58936 INFRA DIAGNOSTIC TOOLS THE WORLD BANK, WASHINGTON DC June 2009 Infrastructure Diagnostic Tools: Results from the Pilot in Peru The Diagnostic Tools was prepared by the World Bank Team at the request of the Peruvian authorities to provide an independent assessment of the impact of the global financial crisis on the infrastructure sectors. The tool aims at helping the authorities accelerate public projects and public-private partnerships PPPs, to identify the key bottlenecks in the capacity to execute project and more broadly and opportunities to strengthen institutional capacity of the Ministry of Finance, Agency for the Promotion of Private Investment (PROINVERSION), and the other bodies involved, including the regulatory agencies -- all objectives very much in the spirit of the Infrastructure Recovery and Assets (INFRA) Platform. More information is available at www.worldbank.org/infra Background Peru has been negatively affected by the global financial crisis through financial and real transmission channels, but it is weathering these shocks significantly better than in the past. As of mid June 2009, the monthly change on the stock market index improved by 15% (even if the yoy change has declined by 17%), the exchange rate appreciated by 1.5% (even if the yoy exchange rate depreciated by 3%) and credit default spread fell by 404 bps (even if the yoy spread increased by 83 bps). This is welcome news for the private sector looking for investment opportunities in Peru, as the cost of borrowing is declining. Peru real GDP growth is expected to drop from 9.8% in 2008 to 1% in 2009. Signs of an economic slowdown are also becoming visible in declines in tax revenue collection data which fell at an annual real rate of 21% in May 2009 the fifth consecutive monthly decline. The Peruvian authorities announced an "anti-crisis" plan to shield the economy from the global crisis. The Government released a new budgetary program for 2010-2012, reinforcing its commitment to a 3.2% of GDP fiscal stimulus plan which mainly encompasses infrastructure projects. The overall fiscal surplus narrowed to 1.6% of GDP in Q1 of 2009, from 2.1% in Q4 of 2008. The execution of 52 public investment projects (of which 15 in the transport, 15 in sanitation, 4 in energy sectors) executed by the Ministry of Finance and 12 infrastructure PPPs executed by PROINVERSION were declared a priority. Simplification of legal requirements for PPPs has been proposed and are currently reviewed by PROINVERSION. An Infrastructure Investment Fund has been created, with an initial capital of US$ 100 million to be provided by the government, with the expectation that COFIDE and institutional investors will raise additional funds. The task was led by Maria Vagliasindi (FEU Economics Team), under the guidance of Jose Luis Guasch and Michel Kerf (LCR). The team also included Joshua Gallo (PPIAF) and Francesco Totaro (LCR), with input from Federico Goni and Ada Karina Izaguirre (FEU Economics Team). Key Results from the Peru Diagnostic Tools Assessment of Economic and Financial Constraints to Fiscal Stimulus On the fiscal front, Peru is among the least vulnerable countries in terms of public debt, access to finance, commodity dependence, even though it display one of the highest expenditure rigidity. This means that there are some solid sources of government revenue that can be used in a sustainable manner to finance infrastructure investment. Assessment of Infrastructure Gaps, Actual Spending and Deficits Peru is significantly lagging behind regional leaders, including not only Chile, but also Brazil, Mexico and Colombia in terms of infrastructure investment needs and quality gaps. Transport gets the lion share of public expenditure (72.5%) followed by the water and sanitation sector (16.7%). These two expenditure items tend to generate higher direct (and indirect) jobs in the short-term and may help alleviate poverty in periods of crisis. Assessment of Quality of Institutions Peru has been characterized by serious deterioration in execution rates even before the financial crisis, a trend that has worsened as the crisis started to hit. The decline in execution rates are striking, with public infrastructure execution rates dropping from a level close to 80% back in 2005 across all infrastructure sectors (except telecom) to about 50%. Policy Recommendations Recommendation 1: Emergency measures in response to the global financial crisis should be temporary and clearly focused, in order to avoid long term negative impact in the regulatory framework, efficiency or prices. The government has reacted quickly to some of the problems in the infrastructure sectors by way of specific changes to the existing legal framework. For example in the energy sector, DL N°1041 has introduced a series of measures with wide impact in system operations and electricity prices/tariffs. Also, the Emergency Decree N°037-2008 allowed state-owned companies to acquire necessary generation capacity to avoid power cuts, following a procedure outside of the established regulatory framework. In addition, the Ministry of Energy and Mining (MINEM) is contemplating using the ad hoc bidding mechanisms of Pro Inversion, instead of the auctions system of the electricity law. MINEM and Pro Inversion interventions should be fully coordinated with the regulator OSINERGMIN, to avoid any contractual conditions that could result in special conditions not contemplated in the established transmission regulations. Recommendation 2: There is a pressing need to simplify procedures, move towards standardized contract and reduce significantly the time lag between decision and execution of public projects and PPPs. In the case of public project, execution rates need to be improved. In the case of PPPs, the high number of revisions to the terms of the tender suggests the need to move towards more standardized forms. In addition, the multiplicity of actors involved (PROINVERSION, OSITRAN, MTC) has in many cases contributed to a dilution of accountability and a weakening of the regulatory mechanisms for PPPs. Recommendation 3: Prompt action must be undertaken to estimate the contingent liabilities for the prioritized list of PPP projects, which is currently available only for one of the twelve projects. Peru is to be commended for selecting Infrastructure Public Investment guided by the highest rates of return and for assessing the PPP value of money, through the application of the Public Private Comparator methodology as well as the calculation of the contingent liabilities associated to each projects. The capacity of the Ministry of Finance to handle such tasks needs to be enhanced.