 40 years of land redistribution efforts, low- income housing programs, and schemes for cross-subsidization among users of infrastructure. In fact, many of those policy efforts were not only ineffective in reducing inequality but also hurtful to growth (as the ensuing market distortions dampened investment). This is an inauspicious position to be in because, in Colombia, inequality has been shown to be a determinant of violence. There are two strategic lines of response for policy: break the lock that interest groups have on the public systems of human capital formation (education, health, labor markets), and attend directly to the needs of those for whom markets will not cater (social safety nets, the displaced, gender discrimination). 45. Recovering the Mechanisms for Human Capital Formation. Some two million, primarily poor, school-age children and youth are out of school, a worrisome fact since reaching nine years of education in Colombia has been found to reduce the risk of poverty by one third. Those inequities are exacerbated by problems with the quality of public education, in turn brought about by outdated teacher training, weak teacher supervision, inflexible curriculums and, most important, weak accountability mechanisms. The sharp inequity and the stagnant quality of the public education system is not due to lack of resources-over the last three decades public education expenditures quadrupled in real terms, while the school-age population grew by less than one third. The policy priorities for education would be to better achieve the benefits of decentralizing by supporting improved capacity at the local level and to link funding to the number,of students rather than teachers, and to promote accountability for results. 46. A similar problem of capture by special interests affects the performance of health and is bringing major parts of it to the brink of financial collapse. In 1993, Colombia implemented a sweeping, pioneering reform of its health system. The new arrangement ensured efficient, effective, and universal coverage by separating the funding of health services from the provision of those services. People would pay for health insurance according to their means, with the poor being subsidized by the government and by a portion of the premium for the nonpoor. The initial results of the reform were impressive-total coverage more than doubled, rural coverage increased sevenfold, and coverage among the poorest decile rose tenfold. The World Health Organization now ranks the overall performance of Colombia's health system as the best in Latin America, and 22nd in the world. These achievements, however, are jeopardized by the fact that public hospitals have not adapted to the new market rules due to labor costs rigidities and, as a result, although public resources for hospitals have more than doubled in real terms since the reform began, two thirds of that increase went to pay for a larger wage bill. 14 47. Improving education and health will mean little in terms of inequality reduction if the poor cannot count on functioning labor markets. However, Colombia's formal labor markets are excessively rigid. High and binding minimum wages, hefty social security contributions, and powerful unions that are primarily concerned with maintaining real wages result in high unemployment (17 percent in mid-2002). The wedge between the cost of labor to the employer and the compensation received by the employee is worth about 50 percent of the wage bill (compared to 39, 31, 19 percent in France, Mexico, and the United States, respectively). Not surprisingly, 60 percent of the workforce operate in the informal sector. This calls for a major overhaul of the labor market legal and regulatory framework. Similarly, employment generation will call for the expansion of low-income financing to entrepreneurs in the informal and micro- enterprise sector, including programs to foster supplier linkages between larger firms and smaller enterprises, and policies to facilitate the transition of non-profit micro-finance organizations into regulated, financial entities. 48. Helping Those for Whom Markets Will Not Work. While strong human capital and functioning labor markets will be an effective means for many Colombians to share in the fruits of growth, there will be others for whom market-based solutions will simply not work and for whom direct government support will be necessary-those that cannot cope with systemic crisis, those that have been displaced, and those that are discriminated against on the basis of gender. 49. Colombia never really had a formal social safety net, something that became painfully clear during the unprecedented macroeconomic crisis of 1999. In response to that crisis, a temporary five-year Social Support Network was created to fund temporary employment conditional cash transfers to poor families and firm-based apprenticeship grants for youth. The network, which took two years to unfold fully, has several loopholes, but one is particularly worrisome-it does not sufficiently protect children and adolescents at risk. All this is both a challenge and an opportunity for the new administration. Based on the lessons that the completion of the Social Support Network will bring in 2004, it should proceed to establish a permanent and comprehensive Social Risk Management System. This need not mean new budget appropriations; rather, it should absorb the funding currently going to the SENA, the Caja de Compensaci6n and the ICBF. 50. Even a properly functioning social safety net would, however, need to be adapted to cater to the urgent needs of Colombia's displaced population. Unofficial estimates put the number of desplazados at some two million people (about five percent of the population). The majority are women, about half are under 18 years old, and one fifth is either Afro-Colombian or Indigenous. Virtually all are poor. To this end, there are five priorities. First is to give them means of political representation, including mobile voter registration services-this would ensure sustained policy attention. Second, support mechanisms should move from mere humanitarian aid to schemes for return, relocation, or integration, and adequate budget resources should be made available. Third, the operating rules of all existing social assistance programs, including those that are based on means tests through the SISBEN, should be modified to allow for priority consideration of displaced cases. Fourth, local governments should be encouraged to take the lead in preventive action in high-risk regions, for which additional resource transfers from the central government will be needed. Fifth, a good method to track and classify the displaced populations should be developed. 51. Finally, ascription of gender-based roles distorts the way many Colombians can profit from the growth process. But, contrary to common observations elsewhere, in Colombia those roles are more harmful for men than women. Girls have higher school enrollment levels than boys, women's fertility and maternal mortality have decreased, women's labor market participation rates have increased, and gender gaps in wages have narrowed. Not only do boys 15 perform worse in education, but also males are more affected by HIVIAIDS-, alcohol-, and drug- consumption-related diseases. More critically, males are the disproportional victims of violent death because of both the armed conflict and crime. School curriculums and learning materials that refrain from gender stereotypes and teach conflict resolution skills; media-based campaigns that provide nonviolent role models; and community-based programs that seek to identify and prevent local sources of violence (like the govemment's Convivencia y Seguridad Ciudadana) are the best ways to address gender-driven social issues for males. Building Efficient, Accountable and Transparent Governance 52. Reaching fast and sustainable growth and giving people the tools to share in the fruits of that growth are difficult goals for any government. Colombia faces an especially formidable challenge, for the armed conflict, the illegal drug industry, and the capture of policymaking by interest groups have all but paralyzed the effective authority of the state. It will therefore be imperative to focus on five areas where the marginal returns are highest-reform of the state's functions, decentralization, budgetary institutions, corruption, and justice. 53. Reform of the State. Reform of the State should be about fixing critical functions within the State, not about reordering reporting lines and shifting personnel among ministries and institutions. Those functions include much-enhanced accountability in decentralization transfers; an initial shift toward results-based investment budgeting in the central budget; a major overhaul of procurement systems (with transparency as the guiding principle); much stronger intemal and external auditing of the central government; currently-missing tools for evaluating public expenditure in terms of their impact; more efficient and more independent regulation in infrastructure (especially in roads, water, electricity, and gas); and better mechanisms to detect, report, and punish abuse of power and rent-seeking. 54. Decentralization. Since the mid-1980s, Colombia led Latin America in embracing decentralization to bring policymaking closer to its beneficiaries (partly as a tool to address the causes of the armed conflict), enshrined it in the Constitution of 1991, and implemented it almost at once. The results have fallen well short of expectations, and have threatened not only the efficiency of sectoral expenditures but also the fiscal pillar of macroeconomic stability. Decentralization remains the best option, but local govemments need support to improve their capacity and to strengthen incentives to rely on local taxation, enhance efficiency in service delivery, and maintain fiscal discipline. A mechanism is needed to evaluate, and hold local govemments accountable for the results they achieve with transferred funds, especially in education. Finally, central govemment resources should be invested in developing a common budgeting, accounting, and reporting framework at all levels of the state, as well as common procurement standards. 55. Budgetary Institutions. In recent years, Colombia has established a single treasury account for its central govemment. This technical improvement has, however, not been matched by better policies in designing and operating the budget itself. The National Development Plan should become a strategic, indicative roadmap, rather than a bloated, legally binding list of wished-for projects, the execution of which is then controlled discretionally through cash management. International accounting standards (like the IME's Government Finance Statistics Manual) should replace the rather loose definitions currently applied in Colombia's budget. Congress and the public should be given access to the government's financial information system and to the currently-under-construction results assessment system (S1NERGIA). The split responsibility for the operational budget (current expenditure) under the ministry of finance, and the investment budget under the ministry of planning should be unified, and only one of 16 those institutions made responsible for the whole budget, something that will avoid funding investment projects without adequate operation and maintenance allocations in subsequent years. 56. Corruption. Corruption in Colombia is widely considered to be one of the most serious development challenges. Surveys have indicated that although corrupt practices in transactions such as tax payments or the processing of permits are relatively infrequent under regional standards, a more systemic but less visible form of state capture permeates most areas of government involvement. Powerful political, economic, and social interests exert influence on policymaking bodies, regulatory entities, economic management and budget, and other key areas of public policy. Although previous Colombian administrations have clearly identified corruption as a main issue, state capture has not been faced in practice. During the Pastrana administration, a Presidential anti-corruption program was set up under the direct leadership of the Vice-President that had some interesting advances in citizen participation, processing cases through the judicial system, and implementing risk-mapping techniques in some institutions. However, the broader issues of the vulnerability of the state, from both policy and strategic viewpoints, were not addressed. 57. Judicial System. This system was one of the main targets of the 1991 Constitution; the overall objective was to raise the Judiciary's legitimacy and performance through a modern institutional set up and increased resources. More that ten years later, in spite of some progress in specific areas, the overall results are disappointing. What can now be done to fix it? First, a new justice paradigm is required to respond to societal demands: providing adequate access to the citizenry to prompt and effective justice services. Second, a critical challenge is related to the Judiciary's governance structure that requires a single leadership, adequate mechanisms and incentives for coordination, and a revised system of nomination of judges that ensures an appropriate balance between independence and accountability. Third, although the resources available to the Judiciary are relatively generous there is plenty of room for productivity improvements; expenditure rigidities and investment preconceptions will need to be addressed as demands for a new management model and style are growing, including more accountability to the system's users through boards that include stakeholders outside the Judiciary itself. Fourth, the Attorney General's Office should continue its restructuring process and become publicly accountable for an agreed set of socially relevant performance indicators (like serious-crime prosecution rates). Finally, a sizable investment in improving the physical infrastructure and computer systems is long overdue. IV. GOVERNMENT'S AGENDA OF POLICIES AND PROGRAMS 58. The government's strategy contains a broad social, political and economic agenda that includes: (a) resuming peace negotiations (after the guerrillas cease all hostilities and kidnappings); (b) restoring sustainable growth and generating employment by implementing successful pension, labor and tax reforms, promoting exports, providing social protection, and increasing coverage and enhancing quality in health and education; (c) supporting the rule of law by ensuring that the government is itself bound by the law, that all Colombians are treated equally under the law, that government authorities (including the judiciary) protect the human dignity of its citizens, and that justice is accessible to all. The rule of law requires transparent legislation, fair laws, predictable enforcement, and accountable governments to maintain order, promote private sector growth, fight poverty, and protect human rights; and, (d) supporting the international fight against terrorism. 59. At the core of this program is the administration's Development Plan for economic and social reform, particularly in the areas of pensions, labor, tax and the modernization of the public 17 administration. The government is still working out the details of the plan, sometimes in collaboration with the WBG. It has five pillars: * Reduce the fiscal deficit by implementing a program that includes expenditure reductions and a comprehensive overhaul of the public sector and of the taxation system. Although the government has recognized the need to strengthen fiscal accounts and has begun to set a solid foundation for further reforms, these will need to be expanded and accelerated in the coming years. Continued fiscal adjustment is unavoidable if debt sustainability is to be attained. Just as important, the quality of the adjustment is vital for a return to the fast and sustainable growth that has historically been the key to poverty reduction in Colombia. Reducing the fiscal gap, while strengthening conflict resolution and building the peace effort, will represent a formidable challenge. * Foster sustainable economic growth and employment generation by (a) implementing labor and pension reform; (b) promoting competitiveness, innovation and technology; (c) fostering trade integration; and (d) increasing private participation in the delivery of public services and infrastructure. * Bring about security by (a) seeking a negotiated solution to the conflict; (b) developing conflict areas through assisting the displaced population, training the army and police regarding human rights, providing basic infrastructure and food security; (c) fighting narcotics through eradication, alternative development and prevention of drug consumption; (d) controlling arms traffic and money laundering; (e) strengthening the army; and (f) improving the judicial system. * Building a more equitable society through (a) broadening the quality and coverage of education; (b) widening and improving social protection; (c) strengthening SMEs and cooperatives; and (e) improving the quality of life in urban areas. * Increasing the efficiency of the State through (a) implementing political and public administration reform; (b) furthering decentralization and territorial development, and (c) strengthening local democracies and civil society participation in public administration. V. WORLD BANK GROUP'S PARTNERSHIP WITH COLOMBIA The Lessons of the Previous CAS 60. The previous CAS was discussed by the Board of Executive Directors in November 1997, and the CAS Progress Report was discussed in November 1999. Following participatory consultations with government leaders and civil society the CAS identified, and the CAS Progress Report reconfirmed, the main objectives of poverty reduction, social development and sustainable growth. Anchored with a stable macroeconomic environment and fiscal sustainability, these objectives were to be achieved by interventions in the following key areas: (a) promoting peace and development; (b) supporting rural development; (c) developing human capital; (d) attaining public sector responsiveness; (e) improving infrastructure services; and, (f) ensuring sustainable development. 61. The Bank's primary support was through a base-case lending program of around US$300 million per year. This relatively low lending ceiling was determined by Colombia's preference to limit its IBRD borrowings. The CAS Progress Report moved the assistance strategy to a high- case lending program, with increased emphasis on adjustment lending, to around US$450 million annually. This program was to be complemented by key non-lending services such as: (a) policy notes to summarize the major challenges in Colombia's social-economic development and to 18 serve as a bridge to the new administration. These included thematic notes on peace, growth, governance, natural resource management, poverty and inequality and notes on 33 essential sector issues. There were discussed in July 2002, and at the request of the government, they will be published as a book; (b) a poverty report to assess the evolution of poverty and inequality in urban and rural areas, the incidence of crime and violence and related household responses, and an overview of public social expenditures; and, (c) an assessment to evaluate the reforms to Colombia's social safety net, both for addressing the needs of vulnerable groups during normal times and for developing counter-cyclical strategies that could be implemented rapidly during times of crisis. 62. There are several lessons of the previous CAS. First, the introduction of civil society in the formulation and implementation of development initiatives will lead to a high level of ownership and commitment to successful project implementation. Second, the transition from reliance on implementation by centralized public entities, particularly in the social sectors, to projects that are managed by decentralized, local levels of government also leads to increased ownership and commitment. Third, in the infrastructure sector, project performance improved due to the implementation of a strategy to shift from direct financing of ventures to activities that aimed at strengthening the regulatory and institutional framework to enable private sector participation. Finally, the Bank's investment in analytical work, especially collaborative ESW products, provides decisive guidance in the design of our operations (Social Safety Net Study and Poverty Assessment) and helps foster a process of debate on key development issues and promotes serious discussion of alternatives facing the country (Policy Notes). 63. IBRD's Portfolio. Colombia's portfolio performance has remained satisfactory throughout the CAS period, and currently only one project is rated unsatisfactory (5.3 percent of commitments). The Bank's portfolio in Colombia contains 26 active projects, including 3 GEF/MP projects, with about US$1.3 billion in net commitments and an undisbursed balance of US$ 569 million. The FY02 disbursement ratio for investment loans was 29.5 percent, versus 19 percent for the LAC Region, and the year-to-date disbursement ratio is about 5.1 percent. 64. OED plans to undertake a Country Assistance Review to assess the implementation results of the 1997 CAS in the third quarter of FY03. Of the 15 projects that closed during the implementation of the 1997 CAS, OED has rated 67 percent as achieving a satisfactory outcome, sustainability was likely for 47 percent, and institutional development impact was substantial for only 27 percent. While Colombia's performance was below average Bank performance for the same period of implementation (for all Bank projects closing between FY97-02, 75 percent achieved a satisfactory outcome, sustainability was likely for 62 percent and institutional development impact was substantial for 43 percent), it is significantly above average Bank performance for projects that have closed in the last two fiscal years. Furthermore, four Colombia projects were assessed by QAG for quality at entry during the CAS period. The overall assessments of these projects was 100 percent satisfactory, while the Bank average was 88 percent satisfactory. Similarly, four Colombia projects were assessed for their quality of supervision and were rated satisfactory or better, while Bank-wide only 78 percent were rated satisfactory. Finally, two Colombia AAA were assessed for quality and both were rated satisfactory. 65. There are two main lessons that can be drawn from the implementation of the IBRD's portfolio during the last CAS period. First during a change of administrations, it is essential that the IBRD assist new counterparts to better understand the portfolio, and to ensure that the new govemment has ownership of the projects under implementation. Second, the previous CAS recognized that poor portfolio performance had impeded the Bank's ability to assist in Colombia's development. An increased focus of the government and Bank's country team on 19 portfolio management helped improve project implementation. This focus included: (a) being responsive to client priorities, including avoiding projects without strong government ownership; (b) maintaining intensive supervision of projects; (c) strengthening the Colombia Country Office; (d) making effective use of CPPRs; and, (e) increasing training aimed at improving procurement, audit, and project management skills of staff in executing agencies. 66. A Country Performance Portfolio Review took place in September 2002. The objectives of the review were: (a) learn from the implementation experience of on-going projects to improve both the implementation of the existing portfolio and the quality of projects under preparation; (b) ensure that the new government has ownership of the projects under implementation; and, (c) discuss systemic problems and develop a time-bound action plan to resolve them and address key project-specific issues. The findings of this review were discussed in a day-long workshop with the government. Systemic problems were identified, particularly in the flow of funds to projects, procurement, financial management and the sub-contracting of project management to administrative agencies. It was agreed that a working group comprised of the National Planning Department, Finance Ministry and the Bank would meet periodically to review progress on the resolution of these issues. 67. IFC Experience. Since early 1990s, the level of lFC's activity in Colombia has fluctuated over time with: (a) the level of private capital flows; (b) the level of private investment; and (c) the pace of reform, particularly in infrastructure and the financial sector (Table 5). In the first half of the l990s, Colombia was a regional leader in economic reform, and by mid-1990s became a pioneer in the development of private infrastructure. Private investment, relative to GDP, increased steadily towards a peak of 16.7 percent (in 1995); however, access to private capital was modest around 2 percent of GDP during the period. This combination of progress in reform, increasing private investment, and increasing yet still constrained access to private capital presented EFC with an opportunity to play a catalytic role in Colombia. IFC supported key sectors, such as the hydrocarbons and financial sectors and notably private infrastructure, with investment totaling $379 million, including syndications, for the period FY91-95. Beginning mid-1990s until the late 1990s, Colombia experienced further improved access to external financing despite a slower progress in reform and declining private investment. This lasted until the loss of investment grade credit ratings. During this period (from FY96 to FY2000), IFC's investment volume decreased to $190 million, with its role with larger companies that had good access to the market declining. IFC's opportunities to support "frontier" sectors, such as the more difficult infrastructure projects and smaller companies also declined, due to a stagnant private investment in these sectors. Table 5. IFC Investments 1991-2002 FY91 - FY95 FY96 - FY00 FY01 - FY02 IFC approvals ($m) $379m $190m $642m IFC: sectors of major Gas transportation Financial sector Support for corporate sector activity Financial sector Oil (reorganization, corporate Ports Tollroads govemance, sustainability) Housing finance Low income finance 68. With the loss of investment grade rating, the Government's strong commitment to reform, and the recognition that broad-based, private sector-led growth plays a critical role in Colombia's efforts to achieve a sustained growth path, demand for IFC to step up its activity in Colombia increased substantially starting in FY2001. IFC's program has been stronger than in any previous period (approval of $642 million for the past two fiscal years alone). At the same time IFC's activity has been more focused in areas of systemic impact, which have been 20 highlighted through continuous dialogue with the Government. These areas included: (a) supporting business groups and companies that form the backbone of the Colombian economy, which were faced with constrained access to long-term financing and needed to improve their organizational and financial structure; (b) expanding access to financing for a wider base of the population (e.g. housing finance, low income financial services); and (c) promoting environmental, social and corporate governance best practices. (See Annex Cl Private Sector Strategy for a more detailed discussion of IFC's focus in Colombia going forward.) Procurement and Financial Management in Colombia's Portfolio 69. Procurement. A Country Procurement Assessment Report (CPAR) was completed in March 2001. The report found that, with a few exceptions, for Bank-assisted projects procurement is carried out in accordance with Bank policies and procedures, and procurement performance under these projects is generally satisfactory and free of major problems. Two procurement audits and four agency procurement capacity assessments carried out in the last two years have found no major problems and determined that the procurement risk in Bank projects is lower than average. However, the CPAR found that public procurement and contract management had deficiencies that had the potential to result in inefficient use of public funds and could be a source of corruption. The main problems include: (a) a multiplicity of legal instruments regulating different aspects of public procurement (namely Law 80 of 1993 plus some 80 regulatory decrees); (b) poor planning due to a complicated budgetary and cash-release management system; (c) the lack of a leading institution responsible for formulating policy, developing regulations and standardizing procurement procedures and documentation; (d) the absence of a procurement career stream; (e) lack of uniformity and cumbersome procedures, including an ineffective registration and qualification system of contractors, consultants and suppliers: (f) a costly and risky environment which discourages good consultants, contractors, and suppliers from doing business with the public sector. 70. The findings and recommendations of the CPAR to strengthen public procurement were discussed and agreed in principle, including: (a) carrying out an inventory and review of all public procurement related regulations reviewing and consolidating it, and if needed amending the procurement law (Law 80) and issuing an integrated regulatory decree; (b) establishing a procurement policy body responsible for providing leadership and oversight to public procurement; (c) adopting standard procurement documents; and (d) putting in place an internet- based public procurement information system. Furthermore, building on the results of the CPAR, the National Department of Planning (DNP) is implementing a Public Procurement Project (Proyecto de Contrataci6n Estatal) with the objective of implementing the CPAR recommendations, which is being supported by Public Financial Management Project (PFMP). An initial output of the project was the development of a policy paper which was adopted by the previous government. 71. The government has expressed its strong commitment to modernizing and introducing transparency to public procurement, and has taken short term actions to increase public participation on the oversight of procurement decisions. It has confirmed its intention to continue with the implementation of the plan, but a specific medium- to long term- implementation program has not yet been developed. The Bank will however assist on the broad objectives of streamlining the legal framework, establishing institutional mechanisms that provide leadership and administrative oversight, streamlining documentation and completing implementation of a procurement information and e-procurement systems. 72. Financial Management. A Country Financial Accountability Assessment (CFAA) was carried out in September 1998. As a result of the recommendations in the 1998 CFAA report, 21 the Office of the Accountant General and public accounting institutions have been strengthened. These efforts have been supported by recently completed sector work on corruption and by the Bank-financed PFMP I and II. These operations have supported the government's measures to strengthen institutional capacity and analysis in a number of key areas of public expenditure; macro-programming, formulation and monitoring of the budget, budget execution, including the development and implementation of an Integrated Financial Management System (SIIF), and evaluation of results of public expenditure, including the implementation of the National System for Evaluation of Results of Public Sector Performance (SINERGIA). 73. Despite important progress in public expenditure management, further strengthening of financial management processes is needed. The Bank would support the govemment to: (a) develop a risk mitigation and capacity building strategy; (b) improve government effectiveness at the national and sub national levels; (c) implement a new accounting model which would consist of revised forms, principles and methods of accounting and financial reporting meeting the requirements of an Integrated Financial Management System; and, (d) define a model of financial agencies to support the financial management systems of projects. The next CFAA is under preparation and will have a special focus on sub-national finances. VI. WORLD BANK GROUP ASSISTANCE STRATEGY 74. The long-standing armed conflict and violence are the most important issues facing Colombia. Although economic prosperity alone will not be sufficient to stop the violence, increased poverty could well further inflame the situation. Therefore, the overarching development objective of this CAS will be to support the government's efforts to achieve economic development as a necessary, albeit not a sufficient, condition for peace. Finding the path to sustainable economic development will be an important foundation upon which Colombia will build national reconciliation and lasting peace. The WBG's strategy, has been fully discussed with the government. It will seek to support Colombia's quest for peace in three essential areas: (a) achieving fast and sustainable growth; (b) sharing the fruits of growth; and, (c) building efficient, accountable, and transparent governance. WBG will prepare periodic progress reports on the implementation of the planned strategy. 75. The Bank's lending program would focus on operations that would: (a) have the most tangible impact on poverty alleviation and help Colombia meet the MDG targets; (b) restore macro-stability and sustainable growth while protecting the poor; (c) incorporate the lessons learned from WBG's operations, particularly from on-going Learning and Innovative Loans, and (d) pilot innovative interventions with important demonstration effects. The Bank would also support Colombia with its analytical work. In order to ensure that these services are demand driven, the Bank would continue to conduct most of its economic and sector work as joint products with the government. The impact of this would be enhanced through close interaction with policymakers and wide dissemination, including the use of seminars and workshops. 76. The CAS envisages a maximum lending program for IBRD of about US$3.3 billion for the remainder of FY03 to FY06, in order to align the WBG's strategy and instruments with the Uribe administration's term of office. About half of the lending program would consist of fast- disbursing operations to support the government's comprehensive reform program. If the government requires technical assistance, the Bank would add accompanying operations of less than US$5 million to support these programs. This increase in lending is justified by the ambitious and broadly supported program of the Uribe administration to build the foundation for lasting peace and to achieve poverty reduction. Colombia, which has traditionally had an excellent relationship with the Bank Group, is now turning to it to help the country through this 22 period when the country is faced with: (a) fiscal difficulties (resulting from fragile economic growth, a drop in exports caused by the recession in countries that are Colombia's main trading partners, declining petroleum production and historically low international coffee prices, and low private investment levels impacted by worsening internal security conditions and delay in certain policy reforms); and (b) restricted access to international capital markets (due to the country's loss of its investment grade credit rating and the general economic turmoil in the Region). At the end of FY02, JIBRD debt outstanding and disbursed was about US$2 billion and constituted less than 2 percent of the total IBRD portfolio, less than 6 percent of the country's total foreign debt, and less than 30 percent of total preferred-creditor debt. This is due, in part, to the country's tradition of competent economic management and access to private creditors, which determined its preference to limit DBRD borrowings and pre-pay IBRD debt when economic performance was strong. 77. This is a performance based strategy, where weakened performance would reduce lending from a high-case to base-case scenario, and, in the event of a stalling of reform, to a low- case scenario. The envelope for the high-case is US$3.3 billion. If the triggers in Table 6 are not met, IBRD would move to a base-case ranging between US$2 billion and US$2.9 billion and the Bank would not proceed with investment lending support for Natural Disasters Prevention, Water and Sanitation, Slum Upgrading, Decentralized Education in FY05 and FY06. Furthermore, lack of progress in sectoral reforms supporting a proposed adjustment operations also serve as a trigger for moving from the high to the base-case and would lead to an immediate downward adjustment of the lending program by the relevant amount. 78. IBRD would review the lending program and move to a low-case scenario of about US$900 million (US$225 million per year) or lower, with a focus on operations targeted to alleviate poverty and build social development, if the reform program were to completely stall or if the security situation were to substantially deteriorate. Table 6. Triggers to Remnain in High-Case Macroeconomic Sustainability Satisfactory macroecononmc performance, as demonstrated by continued implementation of the govemment's program supported by the IMF Stand By arrangement, together with the maintenance of a pnmary surplus sufficient to ensure public debt sustainability.2 Structural Reforms * In the Public Sector, reforms will reduce ngidities of expenditure by implementing intergovemmental fiscal transfers and other budget entitlements, and reducing exemptions in the value-added and income taxes. . In the financial sector, approve and implement amendments to the Banking Law, including a more efficient bank resolution system Social Sustainability * Satisfactory completion of the implementation of the Red de Apoyo Social program. * Passage by Congress of the proposed social protection/labor reform legislation and issuance of enabling regulations for its implementation. Portfolio Performance * A disbursement ratio of not less than 15 percent; * Satisfactory percentage ratings of not less than 80 percent of projects. 79. As reflected in the WBG's Private Sector Strategy (Annex C1), IFC's increased activity will accompany IBRD's enhanced assistance, supporting private sector firms-large and small- and catalyzing a private-sector supply response that Colombia needs for achieving higher, sustained growth and the sharing of that growth. IFC is stepping up its activity in response to the deteriorated market conditions, particularly the decline in private capital flows and low private investment, and the administration's request to help revitalize the private sector. EFC's contributions are expected to also support the areas of corporate governance, environmental and 2. Debt sustainability is defined here to mean the stabilization of the Debt/GDP ratio, not including contingent liabilities. 23 social sustainability, and low-income and micro financing, with its international expertise being transferred to the Colombian private sector. 80. IFC's primary choice of instruments will be structuring and investments (loans, equity and credit enhancement) for individual transactions, supplemented by non-investment activities in (a) private institution strengthening and (b) enabling regulatory environment and investment climate (in collaboration with the Bank). It will place emphasis on reaching out to a broader base of the Colombian private sector through: (a) supporting firms that are engines of growth, and have linkages to wider economic and social activity; (b) reaching out to smaller firms through financial and other intermediaries; and (c) selectively supporting small projects with large potential impact, particularly on the poor. 81. The following is a summarized description of the main instruments for WBG intervention, together with an indication of the strategic objectives they support (see Tables 7 and 8). CAS Objective: Achieving Fast and Sustainable Growth 82. Macroeconomic Framework. To correct fiscal imbalances and face large future fiscal liabilities, the government has recognized the need to strengthen fiscal accounts and has begun to set a solid foundation for further reforms, which will be expanded and accelerated in the coming years. The main objective of the IBRD's strategy in terms of the macroeconomic framework would be to support Colombia's continued fiscal adjustment, including the quality of the adjustment, as key for achieving faster and sustainable growth. To support this, the IBRD, in close collaboration with the IMF and JDB, will prepare a Programmatic series of Fiscal and Institutional Adjustment Loans (total of US$900 mnillion) to support fiscal adjustment, including reforming the tax system, strengthening the tax administration, implementing a fiscal responsibility law and reforming the public sector. These operations will support measures to reduce tax exceptions and expenditure rigidities while ensuring better quality and coverage of public services and investment. Tax reform measures will: a) simplify and expand the tax base (focusing on reducing exemptions to the VAT and the individual and corporate income tax); and b) reduce the disparity of tax rates for the VAT. The program would also include measures to develop public sector capacity to make better use of state assets, including liquidation, privatization and maintenance. Furthermore, these operations will support improvement of the tax administration, with emphasis on reporting and intermediation by the financial system, auditing and collection. A fiscal responsibility law would help reduce the fiscal gap by putting targets and ceilings that serve as safeguards against excessive expenditure and add transparency to budget and treasury operations. 83. As the current level and structure of Colombia's public sector debt pose a risk and make the overall fiscal position vulnerable, an Assessment on Public Debt Management will be carried out in FY03 to identify institutional needs, assist the government design a program to strengthen those needs and develop a comprehensive debt strategy to better manage the risks of the debt portfolio and reduce vulnerabilities. In addition, IBRD would help the government to identify policies for enhanced growth and reduce poverty. This objective would be carried out through a study on Growth for Tackling Inequalities for FY04 which would identify the major constraints to growth and would provide policy recommendations for building an environment conducive to sustained economic growth and greater competitiveness in order to reduce inequalities. Finally, the Bank would also carry out a Public Expenditure Review and Country Economic Memorandum in FY03 and FY05 respectively to enhance its knowledge on the main issues in macroeconomic management, structural reforms, poverty and public service delivery 24 trends, public expenditures, public sector management, and financial sector issues. They will provide diagnostic work and policy advice regarding main issues in these areas. 84. Financial Sector. In a continued effort to help promote the development of a well- functioning financial system that can provide adequate services to all segments of the productive sector and the population at large, and building on the achievements of the Financial Sector Adjustment Loan (FY00), the Bank plans to process a Programmatic Financial Sector Adjustment Loan (total of $300 million) to address the remaining agenda to ensure the health and financial sustainability of the banking system and to foster capital markets development. This will be complemented by: (a) EFC's interventions through individual transactions and technical advice on an enabling regulatory environment (in collaboration with the Bank); and (b) Bank analytical and advisory work to monitor developments in the sector and identify critical areas that require action. Through these initiatives, the WBG expects to support: * Winding up, restructuring, and/or privatizing (possibly with IFC support) the public financial institutions (most important, Banco Cafetero and Granahorrar) as early as possible to avoid further fiscal drain and erosion of the value of these entities. * Review and overhaul policies, procedures, and action plans implemented by CISA, the subsidiary of FOGAFIN responsible for the management and disposition of repossessed assets. * Review of the operations of the various second-tier development banks currently under state control (Instituto de Fomento Industrial, State Industrial Development Bank, II; Financiera de Desarrollo Territorial, FINDETER; Financiera Energetica Nacional, FEN; FINAGRO, and BANCOLDEX) to increase the efficiency and effectiveness of second-tier banking, eliminate the distortions these institutions introduce in the financial system's incentive structure, and reduce their impact on fiscal expenditure and public debt. * A comprehensive agenda for capital market development, anchored in a new capital markets law and appropriate regulations and complemented by transactional support via 1FC, to help improve the operation of markets for government securnties and public debt management, strengthen market disclosure and transparency, put in place institutional strengthening measures for capital markets entities, transform Corporaciones Financieras into investment banks that operate in capital markets and corporate finance under proper regulations and develop new market instruments, including securitization instruments to help promote long term housing finance markets development. * Strengthening/restructuring existing financial groups/institutions, supported by IFC. * Reform of the pension and social security system. * Modification and improvement of the problem bank resolution framework and strengthening risk management in banks. * Review and reform of judicial system procedures as they affect credit and financial system operations, including especially more efficient foreclosure procedures. * Review and reform of the solvency standards in the insurance sector, strengthening of the supervision system and consolidation of the system based on upgraded capital requirements. 25 * Development of sustainable financial services outreach to rural areas, especially to the rural poor, using alternative institutional arrangements to the current scheme anchored in Banco Agrario and FINAGRO. * Assisting the Government of Colombia in assessing its AMLICFT regime and strengthening the legal, regulatory and institutional framework for combating money laundering and the financing of terrorism, and bringing Colombia in compliance with the AMLJCFT international standard. 85. Infrastructure to Foster Competitiveness and Improve Services to the Poor. In light of the high priority being attached by the government to promote competitiveness of the Colombian productive sector and improving access to good quality basic public infrastructure services to the least privileged population segments, the CAS will support Colombia's efforts to establish efficient, effective, and well-managed infrastructure services. There is empirical evidence of a strong causal link between the availability of adequate infrastructure services and enabling economic growth and competitiveness. Moreover, the lack of basic water ad sanitation services, shelter, secondary and community roads, telephone services and electricity has severe adverse social effects on the poorest population in rural and urban areas. 86. In recognition of the urgent need to correct this situation, the Bank will support a broad program of initiatives in the infrastructure areas to: (a) help turn around the significant erosion of infrastructure in recent years which resulted from dwindling public investments for maintenance of existing infrastructure and guerilla-inspired sabotage of critical highways, bridges, and power stations as well as create mechanisms to maximize the possibilities for enhanced private participation in the new infrastructure investments; (b) achieve a reduction in logistics costs in the economy via efficiency increases in the transport and communications systems; and (c) potable water supply, sewerage and wastewater treatment for the least well served areas. 87. Specific Bank lending operations covenng water supply, wastewater and sanitation management (to help Colombia meet its MDG target to increase access to safe water), national urban transportation and urban upgrading strategy (with a focus on improving shelter and basic services to the lowest income deciles) are envisaged for FY03-06. Complementing the Bank's activity, IFC's focus will be on supporting new forms of public-private partnership-where complementary public and private investment could improve access to services and fostering local currency-denominated long-term financing through credit enhancement. Together, these operations would help improve access of essential public services (e.g., water, sanitation and community roads) to the poorest segments of the population, put in place cost recovery and tariff structures that are socially and environmentally responsive, increase private participation and bring in the critically needed investments in these sectors, and help enhance efficiency of infrastructure provision and bring down logistics costs in the economy. The program also envisages taking advantage of opportunities offered by the Kyoto Protocol through sources such as the Prototype Carbon Fund (PCF) or the IFC-Netherlands Carbon Facility to finance off-grid solutions making use of renewable energy sources (e.g., wind power or small, run-of-river hydro power) and thereby contribute to pursuing a better energy-environment balance. 88. To support Colombia's efforts to promote productivity, competitiveness and innovation, the Bank will undertake analytical work to examine the framework for knowledge infrastructure-knowledge management, innovation, technology absorption and modernization at the national and/or regional levels-and make recommendation for needed improvements Specific options to enhance competitiveness and employment generation (e.g., through reinforcement of production chains, integration of small producers into broader economic 26 reactivation programs of the regions and regional development programs that explicitly take account of knowledge building initiatives) would be developed on the basis of this work. 89. The IBRD assistance program will also include non-lending and lending services (including a proposed FY05 lending operation) to help improve Colombia's capacity to manage natural disasters through appropriate preventive measures, appropriate codes design and enforcement and specific initiatives to improve physical and financial contingency planning including innovative use of insurance instruments (e.g., creation of pools and self insurance and re-insurance mechanisms). 90. Private Sector Development and Strategy: Cutting across the WBG's proposed activities, a Private Sector Strategy (PSS, see Annex Cl) forms an integral part of the WBG's overall strategy for Colombia. IBRD, IFC, and MIGA will work closely together in the implementation of the PSS, facilitating the private sector's contributions to the three thematic pillars, especially in accelerating growth and broadly sharing the fruits of growth through private sector initiatives. The Bank's overall strategy in private sector development would be to help foster a business environment that would remove the impediments currently constraining the achievement of the potential of the private sector, including adequate regulatory and competition frameworks, and administrative procedures governing the establishment and operation of firms that are not excessively cumbersome. To this end, and to foster a larger contribution of medium, small and micro-enterprises in economic activity and the associated employment generation, the Bank would undertake economic and sector work as well as a likely FY04 lending operation. Key objectives of these programs would be to help to improve business environment and promote productivity. 91. IFC's continued strong role in this area is envisaged, given the worsened access to financing for the private sector and broad-based needs for reactivating private sector-led growth in Colombia. IFC will thus focus on: helping improve access to financing, particularly through the development of the domestic financial and capital markets; facilitating investor response through support for companies which are an important engine of growth in the Colombian economy; helping the private sector demonstrate tangible benefits of reform (e.g. infrastructure, housing finance, low-income and SME/micro finance); and strengthening the natural resource sectors. In pursuing these objectives, IFC will also focus on activities that help improve the quality of growth-access to investment financing for underserved segments of the population, environmentally and socially sustainable business practices, and corporate governance. IFC's areas of focus responds to the Government's current priorities in facilitating private sector role in the reactivation of the Colombian economy. 92. Linkages in IBRD-IFC Assistance Strategy in Colombia. The Colombia CAS has been built around an integrated approach to Private Sector Development (PSD). Over the years, the Bank Group institutions have had increasingly coordinated actions for the development and strengthening of the private sector in Colombia. The private sector strategy formulated in this CAS is a result of this coherent approach based on a balanced mix of activities ranging from strengthened regulations, to institution building and to investment in private firms. The continuous efforts to integrate IBRD and IFC activities have produced coordinated implementation of the private sector strategy, as the following examples indicate: * The Banking Sector. IBRD and the IFC have closely worked on the strengthening and restructuring of the Colombian banking sector. While IBRD, through the FSAL, has helped the Colombian authorities to properly address the key issues needed to avoid a banking crises and defuse systemic risks in the mortgage sector, IFC has supported: (a) the creation of the first secondary mortgage market company of the country; and (b) the 27 capitalization of the private sector banks. This work has also spanned into a joint work in enhancing the regulatory and supervisory environment, and into EFC' s increased involvement in direct and indirect assistance to the modernization and reorganization of key Colombian financial groups. * Capital Market and Good Corporate Governance. The joint IBRD/IFC assistance on capital market and corporate governance has already produced important changes in the regulatory framework for domestic institutional investors and issuers. This has allowed among other things the opening-up by IFC of the Eldorado bond market (first issue by a supra-national in the domestic market of a local peso bond with the first long term swap into US$) and Colombia becoming one of the pioneers in adopting good corporate governance in Latin America. In this respect, an important pillar of IFC's strategy relates to supporting the adoption by industrial groups of best corporate governance practices. IBRD and EFC are also involved in providing technical assistance for the development of a modern capital market framework law and a new bankruptcy code. * Infrastructure. In a number of sub-sectors where the IBRD's assistance helped improve the regulatory framework, IFC's sequential involvement is focusing on pioneering private infrastructure projects contemplating partial guarantees in local currency to avoid foreign exchange exposure in sectors with local currency cash flows. This synergy is expected to continue in infrastructure subsectors where the private sector is active. * SMEs. IBRD's efforts in helping improve investment climate for smaller firms through economic and sector work (and possible lending operations) on helping remove regulatory and administrative constraints are complemented by lFC's activities in the area of low-income segments/SME lending (through intermediaries), microfinace, and increased involvement with the key Colombian private sector foundations. 93. Rural Development The Uribe administration's plan to address rural poverty, promote social equity, and strengthen the rural sector includes promoting and financing initiatives that boost the competitivity of Colombia's agricultural sector. The Government's strategy includes supporting vertical integration in supply and marketing chains; strengthening the role of the private sector in providing services to producers; promoting vertical integration; creating off- farm opportunities in rural areas; supporting improved access to land for small farners; and providing basic infrastructure and services in rural areas. World Bank's assistance to the government in the area of rural development builds upon a rich history of projects (e.g., Magdalena Medio Regional Development, Rural Education, Earthquake Recovery, Peasant Enterprise Zones projects) targeted towards strengthening local leadership and non-governmental organizations in rural areas as well as generating increased confidence in the national institutions in conflict-affected areas. Building on lessons learned in these operations, the Peace & Development Project will strengthen on-going initiatives throughout Colombia by supporting local, community-driven initiatives relating to increased productivity in rural areas, creation of work opportunities, and the provision of social services to vulnerable groups. The Rural Diversification Project will include (a) support for smallholders affected by the international coffee crisis by improving competitiveness as well as and assisting in a transformation of the rural economy in coffee-producing areas; (b) increase access to land and strengthening the functioning of land markets, thereby increasing productivity in the rural sector; and (c) promote reforestation, afforestation and improved land use management in priority areas. Likewise, the Bank will assist the government in identifying financing sources to strengthen its agricultural research system to improve rural productivity. 28 94. Environmental and Natural Resource Management. The Government has expressed interest in the Bank's support to help promote mainstreaming of environment, and in this context meet its MDG target to ensure environmental sustainability, through an Sustainable Development Adjustment Loan, which will likewise support implementation of reforms to the SINA. Input to this operation would include analytical work to review the licensing system and provide recommendations for making this system more strategic and rapid; as well as analytical work on the legal framework for environmental management, including financial sustainability of environmental institutions. Second, emerging international carbon markets offer opportunities to capture value-added from environmental assets, such as production of certified emission reductions from new renewable energy investments as well as carbon sequestration and storage via land use, land use change and forestry activities. In the case of Colombia, carbon trading could constitute a valuable source of foreign trade and contribute to local sustainable development. The Jepirachi Carbon Offset Project and the Rio Amoya Environmental Services Project, financed by the Prototype Carbon Fund, and the Adaptation to Climate Change Project financed by the Global Environment Facility, offer the possibilities of reducing carbon emissions while fostering important technology transfers to the renewable energy (e.g., wind, small hydro) sector. The National Parks Fund Project, financed by a grant from the Global Environment Facility, will complement a creative portfolio of natural resources management projects, strengthening protected areas and ensuring environmental services which provide water to 25 million Colombians and support the nation's hydropower generation. The Conservation & Sustainable Use of the Colombian Amazon project, financed by a grant from the Global Environment Facility, will support integrated natural resource management in indigenous territories within the departments of Amazonas, Guainfa, Gueaviare and Vaup6s. Complementing the Bank's strategy in this area, IFC will focus on environmentally sustainable practices at the corporate level through individual transactions, which help demonstrate the importance and the value of environmentally sound practices. CAS Objective: Sharing the Fruits of Growth 95. Education and Health. Bank assistance in education for the FY03-06 would help Colombia achieve its MDG target that all children will complete primary education. Specifically, the Bank would provide support for the Government's strategy to face the challenges of enhancing equity in coverage, quality and sector efficiency, within an environment characterized by the need to reinforce the process of decentralization and efforts to reduce intemal conflict and violence. The ongoing program of piloting support for decentralized basic education and targeting selected areas with the poorest inhabitants, important indigenous and African-Colombian populations, and displaced rural communities (Pasto Education, Antioquia Education, Rural Education), would be expanded to include the Cundinamarca region, together with a follow-up Rural Education Project and other regional operations. The policy and institutional framework to enhance decentralization in education is being promoted as a component of the Social Sector SECAL, with a programmatic approach to be pursued through a proposed Programmatic Labor and Social Sector. On the demand side in education, support would continue under the Human Capital Protection Project, with a possible follow up operation (FY05). The same focuses on equity, quality and efficiency would form the bases for the Higher Education Development Project, which would also support improvements on the demand side. IFC will seek to supplement the Bank's assistance in education, as the role of the private sector broadens in higher education, vocational and other training. 96. In health, the reform initiatives of the early 1990s had positive effects on coverage, access, quality and equity, but further reforms are necessary to create a financially sustainable system that provides incentives for greater efficiency. Bank support for the reform effort is 29 initially focusing on policy dialogue and actions being promoted under the ongoing SFAL and Social SECAL, and health sector reform is expected to be an important component of the proposed Programmatic Labor and Social Sector operations. Within this policy framework, proposed studies in health care financing, hospital restructuring and social sector efficiency are expected to lay the bases for a health investment operation to support hospital restructuring as a critical part of the effort to transform transfer to health care facilities into demand side subsidies (FY05). 97. Social Protection. Colombia has traditionally relied on economic growth to provide a safety net, and has yet to implement a comprehensive safety net policy, and needs to provide anti-cyclical financing, bring a strategic focus to a large and disperse set of institutions providing service, and improve poverty targeting. To help Colombia protect its most vulnerable and meet the MDG target of reducing the proportion of people living in extreme poverty, the Bank is providing support to promote a major revamping of the system. Under the Social Sector SECAL, the Govemment is developing a social risk management system, piloting decentralized provision of service, promoting citizen oversight, and evaluating existing safety net activities. Further, under the ongoing Bank operations new approaches are being pioneered using cash transfers (Human Capital Development Project), workfare (Employment Generation Project) and protection of children (Hogares Multiples). As in education and health, these reforms would be deepened as part of the proposed Programmatic Labor and Social Sector operations. 98. Empowerment and Inclusion. A number of projects in recent years have contributed to improved natural resource management in indigenous territories, almost all of them prepared and implemented in close collaboration with indigenous organizations, governments and comnmunities. The Bank's strategy in relation to the indigenous and Afro-Colombian populations during the coming CAS period would include: (a) continuing the programs already begun which include the participation of indigenous and rural Afro-Colombian communities in GEF and Bank-funded projects; (b) opening up a dialogue with the government to provide funding and identify investment opportunities for the implementation of the social, environmental and infra- structural activities included in the Agenda XXI Pacifica and Amazonia reports; (c) ensuring that all analytical work of the Bank, especially in the poverty and human development (e.g., education, health, youth, social protection) areas, includes the disaggregating of data by racial and ethnic groups; (d) assisting the Colombian government, religious and civil society organizations to deal more effectively with the internally displaced persons population (many of whom as noted are indigenous and Afro-descendant persons) through the documentation and scaling-up of pilot activities being funded under the current Japanese Social Development Fund and Post-Conflict Fund grants for Internally Displaced Persons; and, (e) help the government disaggregate data from national household surveys and the national census to assess the status of Afro-descendent and indigenous populations in terms of the meeting the MDGs. 30 Table 7. Colombia-IBRD High-Case Lending Program For FY03-06 ______ FA. ustme't t 450* MS,\7' r f U5 2003 Programmatic Fiscal and Institutional Adjustment Loan I 300 __ Programmatic Financial Sector Adjustment Loan I 150 HRaher Eduecation 200 Bopota Urban Services 100 Cundmamarca Educatilon 15 Jepiroachi Carbon Offset (PCF) 3 Subtotal 768 Adjustmnent 450 Investment 315 2004 Programmatic Fiscal and Institutional Adjustment Loan 11 150 Programrnatic Financial Sector Adjustmnent Loan n1 I SO Programmatic Labor and Social Sector Reform I. 150 PeSusnabe& Development 70 Rural Divers Pricaeon 200 Urban Transiort 120 Protecton for the Displaced 51 Ruo Amoya Environmental Services (PCF) 40 Sierra Nevada (GEF) C Anti-Corruption LIL ationalvity and S Gall & Miero Enterprises 105 Subtotal 1,024 Adjustment 450 Investment 572 2005 Programmatic Fiscal and Institutional Adjustment Loan IV 150 Progrmmmatic Labor and Social Sector Reforrn n 150 Sustamable Development SAL 610 Natura Disasters Prevention 151 Water and Sanitation 125 eRural Education APL 11 50 AHealth mnvestment IS Human Capital Protection Project 100 Judieial Devlopment 40 Adaptateon to Climate Change (GEF) I National Parks Fund (GEF) tI ConservaFton & Ssisttnablhseoe of the Colombian Amazon (GEFa 5ubtotu 1,052 Adjustment 400 Investment 652 2006 Programmatic Fiscal and Institutional Adjustment Loan IV 300 Slum Upgrading 60 Decentralizth g Education 5a Social Safety Net "Hogares Multiples" 51 lAnti-Corruption 30 JSubtotal 490 Adjustment 300 Investment _190 Totals 3,334 A diustment 1,600 Investment 1, 734 99. Forced Displacement. During the last decade, the escalation of the armed conflict has caused increasing displacement of rural people. Given that forced displacement is both dynamic and multifaceted, the policy for displaced populations should be flexible and multiple instruments should be used. In this context, Bank's strategy would include two lending operations in FY04 to assist the government of Colombia to reduce displacement by providing municipalities with the incentives and resources to fulfill the preventive and coordination 31 responsibilities assigned by law, create appropriate incentives and opportunities for the internally displaced to return to their homes or be relocated, and to support the design, implementation, evaluation and dissemination of pilot operations to assist the internally displaced populations (IDP). These operations would also include the support of monitoring activities in order to establish the demographic dimensions of the problem. In addition, the Bank would prepare analytical studies to better understand the key determinants of displacement and to help assess the impact of policy instruments both in term of prevention, emergency assistance and relocation. This would build on current work financed by the Bank, including a US$2 million Japanese Grant and a Post-Conflict Grant of US$800,000. CAS Objective: Building Efficient, Accountable and Transparent Governance 100. Anticorruption. Successive administrations have had presidential programs designed to combat corruption and have had, in general, limited success. The previous administration's Programa Presidencial de Lucha Contra la Corrupci6n, although ambitious in its objectives, was in practice limited to channeling accusations of corruption through the judicial system on behalf of citizens and implementing risk-mapping and analysis tools in certain public sector entities. A comprehensive anticorruption policy, which would promote substantive reforms in the public sector and address the issue of capture of the state by special interests, was sorely absent. With recently available tools, such as a the results of a corruption survey carried out in early 2002, the Bank would focus its support in this area to help the Uribe administration broaden the scope of Colombia's anticorruption program to include the definition and implementation of both policy and strategy, in order to tackle the broader issues of corruption in the public sector. As reported by the survey, the issues are fundamentally the political and economic clientelismo at all levels of government and the need for increased oversight by civil society and regulatory agencies, among others. To support this initiative, the Bank is planning an Anti-Corruption LIL (FY04) and a follow-up project based on lessons learned in the L1L (FY06). Furthermore, the Bank will continue its support in areas that are critical for improving transparency and accountability in the public sector, such as procurement, budgeting and financial management, tax administration, and improved information systems. 101. Judicial Reform. The Bank will continue to support the Judicial authorities' efforts to improve Court services delivery. This strategy involves significant organizational and logistical reforns, and requires effective management and strong leadership. It is expected that during their implementation a major competencies conversion exercise will be conducted within the Judiciary, as well as the required improvement of the current information infrastructure base. Some of the building blocks for this strategy are being developed under the Judicial Conflict Resolution Improvement Project (LIL). The objective of the project is to improve the timeliness, quality and productivity of the Judiciary's conflict resolution system. This would contribute to the system's social legitimacy and ability to respond effectively to society's justice needs, create increased incentives for the resolution of civil, family and labor conflicts through peaceful means, and enable more effective and lower-cost enforcement of civil and commercial contracts. The project will test specific proposals for proactivity, orality and principled reasoning to prevail in judicial conflict resolution; it will go beyond the traditional judicial training paradigm into real "cultural change" initiatives. The lessons learned of this operation may be used to design a follow-up project (FY05) for the Attorney General's Office to adapt to criminal cases the achievements of the civil, family and labor circuit courts. 32 Table 8. Ce!Gki-abia-Bank Knowledge Based Program for FY03-06 Fiscal Y _. 2003 Tax Policy and Administration Social Sector Efficiency Labor Reform Public Debt Management Assessment Public Expenditures Review Country Financial Accountability Assessment 2004 Financial Sector Review Growth for Tackling Inequalities Study SMU & Micro-Enterpnse Development Environmental Impact Assessment%icensing Framework Financial Sustainability of Environment Management Institutions Urban Strategy Health Restructuring 2005 Country Economic Memorandum Disaster Management Indigenous and Afro-Colombian Communities Education Study Country Procurement Assessment Report 2006 Valuation of Natural Capital in the Amazon Basin Knowledge Management to Enhance Productivity and Competitiveness ,Social Safety Net Study 11 102. World Bank Institute Support to Colombia. In the past couple of years, WBI has provided support to Colombia in two specific areas of concern to the country and which were part of the overall World Bank Group program under the last CAS. These were in the area of Governance and in the area of Corporate Social Responsibility. In the first, WBI conducted a series of surveys on "Governance and Anti-corruption" in which a large number of civil servants, users of public services and entrepreneurs participated. The results of the surveys were issued by the Vice Presidency of Colombia and the World Bank in the form of a book in March 2002 which served to outline an anti-corruption strategy for Colombia. In the context of the new CAS, WBI will continue to provide support to the WBG efforts to achieve the objectives pursued by the government in terms of growth, but particularly in terms of the more equitable distribution of that growth among all Colombians and of improved quality of government. This will be done through specific on-demand requests for continued support in the areas of governance and corruption, as well as through the numerous offerings of learning/training regional activities in areas of interest such as Social Safety Net, Labor Markets, rural development, health and education, decentralization and fiscal responsibility and the judicial and legal system to which Colombian participants will continue to be invited. The presence of a distance learning center in Bogota as part of the GDLN network will facilitate and promote the expanded participation of Colombians in these learning activities. 103. MIGA. MIGA will focus on its areas of comparative advantage: the provision of political risk guarantees for private sector investments; hands-on technical assistance for investment promotion intermediaries; and the dissemination of information on investment opportunities in Colombia through its on-line services (IPANet, PrivatizationLink, and FDI Xchange). In the area of political risk guarantees, MIGA's focus will not only be on supporting inward investment into Colombia, but also to assist Colombian investors as they expand their investment activities into other countries of the region, particularly in the Caribbean. Specific demand from investors for MIGA's guarantees, however, will depend on a number of factors related both to the domestic situation in Colombia and to broader regional and international economnic issues. 33 Table 9. Core MDG/CAS Monitoring Benchmarks MDG/CAS Goals MDG/CAS Progress Benchmarks 1. Between 1990 and 2015, reduce by half the proportion Share of population living on less than US$1 a day falls to of people living in extreme poverty and suffering from 18% by 2006 (from 20% in 1998) hunger. 2. Achieve universal completion of primary education by Net pnmary enrollment ratio increases to 90% by 2006 2015 for both boys and girls. (from 87% in 1998). Primary completion rate increases to 90% by 2006 (from 85% in 2000). 3. Elihmnate gender dispanties in primary and secondary Maintain ratio of girls to boys in pnmary and secondary education by 2005, and for all levels by 2015. education close to 100% through 2006 and beyond (It was 101% in 1998). Reduce gap between female and male unemployment rates by half by 2006 (gap was around 6% in 1998-2000 period). 4. Reduce infant mortality rates by two thirds between Decrease of under-5 mortality rate to 18 percent by 2006 1990 and 2015. (rate was 23 per 1000 in 2000). Immunization rates for polio, DPT+DT, BCG, measles, rubella and mump reaches at least 90% by 2006 (immunization rates were between 80-86% in 2001). 5. Reduce maternal mortality rate by three quarters Maternal mortaity rate falls to 50 for very 100,000 births between 1990 and 2015. by 2006 (rate was 67.7 for every 100,000 births in 1999). Access by pregnant women to prenatal assistance by qualified medical staff rises to 95% by 2006 (rate was 91 % in 2000). 6. By 2015, halt and reverse the spread of HIV/AIDS, Incidence rate of HIV by 2006 does not nse beyond 42 malaria, and other diseases. per 10,000 inhabitants. Rate was 35 per 10,000 inhabitants in 2001. Incidence of dengue fever down to 120 per 100,000 inhabitants by 2006. Incidence was 180.1 per 100,000 inhabitants in 2001. Incidence of malaria down to 500 per 100,000 inhabitants by 2006. Incidence was 766.5 per 100,000 inhabitants in 2001. 7. Ensure environmental sustainability. Increased percentage of protected areas from 9% m 1999 to 10% by 2006 Increase in the number of people with access to safe water sources to 95% by 2006, from 91 in 2000. 8. Build a global partnership for development. Progress implementang Doha, increased number of free trade agreements with developed and developing countnes. Monitoring CAS Implementation 104. Overall success in CAS implementation would be assessed on the basis of Colombia's progress in meeting the MDGs (see Table 9). WBG will work in partnership with the government, other donors and NGOs to help Colombia attain these goals and targets. WBG has worked with the government to develop the following key indicators to monitor and evaluate progress in the implementation of the strategy. Exposure and Public Debt Sustainability Under the Proposed Strategy 105. At the end of FY02, IBRD debt outstanding and disbursed was about US$2 billion and constituted less than 2 percent of the total IBRD portfolio, less than 6 percent of the country's total foreign debt, and less than 30 percent of total preferred-creditor debt. This is due, in part, to the country's tradition of competent economic management and access to private creditors, which determined its preference to limit IBRD borrowings and pre-pay LBRD debt when economic performance was strong. Under the planned program, IBRD exposure in Colombia would rise to a maximum between 3-3.5 percent of the total IBRD portfolio after five years (Figure 1). The ratio of IBRD to preferred creditor debt service will remain below 30 percent of total preferred- creditor debt (Figure 2). 34 Figure 1. IBRD Exposure to Colombia 4500 4000 Pro ject 3500 3000 2500 2000 1500 1000N ooo - - -lN , N N N N N N N N N 106. In contrast to the relatively small IBRD exposure, the public debt situation in Colombia presents relatively high risks and vulnerabilities. Over the last seven years, the level of total gross public debt and public debt service in Colombia have been rising steadily in absolute terms and as a proportion of GDP. As of 2002 net public sector debt in Colombia stands at about 45 percent of GDP. In 1997, prior to the onset of the recession, public debt stood at 27 percent of GDP. Spending on interest payments to service public debt now stands at near five percent of GDP, constituting approximately a quarter of the central government's expenditures and more than twice its investment budget. Furthermore, debt-to-GDP, debt-to-exports, and debt service-to-exports ratios are relatively high, underscoring Colombia's external vulnerability. In order to reduce risks and vulnerabilities the government will have to implement policies to strengthen its primary fiscal balance from a primary surplus of about 1.4 percent of GDP in 2001 to a permanent primary surplus of at least 4 percent of GDP in the medium term. Moreover, Colombia's debt portfolio is highly vulnerable to unexpected changes in both real interest and exchange rates. In this context, Colombia is strengthening its debt management capacity to increase its efficiency and effectiveness for managing a vulnerable and complex debt portfolio. Figure 2. Colombia-Ratio of IBRD to Preferred Creditor Debt Service 45 107. ublicDebt ountr Assessme tead Ato ln h ooba uhrte r 35 20 '5- 10 5 0 107. Public Debt Country Assessment and Action Plan. The Colombian authorities are engaged with Bank support in strengthening the government's securities market an debt management. In response to the government's request for TA support from the Bank in the areas of public debt management and government bond market development, a Country Assistance and Action Plan in this area is being implemented in FY03. The objective is to provide support to the Colombian authorities so that they develop an action plan, based on a detailed World Bank assessment, to improve the government's capacity in central government debt and cash management (including management of financial guarantees), and in the development of the domestic debt market. This project will require the active participation of the Colombian 35 authorities to diagnose areas that need strengthening, propose strategies for their resolution and design an action plan. 108. Possible Uses of the IBRD Financial Products. In the context of the new CAS, IBRD could provide a variety of risk management tools to help Colombia manage its debt portfolio. Commodity swaps linked to some of the operations in the new CAS could be particularly relevant for the government given the impact of certain commodity prices on fiscal revenues. At the same time, IBRD local currency financial products linked to the local currency expenditure components of existing or new 1BRD loans could be a potentially helpful tool to reduce or eliminate the foreign exchange risk associated with planned borrowings from the IBRD at the subnational level. VIL COORDINATION WITH PARTNERS AND CIVIL SOCIETY PARTICIPATION 109. IMF Program. As mentioned above, in response to the severe recession of 1998-1999, the government embarked on an ambitious program of stabilization and adjustment. In December 1999, the EMF approved a three-year Extended Fund Facility (EFF) for SDR 1,957 billion in support of the government's program. Considerable macroeconomic stabilization has been achieved through the program but the momentum of Colombia's economic recovery slowed down in 2001 in the context of lower oil exports, weaker extemal demand, and a fall in coffee prices. The situation worsened three months ago, as contagion from other countries in the region intensified along with fiscal slippages. The EFF expires in December. The government is currently negotiating with the IMF a multi-year Stand-By Arrangement and if necessary to build up reserves they will draw from the Arrangement. The Bank-IMF collaboration has been active in macroeconomic management, including exchanging information for monitoring macroeconomic and structural reform. 110. IDB Program. The Inter-American Development Bank assistance program in Colombia, as laid out in their August 1999 country strategy, focuses on five areas: (a) support to the peace- process; (b) poverty and inequality reduction; (c) decentralization consolidation; (d) state modernization; and (e) sustainable growth promotion. 1DB is currently preparing a new strategy for the 2003-2006 period that is expected to be presented to their Board in April 2003. The lending program consists of 28 operations representing about US$2.2 billion as of September 30, 2002, of which about 55 percent has been disbursed. During this calendar year, two loans have been approved for a total of US$79 million to support the peace process in Colombia by investing in social infrastructure and to strengthen the institutions of the capital district of Bogota. New operations for the 2002-2003 period will be discussed during a programming mission to be carried out on November this year. Preliminary discussions indicate that the 1DB will focus on supporting structural economic reforms proposed in the government program, the areas of social protection and steps to improve health services, water and sanitation and housing. In addition, the 1DB will support programs in areas such as microenterprise, transportation, irrigation districts and rural development. The Bank and the IDB are closely coordinating the strategic areas of interventions through both lending and non-lending services. 111. CAF Program. The Andean Development Corporation's (CAF) efforts in Colombia are aimed at creating appropriate conditions for the recovery of productive investment and employment arnid low economic growth and an unfavorable international context. CAF' completed a programming mission in Colombia on the second week of October in agreement with the govemment for financing of US$3.5 billion for the 2003-2006 period. This financing comprises programs and projects in the following areas: macroeconomic stability, structural 36 reforms and integration into intemational markets (US$900 million); infrastructure to support integration, competitiveness and regional logistics (US$1.8 billion), and the modernization and strengthening of the business and financial sectors (US$800 million). In the last four years, the CAF has supported operations totaling US$3 billion, tripling its portfolio from US$600 to US$2.23 billion. One third of CAF's portfolio in Colombia (US$717 million) relates to funds from other financial sources which participated in operations such as syndicated loans and partial credit guarantees, under CAF's umbrellas. In 2001, CAF operations in Colombia totaled US$819 million and disbursements were US$379 million. Colombia is currently the largest beneficiary of CAF loans. The Bank and the CAF are closely coordinating their lending and non-lending services. 112. USAID Program. USAID has maintained a program in Colombia for almost forty years. In FY00, USAID started assistance on specific objectives that complement Plan Colombia which was presented by the Government of Colombia in 1999. Plan Colombia is an integrated proposal to promote the objectives of peace, the rule of law, prosperity and respect for human rights. USAID five-year strategy for Colombia (FY2000-2005) is of approximately US$557 million of which US$224 million have been disbursed. The strategy addresses three areas: (a) reduction of illicit crop production through alternative development and improved social infrastructure (US$265 million); (b) assistance to internally displaced persons and other vulnerable groups through basic humanitarian services and transitional assistance (US$167 million); and (c) strengthening of Colombian democracy through an effective justice system, observance of basic human rights, increased democratic participation, stronger local govemments, and a decline in government corruption (US$125 million). USAID is also involved in two other specific projects in Colombia: the reconstruction of the coffee zone following the January 1999 earthquake in Armenia and Pereira; and, in conjunction with the government of Colombia, the establishment of a mechanism for awarding grants to Colombian NGOs for environmental and child protection projects in the mountains, the Amazon plain, and the Pacific coast, funded by the Enterprise for the Americas Initiative. The Bank and the USAID closely coordinate their activities. 113. United Nations Agencies Program. There are 16 agencies of the United Nations System operating in Colombia supporting programs in multiple areas, among them: humanitarian relief for the displaced population, human rights, alternative development, economic and social development, health and nutrition, education, agricultural development and food security, competitiveness, energy, environmental protection, labor, population policies, and national peace efforts. UNDP has recently submitted their Second Framework of Cooperation with Colombia (2002-06) centered on restoring peace through dialogue and reconciliation, with three specific objectives: poverty reduction, promotion of democratic governability and rule of law, and reduction of the violence and its impact on the Colombians. The Bank and the agencies of the United Nations System closely coordinate their activities, including active participation by the Bank in thematic groups that monitor the MDGs and in the formulation of the Common Country Assessment (CCA) and the United Nations Development Assistance Framework (UNDAF). Colombia CAS Consultation with Civil Society 114. To prepare this CAS, WBG staff organized two full-day seminars with broad and diverse members of Colombian civil society, including members from religious groups, academic institutions, business chambers, indigenous communities and non-governmental organizations. The consultations took place in Cali and Barranquilla with over ninety representatives of civil society. The dialogue helped the WBG to enhance its appreciation of the development challenges facing Colombia, as well as to better define the role that the WBG may play to assist Colombia society to address these challenges. Despite some divergent perspectives on 37 approaches to economic and social development, there was general agreement that the three pillars of the WBG's strategy to support Colombia-(a) achieving fast and sustainable growth; (b) sharng the fruits of growth; and, (c) building efficient, accountable and transparent governance-are key to the development of the country and will help build the conditions for lasting peace. The constructive atmosphere in which the consultations took place contributed to an improved understanding of Colombia's key problems. 115. Many participants stressed that while economic growth is essential for poverty reduction, it will not by itself be sufficient to build an equitable society. Development should be envisaged as a broad and multifaceted process that should also aim to improve the overall well-being of Colombians. Furthermore, it is vital to share the benefits of development with all Colombians- the excluded, the displaced, the Afro-Caribbean, the indigenous, women, youth and children. The well-being of all Colombians must be put at the center of the development process, and at the center of any program of the World Bank in Colombia. This will require new and innovative ways to measure development. The need to strengthen the presence of the State in rural areas, promote tourism, enable the potential of the private sector, and reactivate the coffee sector were amongst the issues mentioned to try to reach sustainable growth. 116. A second point centered on the long-standing conflict and violence which has plagued Colombia for decades. Participants pointed out that violence in Colombia has had a terrible cost. Beyond the destructive impact on the development of the country-up to 2 percent of the annual GDP-violence has contributed to greater inequality in income distribution, land ownership, and lack of access to services such as health, education, clean water, transport and credit. 117. Participants also stressed that to build good governance, it will be essential to strengthen the fight against corruption, build more transparent mechanism and stable rules, increase the capacities of the State and civil society to promote decentralization, as well as promote security and justice. Colombians must recover their trust in the State and its institutions. Participation, democracy, transparency, and the fight against corruption should be promoted by the State, by the private sector, and by all Colombians. While the limits of the public sector, private sector, and civil society must be better understood; they need to be empowered to play a better and more efficient role. In particular, the important role civil society can play to promote peace, sustainable development and the fight against poverty should be recognized. 118. Participants felt that it will also be vital to take into consideration existing regional inequalities for policy formulation and program design. This may imply building the capacity of local/regional govemments and civil society organizations in some regions of the country, as a prerequisite, for successful decentralization or the allocation of resources based on performance criteria. Regarding cultural and ethnic diversity, representatives from indigenous and Afro- Colombian groups felt that their world view should be supported by the State, even if it is different from that of the rest of the country, in their approach to education, health, environment and govemance. 119. At the conclusion of both sessions, participants expressed their appreciation for the opportunity to express their views on the development challenges facing the country. The continuity of WBG projects involving civil society was strongly supported, as was public access to Bank documents such as the Policy Notes and the CAS. A continuation of such dialogue during the implementation period of the WBG's assistance strategy was highly encouraged. 38 Table 10. Partnerships in Colombia's Development Framework Building Efficient, Development Achieving Fast and Sharing Growth with Accountable and Challenges Sustainable Growth All Colombians Transparent Governance Partner Government IBRD IFC IMB CAF USAID United Nations Agencies Civil Society Private Sector High Focus Significant Focus Some Focus 120. Table 10 summarizes the focus of WBG interventions and of our partners in Colombia's development program. 39 VIII. THE RISKS OF THE PROPOSED STRATEGY 121. The WBG strategy faces important risks. First, the conflict and violence associated with illegal drug activity could escalate which would negatively impact the implementation of the Bank's program. Although Colombia is deeply committed to ending the violence that has plagued the country for decades, and has obtained the pledge of the intemational community to support them in this endeavor, the conflict could significantly intensify during the next few years. 122. Second, although President Uribe won the elections with a substantial majority, it is not clear that he will be able to maintain the level of commitment needed to implement important reforms. Congress could block or alter policy initiatives, or the Constitutional Court could reverse key legal reforms. This risk is lessened as the reform program proposed by the Uribe administration has the support of both major political parties. Furthermore, the composition of the Constitutional Court has been changed and its recent rulings have been more pragmatic and market-oriented. 123. Third, the fiscal situation may deteriorate which would jeopardize the macroeconomic situation. It could also increase the risk to the WBG portfolio, as the government may not have access to sufficient counterpart funds to support its investment program. The WBG program, and that of the IMF and IDB, is intended to reduce this risk by supporting the government's program of fiscal adjustment. If any of these three risks were to occur, and could not be mitigated, the WBG would review the composition and processing of new lending. 124. There are also external risks which could be augmented if the adverse economic conditions currently affecting Latin America prove to be deeper and longer than originally anticipated. However, the government is committed to implement a sound program of reforms that will lessen this risk by sending positive signals to the market that Colombia is determined to maintain sound economic management. IX. CONCLUDING REMARKS 125. The objective of this WBG assistance strategy is to support Colombia's efforts to achieve sustainable economic development as a foundation to build national reconciliation and lasting peace. The WBG will support the government's strategy to achieve fast and sustainable growth, share the fruits of growth, and, build good governance. This strategy is the result of analytical work, lessons of operational experience and country consultation. James D. Wolfensohn President By: Shengman Zhang Peter L. Woicke Washington, D.C., December 24, 2002 40 CAS Annex Al- Colombia at a glance 9/14/02 LaUn Lower- POVERTY and SOCIAL Ameica middle- Colombia & Carib. Income Development dbamond* 2001 Population, mid-year (millions) 43.0 524 2,164 Ufe expectancy GNI per capita (Atlas method, US$) 1,890 3.560 1,240 GNI (Atlas method, USS billions) 81.5 1,862 2,677 Average annual growth, 199541 Population (%) 1.8 1.5 1.0 G G Labor forae (%) 2.7 2 2 1.2 GNI > Gross per primary Most recent estimate (latest year available, 1995-01) capita enrollment Poverty (% of population below national poverty line) Urban populaffon (% of total population) 75 76 46 Ute expectancy at birth (years) 72 70 69 Infant mortality (per 1,000 lIve births) 20 29 33 Child malnutrition (% of children under 5) 7 9 11 Access to Improved water source Access to an Improved water source (% of population) 91 85 80 Illiteracy (% of population age 15+) 8 11 15 Grossprimaryenrollment (%of'school-agepopulation) 112 130 107 Colombia Male 112 131 107 Lower-middle-Income group Female 112 128 107 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981 1991 2000 2001 Economic ratios' GDP (US$ billions) 36 4 41 5 83.2 82 4 Gross domestic Investment/GDP 20 6 15 9 13.4 14 9 Trade Exports of goods and semrces/GDP 11.9 21.3 199 19.4 Gross domestic savings/GDP 17.0 23.4 13.7 15.3 Gross nafional savings/GDP 16 5 23.1 12 3 14.3 Current account balance/GDP -4.7 5.7 0.4 -2.2 Domestc Investment Interest payments/GDP 1.3 3.4 2.5 2 5 savIngs Total debt/GDP 240 41.5 41.0 45.1 Total debt service/exports 20.7 36.3 29.9 Present value of debVGDP . 40.2 Present value of debt/exports . . 193.7 Indebtedness 1981-91 1991-01 2000 2001 2001-05 (average annual growth) GOP 3.8 2.5 2.6 1.4 2.3 - Colombla GDP per capita 1.7 0.6 0.7 -0.3 0.6 - - Lower-middle-Income group Exports of goods and services 9 4 4 8 3.3 4.1 2.5 STRUCTURE of the ECONOMY 1981 1991 2000 2001 Growth of investment and GOP (%) (% of GDP) 20 Agriculture 198 174 134 13.0 Industry 31.5 371 30.1 29.9 0 Manufacturing 21.9 20.9 15.9 16.3 -20 Do Servces 48.7 45.4 56.5 57.1 q4 Pnvate consumption 72 5 67.4 64 6 63 6 67 General govemment consumption 10.4 9 2 21 8 21.1 GDI --e-GDP Imports of goods and services 15.4 13.9 19.6 19.0 1981-91 1991-01 2000 2001 Growth ot exports and Imports (%) (average annual growth) Agricuhure 3.3 -1 8 4.7 0.1 1' Industry 5.2 1 2 4.4 -0.1 Manufacturing 3 9 -21 10.5 -0.8 99 97 ServIes 3.2 38 1.2 2.1 -15 \ Pnvate consumption 2 8 1.9 2 6 1.9 General govemment consumption 4.4 9 6 -2.1 0.3 30 Gross domestic investment 0 6 4.3 12.3 9.6 Exports e mports Imports of goods and services 0 8 6.3 4.4 11.2 Note: 2001 data are preliminary estimates. The diamonds show four key indicators In the country (In bold) compared with its Income-group average. It data are missing, the diamond vill be incomplete CAS Annex Al - Colombia PRICES and GOVERNMENT FINANCE Domesic p w e1981 1991 2000 2001 InflatIon (%) (% d-iWan) 25 Consumer prices 27.3 26.8 8 7 6.5 20 Impfldt GDP deflator 22.8 26.0 13.6 7.6 is. Government finance s - . -, (% of GDP, includes current grants) - Currentrevenue . 14.1 11.8 13.3 es 97 g9 99 oo 01 Current budget balance .. 4.8 -5.2 -5.0 GDP deflator iCPI Overall surptus/defldt .. 2.6 -6 0 -.1 TRADE (US$ mlblns) 1981 1991 2300 2001 Export and I'mport leveis (US$5 mlhL) Total export (fob) 3,195 7.653 13,115 12,309 20,000 Coffee 1,423 1,336 1,089 764 Petroleum 36 1,460 4,569 3,083 15.00- Manufactures 928 2,400 5,190 5,606 Total Imports (cif) 5,199 4,963 11,538 12,834 10,o Food 319 280 1,428 1,578 Fuel and energy 726 284 234 189 Capital goods 1,859 1,565 3,414 4,468 8 GS go 97 Gs 899 O 01 Export prica index (1995=130) 8 59 247 243 z 1 9 9 9 o 0 ImportpriceIndex(1995=100) 7 63 193 209 I3 Exports UtnWorts TerTnsoftrade(199S-1=00) 118 94 128 116 BALANCE ot PAYMENTS (US$ millIons) 1981 1991 2000 2001 Currant account balance to GDP (94 Exportsofgoodsandservices 4,678 9,115 15,624 14,932 2-. Imports of goods and services 6,215 6,633 14,400 15,840 Resoure balance -1,537 2,482 1,224 -908 o -o i Net Income -427 -1,832 -2,530 -2,975 Net current transters 243 1,697 1,662 2,094 -2 Current account balance -1,721 2,347 356 -1,789 4 1 7 .:.. Finandng items (net) 1,284 -298 513 2,955 Changes In net reserves 437 -2,049 -869 -1,166 .Z Memo:_ Reserves Including gold (US$ miions) .. .. 9,006 10,245 Conversion rate (DEC, loca1oVS$) 54.5 629.3 2,087.6 2,299.8 EXTERNAL DEBT and RESOURCE FLOWS 19i1 1991 2000 2001 (US$ miliorns) Composition of 2001 debt (US$ miiL) Total debt outstanding and disbursed 8,716 17,201 33,930 38,713 IBRD 1,164 3,728 1,920 2,006 3795 7 IDA 21 14 7 7 Total debt servIce 1,120 3,755 5,i09 7,924 IBRD 161 798 368 365 IDA 1 1 1 1 Composition of net resource flows 104 3 Official grants 7 68 79 Official creditors 277 -150 102 203 Private creditors 1,127 -270 728 Foreign direct Investment 265 457 2,376 2,328 ' ' Porifoto equity 0 0 26 World Bank program Commitments 0 60 350 635 A - BORD E - Bilateral Dlsbursements 251 301 266 368 B - IDA D - Other mutateral F - Prtvate Principal repayments 77 492 243 233 C - IMF G - Short-tam Net fiows 174 -191 24 135 Interest payments 85 307 127 133 Net transfers 89 -498 -103 3 Development Economics 9/14/02 CAR AnnpY A2 COLOMBIA: MILLENNIUM DEVELOPMENT GOALS POVERTY To reduce the proportion of people living on less than $1 a day to half the 1990 level by 2015. Target 1. Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Target 2. Halve, between 1990 and 2015, the proportion of people who suffer from hunger. Country Context Bottlenecks Strategy Instruments Monitoring Partners Achievement of the goals: Slow GDP growth; high Package of macro and Sound macroeconomic Share of population living on less Government, likely, unemployment, unequal microeconomic reforms aimed at management, including strong than US$I a day flls to 18% by IMF, IFC, income distribution; and promoting sustainable economic fiscal adjustment. Labor market 2006 (from 20% in 1998). IADB, CAF, During the last several years inefficiency of the public growth, supplemented by specific reform to facilitate employment civil society and Colombia has expenenced sector. measures aimed at reducing creation. Targeted social the private the worst economic cnsis in poverty. expenditures. Implementation sector. recent history. The situation of public sector reform has been compounded by program., including anti- natural disasters, armed corruption measures. conflict, and forced internal displacement In 1998, 20% WBG: adjustment lending and of Colombia's population AAA/ESW. lived on less than US$1 a day. The prevalence of malnutrition among children under age 5 decreased from 10% in 1990 to 8% in 2000. _ _ EDUCATION Target 3: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete primary schooling. Country Context Bottlenecks Strategy Instruments Monitoring Partners Achievement of the goal: Low administrative capacity at The government's National Implementation of the Net primary enrollment ratio Govemment, likely. several levels; lack of Development Plan aims at creating Education Reorganization increases to 90% by 2006 (from LADB, civil information and evaluation I 5 million new places at all Plan aims at improving the 87% in 1998) society and the In 1998 the net primary tools to support administration educational levels; increasing distribution of physical, private sector. enrollment ratio was 87% of the sector. efficiency of expenditures; human and financial resources Primary completion rate increases rationalizing the distribution of in an equitable. to 90% by 2006 (from 85% in In 2000 the primary The armed conflict has resources and responsibilities across 2000). completion rate was 85%. generated a sharp increase in different levels of government. WBG: adjustmnent and demand for education services investment lendmg, as well as in urban areas. AAA/ESW. GENDER EQUALITY Target 4 Eliminate gender disparity in primary and secondary education, preferably by 2005, and at all levels of education no later than 2015. Country Context Bottlenecks Strategy Instruments Monitoring Partners There are no major gender Slow adaptation of legal Enforce laws against discrimination Legal framework against Maintain ratio of girls to boys in Government, disparities in education. framework to address gender by gender Improve access to discrimination by gender. primary and secondary education IADB, civil However, gender biases issues information and social services by Information dissemination and close to 100% through 2006 and society and the against women still exist in disadvantaged women. access to social services. beyond (it was 101% in 1998). private sector the job market. Achievement Many cultural biases against of the goal: likely. working women. WBG: Include gender Reduce gap between female and perspective in lending male unemployment rates by half Ratio of girls to boys in operations, AAA, and donor by 2006 (gap was around 6% in pnmary and secondary coordination activities. 1998-2000 period). education 101% in 1998. Relatively high female unemployment (23% vs. 17% male unemployment in 1998-2000 period). REDUCE CHILD MORTALITY Target 5. By 2005, reduce by two-thirds the mortality rate of children under 5 years of age. Country Context Bottlenecks Strategy Instruments Monitoring Partners Achievement of the goal: Weakness of the decentralized Maintenance and expansion Vaccination Law, Baby Friendly Decrease of under-5 mortality rate Government, likely. public admmistration, coupled of the nutrition program for Hospital Initiative (UNICEF); to 18 percent by 2006 (rate was IADB, civil with weak coordmation and children under 5 years of fortification of foods for mass 23 per 1000 in 2000). society; The under-5 mortality rate institutional capacity at the age. consumption; improvement of UNICEF, WHO, decreased from 40 per 1000 local level. nutritional support mechanisms for Immunization rates for polio, PAHO; and the in 1990, to 23 per 1000 in Improve data collection children under 5 years of age DPT+DT, BCG, measles, rubella private sector. 2000. Inadequate management of the about nutrition, vaccination, and mump reaches at least 90% targeting instruments meant to and access to health services WBG investment lending, AAA and by 2006 (immunization rates were Immunization coverage in pnoritize access by children to by children. donor coordination activities between 80-86% in 2001). 2001: polio (80.5%), health services DPT+DT (77%), BCG Improved targeting and (84 8%); measles, rubella Socio-economic situation hurts increased access to nutrition and mumps (85.5%) household income, curtails programs, vaccines and other food and health expenditures health services Children under-5 years of age without health or social security. 49% in 2001 IMPROVE MATERNAL HtIAL 1 tl Target 6. Reduce by three quarters, between i990 and 20i5, iie matemai nisria;iLy faiio. Country Context Bottlenecks Strategy Instruments Monitoring Partners Achievement of the goal Lack of qualified personnel in Improved trainig of Improved use of targeting mechanisms Matemal mortality rate falls to 50 Government, likely. some regions healthcare professionals, by social security managers; for very 100,000 births by 2006 IADB, civil better allocation of skilled application of strengthened checks and (rate was 67.7 for every 100,000 society; Matemal mortality rate in Inadequate management of resources across regions; and balances; implementation of births in 1999). WHO, PAHO; 1999 67 7 for every 100,000 targeting instruments. greater attention to the pregnancy and risk pregnancy and the private burths Incidence of corruption, quality of care. assistance, intensified monitoring and Access by pregnant women to sector. patronage or nepotism data collection on maternal deaths. prenatal assistance by qualified Access by pregnant women Enhanced patient education. medical staff rises to 95% by to prenatal assistance by Weak checks and balance WBG. investment lending, AAA and 2006 (rate was 91% in 2000). qualified medical staff in mechanisms in the health Implementation of donor coordination activities. 2000: 91% system reproductive health policies. Births in a health institution Improved data collection relative to total births in about access to health 2000 87 5%. services and assistance conditions Access to medical assistance by mothers with postnatal problems in 2000: 53.9%. COMBAT HIV/AIDS, MALARIA AND OTHER DISEASES Target 7. Halt by 2015 and begin to reverse the spread of HIV/AIDS. Target 8. Halt by 2015 and begin to reverse the incidence of malaria and other major diseases. Country Context Bottlenecks Strategy Instruments Monitoring Partners Achievement of the goals: Social attitudes toward Development and Implementation of reproductive health Incidence rate of HIV by 2006 Government, likely. HIV/AIDS Weak early strengthening of the policy; implementation of national does not rise beyond 42 per IADB, civil diagnostic of population at risk. HIV/AIDS national program. program agamist IV/AIDS, 10,000 inhabitants. Rate was 35 society; Estimated incidence rate of High cost and lack of access to Coordination with implementation of nationwide program per 10,000 inhabitants in 2001 WHO, PAHO; HIV in 2001 was 35 per medication and quality reproductive health policy against vector transmitted diseases. and the private 10,000 inhabitants. treatment Insufficient Incidence of dengue fever down sector information given to the Development of the WBG: investment lending, AAA and to 120 per 100,000 uihabitants by Incidence of dengue fever in community. territorial management and donor coordination activities 2006. Incidence was 180.1 per 2001: 180.1 per 100,000 institutionalization of 100,000 inhabitants in 2001 inhabitants. Growing resistance to anti- monitoring, prevention and malana drugs Weak epidemic assistance mechanisms to Incidence of malaria down to 500 Incidence of malaria in 2001 monitoring and control. address HIV/AIDS per 100,000 mhabitants by 2006. 766 5 per 100,000 epidemic. Incidence was 766.5 per 100,000 inhabitants mhabitants m 2001. Improved vector control and immunization strategy nationwide. ENSURE ENVIRONMENTAL SUSTAINABILITY Target 9. Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. Country Context Bottlenecks Strategy Instruments Monitoring Partners Natural resource depletion Scarce institutional capacity to Resolve legal, fiscal, and Implementation of comprehensive Increased percentage of protected Government, undermnes the country's manage the environmental institutional constraints to legal, fiscal and institutional reforms areas from 9% in 1999 to 10%/o by IADB, civil socio-economic sector reform. effective natural resource aimed at improving management of 2006 society; and the development. In addition, management natural resources. private sector. access to natural resources No valuation of the country's Increase in the number of people is unequal. Achievement national assets. Gaps in WBG: investment lending, use of trust with access to safe water sources of the goal: possible strategy to ensure the financial funds, AAA, and donor coordination to 95% by 2006, from 91 in stability of environmental activities 2000.. INationally protected management mechanisms areas (% of total land areas): 9 in 1999. Gaps tn understanding of the potential for the Colombian C02 emissions (metric national forests to play a role in tons per capita) 1 7 in carbon sequestration. 1999 Access to an improved water source (% of population): 91 in 2000. Access to improved sanitation (% of population): 97 (Urban), 51 (Rural) in 2000. BU ) 'I 5 D A CLOBAL PA FR T l.I 1;i PS T LO D E EVW E EC J{T. ,l l iFNT Country Context Bottlenecks Strategy Instruments Monitoring Partners In the 1980s and early Lack of coordination at the Improved coordination of Competitiveness plans, open trade Progress implementing Doha, Multilateral and 1990s, Colombia was national level, and between national strategy. policy, international trade negotiations. increased number of free trade bilateral aid among the best national and extemal partners Maintenance of strong agreements with developed and agencies, WTO, performers in the LAC relationship with developing countries global NGOs, region. The country's Shared vision often not international financial and macroeconomic complemented by concrete institutions Market-friendly multinational performance has actions. framework policies corporations. deteriorated more Negotiation of free trade recently agreements at regional and I global levels. CAS Annex B2 - Colombia Selected Indicators* of Bank Portfolio Performance and Management As of November 27, 2002 Indicator 2000 2001 2002 2003 Portfolio Assessment Number of Projects Under Implementation 26 22 24 23 Average Implementation Period (years) b 3.4 3.2 3.1 3.5 Percent of Problem Projects by Number "' 7.7 4.5 4.2 4.3 Percent of Problem Projects by Amount C 6.9 5.5 5.0 3.9 Percent of Projects at Risk by Number a d 7.7 4.5 12.5 13.0 Percent of Projects at Risk by Amount ad 6.9 5.5 7.0 5.9 Disbursement Ratio (%) ' 36.6 24.6 29.5 8.0 Portfolio Management CPPR during the year (yes/no) YES NO YES YES Supervision Resources (total US$ 000's) 1,245 1,240 1,594 1,799 Average Supervision (US$ 000's/project) 47.88 59.04 83.89 78.20 Memorandum Item Since FY 80 Last Five FYs Proj Eval by OED by Number 91 7 Proj Eval by OED by Amt (US$ millions) 6,374.6 264.0 % of OED Projects Rated U or HU by Number 27.8 14.3 % of OED Projects Rated U or HU by Amt 27.3 18.1 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. CAS Annex B3 - IlBRD Hligh Case Program Summary - Colombia Proposed As of November 27,2002 Proposed IBRD/IDA Base-Case Lending Program a b b Fiscal Proj ID US$(M) Strategic Rewards Implementation year Pro ID US$(M)(H ) Risks (H/M/L) 2003 Programmatic Fiscal and Institutional Adjustment Loan I 300.0 H H Programmatic Financial Sector Adjustment Loan I 150.0 H H Higher Education 200.0 H H Bogota Urban Services 100.0 M M Cundinamarca Education 15.0 M M Jepirachi Carbon Offset (PCF) 3.0 M M Result 768.0 2004 Programmatic Fiscal and Institutional Adjustment Loan II 150.0 H H Programmatic Financial Sector Adjustment Loan II 150.0 H H Programmatic Labor and Social Sector Reform I 150.0 H H Peace & Development 70.0 H H Rural Diversification 200.0 H M Urban Transport 120.0 H M Protection for the Displaced 55.0 M M Rfo Amoya Enviromnental Services (PCF) 15.0 M M Sierra Nevada (GEF) 9.0 M M Anti-Corruption L1L 5.0 H M Productivity and Small & Micro Enterprises 100.0 H M Result 1,024.0 2005 Programmatic Fiscal and Institutional Adjustment Loan m 150.0 H H Programmatic Labor and Social Sector Reform 1I 150.0 H H Sustainable Development SAL 100.0 H H Natural Disasters Prevention 150.0 H H Water and Sanitation 125.0 H M Rural Education APL II 50.0 M M Health Investment 150.0 H M Human Capital Protection Project 100.0 H M Judicial Development 40.0 M H Adaptation to Climate Change (GEF) 8.0 M M National Parks Fund (GEF) 15.0 M M Conservation & Sustainable Use of the Amazon (GEF) 14.0 M M Result 1,052.0 2006 Programmatic Fiscal and Institutional Adjustment Loan IV 300.0 M M Slum Upgrading 60.0 H H Decentralizing Education 50.0 H M Social Safety Net "Hogares Multiples" 50.0 H M Anti-Corruption 30.0 H M Result 490.0 Result 3,334.0 a. This table presents the Bank's lending program for the next three fiscal years. b. H=High, M=Moderate, L=Low a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L). Template created on 12/20/2002. CAS Annex B3 (IFC & MIGA) - Colombia FY 2000-2003 2000 2001 2002 IFC approvals (US$m)* 224 176 242 Sector (%)* OIL, GAS AND MINING 9 0 15 TRANSPORTATION AND WAREHOUSING 42 0 0 FOOD & BEVERAGES 0 0 41 NONMETALLIC MINERAL 0 10 0 PLASTICS AND RUBBER 6 0 0 FINANCE AND INSURANCE 43 79 44 COLLECTIVE INVESTMENT VEHICLES 0 11 0 Total 100 100 100 Investment instrument(%)* Loans 87 4 52 Equity 2 33 13 Guarantee 0 57 0 Quasi-Equity (Equity Type) 11 0 0 Quasi-Equity (Loan Type) 0 6 35 Total 100 100 100 MIGA guarantees 155 0 0 *IFC's account only. Annex B4 CAS Annex B4 - Summary of Nonlending Services - Colombia As of November 27,2002 Cost FY Product (US$000) Audience a Objective b Recent completions Social Sector CEM 88 G, B KG, PD Agro-Ecology 60 G, B KG, PD Improve Public Expenditure EF 45 G, B KG, PD Colombia Rural Finance 100 G, B KG, PD, PS Poverty Selected Topics 100 G, B, PD KG, PD, PS Social Sector Review 150 G, B, PD KG, PD, PS Environment, Land & Poverty 120 G, B KG, PS Policy Notes 100 G, B PD Underway Tax Policy and Administration 81 G, B KG, PS Social Sector Efficiency 88 G, B KG, PS Labor Reform 110 G, B, PD KG, PS Public Debt Management Assessment 81 G, B KG, PS Public Expenditures Review 72 G, B, PD KG, PS Country Financial Accountability Assessment 130 G, B KG, PS Planned FY04 Financial Sector Review 41 G, B KG, PS Growth for Tackling Inequalities Study 83 G, B, PD KG, PS SMU & Micro-Enterprise Development 83 G, B, PD KG, PS Environmental Impact Assessment/Licensing Framework 79 G, B, PD KG, PD, PS Financial Sustainability of Environment Management Institutions 79 G, B, PD KG, PD, PS Urban Strategy 81 G, B, PD KG, PD, PS Health Restructuring 81 G, B, PD KG, PS FY05 Country Economic Memorandum (CEM) 158 G, B KG, PD Disaster Management 81 G, B KG, PD Indigenous and Afro-Colombian Communities 81 G, B, PD KG, PD, PS Education Study 81 G, B, PD KG, PD, PS Country Procurement Assessment Report 90 G, B KG, PS FY06 Valuation of Natural Capital in the Amazon Basin 158 G, B, PD KG, PD, PS Knowledge Manag. to Enhance Product, and Competitiveness 81 G, B, PD KG, PD, PS Social Safety Net Study 11 81 G, B, PD KG, PD, PS a. G=Government, D=donor, B=Bank, PD=public dissemination. b. KG=Knowledge generation, PD=public debate, PS=problem-solving. CAS Annex BS - Colombia Social Indicators Latest single year Same regionrincome group Latin Lower- America middle- 1970-75 1980-85 1994-01 & Carib. Income POPULATION Total population, mid-year (millions) 25 4 31.7 42 3 515 7 2,047.6 Growth rate (% annual average for period) 2 4 2.1 1 9 1 6 1.1 Urban population (% of population) 60.7 67.0 74.9 75.4 42 0 Total ferbility rate (births per woman) 4.6 3 4 2.6 2.6 2.1 POVERTY (% of population) Poverty rate 80 0 65.0 67 0 Urban poverty rate 70.0 55.0 59 0 Rural poverty rate 94 0 80.0 80 0 INCOME GNI per capita (US$) 560 1,150 2,020 3,670 1,130 ConsumerpnceIndex(1995=100) 1 11 209 144 146 Food price index (1995=100) . 11 191 INCOME/CONSUMPTION DISTRIBUTION Gini index 53 0 54.0 58.0 Lowest quintile (% of income or consumption) ,. 3 0 Highest quintile (% of Income or consumpbon) .. .. 60.9 SOCIAL INDICATORS Public expenditure Heafth (% of GDP) . .. 52 2.8 2.3 Education (% of GDP) 2.2 28 3.5 3.3 4.6 Social security end welfare (% of GDP) .. 27 2.3 7.4 Net primary school enrollment rate (% of age group) Total 65 87 97 91 Male .. .. .. 99 91 Female .. . 98 91 Access to an Improved water source (% of population) Total .. .. 91 85 80 Urban . .. 98 93 95 Rural . . 73 62 69 Immunization rate (% under 12 months) Measles . 51 75 93 89 DPT 61 74 87 89 Child malnutriton (% under 5 years) .. 17 8 9 11 Life expectancy at birth (years) Total 63 67 72 70 69 Male 61 64 68 67 67 Female 65 71 75 74 72 Mortality Infant (per 1,000 rive births) 54 35 20 29 33 Under5(per1.0001ivebirths) 113 58 23 37 41 Adutt (1 5-59) Male (per 1,000 population) 262 237 203 208 192 Female(per1,000popuiabon) 209 162 114 121 125 Matemal (per 100,000 live births) .. 120 Births attended by skilled heaith staff (%) .. .. 85 Noteo 0 or 0.0 means zero or less than half the unit shown. Net enrollment ratios exceeding 100 indicate discrepancies between the estimates of school-age population and reported enrollment data. Annex B6 Page 1 of 2 CAS Annex B6 - Colombia - Key Economic Indicators Actual Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 National accounts (as % of GDP) Gross domestic producta 100 100 100 100 100 100 100 100 100 Agriculture 14 14 14 13 13 13 13 13 13 Industry 29 28 28 30 30 30 30 31 31 Services 57 58 58 56 57 57 56 56 56 Total Consumption 85 86 88 86 85 87 87 86 86 Gross domestic fixed investment 21 20 14 13 13 13 13 14 14 Exports (GNFS)b 15 15 19 20 19 18 20 21 21 Imports (GNFS) 21 21 19 20 19 21 22 23 23 Grossdomestic savings 15 14 12 14 15 13 13 14 14 Gross national savingsc 13 12 10 12 14 13 13 13 13 Memorandum items Gross domestic product 106719 98806 84845 83227 82411 77485 75812 75559 75991 (US$ million at current prices) GNPpercapita(US$, Atlas method) 2570 2450 2150 2150 1980 1860 1780 1720 1720 Real annual growth rates (%, calculated from 1994 pnces) Gross domestic product at market prices 3 4 0 6 -4.1 2.6 1.4 2.0 2.5 3.5 3.5 Gross Domestic Income 3.6 -1.1 -3.8 3.1 2.7 0.2 2.5 3.7 3.7 Real annual per capita growth rates (%, calculated from 1994 prices) Gross domestic product at market prices 1.5 -1.3 -5.7 0.7 -0.3 0.4 0.9 2.0 2.0 Total consumption 3.3 -1.7 -4.2 -0.5 -0.3 1.6 0.5 1.8 1.8 Private consumption 0.5 -2.7 -6.2 0.7 0.1 2.0 0.3 2.5 25 Balance of Payments (US$ millions) Exports (GNFS)b 14195 13432 13919 15624 14932 13933 14971 16048 17059 MerchandcseFOB 11529 11480 12037 13621 12775 11918 12813 13741 14612 Imports (GNFS)b 18411 17344 13405 14400 15840 16031 16853 17736 18602 Merchandise FOB 14371 13930 10262 11090 12267 13005 13671 14388 15090 Resource balance -4216 -3913 515 1224 -908 -2099 -1882 -1688 -1543 Net current transfers 789 446 1435 1662 2094 1973 1810 1873 1939 Current account balance -5953 -5225 353 356 -1789 -2259 -2413 -2349 -2201 Net private foreign direct investment 4830 2032 1353 2031 2287 2333 2391 2475 2561 Long-term loans (net) 2200 1039 357 -1282 -670 -6 565 580 289 Official -452 178 1013 103 986 442 1655 2309 1396 Private 2652 862 -656 -1386 -1656 -448 -1090 -1729 -1107 Other capital (net, mic:. erors & ommussions) -1354 3541 -1742 -1974 -994 -31 -96 -99 -74 Change m reservesd 277 -1388 -320 869 1166 -37 -446 -607 -576 Memorandum items Resource balance (% of GDP) -4.0 -4.0 0.6 1.5 -1.1 -2.7 -2.5 -2.2 -2.0 Real annual growth rates ( YR94 prices) Merchandiseexports (FOB) 5.7 9.1 7.2 3.0 2.9 -3.8 3.9 3.8 3.5 Manufactures 4.2 19.3 1.1 5.4 5.2 -4.0 4.3 4.2 4.0 Merchandise imports (CIF) -4.5 0.3 -25.4 -25.6 67.6 2.1 1.7 2.9 3.5 (Continued) Annex B6 Page 2 of 2 Colombia - Key Economic Indicators (Continued) Actual Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 Public finance (as % of GDP at mnarket prices)' Current revenues 27 4 26.9 27.4 28.2 28.9 28.9 28 9 28 9 30.0 Current expenditures 21.8 22.9 24.5 23.7 24.4 24.3 24.0 23.8 23.4 Current account surplus (+) or deficit (-) 5.6 4.0 2.9 4.5 4.5 4.6 4.9 5.1 6 6 Capital expenditure 9.6 8.0 8.7 8.0 8.1 7.9 7.8 7.8 7.9 Foreign financing 0.6 2.6 1.3 1.8 2.3 3.1 2.2 2.4 1.8 Monetary indicators M2/GDP 36.0 34.4 36.0 32.3 33.2 33.2 33.2 33.2 33.2 Growth of M2(%) 25.8 10.9 10.5 4.7 12.0 8.2 7.1 6.9 6.6 Privatesectorcreditgrowth/ 79.2 76.5 -49.2 20.1 66.2 85.0 66.0 66.0 70.0 total credit growth (%) Price indices( YR94 =100) Merchandise export price index 108.4 93.5 92.9 102.2 93.3 93.9 97.2 100.4 102.9 Merchandise import price index 86.0 81.5 79.6 115.9 76.9 76.4 79.0 80.8 82.2 Merchandisetermsoftradeindex 126.1 114.7 116.6 88.2 121.2 122.9 123.0 124.3 125.1 Real exchangerate (US$/LCU)f 119 1 113.5 102.7 95.6 98.0 91.0 84.0 79.1 75.5 Consumer price index (% change) 17 7 16.7 9.2 8.8 6.5 6.2 6.0 5.0 4.0 GDP deflator (% change) 16.8 15.2 10.2 13.6 7.6 6.0 6.0 5.0 4.0 a. GDP at factor cost b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. NFPS f. An increase denotes appreciation. Annex B7 Page 1 of 1 CAS Annex B7 - Colombia - Key Exposure Indicators Actual Estimate Projected Indicator 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total debt outstanding and 28900 31941 33083 34423 33930 38713 38772 39340 39920 40212 disbursed (TDO) (US$m)8 Net disbursements (US$m)a 4397 3618 820 1262 -194 2973 59 568 583 292 Total debt service (TDS) 5401 4511 4539 6606 5109 7924 5851 7271 6129 6352 (US$m)R Debt and debt service indicators (%) TDO/XGSb 219.9 225.0 246.3 247.3 217.2 259.3 278.3 262.8 248.8 235.7 TDO/GDP 29.7 29.9 33.5 40.6 40.8 47.0 50.0 51.9 52.8 52.9 TDS/XGS 41.1 31.8 33.8 47.5 32.7 53.1 42.0 48.6 38.2 37.2 Concessional/TDO 3.3 2.8 2.7 2.8 2.8 2.3 2.3 2.3 2.2 2.2 IBRD exposure indicators (%) IBRDDS/publicDS 18.2 21.1 11.9 8.2 10.6 7.9 7.5 6.0 8.3 9.4 Preferred creditor DS/public 34.2 42.2 24.8 21.1 26.2 19.4 32.5 30.8 35.3 39.8 DS (%)c IBRD DS/XGS 4.0 4.0 2.6 2.8 2.4 2.4 2.3 2.2 2.2 2.5 IBRD TDO (US$m)d 2177 1723 1740 1960 1920 2006 2147 2521 3097 3597 Share of IBRD portfolio(%) 2.0 1.6 1.5 1.6 1.6 1.6 1.8 2.1 2.7 3.1 IDA TDO (US$m)d 10 10 9 8 7 7 6 5 5 5 IFC (US$m)CA Loans 118 72 61 41 29 29 Equity and quasi-equity' 18 21 17 43 43 56 MIGA MIGA guarantees (US$m) a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, IFC, the regional multilateral development banks, the IMF, and the Bank for International Settlements. d Includes present value of guarantees. e. Excludes participants' account. Excludes guarantees and risk management products. 2002 is actual. f. Includes both loan and equity types of quasi-equity instruments. CAS Annex BS - Colombia Operations Portfolio (IBRD/IDA and Grants) As of November 27, 2002 Closed Projects 145 Total Disbursed (Actve) 666 82 of which has been repaid 24.31 Total Disbursed (Closed) 8,20735 of which hs been repaid 7,90174 Tota1 Disbursed (Active + Closed) 8187417 of which has been repaid 7,926 24 Total Undisbursed (Acive) 547 23 Total Undisbursed (Closed) 000 Total Undisbursed (Active + Closed) 547 23 Differee Between Actve Protec ilst PSR OzrnalB Anmou Expeted and Aclim Supervision Ratng US$ Mitlons Disburrnesents Project ID Project Name Jedooment bn.D=t0n FIscal Year IBRD IDA GRAN Cancel. Undisb. Orig. Frm Rev'd P057692 2nd Magdalena Media Project (LIL) S S 2002 50 28 0 0 P006880 AGRiCULTURETECHNOLO S S 1995 510 67 67 -82 P044140 CARTAGENAWATERSUPPLY&SEWERAGEENVIRO S S 2000 850 629 409 P006891 COANTIOQUIAEDUCATION S S 1998 400 13 2 12 2 3 1 P057369 CO Judicud Resolution Inprovement Pt3 S S 2002 5 0 4 7 11 P046112 CO PASTO EDUCATION S S 1998 7 2 27 27 11 P041642 CO PRODUCrIVE PARTNERSHIPS S S 2002 320 297 -2.3 P040109 CO PUBLIC FINANC MANAGEMENT PROJECr 11 S S 2001 355 33 7 -2.3 P050578 CO RURAL EDUCATION S S 2000 20.0 17 4 97 P073572 CO StDctural Fiscal Adjusmtent Lon HiS HS 2002 400.0 600 P006861 CO URBAN INFRASTRUCTURE U U 1998 75.0 26 0 214 39.3 P065937 CO WATER SECTOR REF ASSISTANCE PROJECT S S 2002 400 390 77 P068762 CO- COMMUNITY WORKS (MANOS A LAOBRA) S S 2000 1000 82.4 531 P069964 CO- Human Captal Prot- Cash Trnsfers 5 5 2001 1500 1228 -27 2 P050576 CO- YOUTH DEVELOPMENT S 5 1999 50 1.4 14 P006884 FINANCIALMARKETSDEVELOPMENT 5 5 1997 150 55 18 73 18 P063317 GEFCO-HIGHANDES S S 2001 00 154 143 20 P054125 MP/COODSPHASEOUTr S S 1999 00 87 76 -07 P053243 PEASANT ENTERPRISE ZONES (LEL) S S 1998 50 21 21 01 P040102 REG REF.TA HS S 1997 125 3.3 3.3 P006894 SANTAFE I (WaledSupply) S S 1996 145 0 35 0 35 0 P057326 SIERRANEVADASUSTAINABLEDEVELOPMENT s s 2000 50 36 -14 P039291 URBANENvlRONMENTTA(TAL) S S 1996 200 13 1.3 1.3 Overal result 1253 2 24 0 55 569 1 1918 -0 7 a. Intended disbursements to dale rilnus actual disbutmemnts to date as projected at appraLsal a Intended disbursements to date minus actual dlsbursements to date as projected at apprarsa CAS Annex B8 (IFC) - Colombia Colombia Statement of IFC's Held and Disbursed Portfolio As of November 30,2002 (In US$ Millions) Held Disbursed FY Approval Comnpany Loan Equity Quasi Partic Loan Equity Quasi Partic 2002 BCSC 0.0 7.0 00 0.0 0.0 70 0.0 0.0 2002 Bavana 70.0 0.0 30.0 1450 70.0 0.0 30.0 145.0 1969/1985/1988/1993/1995 CFdelValle 0.0 7.4 00 00 0.0 7.4 0.0 0.0 2001 CHMC 0.0 10.6 0.0 0.0 0.0 4.0 0.0 0.0 1974/2001 CementosCanbe 4.1 10.0 0.0 13.0 4.1 10.0 0.0 13.0 1963/1968/1969/1990 Coltejer 6.0 0.0 0 0 0.0 6.0 0.0 0.0 0.0 1995/1999 Corfinsura 38.1 0.0 25.0 0.0 13.1 0.0 25.0 0.0 2002 Inversura 0.0 15.0 0.0 0.0 0.0 15.0 0.0 0.0 2002 Omimex Oil 30.0 0.0 5.0 0.0 2.0 0.0 5.0 0.0 1987 PRODESAL 0.0 0 6 0 0 0.0 0.0 0.6 0.0 00 1977/1989/1992V1994/1996Promigas 50 1.1 00 6.3 5.0 1.1 00 6.3 1994/1995 Prormsan 0.0 0.2 0.0 0.0 0.0 0.2 00 0.0 2002 Proteccion 0.0 10.0 0.0 0.0 0.0 7.1 00 0.0 1996 Proyectos 0.0 5.0 0.0 0 0 0.0 5.0 0.0 0.0 2002 SIG 25.0 00 50.0 0.0 25.0 0.0 47.2 0 0 1999 Surenting 0.0 5.1 0.0 0.0 0.0 2.5 0.0 0.0 2001 Tolcemento 3.3 0.0 0.0 10.7 0.0 0.0 0.0 0.0 Total Portfolio: 181.5 72.1 110.0 174.9 125.2 60.0 107.2 164.2 Annex Bg Colombia - CAS Matrix FY03-05 - High Case Diagaessc| PoeBy noadt |ace World Bank Group's Support lstrunentts Progmres Belceimarks |A rtca eniS _______________________ |__________________ _m cial Non-Flin cial Co try | AW CAS Objective: Achieving Fast and Sustainable Growth Macro economics_______ _______ Large trd prtsaces fiseal anbalances he ld to s Tie ern tbae dof tM WBGCs seat.egY is Ps Flme SFit r SeJ Aduj I (FY03), Pig Fias Tx Flihcy and AditDsaxat Sudly (FY03), iNc seorid fiscal cin al anise pibc dlebi Ebha-2ed debate nd bmy to .arsDbil ornsatatsable Vbne debt hsa.s 3.e T ab.c pr is co f the arocxxs, boarnwac w.I be a pIa tad last tdo Lema I (FYOI). PFo Frs Setrl Adj Debt Maagesis Assesa (FY03). Fibi s bibclty Eisa grs ppoahrtes absdsg fiscal powty tel debt samaibihty faes lsp buirune fulcal I is Icbd sdat r '. d ids ttclu iseal adinsla(sat, Ftciaini tuail f (FY04), Pes Fiscal alst Adj ta 0 Expendite Ree (FER) (FY03), Country pila lent t qsalcy of rhe 4woansi (FY04), Froa Fureal WA IL Adj Lnna I (FYOS). Edaxeac Mensracsdst (CEM) (FY05) Piol Flatl ams has AdJ tea IV (FY06) Finasndal Sector Anrtuhas of Oiaisical Icasuia, itscbs Fs f Ui.be 'De WBG W pipsm govessca ascootisidsed Fl FUL Seats AdJ ious I (FY03), fiso FlF. itslecise S teea (FY04) Country Enarica SaDshered iacageasest sanldspcscso WWD rsnanrilly atn eas catlnyti reesan iMF, IDB govniraateaneed tobe restructredxi2ndAm vn adcs)g resatag, ialrevarIuiS sevei Srn Adj [,an n (FY04), feibibe [FC apmin Mceatbs(CEkM) (FY05) asets ah lohansal of ite govertesent laproed tbe ficra k rte ta sanieerect tl bssk pclrb,zed. Dspius ofassetsis Itet lsamdof ctne fialal snaaLns to at ansle ofr tl eenai zlaigb alvdndusal acsasla (FY03-05) sawnsork (fe ba tCi vsageracn sandresosaat. rexaasta t oCbonlnba govasens needs msbe s rse iptd ass eftlceacL (eg., BANCAFE ad GCnalr) toaad afunher Bancabc oeat oradriescaolsi firusork a fiatal desisL weak Jauttlh prcedures as enforce garnaes aal The WBG -1i sen a reformofpabcal Fag* FD Soear Adj t I (FY03). Flog. F. Fiscud Sectew tc (iFY04). Countryy Eimoae Siergl-d eii-sceubfe tse obfteear s of WDG rafally ntys ascalysi frt roteltnof IMF, IDB focile dofpo peiresa ausstolow Brabtcy faeedues diai afflect ccl as)d ri i cyste Sensr Adj tfa 0i (FY04). Febisscumy tao Seed Mesnsa-dans(CCEb) (FY05), possble IFC TA (i gnstalue as) flenose of celieala ilb b-atsty frastewsrl, Fncaedaes sed as be insirdiosed. pcrantas, as well a refonX thatsrengt & Miaso Easerises (FY04) colb-ell ho asih the Bak) (FY03-05) SnrestelrdbabeotIctcy ,anoidrs saainsal tataldon sad other strenlesas tal ,ould help rsdlwe the econtwc bcidesof legrl assd ,dcu ssest Caicta natin se call stLee.de,ldaopl Ietdesseirasa do. tf coqetcive galtaegy to Flo& FitL Seser Ad ) I (FY03), Fer. Fl. FIsli Senior ftce (FY04). Camly nixleacx lowd arvmsy sad Vgdtory fiarsewsik WBG stsecGanisnly contri as to theqxui-ot IMP. 0DB. Suap sory firate rhk f t acte axsatry Is fotaerncaplal ecka etetancut. salag a sew Sactir Adj fea f (FY04), possible iFCic MeMaosianad(CEC ) (FY03) for(fsetosauce o ty iseoarnsorf stea o papi l rarkets ta Ute Ig iey- ay tAIS aiu relalrety weak capti rnkets lat, ou h cki thelasne ute dSacb bxiadoial trancacrcuse (FY03-05) cago) ana,1i lsae Deveoepsca o a ftresc, fiarnnaek(st for tie msurunce idbsay LnnspreQy ades n SdeSgls the bega ((sotesoia bhonslc aist radk cad ael-auory s&- libere re sll gaps ma te legalI,jeglstry sad The WBE -ll assi ft go seeasessng as Fla Ftl Secur Adj toea I (FY03), Flo. Flt Fli Seios Rft (FY04). Country EcBnsasat linadctonlf ao egstessr ed fmeswaka WtDofaG tsbast to asudafnua oofa IMF, iDB. asupe y foirensiod as toombtc aey i eie AWFAF1gpme andsuleegt g toE egal. Sctir, Adj Leas n (FY04) Mberaaten (CEM) (FY05) e saicajsey lain a ndise taro fibasceg. r sve fensnewoco bat rmn ey USAID, asd Lesmri Osateig (AMdCT firenworks) reesay asd mmna i fxeat fr,r laoaeana and terrorist finlscia IOSCO coaidIDg antoey loasbsg sad toe afcaanes of satscom Infrastricture to Foster Competaiveness nd Improve Services to the Poor Lack of bast tcr ad sarcasas,serines, sbelr. SIe WBG i smapsp saon aves ar W (a)s ansaads Bg Urban Serntes Leaa (FY03), Jpesrci UJbt Sna, Scaly (FY04), Dalsaer Masagei frte nsard acs to baste aulces by tie poor WBG coenbtriues to m lsehoesec malt of ieY IDB. CAF stecnyary nasammurity reads, telone srcties ft crucnn of mftlgnxti_e wincn testlds fromi Cal Offse (PCF) (FY03). aRs Dieersfian Stoly (FY05). COay Ecnscan Meanxdum a loressed ecortpetiteess of key ecsas laipjas Cem Vogrses that ucresse, aocess to havec sad dlerciniy has a da,..Mgia budga acesas fse srafteaance asnd Le (FY04). Urbam Tri Leas (FY04). Bio (CEM) (FY05) re5t sercea by to pose WBG aIla s a gpenia i-spsrnesabctnge. (a) expandltoesa ma on Anays Ehahrnasl Seav ces ftCF) (FY04). couantsoin m. Molesn e nd )marnss ((ai5 mcsse asd)omormoumns syitsac. sad (a) Dase War, ansd s) staltana easn (FY05). shotaUpsnadasg to aoarpeutvvencs of Cortatna's enestmr tr foiscrufore by itpoor (FY06). pssable ECZ toupler through bvcdual trunacl"' Annex 89 Colombia - CAS Matrix FY03-05 - High Case (Continued) Parltnest Dln c Policy and Strateyy World B Group's Support lIenS Progress Benchtmrks Active In toh ______________________ ______________________ ~~ ~~~~~Floosidol Non-Pinoodol l Countr W B G CAS Objective: Achieving Fast and Sustainable Growth (Continued) Increase Productivity Through Privas Sector Development ped-,s cn-nly coosaunag the adseo Wbe WBG net wecsk mWeds tte woeestattn of PfrdOnl ty too Soull d Mtctarwtses (FY04) SMU & MrEeosqsnes Dovetepsent Stxly toiat detameheftouoatm t SMEs nod WBG cun to the ntepumntOsha of key IDB. CAF of the poLetl of the pote sereme mdude e us tne PSD stegy tn pou1a,. IFC t1knewtost. dred uam ts.nepuoxte, (FY04). Cty Eouemitcc Meouoeon (CEM) maostpo skes a dyn sc conubnomo to prcousat p s shot th ave the Lfeottset m deqooeaeeogtotery msd ornpeooc fsrr stok si 1constre tolbtoew wogoe o tha ssra (FY05). Kstoewp Maoo-ttO Entatce totc stawts) job cretion.tto cto ntty climate. WBG aslo nmes *coOttbwLoto ord cwtderooe rs ave pocte fteoty snd Cautpfitlonso (FY06) tojectu sod ponos hom t nssoea the cLtnct of go,vestoo tte astailhllntot sstoperstiuondfaresm SkMEs sod oicveotposes to cocte jabs Rural Development iLoo of =te5graout m astyxd am kettm ctint WBG osstonee wtt he tedtoneah ta & Deetjoero (Fy04). Rus Dlhnfoc= Casty E-os Metmoretot(CEM) (FY05) Itod ftUnttsne of ioest nes usiso tod Frt urenrtun df the WHO =Otte IDB. CAF to sod L nrun)slt Gops fipnot. octr stteoheoa toco daed andtor=a) oos i (FY04B cnYf), Pronoetun fet Dploced (FY04), Itrttl telrmreasedinteggmnmn to sotutllotid segy totds tomivedecomtrtoc ettcoes t poowsot of ns,co moden r f L ta-fafto nstn sear toom and gpoootsoc msed caonfdence m Eoo,n APLH (FY05) otrwoly oxtt 0nea5 t md trheng Iral iasotstuns oppatuatois Is ns areats od tutnted acIon to ¢te -s,-atsiuttos mr non ires r Te WHO lttd f(to stut foarnees Gdeenlly weak t alsoosuppout caouretnty-drnveadevelopmem Environmental and Natural Resource Management_ Legal foonk Ir niraturet nonagenat WIe G w i t new the exii ESIA and I qmacid Ctrn Offoset (FPCF) (FY03). Ru Ampoy Erswontstat Ictmi )O Asse smas.0V5o1 Re&tod tcaeran eawOonoso togetea wl deusitEtC wt 0 ct toto w FWY woDB, NGOS snd liUcsotag oechost seeds tobe more stseg Itoetig qsl.m the sew Utoesmg Lato. mod E ..s ott Sante (PCF) (FY04). Stern Iotwok Sady (FY04), Ftsnciast soubtsty nf onto tdsalodtes tothe eesecear acasgtattn ftons, inlts copcty tnstto sod eso. t mtos( tkto n tooas fst fIb hmL- s l ovoI ene-tesn fhe s eg Syt Nesadt (0EF) (FY04). EsetinlesordAl SAL (FY05). Ertosso MWnO tnttntti- (FY04). Suuicofot ft t red euooubttilotey0f saeoett lsusttuts Nfttd sob srtes, sesd mopid. 'le WBG tott ceatto Nsoost Disu , Preuton (FY05), Adaptton to Vatesbsofatnase Cstttat m ¢t Anon Beso capml) tot ne yet bee ppely 2lue& MM= pfUM ¢it offer the pusnbityof redhxins C1Ct nge Chn (GEF) (FY05). N uke F Po (FFY06) carbonemtooou (GEF) (FY05), Smasots todigas People Ito Sast. (oe of te Anmoao (FY05) W HW llS ~ ~ alitj §W Annex 89 Colombia - CAS Matrix FY03-05 - High Case (Continued) Dlongoswc 1 PoUcy and Strategay Wold Bak Groups Support lstnaneots j Progress Benchmarks Acde In this ________________________ _________________________ SFla ncial Non,Bi - cdal Co W BG _ _y_W CAS Objective: Sharing the Fruits of Growth (Continued) Labor aarkets abdr nldtet to Colta, ob aus oody st.ct 1me - Jecbve dofc WBG sltegy t ba a PM LabMd Sonl Sector RetRf I (FY04), Labor Refoen, Swdy (FY03). SOan Safety Nol Tlooed ftctor of lcbor la. tetso SaoSfactaaycepiuso of admnuatoopetrttst DB nto ge restca sod httion son fn wdl be tobedp to tke Ib labor n f ebe. to Pm8 Laad SOat Secutr ofoal (FY05) Strly n (FY06) Coloa loeha to tsedy,sotoc jb ereasod ua a Sd mW raurg s to IbC bctia of lbo workeS. affect fte kvd of eoplymal sod ureraamftrae sbaos fttbs of efcotao gW-fft asd a reaosu of utforaldy ottets t Colootbt Ihe daade betwe foal and mtfomrl labor edace u n s oaa of elts forol strI CAS Objective: Bufilding Efficient, Accountable and Transparent Governance Anticorruption Stccsslc e adtsodsoao lase ntleornated Bsta0 so I resol- of. nana wys mdeAey nArb-ComPrtaon UL(FY04), AratiCoreoupas Conay Fsot Actoatblhty Aosnat ra B oadrnedsrapo of be ortate's anticmruo Sastaty c teutotof oto LILast IDB. UNDP. peesidoual prgoans dsigoor to coaotcotrrupotot ano r eatly 2002. 0t WBG Wai hiep be (FY06) (FY03), Cotury PCrcoreemt Assotrrnt Repon pepogd ordCdOr ta tbe trt.ofpra . orbled ESW OAS at boon bad, at beoedr bord srrcces adatraao brtoadn t lscope of Colorrta's (FY05) iad stcresse Ossptrtwy smd accotabilbty of ototortlait P(ro Ihe rbbc seun| Judiild Refo nrm_ _ _ __ _ _ _ _ _ __ _ _ _ _ _ _ __ _ _ _ _ _ __ _ _ _ _ _ _ Jde calthour boon aleady sadrwed orl Seas of the buddorgt bik fer Ie WBG saue5gy Judacal uDeweps (FY05) RSdctroofccgsurao dso delayst l afttaibal Saccesb corrpi eaerfloeedaoperraroer atd iDB, UNDP. ptrdert to ,hce cs4gado Ioddelays to. da inbrale uatoet of fIt tor- qsuoly and -yatm adtt5tay staree OAS Dobcial tyao Hoaewor. lu rategy itrnlsr podacbyuy of eUcjtiabry's cerdbclrertttsoo g.ftlcan organneurvul and toloisucal rfortt. ad systeorn nttayb peris toarsos, ot ble mre reqans tfecon tnsogesasa ad grong effecute sod lawer coso of etfoeretreet Results-Oriented Public Sector Rcrm and Budget Management Pestdoat Dtrecve NM10 of Augot 10. 2002 WBG td) soplr taln toiry t P Fiscal oat transl AdJ ions I (FY03), Pabhc Espeats ft (FY03). Cranny A nmme result-onrced pbtc sector. b aiBcote f leo a td iDB setso o shona 5d rned-atenrtobjecOs,s ao P0g fuscalal orfort at Iat way et c err ro Focal sod bafltostr Adj Loss 11 (FY04). Fr l Aocnratublitty Assesstuer (FY03). trreased acceuabtlty at mpanecy ESW srb s tsossa rateorre nosgeoe aaomsett allocated snd results mtcrrd. PFn Focad sad ltstallonal Adj Ino HI (FY05). CCy Peneonfi A rssoor Repan (FY05). pcatetteb od mprfore bodhellg. atn5i Pn. Fca1 ard Easdnalnal Adj Lo IV (FY06) Country Ecolsc MOensagadun(CEM) (FY05). oth Scidal Safety Neo Stady n (FY06) CAS Annex Cl Colombia: Private Sector Strategy I. Introduction: After the recent severe economic recession and fiscal instability, which have resulted in a sharp increase in unemployment and a widening of economic inequality, recovery of the Colombian economy to a sustained growth path is essential to the goal of poverty reduction, and is hence an important priority of the World Bank's Country Assistance Strategy (CAS). A return to sustained economic growth will not be achieved without a significant contribution from the private sector, whose own growth has languished in recent years. The performance on all fronts of the private sector - large, medium, small and micro-enterprises - a segment critical to employment generation in the economy, has fallen behind during the past few years. The first priority for Colombia is the return to macro-economic stability, which is essential for the of investor confidence and for the private sector to be able to contribute effectively to the growth process. From a longer-run perspective, structural weaknesses in the economy will need to be addressed, to be able to improve competitiveness and unleash the full potential of the private sector. The agenda that lies ahead is a challenging one, encompassing multiple sectors of the economy and broad segments of the private sector, to which the World Bank Group has the opportunity to be a major contributor and catalyst. It includes the following key priorities: * bringing about a strengthening of the business environment, through improvements in the regulatory framework, and reductions in the administrative burden on enterprises imposed by a myriad of administrative fees and license requirements; * improving the efficiency of the infrastructure and natural resources sectors, through reform of the tariff and tax structure, and focusing on the realities of the security situation; * restoring to health the financial sector, by completing the restructuring of the banking sector, reforming the pensions system and improving asset quality in the housing finance industry, and broadening the base of financial intermediation through development of the capital market; * assisting the restructuring and recovery of otherwise dynamic private firms, that have had the fundamentals right but which suffered from the downturn in the economy and erosion in access to finance. This Private Sector Strategy (PSS) is organized as follows. Section II provides an overview of the development and role of the private sector in the economy, and a diagnosis of the key developmental issues arising. Section m outlines the private sector's agenda and in light of this, the World Bank Group's strategy for promoting the private sector (Section IV). II. Background: The private sector has played a varying role in Colombia's economy since the early 1900s, beginning with coffee and a few other export crops, and continuing with the growth of the textile industry. During the 1970s, it grew fairly rapidly, though mostly behind high tariff and regulatory barriers - which encouraged a concentration of production in import-substituting sectors, especially in capital and intermediate goods. Protection also had the consequence of generating a bias against exports, so that during this period, the private sector had a relatively low share in the country's exports. During the 1980s, Colombian industry was characterized by a relatively high concentration of production, the predominance of a small number of conglomerates spanning a number of sectors, and a declining level of investment and productivity. Through much of this period, private investment as a percentage of total investment in the economy declined, in some years (1983 and 1984) falling below the level of public investment, and the manufacturing sector's share in the economy stagnated at a relatively low level. This situation changed only by the end of the 1980s, when trade policy reforms were introduced, followed by more wide-ranging structural reforms initiated in 1990, under the Apertura, with the aim of improving economic efficiency and productivity. There was a significant opening up of the economy, which had an impact on the structure of industry and its competitiveness. Import licensing requirements, which had covered 99% of goods imported in 1984, and 61% in 1989, virtually disappeared by 1991. Average tariffs declined from 27% across the major sectors in 1990 to 12% in 1992, with effective rates of protection declining from around 90% to less than 30%. A free trade and customs union agreement was signed with Venezuela in 1992. The exchange rate regime was considerably liberalized, with control of the peso rate shifted between 1991-94 from the central bank to the market. Supported by these reforms, private investment grew to a peak of 18% of GDP by 1994, and output by 5% a year during 1992-95. An important focus of the structural transformation process initiated by the Apertura reforms was a strengthening of the overall business environment, together with deregulation of the infrastructure sector. From 1989 onwards, public/quasi-public sector monopolies in the transport, utilities and telecommunications sectors were dismantled in stages, and regulatory frameworks introduced in natural gas and power, to allow for more competition and private sector participation. At the same time, a number of measures were introduced to strengthen the business operating environment, focusing on competition policy, insolvency procedures and legislation, and institutional capacity. In this way, between 1989 and 1993, legislation was introduced to provide legal recourse for contract enforcement and conflict resolution, and to consolidate all bankruptcy, liquidation and reorganization laws and regulations under a consistent commercial code. A new banking law, passed in 1990, similarly sought to introduce greater competition in the financial sector. In its transition from owner to regulator of financial institutions, the Government, through FOGAFIN, took steps to close, restructure and/or privatize several state-owned financial institutions and opened up the banking sector to foreign participation. Through much of the 1980s, until the middle of the 1990s, Colombia's economy was a sustained success. Steady growth of GDP (an annual average rate of 4.6% during 1986-90, one of the best performances in Latin America) was accompanied by diversification away from an excessive reliance on coffee exports, and the development of significant centers of manufacturing activity in Medellin, Bogota, Cali and Barranquilla. The private sector played an 2 increasingly important role in this performance, especially after the reforms, when buoyant demand, led principally by private investment, contributed to growth rates of 5.4% and 5.6% in 1993 and 1994. Unfortunately, this pace of growth proved difficult to sustain. From 1996 onwards, economic performance deteriorated significantly as interest rates rose, as a result of political uncertainties and persistent fiscal deficit, adversely affecting private investment and consumption, and in turn, manufacturing output. This was followed in 1998-99 by a major recession, accompanied by a soaring fiscal deficit, increase in unemployment and a subsequent reduction in access to commercial finance, as a consequence of a downgrading of the country's investment-grade status by the credit rating agencies during 1999. With GDP growth rates tailing off to 0.6% in 1998, -4.3% in 1999, and 2.8% in 2000, Colombia entered an economic downturn from which it has yet to emerge. Overview of the Private Sector: Fluctuating role of the private sector in Colombia's economy: Though Colombia has been a predominantly private economy, private consumption rather than investment has been the principal driver. As seen from Table 1, the share of private consumption to GDP rose to over 69% in the first half of the 1990s, though it declined somewhat after the onset of the recession, to 64.4% in 2000. Private investment as a percentage of GDP was lower than the ratio for almost all comparable countries in the region (Table 2) through most of the 1980s and 90s. Colombia's private investment ratio was 9.9% on average for the decade of the 1980s, which compared poorly with an average of 16% for Brazil, 15.4% for Argentina and 12.9% for Mexico for the same period. It did however pick up during the first half of the 1990s, when it rose to a peak of 16.7% of GDP in 1994 (even so lower than Argentina's 1990's peak of 19.9%, Brazil's of 17.6% and Mexico's of 18.9%), before declining to 5.5% in 1999 - its lowest level in three decades. By way of comparison, levels for Sub-Saharan Africa as a region, fluctuated between 12.2% of GDP and 9.6% during the decade of the 1990s, and for East Asia, between 22.9% and 13.8%. The role of the state on the other hand increased significantly in Colombia during the latter half of the 1990s. Public (government) consumption, which had remained fairly steady in the range of 9 to 12% of GDP during the first half of the decade; rose sharply from 1996 to 1999, from 18% to 24%. At the same time, public investment rose (amidst fluctuations) from a low of 6.4% of GDP in 1990 to a peak of 9.2% in 1997. Several factors were responsible for this, including the developmental agenda of the new constitution, which resulted in new spending commitments for social services, the expansion of the judicial sector and increased defense spending on account of the growing violence and guerrilla conflict. 3 Table 1 Colombia - Private & Public Consumption and Investment (% of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Private 66.4 67.7 67.0 67.5 68.1 69.4 65.5 65.1 65.7 64.7 64.4 Consumption Government 9.4 11.3 12.0 11.7 13.1 13.1 18.0 19.9 20.6 24.0 22.8 Consumption Private 10.2 8.4 8.3 10.8 16.7 14.5 13.0 11.0 9.9 5.5 6.9 Investment Public 6.4 6.5 6.7 8.1 6.6 7.9 8.5 9.2 7.7 8.6 7.4 Investment Sources: (Consumption data): EIU Country Profiles; (Investment data): Trends in Private Investment in Developing Countries: Statistics for 1970-2000 (IFC Discussion Paper No.44), Table C I Table 2 Private Investment in the Region (% of GDP) 1980 1985 1990 1995 2000 Argentina 19.2 12.5 9.4 15.8 15.4 Brazil 17.0 12.9 17.6 16.8 - Chile 11.2 14.1 18.4 19.9 16.4 Mdxico 13.9 12.5 13.6 12.4 18.6 1 Peru 12.0 12.9 19.5 17.0 Colombia 9.8 8.4 10.2 14.5 6.9 Among sectors of activity, agriculture, industry and services accounted in 2000 for 13.8%, 30.5% and 55.7% of GDP, respectively. Since 1990, the services sector has been the fastest growing sector (average annual growth rate of 4.3%), having increased its share ten percentage points from 45.4%. Though the share of industry remained relatively stable over the period, that of the manufacturing sector, which in 1990 had accounted for just over 20% of GDP, declined with the recession to under 14% by 1999. For the decade of the 1990s as a whole, the manufacturing sector recorded a negative average rate of growth (-2.3% per annum). The agricultural sector underwent a contraction over the decade, having been affected by a number of factors, including low commodity prices, exchange rate alignments, the economic liberalization and subsequent uneven policy changes, manifested in a shrinkage in the area under cultivation and a negative (-2.2%) rate of growth for the sector over the period as a whole. Exports and export markets have been relatively concentrated. Exports have steadily increased in value over the past decade, from $7.2 billion in 1991 to $13.1 billion by 2000. However their base has been relatively narrow, with a high dependence on traditional exports, in particular oil and coffee which accounted for more than 50% of the total in recent years (in contrast, exports of industrial products have in recent years accounted for under 40% of total value). The US has consistently been the principal destination for Colombia's exports, especially oil, accounting for between 38 and 50% of total trade during 1996 to 1999. The EU 4 was the second largest market up to 1995, but declined in importance as coffee prices fell in subsequent years. Exports have however been on the increase with other Andean Pact countries, especially Venezuela, Peru and Ecuador, though this has been constrained by the recent deterioration in economic conditions of some of these countries. Private sector involvement is strong in the energy and infrastructure sectors. Colombia's approach to private participation in infrastructure differed significantly from that of other countries in the region, especially from the "big bang" approach of outright privatization followed by Argentina and Chile. In response to stem resistance from the unions, and in part to the fact that much of the country's infrastructure was owned by municipal governments over which the central government had no legal authority, the Colombian approach to ownership has been eclectic, ranging from joint ventures and leases to outright privatization (including the creation of "mixed companies" jointly owned by public and private sectors, providing services under lease contract). Despite a seemingly "gradualist" approach, however, Colombia was successful in introducing a fair degree of private participation and competition in the sector, as well as being able to attract substantial private investment, through project finance, into the sector, until the recent economic downturn . In oil, where Colombia has been a net exporter since the 1980s, private oil companies have been engaged for many years in exploration and production, and in the operation of the major gas and oil fields. As a result of a successful privatization effort, the coal sector is now almost entirely in private hands, and private companies operate the main gas pipelines under Build-Own-Manage-Transfer (BOMT) contracts. The power sector has undergone a major transformation - from almost 100% public ownership in 1990 to around 60% private participation in electricity generation (measured in MW installed) and over 43% participation in supply to final consumers. Colombia was a pioneer in introducing structural and regulatory reforms in the sector, with the result that the supply of power now takes place through a well- functioning wholesale electricity market, based on the British model, which has been successful in bringing about improvements in efficiency, costs and quality of service. Colombia was also a pioneer in promoting the participation of the private sector in development of ports, which handled the bulk of the country's exports, and airports. The country's general cargo port terminals were privatized over a three year period, 1991-93, during which time legal reforms were put into place, due diligence conducted and separate concessions offered for each port. The government kept a 30% share of the ownership structure of the concessions, retaining ownership of the port infrastructure. The concessions, which turned out to be fairly successful, business-wise, resulted in dramatic improvements in port productivity2. As regards airports, in 1993, the government corporatized its Civil Aviation Authority, and undertook development of a second runway at El Dorado international airport in Bogota, under a 20-year BOT concession. Three hub airports and the second Bogota airport terminal were similarly given out under concession contracts. Private participation was also sought to be introduced in the roads and highways sector, through use of toll road concessions. However, highways have been fairly vulnerable to sabotage and road hijackings by guerillas, and this has 1 In 1995, Colombia led Latin America in project finance and ranked fifth in the world, attracting US$1.56 billion of loan finance for infrastructure projects. 2 In 1993 alone, the public ports registered a 45% increase in general cargo throughput. 5 been a constraint on the willingness of private investors and sponsors to enter into new concession agreements . The telecommunications sector lagged behind this progress, having seen relatively limited progress in terms of private sector participation. Currently, only 3.4% of telephone lines in Colombia are in the hands of private companies, compared to an average of 85% for Latin America as a whole. Part of the constraint has been the fragmentation of regulatory institutions in the sub-sector and the relatively low telephone tariffs set (in some cases well below the cost of providing service), which has acted as a major disincentive to private companies considering entry. Colombia also has a very low level of internet penetration - only 0.54 internet hosts per 1,000 inhabitants, well below other countries of comparable GDP per capita, such as Brazil and Mexico. This is something Colombia needs to address in improving its competitiveness in the Information Age. Private firms had relatively good access to commercial rmance until the recession, and relatively poor access thereafter. In the wake of the apertura reforms, improvements in performance of the economy and growth of private GDP during the early 1990s were reflected in an improvement in Colombia's access to foreign capital. Between 1989 and 1992, inflows of foreign direct investment rose sharply from $113 million to $679 million, accompanied by a sizeable increase in new loans from abroad to the private sector. Capital inflows continued to rise in subsequent years, with FDI increasing from $1,298 million (or 1.92% of GDP) in 1994 to a peak of $4,753 million (3.91% of GDP) in 1997. Debt flows to Colombia also increased during the period. As seen from Table 3, net private debt flows rose from $696 million in 1992 to $3,660 million in 1996. Coinciding with these trends, Colombia's credit rating attained investment grade, when S&P provided a (BBB-) investment grade rating for Colombia's foreign currency debt in June 1993 and Moody's followed in September 1995 with its own (Baa3) rating. From 1998, Colombia begun to see a decline in capital flows from external sources. FDI inflows declined sharply from their peak to a low of $1,352 million (0.89% of GDP) in 1999, and private debt flows turned into negative. This overall decline was accompanied by a corresponding decline in the country's credit rating, both S&P's and Moody's downgrading Colombia to below-investment grade in 1999. Apart from FDI and external debt, credit to the private sector from the domestic financial sector also significantly increased between 1992 and 1997, at the rate of 39% per annum, from 5,779 billion pesos to 29,962 billion pesos. This changed from 1997 onwards, in the wake of the banking crisis, when credit to the public sector - which had amounted to a negligible 49 billion pesos in 1992 - expanded much more rapidly, at an annual rate of 45%, from 2,684 billion pesos in 1997 to 11,863 billion pesos by 2001. While credit to the private sector did not completely dry up, its increase was limited to a relatively modest 6% per annum, to 44,702 billion pesos by 2001. 3 Though some of these concessions (including those in which IFC participated) had been quite successful in attracting foreign capital. 6 Table 3 Colombia: Private Capital Flows & Domestic Credit Debt toPrivat 619926 1,73 154 1 1995 1996 1 2, 1 1998 1 1999 1 20 2001 -Foreign FDIC(S$ mn) 679 85710 1,298 71172 2,783 24,753 2,032 1,352 12,124 42,075 % of GDP 1.74 1.39 1.92 0.84 2.76 3.91 1 45 0.89 1.22 4 .11 Equity 65 .203 902 -560 294 -169 346 -1413 -997 -243 Portfolio Investment (US$mn) Debt to Private 696 c,773 2,561 2,325 3,660 2,444 -4,93 -1,561 -460 682 Sector (UJS$rnn)* _Domestic Credit to 5,779 8,591 12,740 17,262 21,765 29,962 37,684 39,627 41,751 44,702 Private Sector (Pesos bn) _ % of GDP 14.80 16.80 18.86 20.44 21.61 24.62 26.82 26.15 24.03 23.88 Credit to Public 49 151 730 1,088 1,233 2,684 4,497 5,959 9,161 11,863 Sector (Pesos bn) % of GDP 0.13 0.30 1.08 1.29 1.22 2.21 3.20 3.93 5.27 6.34 Source: Institute of International Finance, Central Bank *Foreign flows are net flows. A better picture is obtained by looking at credit to private and public sectors in relation to GDP. As a percentage of GDP, domestic credit to the private sector in Colombia rose from 14.8%4 in 1992 to a peak of 26.8% in 1998, but declined thereafter to 23.9% in 2000. Within the region, by 2000, this level compared poorly with Chile, where domestic credit to the private sector was 68% of GDP, Bolivia (59.5%), Brazil (37.6%) and Ecuador (33.4%); but relatively favorably with Argentina, where it was only 23.8% of GDP, Venezuela (12.1%), Mexico (13.2%) and Peru (25.9%)5. Credit to the public sector in contrast rose sharply after 1996, from only 1.22% of GDP to 6.34% by 2000. The reduction in access to commercial finance currently faced by private firms, including some of the larger firms looking to make new investments, is reflected in the decline in share of credit to the private sector. The Financial Sector: The private sector and the State have historically shared the task of providing financial intermediation in Colombia. Dating back to the 1930s, the government had introduced a range of specialized state institutions to provide credit for its industrial and agricultural production, and trade finance for exports. The government was also the traditional owner of a range of other financial institutions, including development finance corporations and insurance companies. Public sector ownership of financial institutions expanded significantly during the financial sector crisis of 1982, as the State took over a large number of insolvent private financial institutions. The Fondo de Garantias de Instituciones Financerias (FOGAFIN) was created to 4 Source: HF Database 5 Source : All data from World Development Indicators 7 oversee the reorganization of these institutions, and a range of reforms introduced to increase the authority of the Central bank and strengthen supervision. This trend reversed itself with the launching of the Apertura reforms in 1991, which brought about heightened competition and fundamental changes in the structure of the financial sector. Most of the nationalized banks were privatized, foreign investment was liberalized, the central bank was granted independence and the new Banking Law provided the basis for a considerable strengthening of supervision of the banking industry. At the same time, the creation of financial groups was permitted, which - together with the introduction of a new regulatory framework - paved the way towards universal banking. Benefiting from these reforms, as well as from the resultant rise in foreign investment in banking institutions, the sector grew rapidly during the 1990s, until the beginning of the banking crisis in 1998-99. The rapid expansion of the banking sector in many ways contributed to the onset of the crisis. By late-1996, the sector was already coming under considerable pressure on account of a significant increase in bad loans at state-owned banks, financial cooperatives, and savings and loans institutions. A lack of liquidity, high inflation (20% in 1998) and unemployment (18% in 1998), compounded these problems, contributing to a further weakening of the loan portfolio, especially in the mortgage sector, where real estate prices had begun to decline. By mid-1998, as the Central Bank sharply increased domestic interest rates, economic growth slowed and the private sector tried to reduce its debt burden, credit demand fell along with a rapid deterioration in the financial institutions' asset quality. In 1998, declaring an economic emergency, the government introduced a number of measures to cope with the situation, including a tax on financial transactions (to fund FOGAFIN), a debt relief program for mortgage debtors, capital injections to institutions taken over by the state and higher loan loss provision requirements. Notwithstanding this, bank earnings remained negative during 1998-2000, with the level of non- performing loans in the system rising from around 7% in early 1998 to a peak of 20% by end- 1999. As of end-December, 2001, Colombia's financial sector (in terms of credit providers) consisted of 28 commercial banks (including 10 foreign), 8 financial corporations (Corporaciones Financieras), 28 commercial finance companies (11 of which were specialized leasing institutions) and 13 cooperatives (Table 4). A result of the regulatory changes that made it possible for banks to diversify into new markets, and of the heightened competition in the marketplace, was that the financial system went through a deep consolidation process that drastically reduced the number of players in the market. Included among these were the savings and loans institutions, which had originally specialized in mortgage finance: as a result of laws passed in 1999; these have now been converted into banks. 8 Table 4 Colombia's Financial Sector (as of end-December, 2001) Number of Assets Net Income Entities (US$ million) (US$ million) Commercial Banks 28 31,600 160.57 Domestic 18 21,286 40.97 Foreign 10 10,314 201.54 Financial Corporations 8 3,909 (185.88) Commnercial Finance 28 1,457 29.47 Companies_ cooperatives 13 159 3.99 Special Official Institutions 9 8,107 265.54 (IOEs)*- Total 86 _ 45,231 314.67 * Government entities which act as the second tier financial institutions channeling resources from multilateral banks and other sources to specific sectors, such as energy, agriculture, urban development, and import and export promotion. Source: SuperBancaria The banking industry has dominated the financial sector, domestic and foreign commercial banks accounting for 69.9% of total assets and 64% of total earnings. As a result of the consolidation process, the industry has become highly concentrated, with eight financial groups currently dominating the market, offering a range of services, from commercial and mortgage banking, leasing, pension fund management, and insurance services. Bancolombia, formed as the result of a merger between Banco de Colombia and Banco Industrial Colombiano in February, 1998, is the country's largest bank, with assets of over $3.5 billion. Other large banks include Banco de Bogota, owned by a local financial sector group, Grupo Aval, with assets of $2.8 billion, Banco Ganadero, owned by Banco Bilbao Viacaya (BBV) of Spain, with assets of $2.5 billion and Bancafe, with assets of $2.3 billion. Colombia's capital markets are relatively underdeveloped, despite the fact that there are no major policy distortions impeding capital market development. Stock exchanges - recently merged - have operated in the three major urban centers, Bogota, Cali and Medellin, but as seen from Table 5, despite a substantial increase over the decade of the 1990s, market capitalization remains small even by regional standards. 9 Table 5 Stock Market Statistics: Colombia and Selected Countries in the Region 1990 2000-2001 Countries Market Value Listed Market Value Listed Capitalization Traded domestic Capitalization Traded domestic $m. % GDP % GDP companies $m % GDP % GDP companies Colombia 1,416 3.5 0.2 80 13,217 11.8 0.5 123 Argentina 3,268 2.3 0.6 179 192,499 58.3 2.1 111 Brazil 16,354 3.5 1.2 581 186,238 38.0 17.0 428 Mdxico 32,725 12.5 4.6 199 121,403 21.8 7.9 168 Chile 13,645 45.0 2.6 215 56,310 85.6 8.6 249 Venezuela 8,361 17.2 4.6 76 6,216 6.7 0.6 63 Peru 812 3.1 0.4 294 11,134 19.8 2.8 207 Source: World Development Indicators (World Bank) As seen from Table 6, the increase in market capitalization in Colombia was not without some fluctuation during the period. From a 1990 base of US$1.4 billion, it rose to a peak of $19.5 billion in 1997, before declining - in the wake of the crisis - to $9.6 billion in 2000 (reviving in 2001 to $13.2 billion). The relatively low level of market capitalization, for what is one of the more developed countries in the region, reflects the fact that relatively few companies in Colombia are publicly owned, and those that are listed on the stock exchanges have, for the most part, a narrow ownership base. Table 6 Colombia - Trends in Market Capitalization (1990-2001) (US$ million) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 1,416 4,036 5,681 9,237 14,028 17893 17,137 19,530 13,357 11,590 9,560 13,217 Capital markets in Colombia are heavily skewed in favor of fixed income securities. Measured at end-2000, equity transactions represented less than 1% of the value of Colombia's capital markets transactions, while fixed income debt securities accounted for the rest. A large part of both primary and secondary capital markets activity in the fixed income sector has been generated by the government debt market, with treasury instruments now catering to maturities of up to 12 years. Institutional investors now invest heavily in government securities. The success and liquidity of this market has - by absorbing most of the available demand in the domestic capital market - in fact begun to crowd out private financing; which is a matter of some concern. Recent issues by supra-nationals have helped diversify somewhat the pool of fixed income securities in the market. However, access to the fixed-income market by non-sovereign issuers needs to be significantly improved. 10 III. Private Sector Development Agenda: The agenda for recovery and growth of Colombia's private sector flows from the structural constraints outlined above, as well as from the macro-economic instability that is currently faced by the country. At the macro level, the enormous increase in public debt, domestic and external, incurred since the beginning of the banking crisis, has resulted in a public sector debt of some 46% of GDP and interest payments of nearly 5% of GDP to service it; and on the external front, for a debt-to-exports ratio of 220% for 2001, accounting for 45% of current account receipts by way of debt service. This situation has been exacerbated by a deterioration in the country's export performance, especially on account of weakness in earnings of traditional exports. The magnitude of the debt, together with an assessment of the difficulties that lie ahead, has been principally responsible for the country's ratings downgrade by the major credit rating agencies, and for the consequential reduction in access to commercial finance by the private sector. If there is to be any real improvement in the private sector's access to finance, restoration of economic stability is an essential prerequisite - calling for prudent economic management, and the introduction of sustainable fiscal policies. Equally important, however, is the existence of a well-functioning domestic financial system, able to provide adequate services to all segments of the productive sector, through healthy banking, housing finance, capital markets, pensions and insurance systems. A key element of the agenda for development of the private sector would be the completion of the reform process for the financial sector, so as to facilitate a deepening of domestic markets, strengthening of the banking sector and development of the capital markets framework. Two other elements of the PSD agenda can be considered a priority. The first, to ensure that the overall business environment is conducive to realizing the full potential of the private sector - calls for a strengthening of regulatory and competition frameworks for commercial enterprises, as well as for the financial sector, a strengthening of the FDI framework and demonstration of a commitment to increased private participation in the economy. The second, to facilitate the international competitiveness of the productive sectors, calls for improving the competitiveness of infrastructure and natural resources sectors (e.g. through reductions in costs of transport and communications). An important part of this agenda would be to further the participation of the private sector in these sectors, both through a reduction in administrative barriers and an acceleration of the privatization process. A key element of this agenda is attaining a strong supply response from the private sector, so as to help fuel growth and facilitate a better distribution of its benefits across various segments of the population - something that was perceived as missing in the reform era of the 1990s, not only in Colombia but in Latin America as a whole. Improving the Investment Climate Strengthening the Framework of Commercial Laws and Regulations: Colombia has already made considerable progress towards establishing a framework of commercial legislation conducive to the development of markets and the needs of a modem private sector. Under the reform process initiated at the beginning of the 1990s, a number of steps were taken to promote deregulation, particularly in the infrastructure sector, and to strengthen the competition framework. This was followed by a new Arbitration and Mediation legislation (Law 23 of 1991), introduced in 1991 to provide mechanisms for contract enforcement and conflict resolution, and legislation in 1994 to consolidate all bankruptcy, liquidation and reorganization laws and regulations under one consistent legal framework. Revisions concerning concordato and bankruptcy procedures included the establishment of the Superintendency as the sole authority over these procedures, and a number of changes to the Commercial Code to strengthen transparency and corporate governance, including the appointment of statutory auditors, reporting on management's compliance with the company's bylaws and shareholder decisions and supervising the operation of internal controls and measures to safeguard assets. Improving the institutional and regulatory framework of the financial sector: Steps already taken to strengthen the framework of laws and regulations for the financial sector, as well as the unfinished agenda awaiting implementation, are included in the discussion on the financial sector, below. Strengthening the EDI framework: As a result of the "opening" of the economy in earlier years, which removed most of the principal barriers to foreign direct investment, the legal and regulatory frameworks for FDI in Colombia have generally been considered to be on par with the most liberal countries in the region. The current FDI regulations6 provide national treatment for foreign investors and permit 100% foreign ownership in almost all sectors of its economy, with the exception of hazardous waste and national security, and the natural resources sector, where foreign exploration and development of petroleum resources must take place as a joint venture with Ecopetrol, the state oil company. Most bureaucratic and screening procedures were replaced by a single, simple registration at the Central bank and most foreign exchange controls were lifted. For 2002, the Heritage Index of Economic Freedom rated Colombia's capital flows and foreign investment regime on par with the United States7. Despite the liberal nature of the regulatory framework, FDI flows to Colombia have to a large extent been influenced by other factors. Until 1997, FDI flows to Colombia increased rapidly, reaching nearly 4% of GDP, well in excess of the regional average. A large share of this increase however was only weakly related to the international competitiveness of the country as a host to foreign investment. According to Central Bank estimates, privatization receipts accounted for 60% of FDI flows in 1997. Similarly, one-third of inflows over the period 1991- 97 took place in the mining and oil sectors, that were also largely independent of the investment climate. Non-regulatory factors have also played a role in the decline in foreign investment 6 Law 9, Resolutions 51, 52 and 53 of the Council on Economic Social Policy and Resolution 21 of the Board of Directors of the Central Bank 7 Rating both countries a score of 2 ("low barriers"). 12 taking place after 1997. In recent years, partly as a result of rising guerilla attacks on pipelines and infrastructure facilities, foreign investors have become more concerned about the security problems arising from the growing violence of the civil conflict, and their associated costs, direct and incidental. Secondly, investors have been increasingly concerned about the macro-economic instability that the economy has been undergoing, and the uncertainties generated as regards the exchange rate. What remains to be done? The dual problems of security and macro-economic stability are in any case high on the government's list of priorities. Though major improvements in the framework are not called for, a number of minor barriers to foreign investment remain which may usefully be addressed. These include: (a) the lack of any treaties for the avoidance of double taxation, which - though not a serious impediment - can sometimes makes investors question the seriousness of a country in seeking foreign investment; (b) the remnants of some forms of exchange controls (e.g. some foreign exchange surrender requirements for exporters) that appear to have survived for largely bureaucratic reasons, imposing an avoidable economic cost; (c) substantial delays in obtaining visas and work permits for expatriates; and (d) frequent changes in the tax system, introducing uncertainty about the rules of the game. Increasing Private Participation: An increase in the size and role of the private sector in the economy, relative to that of the state (which had gone through an unprecedented expansion in recent years), with the state playing the role of regulator rather than operator, will be critical to the country's economic recovery. Initial steps that have been taken in this direction include measures to consolidate the financial sector, including the liquidation of Banco Central Hipothecaria (BCH) in 2001, and the on-going liquidation of Banestado. Of the four remaining public banks, only one (Banco Agrario) is planned to be retained in government hands. Bancafe is being offered for sale, and the Instituto de Fomento Industrial (IF) and GranAhorrar are being assessed for subsequent closure or sale. Turning to infrastructure, in the power sector, the reform process, which had included establishment of the wholesale market for electricity, led to the divestiture of a number of state- owned power plants, leaving ISAGEN, with an installed capacity of 1,460 MW, as the only major power company still in state hands (the privatization of ISAGEN itself was held up on account of a dispute with another utility). Privatization of distribution was initiated through the successful unbundling and recapitalization of EEB in Bogota, and the outright divestiture of several distribution companies on the Atlantic coast that were grouped under two companies, Electrocosta and Electricaribe. What remains to be done? About 20 electrificadoras, smaller distribution companies owned by the central government in conjunction with local governments, have for various reasons been awaiting privatization since 1999. Given the imminence of their privatization, investment in these companies was reduced; however, the delay has meant that their situation has been deteriorating steadily, rendering prospects for a successful divestiture increasingly more difficult. Given that these companies serve over 45% of total users of power, it is imperative that privatization be implemented without further delay, otherwise the increasing debt of these companies with the wholesale market could lead to an eventual cutting off of supplies. 13 Promoting Competitiveness Improving the efficiency of infrastructure services: The quality of infrastructure - power, water, transport and telecommunications - is an important determinant of the competitiveness of modem economies. For Colombia it is even more important, in light of the erosion of facilities that has occurred in recent years, through the periodic acts of sabotage stemming from the insurgency. The substantial inflow of foreign investment that Colombia was able to attract through project finance into the infrastructure sector in earlier years had helped to bring about improvements in the quality of service. However, the contraction of foreign flows during the past three years has meant a drying up of resources to the sector, raising the question of how to ensure the generation of investments necessary for the maintenance of existing assets in the sector. Steps taken by the government over the years to broaden private participation in the sector and introduce regulatory and other reforms proved in many cases to be successful in improving productivity and efficiency of services. In the ports sub-sector for instance, the productivity of cargo port terminals rose significantly after their privatization in 1991-93. Apart from a significant increase in general cargo throughput, rates fell by more than 50% in real terms in the subsequent three years (and by 75% per container), as a result of the increase in competition among ports (and among stevedores at each port), as well as from increased investment in container handling equipment. Similarly, the establishment of the wholesale electricity market brought about significant efficiency gains through reductions in cost and service interruptions. Outcomes were less satisfactory in the telecommunications sub-sector, where opposition from labor unions and local groups during the 1990s prevented the privatization of national and municipal-owned telephone companies, where very low , regulated tariffs were giving rise to financial problems for companies, and where the fixed-wire services remained dominated by government-owned local and long-distance telephone capacity. In comparison, cellular companies were much more private-oriented, though cellular penetration itself in Colombia, at 7 lines per 100 inhabitants, was lower than most other countries in the region, except for Peru. What remains to be done? In telecommunications, reform of local telephone tariffs seems to be an essential pre-requisite to stimulating private investment. Other reforms include the consolidation of the existing regulatory institutions into a single entity, transparent and accountable, as well as permitting greater freedom to local companies into the provision of mobile service, so as to provide incentive for greater domestic competition. In other sub-sectors there is a need to redesign the key elements to take account of evolving circumstances - in particular the realities of the security situation. Reviving investment in the energy sector: The oil industry in Colombia has been in a state of decline for the past several years - manifested in a decrease in export volumes (from 810,000 bbd in 1999 to 630,000 bbd in 2001) and a steady decline in exploration, and hence in proven reserves (from 3,000 Mbbl in 1995 to under 2,000 Mbbl in 2000). Oil investors consider Colombia a high-risk country, as a result of frequent changes in policies and contractual terms, and with high exploration and production costs, 8 In some cases below the cost of providing the service 14 compounded by major security problems (there were more than 180 bombings of the pipelines in 2000 and 2001). At the same time, relatively high taxes and royalties have reduced the competitiveness of the industry in the global context. This has led to a sharp decline in investments in the sector. Total investments of $140 million in 2000 and $282 million in 2001 fell well below the levels of 1997-98, and the number of wells drilled dropped from 292 in 1985 to only 92 in 2000. At current production levels, it is estimated that existing reserves would be sufficient for only eight years. In an effort to promote competitiveness and attract foreign investments, the government has introduced several legislative reforms, but has faced a number of obstacles. A new association agreement distributing production on a 30:70 basis between Ecopetrol and the associated company was introduced in 1999 as part of a National Development Plan, which was however declared unconstitutional by court. Law 619 was introduced in 2000, introducing a sliding scale for royalties in proportion to the size of the fields, and substantially reducing the government's stake, but this too was declared unconstitutional. A new law was approved in June 2002, establishing royalties in relation to size of field and production, and it is hoped that this will stimulate investments in the 18 blocs Ecopetrol opened to international bidding during Round 2000 (estimated by the government at a potential 47 billion barrels of recoverable reserves). Putting the financial sector on a sound footing: Strengthening the legal framework: The legal framework governing banks and financial institutions had originally been introduced in 1923, remaining virtually unchanged until the reforms in 1990. There was a complete overhaul of legislation in 1990, under the financial reform program. Two key pieces of legislation implemented at the time were Law 45/1990, allowing foreign investment in financial institutions, and broadening the scope of activities in which banks could engage in, and Law 35/1993, which outlined the conditions under which the government could intervene in the financial sector. In an attempt to strengthen the banking system, in the wake of the crisis, the Banking Superintendency implemented several new regulations in 1999, including a re-definition of requirements for entering the financial system, capital investments and a new structure for the financial system which is used today. After the banking crisis, several new pieces of legislation were introduced through a new financial sector law, passed in 1999, which redefined the requirements for entering the financial system, its structure and the minimum capital requirements for entry. Also introduced was Decreto 1154 of 1999, which modified the structure of the Superintendency of Banks, by redefining the scope of its supervision and functions, and Law 546 of 1999, which established norms and regulations for mortgage lending. New powers were given to FOGAFIN to expedite mergers and acquisitions, using other banks as trustees to manage credit portfolios. Further progress was made in 2001-02 in modifying the prudential regulations governing the banking system, a principal objective of which was to give banks a more proactive role in risk management. Three important regulatory changes were recently implemented: the first9 of which introduced improvements in the valuation and classification of shares; the second of which incorporated market risk in the calculation of risk-adjusted capital ratiosl°; and the third of 9 Under Circular Externa 033 of August 2002 '0 As prescribed in Circular 048 15 which introduced an additional category for the disclosure of loans under the heading of "Microcredits" , to complement the existing three loan categories (commercial, consumer and mortgage). In addition, banks were also required by the Superintendency to develop their own credit risk administration systems, incorporating policies for evaluating, classifying and controlling risks within prescribed guidelines. Banks were also required to create a general loan loss reserve of 1% by end-June 2002, and guidelines were prescribed to ensure that loan loss reserves did not fall, even under extreme circumstances, below specific levels, according to loan classification. Other measures taken to strengthen the system included the implementation of restructuring programs carried out by FOGAFIN, which during 2001 issued convertible bonds as part of a capitalization program and directly injected funds into two public banks. What remains to be done? The main policy and institutional reforms that are still pending for the sector center around the development of a comprehensive strategy for capital markets and financial intermediaries, aimed at deepening the capital markets, increasing liquidity and helping reduce the excessive fragmentation of the financial market. Towards this end, the new capital markets framework law, which is under discussion, should help reduce obstacles to the issuance of securities by companies and provide the legal basis for developing securitized transactions. Secondly, the government will need to reassess its domestic debt financing strategy so as to encourage access to the fixed-income market by non-sovereign issuers, thereby reducing the crowding out of private financing that is currently occurring. Other steps that should be considered include: (i) strengthening the capacity of the Superintendency of Securities to provide it with the skills to detect and investigate market fraud or insider trading, and (ii) implementing internationally-required accounting and financial reporting norms for the issuance of securities to provide reliable investor information; both of which would be critical to instilling market confidence. Reforning the pensions system (which is also part of the conditions of the current lending agreement with the 1MF): As it stands, the public pensions system is technically insolvent, and with the annual transfer to cover its cash deficit equaling the size of the total health budget, constitutes a major risk to fiscal stability over the medium term. A key reform objective is the transfer of all workers from the public pensions system to the private sector. Until this is done, measures to reduce the future cost of fiscal outlays to fund the public (including municipal) pensions schemes include changes in the contribution rate, some reduction in benefits and more stringent conditions for benefit accrual. Additional reforms would include the consolidation of the various public pension regimes, including the national and territorial cajas and ensuring greater coordination between social security and central budget units in the government to assure accountability from departmental and municipal governments. Completing the restructuring of the banking sector: Though the profitability of the banking system improved in 2001, with banks reporting an average ROA of 0.8% after three consecutive years of losses, the operating environment continues to be weak, with consumer demand weighed down by unemployment rates of over 16%, and continuing concerns about security, low rates of savings and investment (gross domestic savings, which declined for Colombia from over 24% in 1990 to 10.3% of GDP in 2001, being currently among the lowest in 1 Described in Circular Externa 011. As of end-June 2002, niicrocredit loans so described accounted however for only 0.3% of the system's loans 16 the region). Equally importantly, asset quality remains weak (the ratio of non-performing loans to total loans standing at 10.2% as of end-2001), so that completing the restructuring of the banking sector becomes a matter of priority. As part of the government's response to the banking crisis, public banks had earlier been "officialized", with FOGAFIN taking over direct management oversight and ownership stake, with a view to cleaning up their balance sheets, recapitalizing them, and selling or liquidating them. However, after more than three years, the resolution of this process is still not clear. A continuation of the process will include action by the Superintendency of Banks to enforce proper loan classification and provisioning requirements, including reducing the over reliance of banks on collateral property as a substitute for cash provisions. Other factors that have had a destabilizing impact on the system, and which will need to be addressed, include the impact of the drug trade and insurgency via the money laundering of illicit funds. Some major steps have already been taken by the government to begin tracking such monetary assets and to develop an anti-money-laundering legal framework, and more intensive steps will need to be taken in the foreseeable future. Restoring the housing finance industry to soundness: The mortgage banks (CAVs) were particularly badly affected by the crisis, reporting NPLs as high as 23% (at end-May 1999) in contrast to average levels in the 12-15% range for the overall banking system. By end-1999, residential mortgage debt represented a high (31%) proportion of the total debt of the banking system, most of it concentrated on the CAVs. Between 1998 and 1999 various debt relief efforts were provided in the form of debt write-downs or refinanced mortgage loans at lower interest rates, which provided some relief to the mortgage banks in 2000 (though NPLs rose again to the same levels in 2001). Housing Law 546 of December 1999, which permitted commercial banks to provide mortgage loans, also provided for the conversion of the CAVs into banks - regulated and supervised as such -- the standardization of mortgage loans into a few eligible inflation- indexed (UVR) schemes, and new secondary mortgage instruments and institutions, such as mortgage bonds, MBS and securitization agencies. Notwithstanding this, the mortgage portfolio has not significantly improved and represents an area of major potential instability for the financial system. Of the seven banks in which the portfolio is concentrated, only Davivienda consistently earned a profit throughout the financial crisis, and was the only former CAV not to require recapitalization support from FOGAFIN. The situation has been exacerbated by the continuing economic recession and the fact that the State bailouts have to some extent been self- defeating, as they have tended to generate a culture of non-payment among households - which has even begun to contaminate the private banks. In addition, some recent rulings of the Constitutional Court in the wake of the Housing Law - capping interest rates and forbidding out- of-court foreclosure proceedings - have further weakened housing as collateral for the lending institutions, thereby inhibiting interest banks might have in resuming lending in this sector. Immediate priorities for the sector include restoring mortgage collateral strength, while introducing consumer protection regulations, abandoning the interest rate cap and facilitating the issuance of mortgage securities. Strengthening Micro-Finance: Access to credit to the low-income segment of the market is currently provided by two types of micro finance institutions: the first composed of the non- profit organizations (NPOs) that account for 40% of the market, the second by the regulated 17 banking system, which account for the balance 60%. The largest players in the regulated segment include Banco Caja Social (an IFC client), Banco de Colombia and some specialized financial institutions such as Finamerica and Compartir. Micro finance is one of the government's leading programs: through the MiPymes Law, the government has tried to create the conditions that would allow the banking system and the NPOs to continue supporting the sector. Under the slogan "Colombia Pais de Propietarios", the object is to mobilize $120 million per year through the banking system in order to finance micro-enterprises. Banco Caja Social is the leader of the program, with 50% of that amount. The most representative NPO in Colombia is Banco de la Mujer, with more than 127,000 outstanding micro-credits. Other non-profit organizations sponsored by the main economic groups in the country have also played an important role in the micro finance sector, as in the case of Fundacion Mario Santodomingo (Bavaria Group) and Fundacion Carvajal. Strengthening Education: Though Colombia has made considerable progress in improving basic literacy, reducing its adult illiteracy rate from 15.9% in 1980 to 8.6% in 1999 (significantly lower than the Latin America's regional average of 12%12 in that year), its performance has lagged behind the regional average in terms of enrollment at primary and secondary levels'3. There have also been deficiencies in the quality of education, with weaknesses observed at all grade levels, especially in international comparison with countries of similar income levels'4. Together, these have contributed to an overall skills deficiency, which was reflected in the negative growth of total factor productivity in Colombia during much of the 1980s and 1990s'5. As such, Colombia's agenda for the education sector is as much to promote improvements in student achievement and quality of education as a widening of its coverage. Given that Colombia's expenditure on education, public and private, has been higher than in most other Latin American countries, what this translates into is a need for greater focus on efficiency gains, as through programs to develop school infrastructure, and provide teaching materials, and for a better targeting of educational assistance to the poor. The private sector has scope to play a greater role, particularly in higher education, and vocational and other training. IV. The World Bank Group's Private Sector Strategy: The World Bank Group's Private Sector Strategy (PSS) for Columbia is based on the diagnosis of the opportunities and constraints faced by the private sector, outlined above. A key objective of the WBG for Colombia is to promote a revival of private sector investment and growth, to enable it to play an effective role in the country's economic recovery. Over the years, the WBG institutions have had an increasingly coordinated approach to the development and strengthening of the country's private sector, based on a balanced mix of activities ranging from strengthening of the regulatory framework, institution-building and direct investment in private 12 World Bank educational statistics 13 In 1999, Colombia's gross enrollment ratio at the primary level was 112.5% and at the secondary level, 70.9%, well short of the regional averages for Latin America of 131.5 % and 83.9% respectively. 14 Test scores from International Math and Science Study tests, in which 8h grade students from Colombia and Chile participated showed both countries to be among the worst performers. See "Closing the Gap in Education and Technology"; David de Ferranti, Guillermo Perry, et al, (World Bank), 2002. 15 "Closing the Gap....., op.cit., The authors estimated TFP rates for Colombia at -0. 17% per annum for the 1980s and -0.27% for the 1990s (Table 3.2). 18 firms. This coordination has taken place across the full range of sectors and activities. Within the context of this coordinated approach, the specific activities of each institution are defined by their respective comparative advantages in the marketplace. Comparative advantages of IBRD and IFC/MIGA: In pursuing the WBG strategy for the private sector, IFC/MIGA and IBRD will follow a division of labor based on the respective comparative advantages of both institutions. In general, IBRD's comparative advantage lies in its ability to assist governments in macro-economic policy, knowledge building and transfer, sector policy advice and capacity building. The Bank has also been effective in advancing policy dialogue with the Colombian authorities through open and constructive discussion. IFC's (and MIGA's) comparative advantage lies in its ability to help mitigate investor perceptions of country risk, through the financing of successful investments, and through its role in mobilizing commercial finance/insurance. EFC's strength is derived from its practical knowledge of the financial and corporate sectors, dialogue with international and local investors, and its accumulated knowledge and expertise of emerging markets, of corporate governance, and of environmental and social business practices. In Colombia, as in most middle-income countries, demand for IFC's services has primarily been a function of the country's access to other sources of commercial finance and know-how available to the private sector. During much of the 1990s (particularly mid-1990s), on account of the country's investment grade credit rating, and the access to international financing that its top-tier firms and banks were able to have, IFC was able to play only a relatively limited role in financing investments. Between FY95-98, IFC approved only 5 projects for a total IFC net of $60.6 million (with another $25.0 million from syndications), which could be considered a relatively low volume of investment activity for a client country of Colombia's population and economic size. However, the position changed dramatically with the onset of the crisis, and the reduced access to commercial finance. During the three years FY99- 02, project approvals increased significantly in number and value - IFC approving 12 projects for a total IFC net of $493.4 million (plus $248.6 million in syndications). These projects were focused on (i) financial markets, including micro/SME financing, (ii) natural resources sector, and (iii) corporate modernization and restructuring. Along with the loss of alternative financing sources, this period also saw the development within IFC of new expertise - especially in the financial sector - which has been applied in Colombia. During the period to date, IFC has undertaken increasingly complex tasks in financial strategy and corporate restructuring, in introducing new instruments and, together with the World Bank, in advising the government on regulatory improvements. An example of innovation in this area is the first local currency bond in Latin America issued by an international institution. IFC's growing focus and expertise on various aspects of corporate social responsibility are also part of the Corporation's comparative advantage. IFC's ability to help firms better incorporate environmental, social and corporate governance considerations in their operations can significantly improve the competitiveness and sustainability of private economic activity. In infrastructure and financial markets, the Corporation's extensive experience contributes to "getting private activity right", and avoiding the ill-structured transactions that have been visible in many countries and have had political reverberations. In the current climate of popular uncertainty about the benefits and risks of private investment, this "higher quality" investment 19 can play an important role, reducing risks to firms and enhancing developmental gains for the country. Several of IFC's recent investments in Colombia (e.g. SIG, Banco Caja Social and Bavaria - see Boxes 2 & 3 below) illustrate the value-added that the Corporation can bring on this account. IFC's held portfolio for Colombia stood at $541 million, including syndications, for a total of 17 companies, as of October 31, 2002. Specific loss reserve and loan arrears ratios stood at 4. 1% and 1.9% of the portfolio, respectively, mostly on account of two projects. This reflects better than the average ratios across the portfolio in IFC, and contrasts with the high level of arrears in the domestic banking system. As of Sept. 30, 2002, MIGA has one active guarantee in Colombia, with a gross exposure of $62.4 million, and a net exposure of $31.2 million, for a project in the power sector. MIGA has also provided assistance to several other projects in Colombia's infrastructure and banking sectors. The total estimated amount of FDI into Colombia facilitated by MIGA to date is $514 million. IBRD: In a continued effort to help promote the development of a well-functioning financial system that can promote adequate services to all segments of the productive sector and the population at large, and building on the achievements of the Financial Sector Adjustment Loan (FYOO), the Bank plans to process a second Financial Sector Adjustment Loan to address the remaining agenda to ensure the health and financial sustainability of the banking system and to foster capital markets development. This, together with associated analytical work, will support (a) completing the restructuring and privatization of state-owned banks, (b) strengthening problem bank resolution systems as well as the supervisory framework for banking and insurance, (c) consolidating and rationalizing the multiple second-tier banks that are currently operating, and (d) improving judicial system procedures that currently hinder efficient foreclosure. The IBRD will also help foster, via a proposed lending operation and analytical work, simplification of administrative procedures governing the establishment and operation of firms, that are currently excessively cumbersome, and creation of an environment more conducive to increasing economic contributions by medium, small and micro enterprises (including employment generation). The EBRD's assistance strategy in the coming three years will place considerable emphasis on supporting Colombia's efforts to establish efficient, effective and well-managed infrastructure services. In recognition of the urgent need to correct existing gaps the IBRD will support a broad program of initiatives in the infrastructure area to: (i) help turn around the significant erosion of infrastructure in recent years; (ii) create mechanisms to maximize the possibilities for enhanced private sector participation in the new infrastructure investments - most importantly through the strengthening of the regulatory and competition frameworks, establishment of clear rules of the game for concessions, and effective public-private partnerships to enable the efficient provision of infrastructure services, achieving a reduction in logistics costs in the economy via efficiency improvements (e.g. in the transport and telecommunications systems); (iii) urban upgrading and improvement of shelter supply, water, 20 roads, power and telephone services for slum area communities; and (iv) potable water supply, sewerage and wastewater treatment for the least served areas. Specific lending operations covering wastewater and sanitation management, water supply, low-income regional roads, national urban transportation, and an urban upgrading project - and associated analytical work - are envisaged for FY03-06, to provide support along the above lines and make up for the depleted infrastructure. Together, these operations would help improve access of essential public services (e.g. water, sanitation, community roads and telephones) to the poorest segments of the population, put in place cost recovery and tariff structures that are socially and environmentally responsive, increase private participation and bring in the critically-needed investments in these sectors, and help enhance efficiency of infrastructure provision and bring down logistics costs in the economy. The program also envisages taking advantage of opportunities offered by the Kyoto Protocol through the Prototype Carbon Fund (PCF) or the EFC-Netherlands Carbon Facility to finance off-grid solutions making use of renewable energy sources. IFC: Looking forward, IFC's strategy for Colombia aims to help in a broad-based "reactivation" of the country's economic growth by promoting a stepping up of private sector investment and activity, and more broadly-based growth. This approach places emphasis on reaching out to a broader base of the Colombian private sector in facilitating growth and a sharing of its benefits. LFC's interventions will in this way focus on supporting firms that are engines of growth, and have linkages to wider economic and social activity; on reaching out to smaller firms through financial and other intermediaries; and on selectively supporting small projects with large potential impact, particularly on the poor. LFC's strategy is closely aligned to that of the World Bank and is centered around the following four objectives: (a) Improving access to finance through development of domestic financial markets (including a broadening of access to the low-income segment of the market) (b) Facilitating the investment supply response of the private sector (c) Strengthening the Natural Resources sector (d) Help further private participation in the Infrastructure sector Development of domestic financial markets: IFC's approach to strengthening and broadening access to finance has several pillars, including helping to deepen capital markets, promoting the strengthening of the banking sector, helping develop the capital markets framework so as to promote the transition of the financial corporations (Corporaciones Financieras) into investment banks, helping to improve micro and SME financing for the low- income market, and supporting the government's efforts to reform the pension sector. To help deepen capital markets and improve the private sector's access to finance IFC has undertaken a number of transactions in different sub-sectors in recent years. These included a $50 million investment, approved in FY99, in the development finance corporation Corfinsura, including a $25 million revolving credit facility, to strengthen the corporation's capital and liquidity position, allowing it to offer US dollar loans of longer maturities to medium and large- sized companies, at a time of severe credit shortage. In the same year, IEFC invested in Surenting, the first Colombian company dedicated to operating leasing (e.g leasing of truck fleets). In 21 FY01, lFC approved a $140 million investment to help create Colombia's first secondary mortgage market company (Box 1), which issued a first successful MBS, and plans to make a subsequent larger issue. The securitizations have been successful in diversifying the risks of the mortgage originators by converting illiquid mortgage assets into liquid MBS assets and to provide funding sources to these banks. Also in FY01, IFC approved a $19 million investment in the first private equity fund (CCGF) aimed at supporting Colombian middle market companies. BOX 1 Colombia Home Mortgage Corgoration (CHMC) Between 1993 and 1998, IFC had advised the Colombian government regarding the introduction of appropriate regulations for the establishment of a mortgage securitization company. The regulations were passed in 1998, just prior to the recession, and were followed by the new law reforming the mortgage sector and supporting its financing through MBS and other such instruments, in 1999. Titularizadora Colombiana CHMC, Colombia's first secondary mortgage company, was established in 2001 as an independent, multi-function company, with the business objective of acquiring and securitizing high quality residential mortgage loans. The core sponsors of the project were Grupo Bolivar, Grupo Suramericana and Grupo Social, three of the largest private groups in Colombia, and in turn majority shareholders of Davivienda, Conavi and Colmena, respectively, the three largest mortgage originators in the market. Grupo Aval and Grupo Colpatria were also involved in the project from its inception, as junior sponsors. IFC approved an investment of upto $40 million, to take a 25% equity stake in the company, in addition to extending a $100 million local currency guaranty facility, to support the company's funding and securitization programs. CHMC was designed to have a market-wide impact on the country's capital markets and on the mortgage finance sector, by making MBS and the Company's own (highly rated) general corporate debt available for domestic pension funds and life insurance companies. It would help develop the primary mortgage market via improvements in loan quality and products, and improve the affordability of housing finance by making longer term financing available, and by enhancing the liquidity of mortgage assets. Since its establishment, CHMC has already issued a first very successful MBS and has plans for a subsequent issue of up to $400 million (for which IFC will provide enhancement). More recently, IFC launched in FY02, a $100 million domestic Colombian peso "El Dorado" 5-year bond issue - the first AAA-rated local currency bond in Latin America and the first Colombian peso issue by an international institution. The issue, which was more than twice oversubscribed and achieved broad distribution with over 40 domestic investors, including all the large pension funds, will provide a benchmark for future high-grade issuers, increasing investor confidence in the sector and helping develop the local capital markets. Looking forward, IFC intends to provide more local currency instruments in the foreseeable future, through partial credit guarantees and risk hedging intermediation. 22 To promote strengthening of the banking sector, IFC has been in discussion with FOGAFIN about the possibility of investments, in support of privatization, in one of the "intervened" banking institutions. To help develop the capital markets framework IFC has - in conjunction with the World Bank and CAF - initiated discussions with the Supersociedades to provide technical assistance to develop a new bankruptcy framework law to replace the current law (Law 550 of 1999, which is set to expire in 2004). IFC and World Bank are also working with the Superintendencia Bancaria and Superintendencia de Valores to help define a modem regulatory framework for the transformation of the DFCs into investment banks. IFC is also looking at the possibility at helping structure the merger of some of the DFCs, so as to create a strong investment bank that would be able to focus on corporate restructurings, M&A, securities trading and structured term financing for corporates. IFC has also recently approved a $15-25 million partial credit guarantee to facilitate the first ever subordinated bond issue in the local capital market, for Davivienda, Colombia's leading mortgage originator. In supporting the small and micro-enterprise sector, IFC's strategy is to help broaden access to credit to the low-income segment of the market. Towards this end, IFC has recently supported Banco Caja Social with a $7 million investment in FY02, aimed at assisting the expansion of its low-income financing into new geographic areas in the country (see Box 2). LFC is also supporting programs to foster linkages with SMEs, and to foster development of their commercial and technical capacities, as illustrated in the Bavaria project (see Box 3). A third pillar of IFC's strategy in this area is to assist the transition of sustainable NGO micro-finance institutions into for-profit, regulated entities that would in turn be able to provide an enhanced degree of support to productive micro businesses, contributing thereby to growth and employment generation. BOX 2 Banco Caja Social (BCS) Banco Caja Social, owned by Fundacion Social, a non-profit entity in Colombia, has a ninety-year history of working successfully in the low-income finance sector. Over three quarters of its portfolio has been in low-income consumer loans and some 20% in small business loans to entrepreneurs with whom the bank has had a long term savings and personal credit history. In terms of total assets it is the 10'h largest bank in the Colombian system. BCS has historically been one of the most profitable banks in the Colombian system, having developed a hybrid business model of good consumer banking practices and innovative microfinance underwriting. From 1996, BCS earned ROAs and ROEs significantly in excess of the system average. However, its ability to expand and meet the growing demand for financing in the low-income sector was constrained by the rate of growth of its retained earnings. BCS estimated that it could increase its low income portfolio by 60-70% if it had additional capital. To help the institution expand its financing operations and ensure its proper capitalization, IFC approved a $7 million equity investment in May, 2002. The project would enable the bank to expand into urban and rural markets that presently have little or no banking access. In addition, it would allow BCS to develop new electronic banking, ATM and call center services for its low income clients, thereby lowering the cost of providing services. The project is expected to have a strong development impact stemming from an increase in availability of formal credit, and a lowering of the cost of this credit, to low income borrowers; a widening of BSC's geographic reach; and BCS's ability to move into markets that have been underserved, following the collapse of many of Colombia's cooperatives. 23 Investment Supply Response of Private Sector: IFC's approach to facilitating the investment supply response of the private sector focuses on helping build up confidence in the private sector by providing support to companies in manufacturing and other key sectors that would like to undertake investment programs that would in turn promote employment and economic growth, but which are constrained by lack of availability of finance. The focus is on good sponsors, with strong managerial capabilities, whose projects will - by their success - provide a strong demonstration effect for potential investors. One pillar of this approach is the financial restructuring and modernization of corporate group structures; another the financing of their rationalization and expansion plans - both through direct financing by IFC and through its mobilization of commercial finance. Yet another is the strengthening of their corporate governance practices. This support to major companies and business groups is based on the recognition that sustained recovery and employment generation is unlikely to come about in Colombia unless the major corporate entities, which are the backbone of the country's private sector, are able to strengthen their financial standing and improve competitiveness. The need to improve corporate governance and introduce socially sustainable business practices goes hand in hand with this objective, partly as a means of improving access to capital through a strengthening of shareholder trust, partly of improving competitive efficiency through better development of human capital and increased productivity. Economic and social impact on a wider base would result from the demonstration effect of the adoption of socially responsible business practices by these firms, and through their business linkages to smaller economic activities. As part of this approach, in FY00, IFC provided a $10 million loan (in addition to mobilizing another $60 million) to Cementos Caribe, to assist in the modernization and capacity upgrading in Tolcemento in Colombia and Andino in Venezuela. This was followed in FY02, by a $100 million corporate investment package designed by IFC to support various organizational and financial measures being undertaken by Grupo Suramericana (SIG), as part of a program to restructure and reduce its debt, improve its corporate governance practices and rationalize its corporate structure and investment holdings. Most recently, IFC has arranged a $318 million financing package - involving the mobilization of $200 million of finance from participant institutions - for Bavaria S.A., the premier Colombian beverage manufacturer, to finance part of a major ($700 million) modernization and expansion program that it is undertaking. The project also involved recommendations for significant improvement in the company's corporate governance code, including in Board composition and practices, transparency and disclosure, shareholder rights and shareholder relations (see Box 3), as well as improvements to bring the company not only in compliance with World Bank environmental and social guidelines, but to set even higher standards in many areas. In addition, IFC sought commitment from the company that it would expand its social activities in line with the growth of its income and operations. 24 BOX 3 IFC Investment in Bavaria IFC's investment in Bavaria S.A., for which it arranged a financing package of US$318 million in FY02, is an example of its efforts to promote an improvement in a wide range of sustainable business practices that would benefit both the company and the community in which it operates. Improvements were recommended in the following areas: Corporate Governance: IFC recommended that the Company make important changes in respect of (a) the composition and practices of its board of directors, and (b) accounting, audit and disclosure practices. These would result, among other things, in (i) the creation of standing committees of the board, of independent directors, for oversight in areas of potential conflicts of interest and in accounts and audit; (ii) the adoption in the Company's Code of Good Practice provisions for the protection of minority shareholders; and (iii) ensuring that subsidiaries that are not wholly-owned by the Company will incorporate into their own Codes of Good Practice all the dispositions necessary in order to fulfill the same obligations. Oreanizational Structure: Based on a review of the Company's new organization structure, IFC made various recommendations to provide greater transparency and provide an added measure of confidence to external investors. Environmental: IFC made a number of recommendations to not only bring the Company into compliance with World Bank environmental guidelines but to adopt higher standards in many areas. The Company is in any case highly environmentally conscious: for example, it already recovers the carbon dioxide generated in the brewing process, utilizing it in bottling and bright beer storage, and for sale to local carbonated soft-drinks producers. It recovers heat from the wort coolers, which it re-uses for brewing and other purposes. It utilizes waste-water treatment programs, and implements solid waste recycling management (e.g. solid malt residues, which are dried, packaged and sold as animal feed) in many of its installations. Under the project, it will now extend these practices more widely, and to all of its installations. Support to Suppliers: (a) Since 1991, the Company has provided support for programs to modernize barley cultivation and diversify production in traditional barley-growing areas in Colombia. Various programs have been introduced to help barley growers improve yields, adopt sustainable agricultural practices, diversify production and improve marketing strategies. (b) The Company is also starting a program with fruit farmers to increase production yields, improve programming of plantation cycles and achieve the consistencies necessary to develop export markets. (c) As part of its efforts to promote sustainable business practices, the Company provided financial support and training, and outsourced logistics, distribution, sales and marketing functions to retrenched workers in order to dampen the effect of job losses on the affected communities. This program has so far created direct employment for over 100 persons and indirect employment for nearly 8 times that number. 25 Private participation in Infrastructure: In infrastructure, EFC had earlier (FY96) invested $9.5 million to finance the rehabilitation and expansion of the road from Tulua to La Paila as a modem 4-lane highway with emergency assistance and security patrols. This was the first private toll road under the government's highway privatization program. Private investment in infrastructure has been constrained since mid-1990s, reflecting in part a slowing down in progress of reforms in this sector, and in part the general withdrawal of strategic investors from infrastructure in developing countries in recent years. IFC is now focusing its attention on the privatization/deregulation of the telecom sector, where it has been following up closely the PCS process during the last year. IFC's understanding of structures that work, and of those which are less sustainable, can help achieve privatization objectives. The WBG is looking forward to supporting the liberalization process of Colombia's telecom sector by providing a comprehensive service, ranging from the policy/regulatory advice provided by the World Bank to financing the winners of PCS licenses by IFC. The Corporation is also looking at the possibility of making an investment to finance the network expansion and restructuring of liabilities of one of a specific telecom group. IFC is also looking for opportunities to support private participation in other sub-sectors, for instance water, where it is exploring the use of suitable financing instruments, such as local currency/partial risk guarantees. A project to enhance a bond issue through a $20 million partial credit guarantee, for financing the capital expenditures and restructuring of a company in this sector is currently at an advanced stage. Similarly, in the power sub-sector, a project to finance the capital expenditure and restructuring plan for two Colombian distribution companies, that will help bring about a reduction in technical and non-technical losses (which had been as high as 36% in 2000), is currently under consideration. However, opportunities may be limited by the uneven pace of sectoral reform, and the absence of interest in emerging markets on the part of strategic foreign investors in these sectors. Strengthening the Natural Resources Sector: The natural resources sector in Colombia has considerable untapped potential. While it has previously enjoyed access to external financing, current market conditions have increased the need for official support. In the oil and gas sector, IFC has recently approved a $30 million loan to fund the development of three Colombian heavy oil fields (Jazmin, Moriche and Under River) located in the Middle Magdalena Valley, as well as the expansion of Ominex's 190 km Colombian pipeline. IFC is also looking to support improvements in efficiency in mining, through one or two possible operations involving the enhancement of transportation facilities (port and rail) of one of the companies. In these sectors in particular, IFC's expertise in environmental and social issues will be a key ingredient in ensuring sustainable development of resources (witness the widely-publicized exit of a large investor on these grounds). Supporting Education: Poor economic conditions have led to a decline in enrolment rates in private institutions in both secondary and tertiary sectors, revealing an acute need for student financing. In the tertiary sector, attempts to find more creative ways to provide private student financing have emerged, although these schemes, financed directly by universities, are limited in scale and offer primarily short-term payment plans. IFC is examining 26 ways to expand student loan programs, working in conjunction with local banks. Looking ahead, as economic conditions improve, IFC will also consider providing financing to private universities, many of whose plans for expansion are currently on hold. MIGA MIGA continues to see considerable interest for its guarantee instrument - both for investments into Colombia, and from Colombian investors seeking to expand their operations in neighboring countries, especially in the Caribbean region. For example, MIGA signed a memorandum of understanding with Pro-Barranquilla, an investment promotion agency funded by the local corporate sector, which has been able to leverage MIGA' s guarantees as a risk mitigation tool for investments coming into Colombia. MIGA is also working to improve Colombia's ability to attract FDI by assisting the national investment promotion agency, Coinvertir, and training officials from the Free Zones association and chamber of commerce. Nonetheless, demand for MIGA's political risk guarantees will depend heavily on investor reactions both to the on-going civil strife in the country and to broader questions surrounding investments into emerging markets, particularly in Latin America. 27 CAS Annex DI Synthesis of Public Debt Policy Note Summary Over the last seven years the level of total gross public debt in Colombia has been rising steadily in absolute terms and as a proportion of GDP. In addition, public debt service has risen significantly. Both the level of the debt and the debt service are worrisome, and to avoid a debt crisis the government must further strengthen its primary fiscal balance-from a primary surplus of about 1.4 percent of GDP in 2001 to a permanent primary surplus of at least 4 percent of GDP in the medium term. To achieve this, the governnment will have to implement policies to strengthen the fiscal "fundamentals," by cutting public sector expenditures and increasing public sector revenues. Moreover, the government must complement the fiscal adjustment with improvements in public sector debt management, by strengthening debt management capacity and debt portfolio management. I. Background The total gross stock of Colombia's public debt,' both internal and external, increased from about 27 percent of GDP in 1994 to about 58 percent of GDP in 2001.2 This resulted primarily from rising fiscal imbalances at different levels of government throughout the decade (see Figure 1). The steady growth in fiscal imbalances first became visible in the central govemnment accounts, but this was initially masked by surpluses in other parts of the public sector. The central government accounts started the decade of the 1990s with a small surplus. However, since 1992 the central government has posted a series of increasing deficits, which peaked in 1999 with a deficit of 7.4 percent of GDP. Total expenditures increased from about 15 percent of GDP in 1992 to nearly 20 percent of GDP in 1999. By contrast, total revenues fell from about 15 percent of GDP in 1992 to 12 percent in 1999. Behind the deterioration in the central government accounts are some of the institutional changes brought about by the 1991 Constitutional reform, and the resulting impacts of the economic policies implemented throughout the decade. 1. There are several types of public sector habilities other than "debt." The following terminology is adopted throughout this paper (a) direct-explict liabilities are liabllities established by law or contract and include "full faith and credit" debt, expenditures prescnbed by budget law, and claims for services rendered (the timing and amount of these liablitles may nevertheless be affected by contingencies); (b) direct-implhcit liabilities are liabilities on which it is presumed, with good probability, that the government will make good, but without a legal obligation to do so; (c) contingent-explcit liabilities are recognized in legally binding documents, but the extent and timing of payment hinges on uncertain future occurrences; and, (d) contingent-implicit liabilities refer to an expectation that government will accept a liability without having a legal obligation to do so. For more details on the classification of public sector liabilities, see Budgetin,gfor Fiscal Risks, by Allen Schick, World Bank, September 1999. 2. In net terms, the total stock of public debt represented about 46 percent of GDP in 2001. Net debt is total gross debt minus the stock of Treasury bonds (MES) held by all public sector entities. The evolution of debt aggregates in the last decade is discussed with reference to gross aggregates because estimates of net debt in Colombia are available only from 1999 onward. Figure 1. Public Sector Balances 4.0- A. 2-0 1 _. xs mI Wt - 0 f o _ to -2.0 -4.0- -6.0- -8.0 _ (,~ ~ '0 t- 00 O_N CD a, a, 0 0% ON o, 0% %0 M NFPS * Central Govemrnnt Source: IMF and WB Staff estunates The 1991 reforms transfetred to subnational levels of government considerable discretionary spending powers, but not the responsibility to fund this spending. As a result, the central government financed through fiscal transfers subnational expenditures over which it had littde control. In addition, the central government had often negotiated large increases in the salaries and benefits of employees of subnational governments (for example, teachers and health sector personnel) which subsequently had to be funded through additional fiscal transfers. Moreover, recognition of central government implicit and contingent liabilities arising, for example, from the public pension funds (the Cajas PNbIicas) and the financial sector (as evidenced in the 1999 restructuring of the financial sector) put upward pressure on expenditures. Other reforms (although correct for increasing efficiency in resource allocation) negatively affected fiscal revenues (for example, trade liberalization led to a fall in tatiff revenues). More important, several reform packages aimed at strengthening tax revenues were only partially successful. The economic slowdown compounded fiscal weaknesses because tax revenues fell in tandem with sluggish economic activity. This led to increased reliance on nonrecurrent revenue-generating measures, such as privatization, and more significantly on increased public sector debt to finance the central government deficit. By the mid-1990s it became evident that the public sector accounts were rapidly deteriorating. The public sector deficit rose steadily-basically tripling from just over 2 percent of GDP in 1995 to 6.4 percent in 1999. Large central government deficits, growing deficits at the subnational level, dwindling social security surpluses, and volatile oil revenues all contributed to the deterioration in the public sector balance. This is evidenced by the continued erosion of primary balances in the second part of the decade, when the public sector primary balance went from a very small deficit in 1996 to a deficit of 2.7 percent of GDP in 1 999.3 The increased debt service augmented the vulnerability of public sector finances.4 Total public debt interest service increased from about 2.2 percent of GDP in 1994 to about 4.5 percent of GDP in 3. Total public sector revenues have remained at around 27 percent of GDP since the mid-1990s, while total expenditures increased from just under 30 percent of GDP in the mid-1990s to about 33 percent of GDP by 1999. Throughout this period, the Central Bank posted a smaU average surplus equivalent to 0.28 percent of GDP. 4. The real average rate of interest paid on domestic government debt has been high and volatile. It has averaged 7.3 percent since 1997 (for one-year TES securities), peaking at around 20 percent m 1998 and falling as low as 2.2 percent more recendy. It folows that the steady increase in the government's interest burden cannot be explained by high real interest rates alone, although this factor cannot be neglected as an important cost source. 2 2000. Total interest service on internal debt Figure 2. Interest Payments increased more than proportionately-almost of the Public Sector threefold-from 1 percent of GDP in 1994 to about 5.0 2.9 percent of GDP in 2000 (see Figure 2). In 2001, 40- total interest service remained roughly stable at 4.5 | . percent of GDP, with a fall in domestic interest t 301 paymnents to an estimated 2.3 percent of GDP being & offset by an increase in external interest payments. 2.0 &. In this context, both the level and structure of public l ° sector debt changed. In the early 1990s, the 0 . government reduced its total debt from about 40 o 1fi : a, ,, CD percent of GDP in 1991 to about 30 percent of GDP in 1994-mostly through debt retirement and * External E Internal buy-back operations, financed in part by high oil Source:IMFandWBStaffestmutes. revenues. External debt fell sharply from about 32 percent of GDP in 1991 to about 14 percent of GDP in 1996. However, as the public sector accounts began to deteriorate in the mid-1990s (particularly central government accounts), debt levels increased. Throughout this period, central government debt increased more than proportionately, thus taking an increasing share of public debt of the total gross public debt outstanding in 2001, about 40 percent of GDP was central government debt (up from about 16 percent of GDP in 1991). A sizeable portion of the change in the level of total debt occurred through an increase in external debt, which reached about 26 percent of GDP in 2000, bringing the share of external debt in total debt dose to the levels of the early 1990s. Most of the increase in the external debt after 1996 has been driven by central government borrowing-other levels of government have faced statutory and procedural restrictions on external borrowing.5 However, both the central government and subnational entities have continued to issue domestic debt to finance their increasing expenditure program throughout this period. As a result, domestic gross public sector debt rose steadily, from about 14 percent of GDP in 1994 to about 27 percent of GDP by Figure 3. Gross External ad Figure 4. Gross Public Debt by Debtor Domestic Debt of the Public Sector 70 70 X 60 60 0 /- D L- -< 50 C 50 40 0 030 Q40~~~~~~~~~~~~~~~~~~2 0- V ECentral Gvemnent U Sub-National Govemrnmnt *7temal D3 Intemal OOther Public Sector Sources: IMF, MoF, Contraloria and WB Staff estinates Sources: IMF, MoF, Contralona and WB Staff estirates 5. These restrctions are discussed in The Legal Framework and Govemance subsection of this Policy Note. 3 2000 (see Figures 3 and 4). This period is also characterized by a drastic change in the sources of finance (see Figures 5 and 6). At the beginning of the 1990s most new financing was coming from nonmarket sources (for example, bilateral and multilateral agencies, and the Central Bank). However, during the 1990s, as a result of a transformation of the overall public sector institutional framework the government relied more on the financial market (both internally and externally) as the main source of funding-half of domestic debt and two thirds of external debt are Figure 5ovestiebt of the now market based. ~~~~~~Central Government by Creditor now market based. More specifically, the implementation of theth6 Constitutional reforms of the early 1990s led to - elimination of Central Bank financing of the fiscal 12 - deficit. As a result, the central government had to 1_ tap the domestic market on a more competitive 6 basis to finance its expenditure program.6 The 4 domestic debt of the central government continued 2 to rise through a large expansion in issuance of I * * * * * * Treasury bonds (TES). This increase resulted mainly from (a) the need to finance growing defcits, a CentrnBnnk * Bonds* Other and (b) an attempt to limit the exposure to currency risk and to make only limited use of additional external financing.' Tapping the domestic market Figure 6. External Debt of the Cental was also expected to foster development of the Goverment by Type of Creditor domestic capital market through lengthening of the 25 yield curve and deepening the market.8 20 The sources of external financing also changed 115 considerably throughout the decade (see Figure 6). l0 Whereas in 1990 official debt amounted to 66 percent of the total stock of public external debt, 5 this had fallen to only 39 percent by 1999. The share of commercial bank debt fell relative to the m a, a, > a, CD total stock of public external debt, from 32 percent ! O in 1990 to 23 percent in 1999. In contrast, * Mukilateral * Other Official sovereign bonds gained considerable ground over M Conmercial Bank * Bonds this period, increasing from about 2 percent in 1990 6. In 1990, debt to the Central Bank amounted to 50 percent of the total internal debt of the public sector-falling to less than 1 percent by the end of the decade. The Central Bank has nevertheless continued to contribute to financing the government through transfers of its balance sheet surpluses (for example, in 2001, these transfers represented about 0.7 percent of GDP). 7. In the mid-1990s, the authorities expected large foreign currency inflows resulting from exploitatLon of the recently discovered oil fields (Cusiana). This expectation also created incentives for increasing reliance on the local capital markets. 8. The share of TES bonds of longer maturity-five years or longer-increased from 12 percent in 1995 to 37 percent of the outstanding stock of TES bonds in 2000. 4 to over 50 percent of the total external debt of the public sector by 2001. This resulted mainly from Colombia's good access to international financial markets and its borrowing strategy. In contrast to the case of central government debt, the stock of subnational government debt has remained relatively stable since 1991-fluctuating between 7.4 and 9.2 percent of GDP. The borrowing requirement of subnational public entities has been somewhat limited, in part because financing gaps have often been met through direct fiscal transfers from the central government (as has already been mentioned). In fact, the external debt of subnational entities has been continuously falling, mainly as a result of the restrictions on external borrowing by subnational entities; that is, they require Congressional approval to issue external debt. However, this has been fully compensated by Figure 7. Debt Structure of an increase in domestic debt. In 1991, the domestic Sub-National Entities debt of subnational levels of governmnent amounted 10 to about 3 percent of GDP, rising to about 5 percent of GDP by 1995, and to about 6 percent by & 8 1999 (see Figure 7). Domestic commercial bank 6 lending to subnational governments has been the ,l main source of the increase, either directly or e 4 through rediscounting of Financiera de Entidades v 2 Territoriales (FINDETER) loans. This has partly resulted from (a) the explicit or implicit credit 0 guarantees from the central government, and (b) loopholes in the implementation of the LIy de Semadforos, aimed at regulating subnational Source. Contralona and WB Staff government borrowing, creating "perverse" incentives for both subnational governments and banks to expand credit rapidly. Recent fiscal adjustment efforts have made good progress in restoring a fiscally sustainable path. In 2000, the public sector deficit was almost halved, to -3.5 percent of GDP; moreover, the primary fiscal balance showed a surplus (although small) of around 0.9 percent of GDP-for the first time in several years. However, there are still large and growing implicit and contingent public sector liabilities (arising mainly from the pension system in the Social Security system, the financial sector, and subnational levels of government), which are not yet fully reflected in the fiscal accounts, threatening Colombia's fiscal stability in the future.9 II. Issues and Diagnosis A) The Primagy Balance and Debt Sustainabili'y The current level and structure of Colombia's public sector liabilities are risky and vulnerable. Should current trends continue in the absence of comprehensive policy reforms, particularly in Social Security, public sector debt is likely to become unsustainable. To analyze the sustainability of public sector debt, we calculate the primary fiscal balance necessary to keep public sector debt on a 9. The nature and size of this type of liability is discussed at greater length in other Policy Notes. 5 sustainable path'0 using a model that includes (a) the present value of all net public sector liabilities (including implicit and contingent liabilities from Social Security); and (b) key economic parameters and projections in a base case scenario." According to the analysis, to avert an explosion of the debt-to-GDP ratio, the public sector has to generate a permanent primary surplus of about 4 percent of GDP.12 This adjustment can only be done through a combination of measures to simultaneously (a) cut public sector expenditures, and (b) increase public sector revenues. (For details on the specific policy actions and measures to achieve both (a) and (b), see Policy Notes on the Macroeconomic Framework and the Tax System) Such level of fiscal adjustment is a necessary condition for ensuring fiscal sustainability and avoiding the outcome of other countries (for example, Argentina) that have delayed strengthening the "fundamentals," particularly the fiscal accounts, through financial engineering. Table 1. Key Assumptions and Projections* 2002 2003 2004 2005 2006 2010 Real GDP Growth (p.a.) 2.0% 2.5% 3.0% 3.5% 3.5% 3.5% Inflation (p.a.) 6.0% 5.0% 4.0% 4.0% 4.0% 4.0% Nominal Exchange Rate Depreciation 8.0% 7.0% 6.0% 4.0% 3.0% 2.0% Real Interest Rate 4.6% 5.5% 6.2% 5.8% 5.7% 5.2% Total Public Sector Debt (% of GDP) 48.2% 51.2% 53.9% 56.6% 57.6% 56.7% Domestic 20.8% 22.3% 23.7% 25.0% 25.5% 25.1% External 27.4% 28.9% 30.3% 31.6% 32.1% 31.7% Base case scenario. Moreover, by comparison, for the last six years the average primary balance-to-GDP ratio was -0.37 percent (that is, a deficit). During this period, the debt-to-GDP ratio grew very rapidly (the average expansion rate of the debt-to-GDP ratio was about 6 percent per year), thus suggesting that the current path of the debt-to-GDP ratio in the absence of adjustment is not sustainable. It follows that in the absence of comprehensive reforms, keeping debt on a stable path requires a sustained fiscal adjustment in the primary balance of at least 2.6 percent of GDP (to bring the primary surplus to 4 percent of GDP, from about 1.4 percent in 2001). If the primary surplus were kept permanently at 4 percent of GDP, it is estimated that total net debt of the public sector would nevertheless continue increasing, reaching about 57 percent of GDP by 2010 (see Table 1). 10. This is the level of the primary balance expressed as a ratio to GDP that if generated "permanently" by the government, would keep the debt-to-GDP ratio sustainable. However, the debt-to-GDP ratio does not necessarily "stabilize" or reach a "constant" value during the projection penod, because the steady state debt-to-GDP ratio is achieved only in the long term. 11. In the base case scenario, it is assumed that some fiscal policy reformns are implemented, but more comprehensive reforns (for example, reforms to the pension system in the Social Security System) are only partly umplemented. 12. Primary balances are defined here with respect to the consolidated public sector, including Social Security and subnational govemment entities. For consistency with other chapters, we consider that seignorage revenues accrue to the government "above the line" (through the reported Central Bank balance). 6 Figuze 8. Debt-GDP Ratio Figure 9. Debt-GDP Ratio Primary Balance Constant at 2001 Level Primy Balance Set to Keep Debt-GDP Riato Constant 2.00 - 90 70 - 60 Ck. 8~~ ~~ ~~~~~0 0.60- 1 75 _ _ _ _ __6_ _ _ | & X75 ~~~~~~~~~~~~~~70 0 5.0 --5 } i12/ i 30 - 6 40 # 1250 30 130 30 _ _ _ _ _ _ _ _ _ _ _ _ _ _~~~~~~~4 204 I oD i X i i ° i i i !_ A 3 R R30S¢ fi fi ff I00I AIAI I A 10 II -Primary Balance -Debt/GDP Ratio -Primary Balance - Debt/GDP Ratio (2001) Source: World Bank estanates GDP growth at 3.5 percct p.a. Source. World Bank estimates. GDP growth at 3 5 percent p a. The vulnerability embedded in public finances in the absence of comprehensive reforms can also be shown by projecting the path of the total net debt of the public sector under the assumption that the primary balance-to-GDP ratio is kept constant at the 2001 surplus level (just over 1.4 percent of GDP).13 As can be seen in Figure 8, total net debt would rise from about 46 percent of GDP in 2001, to about 80 percent of GDP in 2010 (assuming real GDP growth of 3.5 percent per year). In this scenario, the debt-to-GDP ratio would be rising at an average annual rate of about 8 percent per year, implying an acceleration in the rate of increase of the debt-to-GDP ratio from the 1994-2000 level (when the debt-to-GDP ratio increased at an average annual rate of about 6 percent). Figure 9 shows the path of the primary balance required to stabilize the debt-to-GDP ratio at the 2001 level (about 46 percent of GDP). As can be seen, the primary surplus would have to be maintained in the range of 4 to 6 percent of GDP in the next decade to keep the debt-to-GDP ratio constant (higher than the 4 percent of GDP required to keep debt on a moderately rising but still sustainable path). Table 2 shows the sensitivity of these calculations to changes in the rate of GDP growth; for example, if GDP growth is 2.5 percent per year in the long term (instead of 3.5 percent), the permanent primary surplus that keeps the debt-to-GDP ratio along a sustainable path is 6.2 percent of GDP (instead of 4 percent, as before). The sensitivity of these calculations to the recognition (explicitly) of liability payments arising from Social Security (mainly pensions) in a scenario of limited structural reforms is also shown in Table 2. For example, if GDP is assumed to grow at a rate of 3.5 percent per year and Social Security "payments" (of the implicit liabilities) are excduded from our calculations, a permanent primary surplus of 0.8 percent of GDP would be sufficient to keep the debt-to-GDP ratio on a sustainable path. This should be contrasted with the 4 percent primary balance-to-GDP ratio required once Social Security (implicit liabilities) are included explicitly as flow- payments in these calculations.14 13. If the 2001 primary balance was adjusted to filter out cyclical or noise components, the resulting "structural" primary balance would in fact be lower, since unusually high oil revenues improved the fiscal accounts that year. With the primary sutplus kept constant at the lower, adjusted level, the debt-to-GDP ratio would increase even faster. Similarly, the size of the fiscal adjustment required for debt sustainability would be greater than 2.6 percent of GDP. 14. Should comprehensive Social Security and other reforms take place, the present value of contingent and implicit government liabilities could fall sharply, implying that the permanent primary surplus required to keep the debt-to- GDP ratio on a sustainable path would be smaller than 4 percent of GDP. 7 The impact on debt ratios of slower long-term g 10. DebtGDP Ratio GDP growth can also be illustrated with Prtnu BaConstant at 4% ofGDP reference to a slow-growth scenario (see Figure 70 Slow Crowth Scenaro 70 10). If it is assumed that the primary balance quickly converges to 4 percent of GDP during S 60 60 the projection period, but that GDP growth is . O 50 - slower than in the base case (1.5 percent annually, r. , e 50__ _ __ _ ___ instead of 3.5 percent), ceteris paribus projected . @ 40- total debt would rise to almost 70 percent of t 30 40 GDP in 2010 and keep rising thereafter-instead of stabilizing at about 57 percent as in the base a.0 case. Furthermore, since the permanent primat PnmyasyBalance -DeGDPRatio surplus that generates a nonexplosive debt path Source World Bank estimates GDP growth at 15 percent p a. with long-term growth of 1.5 percent annually is 8 percent of GDP (when pension liabilities are included in the calculations) it is clear that in the slow-growth scenario, a primary surplus of 4 percent of GDP, is not consistent with a stable debt path. Table 2. Permanent Primary Surplus: Sensitivity Analysis* GDP Growth Rate 1.5% 2.5% 3.5% 4.5% Including Social Security 8.0% 6.2% 4.0% 1.3% Excluding Social Security** 1.7% 1.2% 0.8% 02% 'Permanent primary surplus as a percentage of GDP required to ensure a non-explosvie debt path **Hypothetical scenario that excludes the future fiscal impact of inphcit pension liablities Table 3. Permanent Primary Surplus: Sensitivity Analysis* Real Interest Rate 4.5% 5.0% 5.2% 5.5% Including Social Security 17% 3.4% 40% 5 1% Excluding Social Security** 0 3% 0.6% 0 8% 1.0% *Permanent primary surplus as a percentage of GDP required to ensure a non-explosvse debt path -Hypothetical scenario that exctudes the future fiscal impact of implicit pension habitites The average real interest rate has also impacted the fiscal accounts in the past, contributing to the Dverall fiscal deficit. For example, during 1995-96 and 1998-99, from the strictly financing needs of the public accounts, about half of the increase in the overall financing needs of the public sector was due to increased domestic interest payments. Put differently, about half of the increase in total debt in those years could be attributed to financing current interest payments on domestic debt. During 1995-2001 (a period of rapid expansion of public debt stocks) the real interest rate on domestic public debt averaged about 8.5 percent. By contrast, with fiscal adjustments, the average real interest tate on domestic debt could fall to a range of 5 to 6 percent. We also estimated the sensitivity of permanent primary surplus to changes in average real interest t,ates, ceteris paribus (Table 3). For example, if Social Security payments (of implicit liabilities) were included in the analysis and real interest rates amounted to about 5.5 percent over the long term 8 (instead of 5.2 percent as in the base case), the permanent primary surplus required to restore fiscal sustainability would be 5.1 percent of GDP (instead of 4 percent of GDP as in the base case)."5 In sum, the analysis shows that Colombia needs to further strengthen its fiscal accounts in order to increase the primary fiscal balance and ensure fiscal sustainability in the medium and long term. This can only be achieved through policy actions that will cut public expenditures and increase public revenues. This is necessary because, even under a relatively benign macroeconomic scenario but in the absence of comprehensive reforms, an adjustment of at least 2.6 percent of GDP in the primary surplus from the 2001 level is required to restore fiscal sustainability. If this adjustment in the primary balance were carried out, the debt-to-GDP ratio would nevertheless continue rising, reaching about 57 percent of GDP by 2010, but this ratio would likely be in a nonexplosive path. B) Vulnerabiliy and Management Risks in the Debt Structure To complement the fiscal adjustment, Colombia needs to strengthen its debt management capacity to increase its efficiency and effectiveness for managing a vulnerable and complex debt portfolio. Indeed, Colombia's debt portfolio is highly vulnerable to unexpected changes in both real interest and exchange rates.16 The high vulnerability to real interest rates is caused by the relatively large share of debt with short maturities and high refinancing risks. In addition, growth in foreign- currency- and exchange rate-linked debt, has led to an increase in vulnerability to exchange rates. Such exposures could create short-term liquidity problems for the government at times of strong unanticipated adverse movements in real interest or exchange rates. The rapid growth of debt stocks to finance growing expenditures in the past led also to a deterioration in the structure of the portfolio. Management of the debt portfolio has been constrained because (a) domestic markets are shallow and incomplete; (b) access to international markets has been limited, particularly in the last few years"7; and (c) weak debt management capacity. Underdeveloped and incomplete domestic markets led to a reliance on relatively expensive financing sources and shorter maturity instruments.'8 Moreover, the maturity of new external government bonds has been shortened to between three and five years.'9 Given the limited development of domestic markets and the absence of hedging instruments, the government is exposed to liquidity and refinancing risks. Although the value of domestic bonds redeemed every year has not increased significantly relative to the size of the portfolio, the shares of floating and indexed domestic debt instruments grew from 13 percent by the end of 1996 to 48 percent by the end of 2001, thus significantly increasing the interest and exchange rate exposures. Given the high volatility of domestic real interest rates, managing this exposure is a key challenge to 15. It is worth noting that the analysis is "partial equilibrium" in essence, and explores the impact on the permanent primary surplus required to keep debt on a sustainable path, of changes in individual economic variables-that is, all else remaaming the same. 16. Due to lack of comprehensive information on public debt other than central govemment debt, this discussion is centered on the latter. Unless otherwise stated, all references in this subsection are to gross central govemment debt, and the discussion excludes other government liabilities. 17. Colombia lost investment grade rating in 1999. 18. Real interest rates on domestic debt have averaged about 8.5 percent since 1995, compared with about 5 percent Cin real terms) on extemal debt. 19. Constramts on access to intemational markets were eased in 2001 owing to a structured operation that used a World Bank guarantee and that allowed the government to again tap the 10-year segment of the market. 9 be addressed. High domestic real interest rate volatility has translated into highly variable real coupon payments on public domestic debt-the average coupon (expressed in real terms) increased from close to 5 percent in 1998 to nearly 12 percent in 1999, falling steadily to levels dose to 8 percent by 2001. The increase in real interest rates on domestic debt experienced during 1998-99 played an important role in the growth of public debt stocks in those years, as new debt was contracted partly to finance the rise in the cost of servicing public debt. In the mid-1990s, when the government started issuing bonds in domestic markets, the strategy for mitigating the refinancing risk built up in the domestic portfolio was to issue longer-term external debt (10 years or more), increasing therefore, the average maturity and smoothing the external debt profile. However, this strategy could not be sustained for long in the context of large and growing fiscal imbalances, and the deterioration in access to international capital markets. As a result, the external portfolio also has a concentration of refinancing risk (although relatively less than in the case of the domestic portfolio). More specifically, in the external market, debt redemptions are dustering between 2003 and 2005, whereas in the domestic market, debt redemptions are clustered in 2002 and 2003. In 2001, for the first time the government carried out a debt exchange operation in domestic markets, aimed at smoothing out the near-term redemptions schedule. Additional operations of this nature have been implemented in recent months with relative success, however close to 47 percent of domestic debt still matures in the next four years, thus suggesting that important refinancing risks still remain in the portfolio. Exposure of the portfolio to foreign exchange volatility could, in the future, become a serious problem. First, with the abandonment of formal exchange rate targets and recent adoption of an inflation target by the Central Bank, the volatility of the exchange rate could be increased. Second, given the structure of the debt portfolio, the overall impact of the exchange rate on debt service could have a greater impact than interest rate effects because the former affects about half of the "principal" of the portfolio in addition to the interest rate component. Third, the management of foreign currency risk is more difficult because there are no derivatives markets for the government to hedge its currency exposure.in The government has partially managed this risk through matching, to the extent possible, assets and liabilities in terms of currency structure. Nevertheless, the accelerated increase in the foreign stock of debt has outpaced growth in international reserves and exports, increasing foreign exchange exposure. In addition, there is an increasing proportion of domestic debt indexed to the exchange rate. Thus, the government's debt management strategy in the future will have to focus on managing the exposure of the total debt portfolio denominated in foreign currency or linked to the exchange rate. Effective debt management has also been limited by weak institutional capacity and lack of an appropriate governance framework.2' Moreover, the lack of well-defined formal benchmarks used in day-to-day operations for the overall debt portfoliora has also constrained efficiency in debt portfolio management. 20. This is to be expected. Smce the government can choose to set or influence the value of domestic currency through various policy instruments, issues of moral hazard immediately arise. In the absence of comprehensive monitoring and supervision mechanisms available to potential counterparts, the availability of hedging instruments is generally very limited. 21. Issues relating to the institutional framework and the need for thorough nsk management analysis will be discussed in subsequent sections. 22. No formal domestic benchmark has been produced. A benchmark for the external portfolio has been produced but it has never been implemented. 10 i. Colombian Internal Debt The largest share of internal central government debt consists of Treasury bonds (ThS).' At the end of 2000, TES issuance accounted for 86 percent of total internal debt. There are four types of TES issuance: fixed-rate bonds, CPI- and UVR-indexed bonds, and USD-indexed bonds. CPI- and UVR-indexed bonds also differ in that the latter type capitalizes the interest payments while the former type does not. The various types of bonds are also available in different combinations of maturities (see Table 4). Table 4. Types of Domestic Treasury Type of Rate Denomination Maturity (years) Fixed rate COP 1, 2,3 and 5 CPI-floating rate COP 5, 7 and 10 (no capitalization of interest) Fixed rate UVR*-indexed 5 and 7 (capitalization of interest) Fixed rate USD**-indexed 2 and 3 *Real Value Units **US dollar Figure 11 shows the outstanding value of these four types of instruments since 1996. The shares of floating and indexed debt instruments grew from 11 percent at the end of 1996 to 42 percent of the outstanding stock of TES by the end of 2001. UVR-indexed bonds remain a very small part of the domestic debt portfolio, since most of the increase in the stock of bonds since 1996 took place in CPI-indexed and USD-indexed bonds. Together with this change in structure of the domestic debt portfolio, exposures to the exchange rate and inflation have increased considerably. Figure 12. Half Life and Duration of Domestic Central Government Debt Figure 11. Domestic Central 5.o Government Debt by Type of Coupon 4 - TES Bonds 14-8 ,4.0 - 1 2 - 3 | | E lo _. _ '3.5 10.~ ~~~~~~~~~~~~~. 0.5 *FaxedRnatCOP IDCPIPloatmgRale DUSDFzxedRate DuvrRFxdte 0.0 _ - _ - _- 6 2.0~~~~~~~~~~. -0 '0 . 1.0 . '0 . - Source MoF, DGCP v ' o % l -Half Life--- Duration - - - Modified Duration Source: MoF, DGCP 23. Due to lack of consistent information on public debt other than central government debt, this discussion is centered on the latter. Unless otherwise stated, all references are to gross central government debt. This discussion excludes government liabilitLes other than debt (for example, contingent or implicit liablities arising from Social Security or subnational levels of government), since no comprehensive inventory of all government liabilities exists. 11 The duration and modified duration of the domestic portfolio have been rising steadily since 1998, but are still low (remaining at around 2). This is the result of high interest rates, which quickly return to investors (in the form of coupon payments) substantial amounts of their investment.24 The half- life of the portfolio increased sharply in 1998 to about 4.5, then fell in 1999 and 2000 to 3.5, and again recovered to 4.5 by late 2001 (see Figure 12). Figure 13 shows the evolution of the domestic debt maturity structure since 1997. At the end of 1997, almost 90 percent of domestic debt would mature within four years. By contrast, at the end of 2001, about 47 percent of total domestic debt is expected to mature over the next four years. This suggests that with a "flattening" of the maturity structure, refinancing risks have improved since 1997. However, there is still an imnmediate and significant refinancing risk, because 30 percent of the domestic debt portfolio will mature within a year.' Figure 13. Maturity of Domestic Central Government Debt 50 2 3 l 11 31 ~45 40 35 130 ~25 Maturity (Years) 01997 1999 200 Source: MoF, DGCP i. Colombian External Debt The evolution of the currency composition of external debt is shown in Figures 14 and 15. At the end of 2001, USD, EUR, and JPY debt account for 77 percent, 17 percent, and 5 percent of total external debt, respectively. The current benchmark portfolio is USD (83 percent), EUR (13 percent), 24. Duration can also be thought of as a measure of the time that an investor keeps his money invested. For zero coupon bonds, maturity is a straightforward measure, since investor's money is tied to maturity. By contrast, with coupon bonds, maturity is an imperfect measure of investment time since part of the value of the investment is returned in the form of coupon payments before the bond matures. 25. Formally, to conduct a more comprehensive assessment of refinancing risk we would need to identify the main holders of maturing domestic government debt and estimate their propensity to agree to offer refinancing. However, it remains true that refinancing risk is higher than it would be (keeping the identity of bondholders constant) if the debt profile were "flatter." 12 and JPY (4 percent). The increase in the share of EUR-denominated debt and decline of USD debt during 2001 has meant a further departure from the existing benchmark currency composition. Figure 14. Currency Structure of Figure 15. Currency Structure of External Public Debt External Public Debt 90 - 25,000 80 -7 70- 20,000 60 - .12 15,000 n50 U~10,000 30 10 JPY EUR USD - m e O m 0o o 01999 12000 032001 Cnernchmnark …… … DMUSD El EUR ElJPY aOter Source MoF, DGCP Source: MoF, DGCP External debt has a larger share of fixed-rate debt than in the case of domestic debt (compare Figures 11 and 16). Fixed-rate debt accounted for about 65 percent of external debt at the end of 2001, with variable and semivariable rates accounting for the rest of the portfolio. The coupon structure of the external debt portfolio has remained relatively stable over time, with perhaps a mild trend against semivariable rates and in favor of variable rates. In addition, the external portfolio traditionally has had longer duration (around 3.5 years) than the FigurlCentral Government internal portfolio (compare Figures 12 and 17). Figure 16. External Coupo n In addition, the half-life of the external portfolio 20 b p is also higher and more stable than the half-life of t54 . . . . . . . . the domestic portfolio. 10 .. . . Together, these characteristics imply a smaller I:::::" interest rate risk than in the case of domestic debt. Figure 18 shows the evolution of the o external debt maturity structure during 1998- ! eX 2001. Compared with domestic debt, the EFixed ElSemi-Vanable 0Variable external debt has a relatively smooth maturity Source MoF, DGCP structure. As a result, only 11 percent of external debt matures within a year (compared with 30 percent for internal debt). However, relatively more significant external refinancing needs will arise in 2003, when 16 percent of the current external debt will mature. As can be seen in Figure 18, the proportion of the external portfolio maturing in the one-to-three-year range increased considerably in 2001, relative to the levels of 1997 (36 percent versus 27 percent, respectively). Correspondingly, the share in the portfolio of longer maturities has fallen markedly from the levels of earlier years. External refinancing risk has thus been rising steadily in the last five years. 13 Figure 17. Half Life and Duration of External Central Government Debt 7.0 6.0- 5.0 4.0 - - _ - _- 3.0 2.0 1.0 0.0 - 00 00 CN) 0 C Half --Duratio--' Modified Source: MoF, DGCP Figure 18. Maturity Structure of External Central Government Debt .5 1 2 3 4 5 6 7 8 9 10 Maturity (Years) ____1997 .. -- 1999 - 2001 -Benchmark Source MoP, DGCP C) Key Government Liabilities and PotentialImpact on DebtManagement Explicit, implicit, and contingent liabilities arising from subnational government entities, the Social Security and pension systems, and the financial system, among other factors, have increased the vulnerability of fiscal accounts and are likely to worsen debt exposures. The existing framework for debt management faces severe limitations on handling these types of liabilities because no entity has the mandate nor the capacity to register and quantify them. Subnational government entities are currently exposed to refinancing risks, because most of their debt has maturities of between three and five years. In addition, debt servicing is mostly linked to the 60-day deposit rate, creating substantial exposure to interest rate risk." To complicate matters further, a new law requires the government to provide a formal guarantee that could cover up to 40 percent of the outstanding debt and 100 percent of the new debt of departments and municipalities 26. Interest rate exposure already induced a major debt-servicing problem for subnational entities in 1998 and 1999, after real mnterest rates on domestic debt increased substantially (the applicable nominal interest rate reached almost 37 percent per year in mid-1998, when inflation averaged just under 19 percent). 14 that negotiate a debt restructuring and fiscal adjustment program. This would shift the problem of debt servicing and financing from the subnational level to the central government.27 In addition, the recent crisis of the financal system, and in particular of the Housing Savings and Loan Associations (CAVs), has also led to an increase in government liabilities (funded through the issuance of government debt as per Law 546, and Fondo de Garantia de las Instituciones Financieras [Financial Institutions Guarantee Fund, FOGAFIN] debt instruments with the guarantee of the central government). The combination of these liabilities (both direct and contingent) represents an increase of nearly 7 percent of GDP in total government liabilities in 2001 alone."' Furthermore, the public sector has also accumulated large pension liabilities (for example, in Social Security). Calculations of pension system liabilities vary, but there is agreement that at the end of 2001 the order of magnitude of the net present value of these types of liabilities amounted to about 200 percent of GDP. The government also faces other contingent liabilities arising from the efforts during the last decade to involve private sector participation in infrastructure, which included power purchase agreements and "minimum traffic" toll road guarantees. In 2000, a law was passed by the Congress requiring the central government and other public sector entities to quantify all implicit and explicit risks associated with guarantees, and to appropriately budget for them. More recently, the public telecommunications company provided guarantees to the private sector to foster an expansion of telecommunications infrastructure; limited monitoring capacity meant that no provisions were made by the government for these liabilities at the time of budget preparation. Information on these liabilities remains sparse because no entity currently has the mandate nor the capacity to register and quantify the magnitude of all implicit and contingent liabilities of the public sector in Colombia. The government has recently started adopting a more systematic approach to the management of these types of liabilities. In 1997 the Department of National Planning (DNP) conducted, for the first time, a study to quantify the value of contingent and implicit liabilities.29 Law 448 of 1998 provided a legal framework that introduced the obligation to quantify and budget for the risks associated with the public sector's contingent liabilities. This law also authorized the creation of a Guarantee Fund that would facilitate the financial management of resources budgeted by different public sector entities to deal with contingent liabilities, mandating the Ministry of Finance to oversee the operations of the overall scheme. A small unit within the General Directorate for Public Credit at the Ministry of Finance was created in 2001 to fu lfill the Ministry's responsibilities in this area?. Although the scope of operations of the new unit is still limited and its authority insufficient to fully address all issues pertaining to management of the public sector's contingent liabilities, its creation is nonetheless an important step in the right direction. 27. Most large and medium-sized municipalities (excluding Bogota) had already renegotiated their debt by end 2001. However, these restructunngs mostly addressed refinancing risks by smoothing the debt profile, but did not deal with interest rate exposures (most municipal debt carries floating interest rates). At the same time, the central government has now provided a more formal guarantee on municipal debts. 28. Recent reforms of the supervisory and regulatory framework for the financial sector may have lowered the relative magnitude of contingent liabilities. 29. The 1997 DNP Report estimated that total public sector contingent liabilities amounted to 154 percent of GDP, with pension and infrastructure-related liabilities accounting for 140 percent and 8 percent of GDP, respectively. 30. See "Manejo de Pasivos Contingentes en el Marro de la Dixapkna Fiscal en Colombia, " 2002, by Jorge Enrique Cardona, xrv Regional Seminar on Fiscal Policy; 28-30 January-, Santiago, Chile. 15 Box 1. Legul Framework for Debt Management in Colombia The legal framework for pubhc debt management in Colombia is complex: * Issuance of Treasury bonds is regulated by a law that sets a ceiling consistent with the budget approved every year. . The Treasury (not DGCP) is authorized to issue short-term paper for cash management purposes, but not for budgetary financing purposes. * A 1992 Central Bank resolution gives the Central Bank authority over the issuance of short-term domestic public debt The resolution also estabhshes that the Central Bank must approve the financial terms of all mternational public debt operations. . In 1995 Congress gave the Finance Ministry increased flexibility with mternational bond operations. Congress would approve a multiyear quota for the gross value of operations that can be executed without requirng case-by-case authorization by Congress. The annual authorization to issue external debt was subsequently changed from a gross to a net basis. * The Finance Ministry has authornty over debt issuance by pubhc entities. Subnational governments need additional approval by Congress to issue foreign debt. . The Ley de Semajoro of 1997 lnks the total indebtedness of a public entity to its debt servicing capacity. * A 1998 law establishes that any publhc entity issumg any type of contingent-explicit liability should estLmate the magnitude of the liability incurred and its capacity to service the liability. D) Legal and Institutional Framework for Central Government Debt Management The lack of a comprehensive and coherent conceptual and legal framework for debt management, combined with overlapping responsibilities among various institutions of the government and the Central Bank, substantially reduce the effectiveness and efficiency of the country's debt-management system. Weaknesses and gaps in the legal and regulatory framework reduce transparency and accountability. The scope of debt management is unnecessarily restricted-no entity currently has the legal mandate or capacity to comprehensively manage all types of explicit, implicit, and contingent liabilities of the public sector, as part of a unified strategy. In fact, Colombia's debt policy has been driven mainly by the need to finance the fiscal deficit, and consequently, debt decisions have been taken with limited systematic analysis of risks, and without a strategic framework for debt management. While there is no single framework law for public debt management (see Box 1), the governance structure for debt management is also deficient. There is no clear separation of accountabilities and responsibilities between the higher-level bodies responsible for policy design and approval (the Minister of Finance and the Debt Committee), and the levels in the Ministry responsible for policy execution (the DGCP and Treasury). As a result, the Minister needs to formally approve (by means of a resolution) the execution of many individual operations carried out by the DGCP and Treasury.3" Given the dynamics of capital market operations and the limited time a Minister can allocate to this process, in fact, the decisions are taken by the DGCP and Treasury but the formal accountabilities are not properly established. 31. In the case of domestic Treasury debt auctions, the Minister is consulted about at what rates to declare an auction vacant. The Minister is also regularly consulted on the terrns of the international bond operations. 16 E) Domestic Debt Markets In the 1 990s, Colombia underwent a series of important institutional changes in the domestic capital markets, including the privatization32 and internationalization of banking services, the creation of a public debt market, and the reform of Social Security that led to the creation of private pension funds. Despite some progress, domestic debt markets remain shallow and underdeveloped. Key obstacles to their development indude (a) the use of a complex, nontransparent benchmark for the minimum rate of return of pension funds (established by law); (b) the presence of conflicting incentives that do not stimulate efficiency gains in the mutual fund industry; (c) limited know-how of mutual fund management techniques; (d) deficiencies in the current market makers system: liquidity is concentrated in very few points of the curve, the current ranking is too biased to the longer term instruments and some of the market makers(particularly the security houses) may be exposed to serious duration risk that could affect the capacity of the system to support the market in the difficult times (e.g increases of the interest rate) (e) money mtrkets are very inactive affecting the secondary market activity of the government bond market (f)cumbersome procedures for the authorization of securities-lending transactions that increase transaction costs; and (e) the use of an old and possibly biased methodology for calculating the Interest Rate Index (DTF) rate, which might limit its value as a benchmark for the wholesale market for bank asset operations (loans) and contributes to the segmentation of the markets. III. Policy Recommendations on Debt Management Colombia's fiscal imbalances require strong fiscal adjustments. In addition, in light of the large risk exposures and vulnerabilities of its debt portfolio, it requires a transparent policy for debt management. An improved fiscal discipline, together with strong debt portfolio management, including the control of the growth of debt stocks, will help restore fiscal and debt sustainability. The initial success of the fiscal stabilization program provides the government with the necessary credibility to implement an active debt management strategy. Actions in this regard will also provide additional comfort to investors and thus help reduce the costs of borrowing and keep liquidity and refinancing risks to a minimum. Failure to address the issues raised by the portfolio structure, and shortcomings of the institutional framework and the portfolio strategy for debt mnanagement, could significantly delay the full impact of the fiscal stabilization efforts. 33 A) Debt Management Strategy and Ponforko Restructuring To improve debt management and debt portfolio structure, the following specific steps could be considered (a) the Debt Office (or the DGCP) should develop new portfolio benchmarks for the short, medium, and long term3; (b) the new benchmark strategies should be presented to the Debt Committee, and submitted for subsequent approval by the Minister of Finance with the Committee's 32. Most of the privatized banks had been nationalized in the 1980s during the financial crisis. 33. For example, in the late 1990s, the full impact of the fiscal adjustment in Brazil was delayed because, at that time, Brazil lacked an adequate debt management strategy to deal with a vulnerable debt structure. 34. The strategy should distinguish between portfolio and issuing (funding) benchmarking, and should include a formal risk management framework as a guiding principle (for example, use the concept of maximum tolerable budget-at- risk-that is, maximum BaR-as a selection criterion). 17 advice35; (c) the strategy should include the systematic use of active debt management operations (exchanges, swaps, buybacks, and so forth) to modify the existing stocks and the funding strategy for the new operations; and (d) the Minister of Finance, with the advice of the Debt Committee, should provide clear guidelines to the Debt Office (or the DGCP) for implementation of the strategy. In addition, to facilitate management of the explicit contingent liabilities of the government, the Debt Office (or the DGCP) should develop and implement a plan to improve monitoring (registration and quantification) of these types of liabilities. The portfolio and issuing (funding) strategies should integrate the long-term fiscal and debt sustainability analysis of the government, with a thorough analysis of portfolio risk exposures. These benchmarks should reflect the government's assessment of an "acceptable" level of fiscal risk (budget-at-risk and or cash-flow-at-risk) relative to the expected reduction in cost of funding. To reduce central government debt exposure, a comprehensive restructuring of the debt portfolio is warranted. More specifically, debt portfolio restructuring should address the "bunching" of domestic debt and external debt amortization. The strategy could include the maximum level of amortizations that the government could "tolerate" under different scenarios of interest and exchange rates, and seek a set of financial instruments and terms that could achieve that benchmark. Given that there are no hedging instruments available that could be used to manage foreign exchange risks of the size associated with the government's portfolio, and that international reserves provide only a limited natural hedge, this type of risk should be managed through the control of the primary issuance of instruments and making strong efforts to deepen the domestic debt markets. It is recommended that a unified view on debt risks be developed by the DGCP and the macroeconomic programming unit. Ultimately both units should be concerned with budget risk, that is, the magnitude of the risk that debt service can bring to the budget. The macroeconomic programming unit can conduct an analysis of the government's balance sheet, in particular, of revenue and expenditure patterns. Based on such analysis, a maximum "budget-at-risk" (max-BaR) can be derived, which can be defined as the maximum tolerable risk (the amount of debt service) that the budget can sustain. The DGCP can then use this max-BaR as a risk benchmark-the DGCP should choose only funding strategies and portfolios that imply smaller BaRs than the max-BaR. B) Strengthening the Capaty of the Debt Office To strengthen the capacity of the Debt Office, the Ministry of Finance should centralize operations in a single Debt Office, with expertise in both cash and debt management (merging the DGCP and Treasury), alternatively, within or outside the Ministry (as a special administrative unit or an institute), in accordance with the new framework law. In the short term, the government should prepare an action plan that indudes at least the following key elements: (a) an organizational chart, including a front office, a middle office responsible for strategic debt analysis and risk management, and a back office;36 (b) a human resources plan, including staffing and training; (c) a comprehensive diagnosis of information systems and plans for improvement; and (d) proposals for the elimination or transfer to other entities of all non-core functions. The proposed functional structure consists of a unit responsible for leading transactions (the front office), one responsible for analyzing portfolio risks and aligning the actual portfolio with the 35. In some countres (for example, Poland, Sweden, and the United Kingdom) the Committee is actually a board chaired by the Minister of Finance and empowered to take key decisions. 36. The front and back offices should ideally be the same ones for cash and debt management operations. 18 benchmarks (the middle office) and, finally, a unit in charge of settlements (the back office). The DGCP and Treasury should be merged into a debt management unit to ensure consistency along all the term-structure of government debt, and to eliminate overlaps (especially in the back office and domestic front offices). Two possible alternatives for institutional design have been identified: (a) transforming the Debt Office into a special administrative unit under the Ministry's structure (following the example of the tax and customs units), or (b) creating a separate institute under the Ministry of Finance following the structure of institutions like FOGAFIN. There are advantages and disadvantages to both options. Under the first option, constraints on salaries and adlministratve procedures are likely to remain, but the smooth flow of information within the Ministry will be preserved. Under the second option, there will likely be more salary and structure flexibility that will help increase the capacity of the Debt Office, but relationships with Ministry departments-units will likely be negatively affected. With a clearer governance framework provided by a new law, the latter may nevertheless become the preferred option. Non-core business activities currently under the DGCP and Treasury should be phased out or transferred to other units within the Ministry or other institutions like the National Planning Department.37 However, the current arrangements whereby a specific group within the Debt Office is responsible for monitoring contingent liabilities should be strengthened and given increased authority to request timely information from other government entities responsible for the management of those liabilities. The new unit should have access to necessary human resources and skills to carry out its functions, and should have the admmistrative flexibility to act and respond to fast changes and opportunities in the financial market. This requires adjusting the salary level and structure to make it more competitive vis-a-vis the private sector. It is also important to establish and institutionalize a comprehensive training program, including specialized courses, scholarships, and internships in public and private sector institutions in Colombia and abroad. The proposed reforms of the organizational structure will require a new, fully reengineered information and technology system.38 The Ministry of Finance should also issue comprehensive regulations and guidelines for debt management and for Debt Office operational procedures. These regulations and guidelines should clearly define responsibilities and internal accountabilities; ensure that adequate checks and balances are maintained; address issues of actual or potential conflicts of interest encountered by Debt Office staff; define mechanisms and procedures for preserving the confidentiality of information and operations of the Debt Office; and establish a code of conduct to guide the behavior of Debt Office staff, consultants, and all other entities or persons rendering services to the Debt Office. C) Legal and Institutional Reforms To create a proper legal and governance framework for debt management operations, the government should prepare and submit for Congressional approval a framework law consolidating all legal and regulatory instruments on debt management. Key principles of the proposed framework law39 should include provisions for (a) separation of policy formulation, implementation, and 37. Noncore business activities include participation in negotiations of multilateral and bilateral loans, supervision of the issuance of domestic bonds by subnational government entities, and involvement in the financal design of infrastructure projects and in the process of privatizing public companies. 38. The decision to introduce the UNDP database (CIGADE) that centralizes all debt operations is an important step in the right direction. 39. For further discussion of the key principles that could underpin a new framework law, see "Guidelines for Public Debt Management," World Bank and IMF, March 2001. 19 evaluation functions; (b) creation of a new Debt Office (by merging the DGCP and Treasury) and redefinition of the role and structure of the Debt Committee in light of the proposed new framework; (c) creation of an independent entity reporting directly to the Minister of Finance for the evaluation of debt policy implementation, including the definition of provisions for ensuring adequate checks and balances'; (d) very clear objectives that include risk-cost tradeoff issues as a central dimension of debt management; (e) use of modern financial instruments and tools for active debt management; (f) definition of responsibilities and accountabilities at different levels of the government; and (g) separation of debt management from the Central Bank's mandate, particularly with regard to the issuance of short-term Treasury bills to improve the government's cash management flexibility. Within this new framework, the Minister of Finance, with the advice of the Debt Committee, should define a set of portfolio benchmarks and the overall strategy to achieve it. A clear and transparent mandate for the execution of this policy decision should then be given to the Debt Office (or the DGCP). Moreover, the assessment and evaluation of the quality of the execution of debt policy should be conducted by an entity or auditing unit (or external audits) independent of the Debt Committee and the Debt Office. D) Deepening the Domestic Debt Markets To enhance and deepen the functioning of domestic markets, thus facilitating the management of public debt, the Ministry of Finance should draft and submit for Congressional approval a legal amendment to simplify the benchmark for the minimum rate of return of pension funds.4" The benchmark for the minimum rate of return of pension funds should be changed to the lowest nonbinding benchmark of either (a) a real rate of return calculated so as to achieve a specific pension replacement rate, or (b) an average of the current rate of return on the government's medium-term bonds. In addition, the Ministry of Finance should undertake a study to identify the major regulatory and incentive constraints for increasing the efficiency of collective investment vehicles and mutual funds, and to develop an action plan to remove such constraints. The government could also explore and analyze the conditions for establishing a securities-lending backstop facility that, in exchange for cash or securities, lends different securities to an intermediary to support repo and short-selling activities. Finally, the government and the Central Bank should assess the suitability of the current DTF rate calculation methodology and evaluate with the industry the possible introduction of an alternative market reference rate (for example, the London Inter-Bank Operations Rate [LIBOR] type) for secondary market activities. ro successfully develop domestic debt (and capital) markets, the investor base must be expanded. 'The market needs a strong and diversified group of institutional investors (including pension funds, nsurance, mutual funds, and foreign investors) that can generate demand for different segments of the yield curve (short, medium, and long term), and generate a liquid secondary market. Reducing transaction and information costs could facilitate this process. One important step toward domestic ,:apital market development is the phasing out of government reliance on captive investors. Currently, nearly 50 percent of new issuing is allocated to a group of captive investors-the so-called nversionesforZosasy convenidas for a breakdown of domestic public debt by type of holder). These are basically the public pension fund (at the Social Security Institute) and government entities running 10. Extemal auditing could be used as an altemative to the creation of a new auditing unit. -1. See "Developing Governrnent Bond Markets: A Handbook," 2001, Washington, D.C.: World Bank and IMF. 20 cash surpluses that, by regulation, have to be invested in a portfolio of government bonds through direct negotiations with the Treasury. The size and importance of captive sources in government financing have introduced market distortions (segmentation) and have negatively affected the development of the investment and mutual fund industry. In the case of the pension funds, simplifying complex regulations behind the calculation of the minimum yield on pension fund investments could reduce unnecessary "noise" and reduce information costs. For mutual funds, further market opening for foreign financial companies managing mutual pension, and investment funds could create competition in the mutual fund industry to diversify and extend portfolio duration. These changes will likely induce consolidation in the industry, which will also reinforce the process of modernizing financial management companies. The government could also promote the rating of asset management companies (and of the funds they administer) by local or international rating agencies, reducing information costs for investors and increasing competition and transparency. While most of the above principles also apply to the insurance funds industry, promoting the development of annuity products (rentas vitalicias) through new regulation (now under preparation) would further promote the development of domestic capital markets. One important area for improvement relates to the existing relationship of the Debt Office with primary dealers. The system needs to be reformed to introduce liquidity along the entire yield curve and not just at a few points in the longer-term segment, as it currently operates. This would require that the valuation procedure put equal emphasis on key points along the curve. The government should also consider a rotating system by which each dealer is given a combination of off-the-run and on-the-run points, so that pressure is put along the entire curve. This will allow the government to move effectively along the curve depending on expectations and market conditions. An important issue that needs proper government supervision is the level of risk exposure that key market makers acquire when acting as Primary Dealers (PDs) of the government. In particular, security houses seem to be taking large risks, given the relatively lenient capital adequacy standards and limited enforcement that they currently face. This situation presents a sharp contrast with that of another important group of intermediaries-the banks-which are subject to more demanding capital adequacy and supervision standards. This is important for the financial system as a whole and for the sound operation of the PD system, because a sudden increase in interest rates could conceivably force an important group of PDs to move out of the market-making business, or even to go out of business altogether. Market liquidity and the risk exposure of government would likely deteriorate in such a situation, highlighting the need for joint action by the Debt Office and the securities market regulator. To support a more active secondary market and facilitate the holding of longer-term instruments, matket agents need to be able to access instruments that will promote liquidity and hedge unnecessary risks (such as repos or simultdneas). However, there are constraints on the development of secondary markets, including the lack of standardized and fungible issues. A possible solution to be explored is the introduction of a securities-lending backstop facility that, in exchange for cash or securities, lends different securities to an intermediary. These and similar arrangements have been adopted in several countries. The Colombian government could explore this or other types of solutions to facilitate the development of secondary markets. 21 The introduction of altemative reference rates to the current DTF may contribute to an improvement of financial market integration and price signaling within financial mnarket segments (for example, bank deposits and lending, money markets, and government bond markets). The alternative reference rate should be transparent and consistent with the activity of the secondary markets to effectively facilitate the pricing of financial assets and liabilities. For example, a group of financial institutions (market makers) has already been working on a proposal to create a Bogoti Inter-Bank Operations Rate [BIBOR], a concept similar to LIBOR). The government jointly with the Central Bank should evaluate and explore alternative solutions. Finally, promoting the development of retail investors could also strengthen capital markets. In general, there are two main avenues to tap this market: (a) the creation of specialized Treasury bond funds (for example, Spain was very successful in promoting specialized government bond funds as close substitutes for bank deposits); and (b) the direct distribution of securities (through, for example, the Internet). 22 CAS Annex El Executive Summary of Voices of the Poor Colombia Introduction To inform the formulation of the Colombia Country Assistance Strategy (CAS) 2002-2006, the Voices of the Poor study explores poverty from the perspectives of poor women and poor men from different regions of Colombia. The study was designed to enable a wide range of poor people in diverse contexts in the country to express, analyse and share their realities, priorities and perceptions, and to organize and present these reflections in such a way that they can inform policies and programs to reduce poverty in Colombia. The Colombian study has two features that makes it different from the global Voices of the Poor study: its study agenda is more focused on areas of particular relevance to poverty and development in Colombia and the study design is oriented to developing action proposals. The three major themes explored in the new study are work and employment, education and capacities, and violence and security, and they were framed by the findings from recent quantitative and qualitative World Bank studies of Colombia, in particular, the new Poverty and Social Safety Net reports.' The effort to generate poor people's own policy proposals for improving their lives seeks to support the design of more appropriate and effective policies and programs to reduce poverty. Building on the World Development Report: Attacking Poverty, 2000/1, the World Bank's Strategic Framework Paper identifies "empowering poor people and investing in their assets" as well as "building the climate for investment, jobs and 2 growth" as the two priority areas for Bank support to client governments. The study methods were adapted from the participatory and qualitative tools used in the global Voices of the Poor study and from a growing body of participatory work worldwide. The research approach, which engages poor people directly in data gathering and analysis, provides a strong foundation for bringing greater poverty focus and supporting empowerment strategies in World Bank's activities in Colombia. Given the country's worsening poverty trends, continuing civil conflicts, and new government, the study was well timed to strengthen awareness of poverty issues, support peace-building efforts, and contribute to activities to reduce poverty. l World Bank, Colombia,Poverty Report, March 2002, Green Cover, Washington, D.C. World Bank, Colombia Social Safety Net Assessment, April 2002, Report N 22255-CO, Washington, D.C. 2World Bank, "Empowerment and Poverty Reduction: The World Bank's Agenda," November 30, 2001 draft. The election of a new government made the study particularly relevant as it provides an opportunity for the findings of the study to influence the preparation of the National Development Plan for the period 2002-2006. Study Design The study was conducted in 10 sites selected to ensure regional diversity, rural and urban contexts, ethnic diversity, special vulnerabilities, high and low intensity of and armed conflict. The sites included urban neighborhoods in Cartagena, Medellin, Pasto, Cali and Barrancabermeja, an Afro-Colombian fisherman community in the Pacific Coast of Narifno, a periurban neighborhood of an internally displaced population on the outskirts of Bogota, rural sites in Gir6n (Santander), Usme (Bogota), and an Indian community in Northern Cauca. Five research teams were trained by the World Bank to conduct the fieldwork. The researchers were affiliated with two universities, Javeriana in Bogota and Valle in Cali, NGO's specialized on violence, youth and communications for development, and grass-roots movements. Some of the teams had contacts with the communities where they conducted the study, thus facilitating their entry to begin the fieldwork and providing some security in areas of conflict. Fort other sites entry and security were ensured through national NGO's with a presence in that locality. Within communities, researchers met with poor men and poor women, youth and children. The study topics were explored in small and large discussion group settings with women, with men, and with both genders. Open-ended individual interviews with poor people and key informants such as local leaders and schoolteachers were also conducted. A variety of qualitative and participatory visual techniques were used, such as institutional mapping, Venn diagrams, time lines, and calendar of events. The development of visuals gives poor people a more systematic means to identify and assess options and alternatives useful for social policy and institutional changes that could bring meaningful improvements to their lives. In this way, the study in Colombia gives greater emphasis to proposal for action than to the diagnostic of poverty., Key study findings Poverty in Colombia, is perceived by poor people in the different sites as having multiple dimensions, including unemployment, lack of assets, inadequate social opportunities and powerlessness. What makes the over experience of poverty in Colombia different from that of other countries is the overwhelming consensus about work as the number one condition for wellbeing, the shortcomings of education as a means to get a job, the extreme disempowerment and stigmatization of poor people due to violence, the extreme vulnerability of children and youth, the 2 perception of a state that is largely absent, and a widespread desire by poor people for stronger community groups and local institutions. 1. The overwhelming consensus around work as the number one condition for welbeing. 'Estar bien es tener trabajo... El trabajo es la base de la sustentaci6n de la familia...' - a woman from Barrancabermeja 'Con empleo uno vivefeliz' - a young man from a barrio of Medellin Having a job that offers a decent and stable income, not just any job, was ranked by both male and female study participants as the number one condition for well-being - above health and education in all but three sites. Conversely, the absence of work is seen as the chief source of fear and despair in the home. Across the 6 urban sites of the study, people report that their work prospects have worsened since the start of the economic crisis in the mid 1990s. People repeatedly commented that they now work more than before but earn less. This finding is consistent with the conclusions of the recent Poverty Report which show that increased labour by the household is not matched by an equivalent increase in income. Furthermore, poor people display incredible versatility in finding ways to make a living and adapt to adverse conditions, but this versatility and willingness to work hard are not rewarded by the market or by government programs. On the other hand, the feminization of work as a consequence of the economic crisis of 1995 has led to tensions in the family by the new demands on men to collaborate at home and has increased the vulnerability of children. Finally, there is an increasing acceptance of illegal ways of making a living such as through drugs, armed robbery, petty crime, and prostitution. 2. The shortcomings of education as a means to get a job. '4 muchachos terminaron bachillerato y no han conseguido trabajo... Hay muchos ejemplos ast, entonces epara que?' (discussion group on education with Cali youths). 'El estudio que recibi de bachillerato no me sirve para trabajar, porque en lo que me sale trabajo no necesito ser bachiller sino celador, mensajero' (Cazuca youth). The poor want education to improve their work opportunities, but what they find, overwhelmingly, is that public education is failing to equip them with the skills the labour market requires. The economic crisis has shown the shortcomings of formal education as a means to get a job. Dropping out at an early age is on the increase. In every study site without exception, researchers discovered that the 3 majority of children do not complete secondary school. The material collected in the study puts the average age of those who drop out of school definitively at 13, with considerable evidence of children leaving school much earlier, as early as age 8 or 9. One of the more disturbing reasons given to justify the high drop out rate in schools is children's and parents' widespread disaffection with the public education system. The poor consistently report that teachers are often bad or absent, the costs of education (in relation to its meagre benefits) considerable, and, most serious of all, there is little evidence that it improves children's future work prospects. The need to make some extra cash was also cited across the sites as the most common reason for dropping out of school. Education is also idealized as a vehicle for values, personal development, and better social relations, but reality paints another story. The school is no refuge for children suffering abuse in the family. Discrimnination of children from the poorest families, sometimes expressed through teacher abuse, is alarmingly common. The trend is justified by parents and children on the grounds that the school system is failing to prepare students adequately for work. What is so striking is that despite their biting criticisms of the education system, the poor continue to believe in education as an ideal. Education is frequently present in their proposals to overcome their problems. The proposals formulated by study participants across the sites to improve education focus on options to make it more vocational, more accessible, and better suited to local culture and conditions. 3. The extreme disempowerment and discrimination of poor people due to violence. "La gente esta enferma por la impotencia, por el miedo..." -- An Afro- Colombian in poor rural community on the Pacific Coast "La presencia de grupos arnados ha limitado las posibilidades de organizaci6n. " "Ser lider lo Ilevo en la sangre..." "-- Study participant in a poor neighborhood of Medellin Poor people in Colombia view the political violence and drug trade as fueling ever more juvenile delinquency and neighborhood crime and violence -- as well as a cascade of other harmful political, social and economic impacts. They also describe widespread violence in the home against women and children. All of these types of violence feed on each other to create vicious cycles of violence that begin at very young ages, and leave poor people increasingly fearful and isolated in their homes and communities. Against this backdrop, poor people express profound sense of disempowerment that takes many forms -- inability to make ends meet, to protect their own children or to keep conflict out of the home, to move about freely on their own streets, or even for neighbors and leaders to come together. In addition, violence of all kinds is leading to more and more single mother homes, which in turn increases 4 the vulnerability of children to greater poverty, higher rates of school dropouts, and more violence in the community, and the cycle goes on. Pupils from Barrancabermeja, Cali, Sanquianga, the outskirts of Bogota, and Cazuca, told researchers repeatedly that other children, and sometimes teachers, treat them badly. Poor clothing (beneath the uniform) and shoes, a different accent, rural origin, darker skin, and at times a slower learning rate, are frequently the object of ridicule and reprimand. For black children from the poorest families, getting admitted to a school is a problem. In an AfroColombian barrio of Cali, teenagers say they are forced to lie about where they are from. Most alarming is the situation of displaced children in Cazuca. Children feel acutely that their rural origin is the object of ridicule by other children. These children long to return to the schools they attended before being displaced. 4. The Extreme Vulnerability of Children and Youth "Los muchachos se crian en un ambiente de violencia y en la escuela lo repiten agrediendo a sus companieros y a los maestros" - a teacher from Sanquianga" " Cuando llega el hambre, la moral se va, -a young womanfirom a neighorhood in Medellin. In all sites, parents and local leaders expressed a deep concern for the increasing vulnerability of children. They are exposed to abuse inside and outside home, increased abandonment as a result of all adults at work, and the loss of human capital by malnutrition, lack of access to health services, and their absence or drop- out from school. In at least 5 of the 10 sites, malnourishment was identified as a problem seriously affecting child development. In Cartagena, the Cauca, Cali, Medellin, and Sanquianga on the Pacific Coast, teachers report that a significant number of children find it difficult to concentrate and follow classes. So perhaps it should come to little surprise that a major reason cited by parents for sending their children to- school is for the free lunch. School may do little to prepare children for a working future, but at least it is a place, say parents, where they get a free balanced meal. Teachers, social workers and poor people suggest that children who have experienced or witnessed violence at home frequently reproduce the violence with family members, in their schools and on the streets. Youth are widely seen as the population group most vulnerable to and engaged in crime, violence and immoral activities in their communities, and this is frequently linked to their frustration over the lack of work opportunities. Parents express deep concerns that their children's only options is to be recruited by guerrilla, 5 paramilitary or drug related groups. The attractions of drugs, alcohol, 'easy money', and consumerism, were also cited as reasons for leaving school, particularly in the urban sites. In Barrancabermeja, a discussion group of teenagers admitted that 'algunos somos viciosos y borrachines. Nos empieza a gustar tener plata, entonces no estudiamos mas'. In Cali and Medellin, youths spoke of the easy money that comes from selling drugs and stealing. The money is spent on flashy consumer goods to impress friends - the latest sneakers, an expensive watch, a CD player. Easy money and the consumerism it breeds then becomes a drug in itself. 5. A state that is both present and absent. "...para jo'venes en Acci6n solo recibieron catorce y aqui hay mas o menos trescientos o cuatrocientos j6venes. " -- A poor person in Cartagena Unlike very many other poor communities around the world, the ten Colombian sites visited do not seem to contend with basic infrastructure and human development gaps like unreliable and polluted water, lack of electricity, distant primary schools and health clinics, or isolation due to lack of roads and transport, except on the Atlantic Coast. This suggests a more decentralized state presence and capacity than one might have assumed given problems of violence. Nonetheless, people in the study express a deep sense of abandonment by the state on other key threats to their wellbeing --- namely the total lack of public safety and justice, but also increasing hunger, very poor work opportunities and the deep vulnerability of children and youth to experiencing diverse forms of violence, to leaving school, and to being drawn into illegal work activities once on the streets. . Police are absent from most of the 10 sites of the study and thus people find their own means to provide security and apply justice. This lack of state security results in more intrusion by irregular forces, less investment, more stigmatization, more youths caught up in gangs and irregular forces, and weakened community organizations pray to armed gangs. These disturbing trends have worsened since 1995, as the economy has struggled with crisis and slow recovery and conflict has intensified. 6. A widespread desire among poor people for stronger community groups. "El problema mas grave es la desunion de la gente. Si estamos asociados podemos hacer reclamaciones juntos y asi nos escuchen mas. " -- Hombre de 43 anos. from an isolated rural community forty minutes away from Bucaramanga What is especially striking about Colombia is that poor people across all ten communities emphasized solutions that would strengthen their local groups and that would especially provide resources directly to them. In particular, poor people sought help with overcoming obstacles such as weak or corrupt local leaders, lack of trust among people, and politicians who divide their communities or make empty promises. One community, an indigenous village in the Department of Cauca, had a very strong community organization and tradition of collective action, and this was 6 clearly seen to have brought greater physical safety and economic security as well as a sense of social belonging to all of the people who lived there. The proposals for poverty reduction coming from the voices of the poor Three major policy implications underlie the findings of the study. First is the fact that poor people clearly see rising insecurity, poor work opportunities, and problems with the relevance of education as tightly linked and propose integrated solutions. In contrast with the sectoral approach of the poverty experts, poor people in Colombia see their needs as multidimensional and thus consider that the ways to address them must be integrated. This has implications for both the government and the Bank on the design and implementation of more integrated approaches that simultaneously address the linkages across problems of lack of work, violence and poor educational opportunities. There were frequent proposals for services that targeted poor households as a unit, and that would reduce conflict and support greater cohesion at this level. Second, each community presented different priorities, obstacles and opportunities for addressing these problems, and thus the government needed greater capacity to deliver flexible yet tailored services. Poverty is contextual: it varies from place to place. For example, communities expressed different preferences regarding the content and form of education and training programs that would best enhance local work opportunities; and communities had different views about the need to integrate values, better family and community relations, recreation, cultural concerns and so forth into education efforts. Third, poor people's proposals across the study communities called for stronger community organizations, greater local presence of the State, and the opportunity to relate directly to government institutions. In all sites, poor people perceive their local organizations as a necessary instrument to enhance their welbeing. However, they want support to strengthen the capacity of these organizations to become more representative, better able to manage collective activities, and to interact more effectively with local government institutions. At the same time, poor people call for more state presence, particularly to improve public safety and access to justice. They also seek more responsive public institutions and better access to information about how the government works and the various social programs and services available. And they want to relate directly to these institutions without intermediaries. With enhanced local organizational capacities and closer relations between poor citizens and the State, poor people express confidence that public institutions will be more responsive to their needs and the effectiveness of policies and programs to reduce poverty will improve. 7 More specific proposals discussed by groups from the 10 sites to address the different dimensions of poverty are listed below: * Access to a microfinance program to support self- employment and cooperative enterprises that guarantees access to poor families in urban and rural areas. This will create work opportunities, the single most cited mechanism by poor people against poverty, violence and armed conflict; * Vocational and technical training opportunities responsive to needs and conditions of local people and real demands of the market. This implies the expansion and improvement of the services of SENA in partnership with experienced and specialized NGO's; * Access to formal education that is relevant to the conditions of the locality, specific in terms of information, knowledge and skills that are demanded by the market, and integral, that is for family and community life, work and self- employment; * Increasing the protection of children through integrated family programs of family care and thus expand the services of ICBF. In the long term, the best option is to increase family income; * Provide psychological counseling to families to help deal with increased internal and external tensions and violence generated by the economic crisis. Concluding Comment Many proposals by poor people call for simultaneous initiatives to improve local livelihoods, public safety and educational opportunities. Not only must strategies to reduce poverty be more holistic and integrated, but poor people also seek interventions that are more flexible and able to adapt to and support the needs of Colombia's diverse communities and cultures. Underlying these proposals is a widely seen view that the causes of poverty and insecurity where they live are numerous and tightly interlocking, and that previous governmental efforts to change this have largely passed them by. 8 C~~~~~~~~~~~~~~~~~~~~~~~~~~IR a3r1251e r 780 - -12' Caribbean VNZUL |< PaNAX 4s'MA _ O CEA N A D CCUNDINAMA Ten1n C A SA NA RE/ COLOMBIA~~~~~~~~~~~~~~~OLMI i~~~O v Ba R A Zf,5 I L g Nationa Capital< / 0 100 200 KILOMEtERS~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I C A U C AG h HUMAJW W DVC R PA3M C IARE t , 780 74 414 > X V A U P E S . CDX70' B.o DECUADOR to5Y_W7tx ~ DEEMBE 200 COLOMB~NT Q IA DE ARAUC s ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~f Casool nplre il0A 50 Iq FSO CIE Car4 78°~~~~ ~ ~ CUDIAM *Tu a C0 I~~~ ~~~~~~~~~~~~~~~~~~~ I C HI D~~~~~~~~~~~~~~~~~~~~~~~~EEBR20 *nlrLD- N. . 25129 CO Type: CAS