Report No. PIC3796 Project Name Brazil-Rio de Janeiro State (@+) ... Reform--Privatization Loan Region Latin America and Caribbean Sector Privatization Project ID BRPE39197 Borrower State of Rio de Janeiro Implementing Agency Rio de Janeiro Secretariat of Planning Date this PID Prepared March 31, 1997 Appraisal Date May 1996 Board Date Second Quarter of 1997 1. Country and Sector Background. Brazil recently completed the second year under a stabilization plan that has seen an impressive reduction in the monthly rate of inflation from about 40 percent at mid-1994 to around one percent currently. The economy has grown at an annual rate of close to 3.5 percent over the same period, while the external current account deficit has been limited to about 2.5 percent of GDP. Strong capital inflows permitted a buildup in international reserves to US$60 billion at end-June 1996, or 13 months of imports of goods and nonfactor services. However, fiscal policy weakened in 1995. The primary fiscal balance of the public sector remained in surplus in 1995 and 1996 (0.4 and 0.6 percent of GDP respectively), but was significantly lower than in 1994 (5.2 percent of GDP). The most important factors behind this deterioration were an increase in wages and a much higher domestic interest bill resulting from tight monetary policy and an accumulation of internal debt by Federal and State governments. 2. State and local governments have large financing requirements (operational deficits, refinancing of short-term bonds, and deficits of state-owned banks) which must be reduced to consolidate the stabilization program. Some reduction in the deficit of states is achievable with strong programs in at least three of the four largest states, Minas Gerais, Rio de Janeiro (RJ), and Rio Grande do Sul, with which the World Bank is working on state reform programs. From a microeconomic perspective, there is concern that the large volume of resources spent by subnational governments (about half of total budgetary public expenditures) is not spent efficiently, with vast overstaffing, poor service delivery, and inefficient and subsidized state-owned enterprises. 3. As with other states, weak public administration and state ownership and monopoly of key commercial enterprises have contributed to undermining RJ's financial and economic performance and, ultimately, investment and services in those sectors. Therefore, the components of the Rio de Janeiro State Reform--Privatization Loan (SRPL) seek to improve the state's efficiency and delivery of public sector and infrastructure services (through privatization of these services) and to remove one major source of quasi-fiscal losses by privatization of the state bank. 4. Project Objective. The project's objectives are those of the state's reform program as a whole: to yield a state government that is more efficient in the delivery of public services. The specific role of the project is to improve the quality of the design and implementation of the state privatization program and finance some of the privatization costs. 5. Project Description. To support these objectives, the project includes the following components: (i) privatization/liquidation of the state bank; and (ii) privatization or concession of public enterprises. 6. Project Financing. The Bank is considering a US$250-million loan to the State of Rio de Janeiro, with the Guarantee of the Federative Republic of Brazil, to help finance Rio's State Privatization Program. The total cost of the program is estimated at US$5.9 billion. This amount includes costs of (a) liquidating liabilities of the state bank (BANERJ) to depositors, pensioners and other creditors; (b) severance payments for staff dismissed from public enterprises; (c) incremental costs of the reform, particularly treasury transfers to an urban transport public enterprise. Sources of financing comprise the Rio government budget (which includes receipts from privatization and concessions), the proposed loan from the World Bank, and loans from the federal government. 7. Project Implementation. A project implementation unit will be established in the Privatization Commission under the Planning Secretariat to ensure (a) continuous monitoring of the Privatization Program; (b) implementation of required conditions for disbursements; and (c) compliance with disbursement and auditing agreements. 8. Project Sustainability. The SRPL focuses on the implementation of reforms which are difficult to reverse. In particular, the state government will privatize the state bank, BANERJ, and the electricity and gas distribution state enterprises. It will also grant private concessions for the provision of public services, particularly of urban transport, water and sanitation services (the electricity distribution state enterprise has already been sold). 9. Lessons Learned from Previous Operations. Key lessons of the Bank's extensive experience in the reform of the public sector are summarized as follows. First, projects must focus on a few significant reforms that are hard to reverse -- such as privatization of public enterprises and banks, and reforms passed through legislation -- and that can be fully implemented during the mandate of a government. Second, project design and implementation arrangements must be flexible enough to achieve targeted reform objectives. Third, as reform projects for subnational governments can have high supervision costs, project implementation should seek to include as much private participation as possible in such areas -2 - as auditing and procurement. Finally, to ensure commitment in implementation, the initiative to undertake the project components should be the government's. The Bank's role should be to provide financial and technical support. 10. Poverty Category. Not applicable. 11. Environmental Aspects. This project is classified as a category 'B'. The proposed reforms would have neutral or beneficial environmental impacts. In particular, the project will not only contain safeguards against possible negative environmental impacts of other project components, but also actively contribute to improvements in environmental management by the state. Potentially polluting enterprises will have environmental audits requiring new owners or concessionaires to address the eventual environmental problems. 12. Program Objectives Category. Private Sector Development (PV). Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington, D.C. 20433 Telephone No.: (202) 458-5454 Fax No.: (202) 522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by the Public Information Center week ending April 18, 1997. - 3 - Annex Environmental Environmental Impact Category 13. The proposed project would finance reforms that would have neutral or beneficial environmental impacts, and has been classified as Category B regarding its environmental impacts. Rio's Environmental Management System 14. In parallel with the preparation of the proposed project, the Bank has been actively involved in helping the government improve its environmental management system (seel/) , because of the close linkage between improved environmental management and the reform of the water and sanitation sector undertaken under the SRPL. Thus, the project will not only contain safeguards against possible negative environmental impacts of the project components, but also actively contribute to improved environmental management by the state. 15. The thorough modernization of environmental management instruments will focus on economic instruments to replace, or amend, step by step, existing administrative instruments and complex licensing procedures. The introduction of a comprehensive system of water basin management is the key element of these reforms. Plans for the introduction of this system are well advanced. A bill will be presented to the state assembly during 1997. One of the main features of the bill will be an effluent discharge fee and the right for the state to impose a penalty on users if a water basin agency has not been formed or has not produced an acceptable pollution management plan within a specified time period. These mechanisms will create efficient economic incentives for pollution reduction and prevent a perverse incentive against the formation of water basin agencies if discharge fees were only levied within such systems. The discharge fee will be phased in gradually over a period of several years. Environmental Aspects of the Rio de Janeiro State Privatization Program 16. The State Environment Secretariat, SEMA, and the environmental agencies are actively involved in an analysis of the potential environmental effects of all aspects of the state privatization program. As an example, environmental audits were undertaken before the privatization of the electricity company (CERJ). Similarly, environmental audits will be conducted for companies to be concessioned or privatized in the future. The environmental audits will identify environmental problems associated with past and current time practices and provide solutions to mitigate these problems along with estimated costs and schedule. 17. Water and Sanitation Sector. One of the reasons for considering increased private sector participation in the water and sanitation sector is the need to generate the financing needed to - 4 - expand basic sanitation services and associated wastewater treatment. The reforms have, thus, a significant positive environmental effect, and if properly designed, can contribute greatly to improved environmental management in the state. A set of environmental targets and obligations for the restructured utilities is being developed through a coordinated mechanism between the water and sanitation sector, on the one hand, and the environment sector on the other. In this way, the potential implications of alternative options for investment requirements, tariffs, and environmental quality can be assessed by all interested parties. 18. Transport Sector. The state privatization program includes the sale of an extremely small share of the city's total bus fleet. All buses to be sold will be required to have a certificate of compliance with environmental regulations prior to and at the point of sale. For ferry boats, Flumitrens, and Metro facilities, an inspection for compliance with environmental and safety regulations will be carried out prior to inviting the concession bids--it is part of the mandate of the financial advisors' consortium in charge of preparing and promoting the Flumitrens and Metro concessions. 1/ Bank sector work is reported in Brazil: Managing Environmental Pollution in the State of Rio de Janeiro, Bank Report No. 15488-BR, (August 22, 1996). -5-