53685 THIRD ANDHRA PRADESH ECONOMIC REFORM LOAN/CREDIT TRANCHE RELEASE DOCUMENT - FULL COMPLIANCE I. INTRODUCTION 1. This memorandum summarizes progress in the implementation of the third policy-based operation in support of the State of Andhra Pradesh's medium term development program. It focuses on the actions taken by the Government of Andhra Pradesh (GoAP) to meet the specific conditions for the release of the second tranche of the Third Andhra Pradesh Economic Reform Loan/Credit (APERL3). It should be read in conjunction with the main Program Document. 1 2. APERL3 is the third in a series of programmatic budget support operations to Andhra Pradesh (AP). It provides financial support for the implementation of a policy and institutional reform program of the GoAP, which has been under implementation for over a decade. The first of these loans, Andhra Pradesh Economic Reform Loan (APERLl) was approved in March 2002, APERL2 in February 2004, and APERL3 in January 2007. While the first two budget support operations comprised only one tranche, APERL3 was designed as a two-tranche operation in accordance with the Government of India's guidelines for policy-based assistance to states. Key elements of the GoAP's reform program supported by the third operation are: (a) Improving the state's investment climate through opening up agricultural markets for the private sector, correcting problems in land and labor markets, creating a framework to promote rapid clearance procedures for establishing private enterprises and supporting a more conducive environment for enabling Public Private Partnerships (PPPs). (b) Fiscal consolidation and strengthening public financial management through improving fiscal discipline and enhancing revenue generation to create sustainable increases in fiscal space, along with shifting resources towards priority expenditures and supporting a more transparent and efficient use of public resources through better fund flows, cash management, procurement practices, accountability and internal monitoring. (c) Improving governance and raising the quality of service delivery in sectors through enhancing institutional capacity for improved service delivery, accountability and transparency in government operations, and research based policy and budgetary support to sectors including education and power. (d) Better targeting of antipoverty programs through more effective monitoring and evaluation and enhanced access to social safety nets for vulnerable groups. 3. The GoAP has made considerable progress on all the key elements of the reform program, over and above the prior actions committed to under APERL3. The state continues to be ranked amongst the best in India on investment climate. It continues to address difficult land and labor issues. Large scale infrastructure projects have been implemented through PPPs. The GoAP has adhered to the path of fiscal consolidation, despite pressures brought on by elections, increases in civil servant salaries following the sixth pay commission award and a significant slowdown in growth. AP has made substantial progress on governance reforms, adopting a number of initiatives to improve transparency and accountability in service delivery through better internal 1 See the Program Document for the Operation (IN-P075174), Report No. 36927-IN. 1 controls and use of e-governance solutions. The state's achievements in implementing the reform program for improved targeting of antipoverty programs and access to social safety nets for vulnerable groups have consistently exceeded state's own targets for 2007-09, discussed during APERL3. 4. At the same time, progress has been mixed in some areas. There has been no increase in operations and maintenance expenditure and the share of capital expenditure has not increased. On the other hand, food and power subsidies have increased substantially, weakening the potential developmental impact of AP's increased fiscal space. In particular, the power sector remains a drain on public finances, though some efforts have been made to improve efficiency. Detailed progress on each element of the program under APERL3 is described in Section III. While the endeavor has been to focus on reforms undertaken after the 1st tranche of APERL3, in a few areas it was important to highlight the background and context of these reforms, especially the ones supported by the previous two operations. 5. Release of the second tranche has been delayed because the tabling of a procurement law before AP's state legislature, a tranche-release condition, took longer than anticipated. This delay was due primarily to two reasons. First, the state government conducted an extensive two-year consultation process with stakeholders on the law to build a consensus around its substantive principles. Second, AP experienced a period of political uncertainty after the tragic death of its Chief Minister, Mr. Y.S.Rajasekhara Reddy, in September 2009, which was followed by violent agitation for a separate state in the Telengana region. However, the procurement law was tabled before the legislature on March 4,2010. 6. According to the legal agreements for this operation, the release of the second tranche of the loan and credit are based on the following requirements: (i) Andhra Pradesh has made progress, satisfactory to the Association and the Bank, in carrying out the Program. (ii) The macroeconomic policy framework of Andhra Pradesh is appropriate, including achieving the targets for realized revenue and fiscal deficit for Fiscal Year 2006/07 consistent with the provisions of the State's Fiscal Responsibility and Budget Management Act, 2005. (iii) Andhra Pradesh has introduced in its State Assembly a legislation for strengthening the regulation of public procurement. (iv) Andhra Pradesh has completed an independent third party verification of agricultural electricity consumption (at the feeder level) based on the methodology approved by the State's Electricity Regulation Commission. 7. The next section describes the overall macro-economic policy framework in India as well as recent trends in development outcomes in Andhra Pradesh. Section III discusses progress in the implementation of the GoAP's overall reform program. Section IV details the status of specific tranche release conditions. The memorandum concludes that the conditions for the release of the second tranche have been met and that substantial progress has been made in implementing the measures outlined in the GoAP's Letter of Development Policy (see Annex A of the Program Document). II. RECENT ECONOMIC DEVELOPMENTS 8. India is coming out of the global financial crisis. While the recovery has been a strong V for now, risks linked to uncertain global growth rates remain. After hovering around 6 percent for the 2 previous three quarters, Gross Domestic Product (GDP) growth rose to 7.9 percent in the second quarter of the 2009/10 fiscal year (July-September 2009), before declining again to 6 percent in the third quarter (October-December 2009) primarily due to negative growth in the agriculture sector on account of a bad monsoon and other seasonal factors. Overall growth for 200911 0 is likely to be 7.2 percent, according to Central Statistical Organization advance estimates, largely due to strong growth in the manufacturing and services sectors in the hi.st quarter. Signs of renewed optimism are lifting the stock market. However, inflation is resurfacing because of increasing energy and food prices. 9. The short- to medium-term outlook for India is bright. A path to return to fiscal discipline has been traced with the Central Government fiscal deficit targeted at 5.5 percent of GDP in FY 2010111, down from an estimated 6.9 percent deficit in 2009/10. The budget for FY 2010/11 also cautiously rolled back some of the stimulus measures adop~ed in the second half of FY 2008/09. In the medium-term fiscal framework, a fiscal consolidation path has been adopted by Gol based on the recommendations of the 13th Finance Commission. The report of the Commission envisages bringing down the fiscal deficit to 3 percent ofGDP by 2013114 and adopting an explicit ceiling for the debt-to-GDP ratio of68 percent by 2014115 from the current 75.6 percent. 10. With the direction of exports undecided, recovery has relied on domestic demand. The Index of Industrial Production (llP) staged a strong recovery since June 2009 and grew by an average of 11.5 percent between June 2009 and January 2010. Much of this recovery was fuelled by capital goods and intermediate goods production indicating signs of an investment revival. However, export growth, after improving through most of 2009, began to shift downwards in December 2009 and January 2010. The decline in government consumption pushed down the overall rate of consumption growth to only 0.9 percent in the third quarter ofFY 2009110. Private consumption also experienced a slowdown declining to 3.4 percent in the third quarter of 2009110 compared to 5.5 percent in the previous quarter. In contrast, capital formation continued its robust growth, growing at 8.9 percent, the highest rate in the last 7 quarters. 11. Inflation has been high for several weeks on account of high food prices and the base effect of low international commodity prices at the end of 2008. Inflation rates based on the Wholesale Price Index (WPI) moved from being negative in mid-2009 to nearly 10 percent in March 2010. Consumer Price Index based measures indicate an even higher rate of inflation between 15 and 17 percent. The bulk of the increase has been on account of the rising prices of staple food items which have grown between 17 and 19 percent. A good winter harvest is likely to mitigate some inflationary pressures. Lately, core (non-food, non-energy) inflation measures have also shown some increase. This raised concerns that inflation could become entrenched, and the RBI continued tightening its monetary policy stance with a 25 basis points rise in key policy rates a month ahead of its regular monetary policy review at end-April. 12. While the trade balance deteriorated, the overall balance of payments moved into surplus due to strong capital inflows. During the first half of the current fiscal year, imports rose with rising international prices, while exports remained subdued. Although service exports remained the bright spot during the global recession, the surplus in the services balance continued to deteriorate since the second quarter of 2008/09. As a result, the current account turned negative in the first two quarters ofthe current year. With portfolio capital flows resuming after the May 2009 elections, the capital account turned positive just as the current account dipped. In the first half of the current fiscal year, the capital account rebounded to the pre-crisis level. 13. Reserve Bank of India reserves continued to grow during the current financial year to US $278.4 billion in February 2010 from US $252 billion in March 2009. However, much of the 3 gain was due to valuation changes as the U.S. dollar continued to depreciate against some of the major currencies in first quarter of the fiscal year. Similarly, India's stock of external debt increased to $242.8 billion in September 2009 increasing by $18.2 billion from March 2009, with about half the increase was due to valuation changes between the U.S. dollar and other major currencies. 14. India's macroeconomic policy framework has been adequate to respond to the global financial crisis and set the stage for a return to high growth rates. Monetary policy was eased significantly after the collapse of Lehman Brothers in September 2008 with a reduction in policy rates by more than 400 basis points, and liquidity injections through lower prudential rules and open market operations. Fiscal policy stance was widened by 3.5 percent of GOP in FY2008/09 compared with the previous year, and some further expansion in 200911 0, through tax reductions and expenditure increases. Strength of government demand supported GDP growth in the second half of FY2008/09, when private demand slumped. Monetary policy tightening started in October 2009, with the return to higher prudential norms, and continued on March 19 with a 25 basis points increase in the policy rates. The central government budget for FY201 0111 also signals a phased return to fiscal prudence with a significant reduction in the fiscal deficit target. Both World Bank and IMF assessments conclude that the macroeconomic framework is appropriate. Developments in AP 15. AP continues to be one ofIndia's fast growing and most reform-minded states. After growing at about 5.3 percent during the 1990s (below the all India average of 5.6 percent), AP grew at an average of 9 percent between 2004/05 and 2008/09, above the all-India average growth of 8.5 percent. This increase coincided with the adoption of a sustained policy and institutional reform program in the state that accelerated private sector-led growth and achieved various improvements in the quality of public service delivery. Although growth has been driven largely by the industrial and services sector, agricultural growth, though volatile, has performed well on average. In recent years, AP has emerged as a major industrial and IT hub with exports of computer software contributing to more than half of the exports from the state. 16. The global financial crisis and poor monsoons affected AP adversely in 2008/09 and recovery has be~n slow in 2009/10. Estimates show that growth in 2008/09 came down to around 5 percent, with declining growth rates in both agriculture and industry. Poor rains in 2008/09 affected agricultural output adversely. Following the financial crisis, exports in 2008/09 went down steeply in some sectors like agri-based and forest products, leather, animal and marine products; and in some manufacturing sectors like hand loom and textiles, handicrafts, and drug, pharmaceutical and allied chemical plastics.2 Agricultural growth is expected to remain negative (-4.7 percent) in 2009/2010 due to severe drought followed by floods in late 2009. Industry is showing healthy signs of revival with an estimated growth of 5.9 percent in 2009110 as against growth of only 0.22 percent in 2008/09. The services sector continues to grow strongly, posting above 9 percent growth. 17. AP has made progress in improving some human development outcomes. AP's poverty headcount at 15.8 percent is below the all-India level of 27.5 percent in 2004/05, having declined from 22.2 percent in 1999/00. The state has been able to improve access to schooling with nearly 99 percent of households having access to an elementary school and 85 percent to a secondary school. Teacher-pupil ratios have also improved at all levels since 2004/05. Enrolment rates are 2 Socio-Economic Survey 200912010, Planning Department, GoAP. 4 high, and as per state estimates, drop-out rates have declined significantly in the past decade. This indicates that not only are more students being enrolled in schools in AP, but a larger percentage of them are also advancing in the school system. Health outcomes show mixed results. While there have been some declines in infant mortality, and the number of children who are underweight, these improvements are lower than what is necessary for AP to achieve the Millennium Development Goals (MDGs). On the other hand, the state is on track to achieve its target of reducing maternal mortality to three-quarters of its 1990 level by 2015, and the goal of halving the proportion of people without access to safe drinking water. III. PROGRESS IN IMPLEMENTING THE REFORM PROGRAM A. Improving the State's Investment Climate 18. AP continues to be ranked as one of the most attractive investment climates among Indian states. AP was classified amongst the top five states in India in the World Bank's Investment Climate Assessment Report (2008), and the capital city of Hyderabad as the second best city in terms of 'ease of doing business' by the Sub-National Doing Business Report for India (2009). It was the first state to enact the Single Window Act, to prepare legislation supporting public-private partnerships, to amend laws to make the labor market more flexible, and to liberalize the wholesale market for agricultural goods. The state has continued to attract large scale industrial investments with present outstanding commitments of early stage and under implementation proposals of about $70 billion, which is expected to generate direct employment of over 400,000 people. 3 AP has also been one of the most preferred destinations for foreign direct investment (FDI) in India, attracting over $3.5 billion in the last four years - second only to Gujarat among Indian states. 19. The GoAP has done much to facilitate investments in the state. In the small and medium enterprise (SME) sector, the state has enabled significant investments in many of the industrial parks and facilitated the establishment of over 40,000 units through an effective single window system since 2002. In addition, in 2009, the state has set up a dedicated fast track mechanism facilitating Mega Projects (with investments more than Rs.l billion). So far, 185 large scale industrial projects (with an expected total investment of $27 billion) have been implemented or are under implementation. 20. Progress has been made in remedying problems in land markets. An important reform agenda for the GoAP has been to bring about more effective land usage. This has been addressed through the provision of industrial parks and land banks. The government is also in the process of setting a Geographic Information System (GIS) based Land Information System which would provide prospective investors with information and indicative prices of available land for future industrial investments. A large number of Special Economic Zones (SEZs) are at various stages of implementation. These are being developed and operated by the private sector in line with the SEZ Act of Government of India (Gol). Out of the 571 SEZs proposals approved by the GoI Ministry of Commerce and Industries, AP has 102, of which 72 have been notified. 4 21. AP has been facilitating investments in infrastructure and Public Private Partnership (PPPs). AP is one of the few states that have created a separate department for infrastructure with a focus on PPPs. Major infrastructure projects, such as ports and airports, are being implemented on a PPP basis by this department. AP has also been one of the first states to enact an 3 Andhra Pradesh Economic Survey 2009/lO. 4 www.sezindia.nic.in 5 Infrastructure Enabling Act which provides for infrastructure project development on a PPP basis. As of March 2009, the GoAP is in the process of developing and implementing about 132 PPP projects in various sectors (roads, ports, railways, tourism, and urban) with an estimated investment of about $10 billion. 5 B. Strengthening Revenue, Public Expenditure and Financial Management ~iscalftfanaget.nent 22. AP's medium-term reform program involved strengthening fiscal discipline and improving the composition of spending by ensuring adequate spending on capital investment and on primary education and health. The reform path, enshrined in the Andhra Pradesh Fiscal Responsibility and Budget Management (APFRBM) Act of 2005, called for an elimination of the revenue deficit in 2008/09 and bringing down the fiscal deficit to 3 percent of Gross State Domestic Product (GSDP) by the same year. Following a series of fiscal stimulus measures undertaken by GoI in response to the global financial crisis, state governments were allowed to expand their fiscal deficits to 3.5 percent of GSDP in fiscal year 2008/09 and 4 percent in 2009/1 O. 23. The GoAP has adhered to its fiscal consolidation path. The GoAP first registered a revenue surplus in 2006/07, two years ahead of schedule and this has been sustained since. The fiscal deficit has also been contained within the APFRBM limits. 6 The fiscal deficit in 2008/09 was 3.3 percent and the figure for 2009/10 7 is 3.5 percent, both within the revised limits. These achievements came despite the civil servant salary increases consequent to the Sixth Pay Commission award, successive droughts and floods, and a sharply reduced growth rate. Budget estimates for 2010/11 suggest a return to the earlier consolidation trajectory. The fiscal deficit is expected to fall below 3 percent of GSDP, with a further increase in the revenue surplus. AP stands to benefit from the award of the 13 th Finance Commission as it is expected to get Rs 1.1 trillion over the next 5 years, through shared central taxes and grants, almost a doubling of the actual receipts over the period 2005-10. 24. Debt has stabilized as a proportion of state GDP. AP's debt, in relation to the size of its economy, has historically been higher than the average for Indian states. However, fiscal consolidation over the past few years has led to some improvement. The debt to GSDP ratio came down from 30.9 percent in 2003/04 to 24.8 percent in 2008/09, though it rose again to 27 percent in 2009/2010. This is still below the APFRBM target. Encouragingly, the ratio of interest payments to revenue receipts has come down significantly from 25.5 percent in 2003/04 to 13.5 percent in 2008/09 and 12.5 percent in 200912010. 8 25. AP's improved fiscal situation can be largely attributed to strong revenue growth. The state's own revenue to GSDP ratio increased from 9.3 percent in 2005/06 to 12.2 percent in 2009110. This has been driven by rapid growth in both own tax and non-tax revenue growth. The growth in the state's own tax revenues can be attributed to high economic growth rates, as well as improvements in tax collection. These improvements in tax collection have helped the state weather the lower growth rates of the last two fiscal years, and the state's own tax revenues have 5 www.pppinindia.com 6 See table 1 7 All figures for 2009110 are revised estimates and for 2010111 are budget estimates from AP budget documents. 8 All revenue and expenditure figures have been adjusted for contra interest entries. 6 continued to grow strongly by 21.9 percent in 2009110 over the previous year. Non-tax revenue collections have also grown rapidly, increasing by 37.4 percent between 200S/09 and 2009110, on the back of a 69.3 percent growth registered between 200S/09 and 2007/0S. 26. Progress in improving the composition of public expenditure is mixed. Total expenditure increased from 17.2 percent of GSDP in 2005/06 to 22 percent in 200912010. On the positive side, this period saw the share of committed expenditures, i.e. interest payments, salaries and pensions, in total expenditures declining from 49.7 percent in 2005/06 to 40 percent in 200911 0, increasing fiscal space. However, the share of capital outlay in total expenditures has remained stagnant at around 20 percent. O&M expenditures have also remained around 9 percent. The GoAP has also been unable to contain the subsidy bill. Subsidies, mostly on power and food subsidies, and other transfers have increased from 19.5 percent of total expenditures in 2005/06 to 29.2 percent in 2009110. The GoAP has announced its intention to cut the power subsidy bill by Rs.15.4 billion and food subsidy by Rs 5 billion in 2010111, amounting to 2.1 percent of total expenditures (0.5 percent of GSDP) in 2010/2011. 27. The GoAP's strategy in phase 3 of the Public Enterprise Reform has undergone a change keeping in mind the socio-economic functions of the entities covered under this phase. The strategy in Phase 1 and 2 of the reform program, supported by APERL 1 and 2, and UK, DFID was to close/restructure/privatize unprofitable enterprises and re-orient the role of government from 'service provider' to 'service enabler'. Enterprises in Phase 3 are mostly cooperatives, sugar mills and those with social welfare functions, which may need continued support from the government. The GoAP has taken gradual incremental steps to improve the management and financial performance of some of these enterprises. A few redundant or unprofitable businesses have been closed, some with similar functions have been merged and in others the state government has entered into Memoranda of Understanding for improvement in performance within a specified time frame. Some tasks from closure, sale or privatization of enterprises in phase 1 and 2 are still being concluded. These mostly pertain to sale of assets, transfer of titles and compensation for voluntary retirement scheme. This is very time consuming and tedious and has lessons for future reforms in this area. Financial Management 2S. AP embarked on a comprehensive budget and financial management reform program that has continued for almost a decade. These reforms, critical in strengthening the link between public spending, service delivery and development outcomes, have been supported through the APDPL series. AP conducted a State Financial Accountability Assessment (SF AA) as a part of its on-going reform program in 2003. The Assessment examined the areas of budget formulation and execution, accounting and reporting, internal controls and external auditing. It identified strengths and weaknesses and made recommendations for improving the overall financial management and accountability systems in the state. Guided by the findings of the SFAA, several steps have been taken in the areas of budget execution, monitoring, and cash management. These have produced demonstrable results like transparency in budget execution and improved cash flows, and provided a strong trajectory for public financial management improvement. In addition to the support through APDPL, the GoAP received an Institutional Development Fund grant to improve public financial management systems and accountability within the line departments. 29. The medium term reform agenda of the state has included improved debt and asset management, improved financial accountability of Public Sector Undertakings (PSUs), and a Public Financial Management Impact assessment using the Public Expenditure and Financial Accountability (PEF A) framework. Progress on the reform agenda set out in 7 APERL3 has continued through the implementation of an Institutional Development Fund (IDF) grant from the World Bank. Key areas of progress under the grant include budget reform, strengthening of internal controls, and setting up of an internal audit unit. The existing GoAP Internal Audit Manual has been revised and updated with the assistance of the Centre for Good Governance and pilot testing of the revised manual has commenced in some key line departments. A series of trainings and capacity building activities are also in progress under the Grant. On impact assessment, the GoAP commissioned an assessment of the implementation of the recommendations of the SFAA report. 30. On-going partnership with the Bank and use of country systems. Recently the GoAP and the Bank have negotiated three projects. For each of these projects, the GoAP has issued a separate Government Order (GO) documenting the implementation, financial management, and monitoring and oversight arrangements. These guiding documents will enable the Bank task teams and the client implementation teams to monitor implementation and financial management arrangements in a structured manner. Further, the Bank and the GoAP have agreed that all recently negotiated projects should follow the state's own systems regarding financial management and oversight arrangements. These systems are being regularly updated and strengthened to capture all the required information and provide necessary assurance on the usage of Bank funds. The financial management arrangements of these projects are governed by the standard codes and manuals of the GoAP, ensuring consistency in the application of the various financial rules and procedures and oversight arrangements across projects in different sectors. Procurement 31. AP has tabled legislation in the State Assembly for strengthening the regulation of public procurement. The law has a number of provisions which will help enhance transparency in procurement. It will help government get better value for money and for procurement of goods and services across all departments. This was one of the conditions for the release of the second tranche of this operation. It has taken the state more than two years to undertake this very important reform. A long consultative process was required to obtain a broad political consensus on the legislation. Further delays were caused due to political uncertainty resulting from the untimely demise of the Chief Minister and protests advocating bifurcation of the state. 32. The GoAP continues to follow a two-pronged strategy to improve accountability and transparency in procurement. One prong focuses on tightening rules and procedures and has been taken further through the procurement law recently, and the other on use of modem . Information and Communication Technology. In addition, the state has already had considerable success in the introduction of an e-procurement system, currently covering nearly 90 percent of all procurements. E-procurement is mandatory for all tenders over 1 million rupees. Recently, the GoAP has contracted out the hosting and management of the system to the private sector through an independent service provider. Other South Asian governments are now approaching Andhra Pradesh and paying royalties for the use of this system. C. Us bering in Improved Governance Practices and Raising the Quality of Service Delivery in Sectors Governance Reforms 33. The GoAP has made substantial progress on governance reforms. The first phase of AP's Governance Reform Program (2001-2005) supported by APERL 1 and 2 aimed at building the institutional champions for governance reform including the CGG and Strategy and Performance 8 Innovation .Units (SPIUs) in line departments. The second phase of the program (2005-2009), supported by APERL 2 and APERL3 and partly implemented through the "Delivery of Improved Services in Administration" (DISA) Program funded by UK DFID, has focused on the more difficult themes of human resource management and institutional change in departments for improved service delivery. This has gone hand in hand with a continuing focus on innovative e- governance and tr~sparency initiatives' taken forward by both the state government and by the eGG, which remains a hub for analytical and consultancy support for governance reform and has since evolved into a national resource. 34. Embedding institutional capacity for reform in key departments and developing department level change and development plans was a key strategy. The establishment and staffing of SPIUs in key departments and expanding this concept to districts were seen as key to institutionalizing the reform .agenda within government. Departments testify that SPIU's have provided useful technical and reform leadership and support. These technical support units have supported the implementation of a wide range of departmental reform activities induding the rolling out of an innovative caseload management system which for example has allowed the Education Department to bring down its pendency rate of cases by 50 percent, drafting the procurement act, and supporting the development of an innovative Health Sector reform program. The SPIU in the Rural Development Department has been responsible for supporting 'the roll out of AP's well-regarded social audit process and has now been converted by government into an autonomous society for social audit. District level SPIUs have been piloted in one district. 35. Progress on human resource management, a central pillar of the civil service reform agenda, has been good. The GoAP has established a centralized Human Resource Management (HRM) Unit in the General Administration (GA) Department through an order dated 12.2.2008 and has re- designated the Secretary (Services) as the Secretary (Services and HRM). HRM in most states in India suffers from a fractured mandate and responsibility for this function is divided amongst general administration departments, finance and line departments. This move by the GoAP should allow for better management of human resource functions across government and the unit will focus on streamlining the human resource function across government including recruitment, training and accountability and motivation related issues. A draft approach paper for an HRM strategy was prepared in April 2009 and a format for establishing a Human Resource Management Information System (HRMlS)/Employees database has been prepared and is being piloted in the GA Department. The unit has also prepared a performance management system for staff that flows out of the departmental performance indicators and includes both qualitative and quantitative indicators. In addition, a study has been completed which recommends fundamental revisions in service rules. These rules were formulated in 1922 and have loopholes and discrepancies, which are a major cause of litigation and inefficiency. The revisions are being studied and will need to be formally adopted by government. 36. A strategy is in place for improving financial management in the health sector. Although a Financial Management Unit is not yet operational, an information technology enabled financial system plan has been created for improved financial management in the health sector. This initiative has been accompanied by a training needs assessment and a training plan has been drawn up for improved financial management. 37. Improving transparency accountability and service delivery including through the use of e- governance solutions has been a core aspect of the GoAP's ·reform strategy. This focus has resulted in a number of accountability and transparency related initiatives, including tabling of the procurement law (discussed in paras 31-32). Social audits are nOw an integral part of the government's citizen-focused monitoring system and community score cards have been piloted in 9 rural development and health-related service delivery. A system for school score cards has also been introduced. Although formal expenditure tracking has not been utilized, the welfare departments launched a number of studies to identifY leakages and vulnerabilities and to improve targeting and efficiency. Studies conducted in a number of programs related to services being provided to 'excluded groups' have led to major reforms. A social benefits tracking system has been established and a complete overhaul of the existing scholarship program and government hostel program has led to substantial savings and improved service delivery. Quality assurance systems are being established and a pilot is being taken forward by Health Department where independent quality assurance agencies have been hired to monitor quality in two teaching and one district hospital. The state government hopes to expand this independent quality assurance mechanism in the future. 38. The use of e-governance for improving service delivery remains central to AP's reform agenda. AP has in the past led in providing urban services, both government to citizen and business to citizen, through its innovative e- sewa program which remains important. The government's e-governance strategy then expanded to include rural service delivery through a network of Rajiv kiosks. This strategy has now been merged into the larger national e-governance program. So far 1500 such kiosks have been established and 500 more are scheduled to be established by the end of March 2010. Education 39. Having achieved an increase in class-to-class transition rates at the elementary level and student and teacher attendance level (both prior actions for APERL3), the state's subsequent reform agenda included enhancing access and quality of education and supporting research for policy formulation. The Department of School Education (DSE) was split into two - with the creation of a new department to deal exclusively with Sarva Shiksha Abhiyaan (SSA), the Gol's flagship program for universal primary education, which is the main vehicle for enhancing access and quality of education in public elementary schools throughout the country. All other functions of the DSE remained in the main unit. Furthermore, a legal cell was created to help the administration deal with the large number of teac4er management issues, and in particular to deal with the large number of court cases regarding transfers and postings. The legal cell has helped ensure that the time spent by senior bureaucrats of the DSE on court cases concerning teacher service rules or transfers has been considerably reduced. The GoAP has strengthened the capacities of Parent Teacher Associations to improve service delivery at the school level and provide community oversight on the functioning of the schools. This has lead to a reduction in teacher absenteeism. 40. New programs have been introduced to improve reading ability of children and their effectiveness is being monitored and evaluated for the first time. This has been a significant breakthrough in a country where programs are very poorly monitored and almost never evaluated. Recognizing the low levels of reading ability of children, the GoAP introduced the Children's Language Improvement Program and the Children's Learning Acceleration Program in a Sustainable Way. Building on an existing program, the government launched a residential school program across large parts of the state to help address access issues for the most marginalized communities. The more recent residential programs have combined merit based admissions with a need-based approach. The out-of-school-children numbers have fallen by 2 percentage points as independently evaluated by Indian Market Research Bureau in 2007. 41. The GoAP has shown its commitment to support research-based policy reform in education by supporting a five year research project. The Andhra Pradesh Randomized Evaluation Study 10 is a three-way partnership between the GoAP, the World Bank, and the Azim Premji Foundation to pilot alternative policy options to improve rural primary education and rigorously measure their impact in rural areas of AP. The GoAP had committed an annual allocation ofRs. 20 million for this program. This research has generated global interest both in academic and policy circles and was recently cited in The Economist. Of the allocated amounts, the research project has not received the Rs. 20 million every year, although an allocation for Rs. 10 million with a commitment of another Rs. 10 million has been made in the budget for this year (200911 0). Power 42. To improve access and efficiency in the sector, key reforms supported under APERL3 include reduction in subsidy and transmission and distribution losses, increase in metered sales, management of agricultural consumption and improvements on the regulatory front. While a reduction in cross subsidies remains a huge socio-political challenge, the state government has made good progress on all other fronts in the power sector. It has increased investments in the transmission and distribution (T&D) system in the state and also raised metered sales. The transmission utility and the distribution utilities in the state have together invested an average Rs. 22.3 billion/year from 2007-2009 compared to an average Rs. 18.5 billion/year during FY 2004/05 and FY 2005/06, a total increase of almost 20 percent. Metered sales continue to show a gradual upward trend, increasing from 50 percent of input energy in 2004/05 to about 57 percent in 2008/09. T&D losses have declined over time, from 35 percent in 2000/01 to 19.1 percent in 2008/09. It is commendable that this has happened alongside increased rural electrification. As of January 2010, the state has achieved close to 90 percent household electrification level in rural areas. 43. AP demonstrates strong performance on the regulatory front. Consistent with the Electricity Act 2003, the Andhra Pradesh Electricity Regulatory Commission (APERC) has issued terms and conditions of open access to intra-state transmission and distribution networks in July 2005 and currently open access above 1 MW is effective. The Commission has also moved forward on the implementation of a multi-year tariff regime providing a stable and increasingly predictable regulatory framework. 44. Overall support from the government to the power sector has gone up, but is predicted to decline in 2010/2011. Support from the state government to the power sector increased due to an increase in the costs of input power and no revision in retail tariffs, except in the case of industrial consumers where tariffs have actually been going down. Costs have been rising on account of an increase in the costs of generation, a drop in available low-cost hydropower, and generation capacity addition not keeping pace with the increase in demand leading to expensive purchases from the market at times. Average per unit power purchase costs went up by around 22 percent per year between FY 2006/07 and 2008/09. Efforts are being made to contain these rising costs. The government is taking steps to add generation capacity in a major way through the state generating company, Central Public Sector Undertakings and private power producers. However, the state is likely to continue to face power shortages in the short to medium term. The distribution companies are also considering inviting bids to procure power through long term purchasing power agreement. The government is targeting a reduction of Rs.15.4 billion in the power subsidy bill for 2010/11. However the indebtedness of the sector has significantly increased with the total outstanding debt to the transmission and distribution segment at Rs. 120 billion (with short term debt of Rs. 56 billion) in 2008/09 compared to Rs. 63 billion (with short term debt ofRs. 7 billion) in 2006/07. 11 45. Andhra Pradesh completed an independent third party verification of agricultural electricity consumption at the feeder level. This was one of the conditions for the release of the second tranche of APERL3. This was deemed important as, even though the state government is providing free power to the farmers since 2004, it is aware of the importance of monitoring and managing power consumption for agricultural purposes. In order to enhance the credibility of measuring agricultural consumption, it was proposed that the measurement be verified by an independent third party on the basis of a methodology that has been approved by the APERC. The Indian Statistical Institute, Hyderabad was appointed for third-party verification of electricity consumption at the feeder level. The Institute completed the study and shared the reportl findings with the APERC. Based on the findings of the study and detailed discussions with different stakeholders, APERC, in February 2010, has approved a revised methodology for the measurement of electricity consumption in agriculture. APERC has suggested that the revised methodology be used on a pilot basis to measure agricultural electricity consumption in all the four distribution companies for a period of two years starting from May 2010. The efficacy of the new system may be reviewed after one year. D. Better Targeting of Antipoverty Programs Through More Effective Monitoring and Evaluation 46. The GoAP's achievements in implementing the reform program for improved targeting of antipoverty programs have consistently exceeded the targets indicated for the years 2007- 2009. The two pillars of the reform program were: (i) strengthening the effectiveness of antipoverty programs; and (ii) increasing access of the poor to land and employment, and expanding social safety nets for vulnerable groups. 47. Regular and concurrent social audits and the use of information technology for transparency have improved the effectiveness of antipoverty programs in AP. Social audit rules under the National Rural Employment Guarantee Act (NREGA) have been approved and issued and social audits are now done across all 22 districts. This started with the first 13 NREGA districts in June 2006, but has expanded subsequently to cover the entire state. Techniques and rules have been continuously evolving over the last few years, based on analysis and feedback, incorporating lessons learned. Social audits are done in each village once every six months, based on schedules drawn up by the district administration and social audit teams. In addition, in order to empower the people to administer the scheme, concurrent social audits are done by the village people themselves. The GoAP acts as a facilitator and guides the concurrent social audits with training and inputs. This has improved the quality of these audits overtime. IT back-offices have been set up, and are analyzing data from all NREGA districts. Social audit reports are available publicly in downloadable format on the GoAP's social audit website. 48. Increased availability of land for the poor, enhanced coverage of social pensioners and employment to rural youth have helped vulnerable groups in AP. In order to enhance access to land to the poor, the government has proactively redistributed land with more than 0.12 million acres being redistributed every year since 2006/07 with titles going to poor women. Data on this is available on the website of the Chief Commissioner of Land Administration. In total, about 0.4 million acres have been redistributed so far. In addition, the GoAP is preparing legislation to lease out agriculture land for the rural landless poor women self help groups, and to protect the interests of lessors and lessees of the agriculture lands, further enhancing access to land. Social pension rates have been fixed at Rs. 200 per month and there were more than 6.6 million social pensioners across the state in 2008/09 (against an APERL3 target of 4.8 million).9 Additions to the total pool 9 As per data received from the State's Rural Department. 12 of social pensioners exceeded 1.5 million in 2007/08, and 2.2 million in 2008/09, as against APERL3 targets of 1.2 million and 1.8 million respectively. The GoAP has made impressive progress in providing rural youth with remunerative private sector employment. The Employment Guarantee and Marketing Mission seeks to provide employment to and enhance employability of rural youth from economically and socially underprivileged families in remote areas. Over 2006/07 to 2008109, about 0.215 million rural youth have been provided short-course training, of whom about 0.175 million have found placements in over 100 private sector companies - as against an APERL3 target of 0.1 million over the same period. From 2005 to date, 0.268 million rural and tribal youth have been trained free of cost, with placement rates exceeding 70 percent. The target for 2010/11, developed through a careful exercise, is to train and place another 0.13 million rural youth. IV. COMPLIANCE WITH TRANCHE RELEASE CRITERIA 49. The legal agreements for this operation require four tranche-release conditions to be met for release of the second tranche of the loan and credit. Condition One: Andhra Pradesh has made progress, satisfactory to the Association and the Bank, in carrying out the Program. This condition has been met. See progress under the key elements of the reform program under APERL3 as described in Section III of this document. Condition Two: The macroeconomic policy framework of Andhra Pradesh is appropriate, including achieving the targets for realized revenue and fiscal deficit for Fiscal Year 2006/07 consistent with the provisions of the State's Fiscal Responsibility and Budget Management Act, 2005. This condition has been met. All the revenue and fiscal targets laid out in the APFRBM have been met. There were four targets as described in Table 1: Table 1: Achievement against APFRBM Targets Fiscal Indicators Targets Achievement Revenue Deficit Progressively eliminate revenue AP eliminated deficits by 2006/07 deficit by 2008/09, with the revenue and has been running revenue deficit not exceeding surpluses as follows(percentage of -0.6% of GSDP in 2006/07 GSDP): 2006/07: 1.0% 2007/08: 0.05%; 2008/09: 0.3%; 2009/10 (R.E.): 0.7% Fiscal Deficit Reducing the fiscal deficit to -3% by Fiscal deficit (as a percentage of the end of 2008/09, with the deficit GSDP) has been below limit as for 2006/07 not exceeding -3.6% of follows: GSDP. Target for 2008/09 2006/07: -2.0% subsequently revised to 2007/08: -2.7% -3.5% * 2008/09: -3.3%; 2009/10 (R.E): -3.5% 13 Fiscal Indicators Targets Achievement Debt Constraining outstanding liabilities to Outstanding liabilities for the year no more than 35% of GSDP by 2009110 as a percentage of GSDP 2009110. are 27% Guarantees Limiting the amount of annual Total outstanding government incremental risk-weighted guarantees guarantees as a percent of total to 90% of the total revenue receipts revenue receipts of the second ofsecond preceding year preceding year have been below the limit as follows: 2006/07: 48.5% 2007/08: 37.4% 2008/09: 37.9%; 2009110: 24.8% * AP has consistently maintained its fiscal deficit under 3 percent for the first three years. In 2008109, in response to the global financial crisis, the Gol authorized states to marginally increase their fiscal deficits to 3.5% of their GSDPs. It also pointed out that state FRBMs may have to be amended for this purpose. The APFRBM permits the state government to exceed its fiscal targets due to unforeseen demands on the government'sfinances arising out of internal disturbances or natural calamity or other exceptional grounds. If the state government invokes this statutory exception to the targets, it must table a statement to this effect before the State legislature. The GoAP has already begun the process of tabling such a statement explaining the rationale for exceeding the FRBM's fiscal deficit target. Condition Three: Andhra Pradesh has introduced in its State Assembly a legislation for strengthening the regulation of public procurement. This condition has been met. The GoAP introduced legislation to strengthen the regulation of public procurement in its State Assembly on March 4, 2010 (see paras 31-32). Condition Four: Andhra Pradesh has completed an independent third party verification of agricultural electricity consumption (at the feeder level) based on the methodology approved by the State's Electricity Regulation Commission. This condition has been met. An independent third party verification of consumption of electricity in the agriculture sector based on approved methodology has been done (see para 45). V. CONCLUSION 50. In view of the overall performance and progress with the implementation of the program supported by the loan and credit, and in compliance with the specific conditions of release as described in Part C of Schedule 1 of the Loan Agreement and Financial Agreement and Part B of Schedule 2 of the Program Agreement, the Bank has informed India (as the borrower of the IBRD loan and the recipient of the IDA credit) that the second tranche of the financing (consisting of IBRD loan of US$150 million and IDA credit ofSDR 50.80 million) is available for withdrawal. 14 Annex 1: Key Fiscal Outcomes in Andhra Pradesh Rs. Billion 2005/06 2006/07 2007/08 2008/09 2009-10(RE) 2010-11 (BE) Revenue 329.13 422.31 508.49 595.58 730.68 837.75 State's own revenue 223.65 284.00 325.64 397.42 494.32 558.29 Tax 196.11 239.26 287.94 333.58 406.64 469.99 Non-Tax 27.53 44.74 37.70 63.83 87.68 88.30 Central Resources 105.48 138.31 182.85 198.17 236.36 279.46 Shared Taxes 69.51 88.66 111.84 118.02 121.09 145.05 Grants 35.97 49.65 71.01 80.15 115.26 134.41 Non-interest Expenditure Salary 102.66 119.21 130.02 142.77 189.99 250.38 Pensions 31.97 41.50 50.92 55.18 68.43 84.28 Subsidies and Transfers 81.40 106.73 180.75 234.19 255.24 241.69 Non-Wage O&M 37.01 47.09 54.94 58.51 78.0S 81.73 Other Revenue Expenditures 6.64 6.89 14.38 14.28 18.50 42.22 Capital outlay 76.62 99.04 127.74 103.66 160.04 143.37 Net lending 5.74 4.35 27.30 30.44 12.20 21.94 Primary Balance -12.91 -2.50 -77.S6 -43.45 -51.77 -27.86 Interest Payments 70.08 72.80 75.89 80.S7 91.04 101.96 Revenue Balance -0.63 28.09 1.59 10.08 29.44 35.49 Fiscal Balance -82.99 -56.43 -87.87 -124.02 -142.81 -129.82 Debt stock 704.08 753.99 824.79 935.68 1097.57 1228.30 GSDP 2396.83 2772.86 3265.47 3773.46 4066.41 4473.05 Percent GSDP 2005/06 2006/07 2007/08 2008/09 2009-1 O(RE) 2010-11 (BE) Revenue 13.7% 15.2% 15.6% 15.8% 18.0% 18.7% State's own revenue 9.3% 10.2% 10.0% 10.5% 12.2% 12.5% Tax 8.2% 8.6% 8.8% 8.8% 10.0% IO.S% Non-Tax l.l% 1.6% 1.2% 1.7% 2.2% 2.0% Central Resources 4.4% 5.0% 5.6% 5.3% 5.8% 6.2% Shared Taxes 2.9% 3.2% 3.4% 3.1% 3.0% 3.2% Grants 1.5% 1.8% 2.2% 2.1% 2.8% 3.0% Non-interest Expenditure Salary 4.3% 4.3% 4.0% 3.8% 4.7% 5.6% Pensions 1.3% 1.5% 1.6% I.S% 1.7% 1.9% Subsidies and Transfers 3.4% 3.8% 5.S% 6.2% 6.3% 5.4% Non-Wage O&M 1.5% 1.7% 1.7% 1.6% 1.9% 1.8% Other Revenue Expenditures 0.3% 0.2% 0.4% 0.4% 0.5% 0.9% Capital outlay 3.2% 3.6% 3.9% 2.7% 3.9% 3.2% Net lending 0.2% 0.2% 0.8% 0.8% 0.3% 0.5% Primary Balance -0.54% -0.09% -2.38% -1.15% -1.27% -0.62% Interest Payments 2.9% 2.6% 2.3% 2.1% 2.2% 2.3% Revenue Balance -0.03% 1.01% 0.05% 0.27% 0.72% 0.79% Fiscal Balance -3.46% -2.D4% -2.69% -3.29% -3.51% -2.90% Debt stock 29.4% 27.2% 25.3% 24.8% 27.0% 27.5% * FiscallPrimarylRevenue Balance in the above table implies FiscallPrimary IRevenue deficit (-) or surplus (+) ** Fiscal .Balance for 2006/07 and 2007/08 includes receipts from sale ofland ofRs 18.89 billion and Rs. 65.S8 billion respectively Source: Finance Department, Government of Andhra Pradesh Annex 2: India Macro Indicators National accounts (as % ofGDP) Gross domestic product" 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 19.1 18.2 18.1 17.5 15.9 15.9 15.2 Industry 28.8 29.5 29.5 28.8 27.6 28.2 27.7 Services 52.2 52.4 52.4 53.7 56.5 55.9 57.1 Total Consumption 68.0 66.7 64.8 65.7 65.2 64.9 65.0 Gross domestic investment 34.8 36.4 38.7 39.7 40.4 40.6 40.0 Government investment 7.6 8.0 9.1 8.3 8.2 8.2 Private investment 26.1 27.2 28.5 32.1 32.4 31.8 b Exports (GNFS) 19.9 22.2 21.2 22.7 23.4 22.0 20.6 Imports (GNFS) 22.7 25.2 24.7 28.0 29.0 27.6 25.6 Gross domestic savings 32.0 33.3 35.2 34.3 34.8 35.1 35.0 c Gross national savings 34.3 35.9 38.2 37.6 37.8 37.5 37.1 Memorandum items Gross domestic product 810.2 914.9 1,176.9 1,159.2 1,222.8 1,415.1 1,636.7 (US$ billion at current prices) GNI per capita (US$, Atlas method) 740 820 950 1,040 1,100 1,160 1,300 Real annual growth rates (%, calculated from 00 prices) Gross domestic product at market prices 9.4 9.7 9.1 6.1 6.0 7.5 8.5 Gross Domestic Income 13.1 10.9 8.7 5.8 8.0 7.9 8.2 Real annual per capita growth rates (%, calculated from 00 prices) Gross domestic product at market prices 7.9 8.2 7.7 4.6 4.5 6.0 7.0 Total consumption 10.5 8.4 5.1 4.5 7.2 6.2 5.1 Private consumption 11.7 9.0 4.8 2.2 7.9 4.3 3.9 Balance of Payments (US$ billion) Exports (GNFS)b 162.8 202.7 256.2 276.4 286.6 311.4 336.8 Merchandise FOB 105.2 128.9 166.2 175.2 177.5 192.0 206.9 b Imports (GNFS) 191.5 235.0 310.3 346.0 354.9 389;9 419.1 Merchandise FOB 157.1 190.7 257.8 294.6 303.1 332.0 353.9 Resource balance -28.7 -32.3 -54.1 -69.6 -68.3 -78.6 -82.3 Net current transfers 24.5 30.1 41.9 44.3 48.3 49.2 52.2 Current account balance -10.1 -9.8 -17.3 -30.0 -32.5 -43.7 -47.8 Net private foreign direct investment 3.0 7.7 15.4 17.5 24.7 18.6 18.6 Long-term loans (net) 4.2 17.9 24.7 10.8 37.7 30.5 22.7 Official 1.4 2.4 1.8 2.7 4.9 2.4 2.4 Private 2.8 15.4 22.9 8.1 32.8 28.0 20.3 Other capital (net, inc!. errors & ommissions) 17.9 20.9 69.3 -18.3 18.3 17.7 34.5 d Change in reserves -15.1 -36.6 -92.2 20.1 -48.2 -23.0 -28.0 Memorandum items Resource balance (% ofGDP) -2.8 -3.0 -3.6 -5.4 -5.6 -5.6 -5.0 Real annual growth rates ( YROO prices) Merchandise exports (FOB) 23.4 22.6 28.9 5.4 1.3 8.2 7.8 Merchandise imports (CIF) 32.1 21.4 35.2 14.3 2.9 9.5 6.6 Annex 2 (Contd): India Macro Indicators Public finance (as % ofGDP at market prices)e Current revenues 19.7 20.8 21.9 20.9 20.5 21.0 21.8 Current expenditures 24.2 24.4 25.2 28.5 28.7 28.3 28.2 Current account surplus (+) or deficit (-) -4.5 -3.6 -3.2 -7.6 -8.2 -7.3 -6.4 Capital expenditure 2.3 2.0 2.8 2.0 2.1 2.0 2.0 Foreign fmancing 1.2 0.2 0.2 0.2 0.4 0.2 0.2 Monetary indicators M2/GDP 76.1 80.3 85.1 89.8 103.7 104.4 104.8 Growth ofM2 (%) 21.2 21.5 21.2 19.0 26.0 14.2 14.4 Private sector credit growth I 97.7 86.6 86.2 63.5 54.9 58.5 63.4 total credit growth (%) Price indices(YROO =100) (period average) Consumer price index (% change) 4.2 6.4 6.2 8.0 3.0 5.5 5.0 GDP deflator (% change) 4.1 5.0 4.9 6.2 3.0 5.5 5.0 a. GDP at factor cost b. "GNFS" denotes" goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use ofIMF resources. e. Consolidated central government. f "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.