DOCUMENT OF

THE VVORLD BANK GROUP

FOR OFFICIAL USE ONLY

REPORT NO. 24235 GU

MEMORANDUM OF THE PRESIDENT

OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ONA

COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT

FOR

THE REPUBLIC OF GUATEMALA

May31, 2002

Central America Country Management Unit]Latin America and the Caribbean Regional Office

L This document 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 without World Bank authorization.

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Government Fiscal Year

January l-December 31

Currency and Equivalents

Currency Unit = Quetzal (QZ)US$1.00 = 7.8 1QZ (May, 2002)

WEIGHTS AND MEASURES

METRIC SYSTEM

Acronyms and Abbreviations

BANGUAT - Central Bank of GuatemalaCABEI - Central American Bank for Economic IntegrationCAS - Country Assistance StrategyCDF - Comprehensive Development FrameworkCG - Consultative GroupCSIR - Country Strategy and Implementation ReviewEU - European UnionFIS - Social Investment Fund (Fondo de Inversiones Sociales)FONAPAZ - National Peace Fund (Fondo Nacional de la Paz)FRG - Guatemalan Republican Front (Frente Republicano Guatemalteco)FSAP - Financial Sector Assessment PaperGEG - Global Environment FundIBRD - International Bank for Reconstruction and DevelopmentEDB - Inter-American Development BankIDF - Institutional Development FundIFC - International Finance CorporationIFML - Integrated Financial Management LoanHG - Invest in GuatemalaILO - International Labor OrganizationIMF - International Monetary FundLIL - Learning and Innovation LoanLSMS - Learning Standards Measurement SurveyMDG - Millennium Development GoalsMIGA - Multilateral Investment Guarantee AgencyMINUGUA - UN Special Mission to GuatemalaNGO - Non-Governmental OrganizationOED - Operations Evaluation DepartmentPAN - National Advancement Party (Partido de Avanzada Nacional)PER - Public Expenditure ReviewPRONACOM - National Program of CompetitivenessPRONADE - National Program of EducationPRSP - Poverty Reduction Strategy PaperTA - Technical AssistanceUNDP - United Nations Development Programme

Vice President: David de FerrantiCountry Director: Donna Dowsett-CoiroloTask Manager: Eduardo Somensatto/Suzana Abbott

FOR OFFICIAL USE ONLY

GUATEMALA

COUNTRY ASSISTANCE STRATEGYPROGRESS REPORT

Iable of Contents

Executive Summary

I. Background and Recent Developments .................................... I* Social and Economic Background ................................... 1* The Peace Process ..................................... 3* Political Developments .................................... 4* Economic Developments ..................................... 4

II. The Government's Poverty Reduction Strategy .................................... 8* Growth with Equity .................................... 9* Investment in Human and Physical Capital ................................... 10

III. Prospects, Financing Requirements and Risks . ............................... 12* Medium Term Outlook ................................... 12* Financing Requirements ................................... 14* Risks ................................... 15

IV. The Bank Group's Country Assistance Strategy . .............................. 16* Evaluation of FY99-01 Assistance .................................... 16* Portfolio Perfonnance .................................... 19* Lending during the Previous CAS Period .................................... 19* IFC and MIGA Experience ................................... 20* Bank Group Assistance Strategy .................................... 21* Lending ................................... 27* Exposure .................................... 27* Analytical Work .................................... 27* Role of Other Donors ................................... 28* Monitoring and Evaluation ................................... 29

IV. CAS Risks ................................... 30

This docume,nt has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

Tables and Boxes

Table 1: Key Social Indicators .............................. 1Table 2: Key Economic Indicators .............................. 5Table 3: Medium Economic Indicators ............................. 13Table 4: Financing Requirements and Sources ............................. 15

Figure 1: Poverty and Inequality Trends .............................. 2

Box 1: Progress on Anti-Money Laundering .............................. 8Box 2: Millennium Development Goals .............................. 11Box 3: OED's Country Assistance Evaluation ............................. 17Box 4: Governance Issues ............................. 26

ANNEXES

ANNEX I: The Government's Poverty Reduction ProgramANNEX AI: Key Economic and Program IndicatorsANNEX A2: Guatemala at a GlanceANNEX B1: CAS Program Matrix FY02-03ANNEX B2: Selected Indicators of Bank Portfolio Performance and ManagementANNEX B3: IBRD Program SummaryANNEX B4: Summary of Non-Lending ServicesANNEX B6: Key Economic IndicatorsANNEX B7: Key Exposure IndicatorsANNEX B8: Status of Bank Group Operations

REPUBLIC OF GUATEMALACOUNTRY ASSISTANCE STRATEGY

PROGRESS REPORT FY02

EXECUTIVE SUMMARY

1. The Government of Guatemala has recently undertaken important legislative reforms inthe financial sector, and has requested assistance from the World Bank and the Inter-AmericanDevelopment Bank (IDB) to support implementation of those reforms. A proposed FinancialSector Adjustment Loan (FSAL) and companion Technical Assistance Loan (FTAL) are beingsubmitted for consideration together with this Progress Report. This Progress Report is beingpresented at this time to provide an update on the World Bank Group's Country AssistanceStrategy (CAS) that takes into account these important reforms, and Guatemala'.smacroeconomic program that is being supported by an IMF Standby. A full CAS for FY03-05 isunder preparation and will be presented for consideration by the Executive Directors in FY03.Accelerating preparation of the full CAS to accompany the FSAL/FTAL would not have beenadvisable, given the importance of consultations underway on the Government's PRSP effort andthe related Bank Poverty Assessment.

2. The Peace Accords signed on December 29, 1996, marked not only the end of a longinternal armed conflict but also established a broad development agenda aimed at building amore inclusive society. The Accords identified the reduction of poverty, particularly amongrural and indigenous people, as essential for lasting peace. The Peace program included anumber of policy actions and outcome targets, covering areas such as economic, social, andhuman development, public sector reforms, justice and human rights, security andreconciliation, in a broad and challenging agenda.

3. Implementation of the Peace Accords has been uneven. Despite successes in some areas,compliance in other areas will require more time, and consequently, targets have beenrescheduled. Nonetheless, there is widespread agreement in Guatemala that the Accordsrenmain the basis the country's medium term development. Perhaps the most importantobservable trend is the fact that differences within and between the Government and otherstakeeholders are now being addressed in the political arena, rather than through any return toinsurgent activity. Since the time of the Peace Accords, tuatemala has made signifcantprogress in structural reforms, particularly by promoting private participation in infrastructure,eliminating restrictions to trade, improving public financial management, and more recently,increasing revenues and strengthening revenue administration through tax reforms. Thefincncial sector reforms supported by the FSAL/FTAL provide an important complement toprevious progress.

4. Although not an IDA-eligible country, the Government of Guatemala has elected toprepare a PRSP and presented the results to date of its work to a Consultative Group Meetingchaired by the IDB in mid-February 2002. It is now working on consultations with civilsociety, and hopes to use the PRSP as an instrument for the preparation of regional and localdevelopment programs. The PRSP is not intended to replace the Peace Accords, but rather to

complement them and address key policy and institutional issues that are essential to the long-term sustainability of the Accords.

5. The World Bank Group worked closely with the Government and the internationalcommunity in the design and implementation of the peace program, as described in the last CAS(Report No. 18036 dated June 19, 1998), discussed by the Board of Directors on July 14, 1998.The CAS was designed to support programs aimed at ending the exclusion that has longcharacterized Guatemala's dualistic society and economy within a CDF-type framework thatprovided coordination with other donors and civil society. Within this broad theme, the CAShighlighted four areas as the focus of the World Bank Group's program: 1) Building socialcohesion and strengthening participatory decision processes; 2) Reducing poverty; 3) Improvingeconomic management to maintain stability and foster growth; and 4) Modernizing the publicsector to make it more effective at essential tasks.

6. Bank assistance to Guatemala intensified considerably'during the CAS implementationperiod. Ten new projects were approvedfrom FY98 to FY01, and the portfolio today contains 13projects for a total net commitment of US$435.9 million. Assistance expanded considerably inthe areas of policy analysis, civil society engagements, decentralization, and special focus ongender and indigenous issues.

7. This Progress Report provides a stocktaking of the achievements and challenges faced inimplementing the last CAS, updates information on economic developments and prospects, andsets forth Bank assistance plans during the interim period until the next CAS is ready. Importantinputs to the design of the CAS are underway, inc'luding major analytical and consultative workon poverty, which continues to be the main thrust of the Government's development prioritiesand the focus of the World Bank Group's assistance. The Bank is finalizing a highlyparticipatory Poverty Assessment that builds upon quantitative information from a 2001 LivingStandards Measurement Study (LSMS). The analytical work has been completed, and hasprovided an important input for preparation of the aforementioned PRSP.

8. The Bank's country assistance strategy objectives for FY02-03 remain consistent withthose presented in the FY98 CAS. On a broad level, they continue to focus on poverty reductionby assisting Guatemala to secure implementation of the Peace Accords. The four interlinkeddevelopment priorities outlined in the previous CAS (para. 5) continue to be relevant. Areascurrently receiving increased attention include the financial sector and governance, and it islikely that the next CAS will also emphasize health and malnutrition issues more than in the past,reflecting thefindings of the Poverty Assessment and the Government's PRSP work

MEMORANDUM OF THE PRESIDENT OF THEINTERNATIONAL BANK FOR RECONSTRUCTION AND

D)EVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRYASSISTANCE STRATEGY PROGRESS REPORT FOR

THE REPUBLIC OF GUATEMALA

I. BACKGROUND AND RECENT DEVELOPMENTS

Social and Economic Background

1. Poverty and Social Indicators. Guatemala is the largest country in Central America,wiiih a population close to 12 million inhabitants. Approximately half of the population isindigenous, including 23 ethno-linguistic groups. It has one of the highest poverty rates in LatinAmerica, and some of its weakest social indicators. According to a 2001 Living StandardsMeasurement Survey (LSMS), about 56 percent of the population is poor and 16 percent lives inextreme poverty. Evidence suggests that poverty in Guatemala is higher than in other CentralAmerican countries, despite its middle income country status (per capita income of $1,670 in201)1).

2. Poverty is higher amongst the indigenous population (76 percent), as compared with thenon-indigenous population (41 percent), and is almost three times as high in rural as in urbanareas. Over 81 percent of the poor and 93 percent of the extreme poor live in the countryside.Guatemala has the second most skewed income distribution pattern in Latin America. The topquintile of the population accounts for 54 percent of total consumption, while the largeincligenous population accounts for less than one quarter of total income and consumption (See

Figure 1).

Table 1 - Guatemala Key Social Indicators 3. Poverty is clearly associated withIncidenc of Poverty lower levels of education, access to physical

%of Headcountindex (%oof pop.) assets (including basic utility services, land,National HeconIne(%opp.Poplationa All Poor Extmme Poor and housing), the productivity of labor, and

weak social capital. Geographic location andTotal Guaterala 100.0 56.2 15.7 household size are also found to be importantBy Geographic Area correlates of poverty. Disparities in assets

Urban 38.6 27.1 2.8Rural 61.4 74.5 23.8 accumulabon also constitute the mam

By Ethnicity sources of inequality, with education (orNon-Indigenous 57.6 41.4 7.7 human capital) accounting for over half of allIndigenous 42.6 76.1 26.5 inequality in Guatemala.

Source: Living Conditions Measurement Survey. Instituto Nacional deEstatisticas 2001.

2 Guatemala: Countrv Assistance StrateEv Progress Revort

Figure 1: Guatemala CAS: Poverty and Inequality Trends

Inequality: % of total consumption Tentative Trends in Poverty over Timereceived by each quintile (1989-2000)

60% 540ml 100% A

40% - 80% 62%5%40% - ~~~~~~~~~60%-56o

30% -2e40%

20% -

10%- 0 ~44

01 Q2 03 04 0 1989 2000

SOUrce. Guatermaa Poverty Assessment, 2002.

4. Guatemala has some of poorest health indicators in LAC, ranking among the lowest forlife expectancy (65 years), and highest in maternal (190 per 100,000) and infant mortality (45 per1000 live births.) Only about 60 percent of the population have access to basic health services.A Poverty Assessment under preparation by the Bank reports that close to half of all children andover two thirds of indigenous children suffer from malnutrition. These poor health and nutritionoutcomes are due in great part to the lack of potable water, proper disposal and treatment ofsewage and lack of hygiene, especially in handling food.

5. Although Guatemala's performance in education still lags other countries, there has beensignificant progress lately. Net enrollment in primary education increased from 72 percent in1997 to more than 82 percent in 2001. Still, with an illiteracy rate of 31 percent, only Nicaraguaand Haiti rank worse than Guatemala in LAC. Illiteracy is particularly high among indigenouswomen (62 percent). Likewise, educational attainment is extremely low (4.3 years on average).While primary enrollment has improved in the last few years, 21 percent of primary school-agedchildren are still not enrolled in school.

6. Progress is also evident for basic utility services, although some gaps and disparitiesremain. Overall, about 70 percent of Guatemalan households have piped water and electricity.Almost 90 percent have some kind of basic sanitation, though fewer than half have sewerage.Expansions in coverage have accelerated since the signing of the Peace Accords, but inequalitiesremain, with significant coverage gaps for the poor. A deficient network of roads, especially inrural areas, effectively limits access of the poor to basic services and constrains the distributionof agricultural crops.

7. The poor are highly dependent on agricultural income (which accounts for about half ofthe total income of the poorest quintile compared with just three percent for the top quintile).Poorer households are fairly homogeneous in their occupations, dividing their labor primarilybetween agriculture, self-employment and blue collar jobs, mainly in the informal sector.Women and the indigenous population face both constrained opportunities and discrimination inthe labor market, and are limited mostly to lower return jobs in agriculture and the informalsector. Land ownership in Guatemala is among the most highly unequal in the world; the poor

Guatemala: Country Assistance Stratezv Proeress Report 3

are less likely to use land markets or possess title to their land than the non-poor, which presentsan obstacle to obtaining credit in rural areas.

The Peace Process

S. Recent developments in Guatemala have been shaped in great part by the signing of thePeace Accords in December 1996. The Accords redefined the country's economic and socialdevelopment agenda, with the vision to build a more prosperous, inclusive and egalitariansociety. The Accords focused mainly on: a) resettlement, re-incorporation and reconciliationissues; b) an integral human development program; c) goals for productive and sustainabledevelopment; and d) a program for the modernization of the State. A Peace Commission, whichincludes representatives of former combatants, Government and civil society, was established tooversee the implementation of the Accords.

9. The Peace Accords contained specific targets and deadlines for achieving the goals ofmany programs. They included the adoption of policies and expected outcomes in areas such aseducation, health, the judiciary, the military and police, security, human rights protection, ruraldevelopment, access to land and land reform, modernization of the public administration, civilservice reforms, decentralization, and community participation, among others.

10. The targets were very ambitious, but since signing the Peace Accords, successivegovernments have made considerable progress in a number of areas, especially in terms ofincreasing public spending in line with the social and economic targets, reversing decades ofunder-investment in basic infrastructure and social services, modernizing public sectormanagement, and improving the coverage and equity of education and basic services.

11. Results on other outcome indicators, however, have not been as positive. After proposedconstitutional reforms linked to the peace process were defeated in a 1999 referendum, theCGovernment realized it faced considerable challenges in implementing some elements of thePeace Accords. Thus, after the initial strong progress, the reforms lost some momentum,particularly in the areas of security, military reforms, human rights protection and ruraldevelopment.

12. The implementation of the Peace Accords was also affected by the political cycle. Thetiansition to a new Government in early 2000 led to a slow down in the introduction of policiesduring the campaign, and then to a re-evaluation of the program by the new Government. As aresult, the Commission Accompanying the Peace Agreements, in consultation with the newGovernment, rescheduled many of the targets in late 2000, postponing their deadlines until theyear 2004. One of the main factors that have delayed the progress in meeting the Peace Accordtargets has been the Government's inability to reach the projected tax revenue target ratio of 12percent of GDP-a key target for channeling increased resources to tackle poverty.

13. The Peace Accords unleashed expectations of major changes, which in turn broughtirncreased intemational support for Guatemala's efforts within a CDF context. At the firstConsultative Group (CG) Meeting for Guatemala in January 1997, the international donorcommunity extended offers of aid in excess of $2.0 billion for the 1997-2000 period in supportof the peace process. The international community re-affirmed this support at a subsequent

4 Guatemala: Country Assistance Strate-av Proeress Report

meeting, where the pre-eminent issue was the need for Guatemala to increase its own efforts tosecure additional resources, primarily by achieving the Peace Accord tax revenue target of 12percent of GDP. The latest CG Meeting for Guatemala was held on February 11-12, 2002. Inthat forum, the Government presented its macroeconomic program, for which it has sincesecured IMF support, as well as its plans for financial sector reform and an anti-corruptioncampaign. The Government also reemphasized its commitment to the re-programmed PeaceAccords.

Political Developments

14. President Alfonso Portillo took office in January 2000. He was elected by a largemajority (68 percent) of the popular vote, with broad support coming from the poorer, ruralcommunities. His administration includes a diverse cabinet, with representatives from differentideological groups and of indigenous peoples.

15. President Portillo was elected under the banner of the Frente Republicano Guatemalteco(FRG), a party that was co-founded by the current President of Congress, General Efrain Rios-Mont and by the current Vice-President, Francisco Lopez. Both men share in the politicaldecision making process within the Administration. The FRG also controls Congress since itsecured 61 of the 113 seats during the last elections.

16. Upon assuming office, President Portillo outlined the main policy goals of hisadministration, including: a) in the economic area, continued liberalization of the economy andthe trade regime, increased investments in infrastructure and human capital, reform of thefinancial sector and of the tax system and efforts to improve tax administration, and strengthenedproperty rights; and b) in the political area, greater transparency in the management of publicaffairs, reform of the military, strengthened protection of human rights, and more importantly, acontinued commitment to the agenda of the Peace Accords.

17. President Portillo is in the third year of his four year term. His administration hasconfronted many difficulties due in part to a deteriorating economy, growing allegations ofcorruption and a perceived confrontational attitude towards the elite and the businesscommunity. The Government has also been affected by constant changes in cabinet members,and the differing interests of the Executive and the Legislative branches of Government.Constitutional restrictions prevent the President from being re-elected. Recently, the Congresshas assumed a growing role in policy deliberation and initiative, and an agreement amongseveral parties has led to the passage of important legislation, including the financial sector lawsand laws on transparency and corruption.

Economic Developments

18. Economic Background. Guatemala has maintained a respectable track record ofgrowth and stability over the past decade. Since 1990, real GDP growth has averaged 4.0percent (compared to an average increase in the population growth of 2.7 percent). Afterreaching a high of 42 percent in 1990, inflation has declined to less than 8 percent in 2001.

Guatemala: Country Assistance Stratewjy Prog-ress Report 5

External debt management has been prudent, and today Guatemala has one of the lowest levelsof external indebtedness (17 percent of GDP) among countries at similar stages of development.

'19. Economic growth on per capita basis, however, has not been sufficiently fast to reducethe country's high poverty rates. The poverty rate has declined from approximately 62 percent in:1989 to 56 percent in 2000 (Figure 1), a reduction of less than 10 percent during a period whenincome per capita grew by approximately 15 percent. Economic growth has had a low impact onpoverty since the traditional agricultural sector--where most of the rural poor are either employedor depend-grew at only around 3 percent per year, or one percentage point lower than thewvhole economy, during the same period.

Table 2: Guatemala - Key Economic Indicators *(as % of GDP, unless otherwise indicated)

Actual Estimate1997 1998 1999 2000 2001

National Accounts and PricesRealGDP (%change) 4.4 5.0 3.8 3.6 2.1Consumer price index (% change, average) 9.2 6.6 5.2 6.0 7.3Real exchange rate, % change, (Us/Qz) 13.0 2.4 -8.9 1.6 5.5Gross Domestic Investment (as % of GDP) 13.7 17.4 17.4 18.1 16.2Gross National Savings (as%ofGDP) 9.8 12.1 11.8 13.6 10.9

Central Government financeTotal revenues 9.4 9.7 10.5 10.5 11.0

Total expenditures 10.1 11.9 13.3 12.4 13.8

of which, Social expenditure 4.3 5.8 5.3 5.0 5.5

Deficit (-) Surplus (+) -0.4 -2.2 -3.3 -2.2 -2.8

of which, Net Foreign financing 2.0 1.5 2.4 0.9 0.9

Balance of PaymentsExports of GNFS 17.8 17.8 18.8 19.9 18.4

Imports of GNFS 23.5 25.9 27.2 27.8 27.7Current account balance -3.9 -5.4 -5.6 -5.5 -5.3

Reserves as months of imports of GNFS 2.8 2.9 2.6 3.9 4.8

Public and Publicly Guarantee DebtTotal Debt 20.2 20.1 23.7 23.1 22.3

Domestic Debt 5.4 5.0 5.8 5.8 5.4External Debt 14.7 15.0 18.0 17.2 16.9

External Debt Service / Exports of GNFS 16.5 14.5 14.1 20.2 22.5

Memorandum itemsGross domestic product (US$ million) 17,768 19,306 18,225 19,070 20,573

Source: Bank of GuateTnala, IMF and World Bank Staff estimnates.GNFS = goods and nonfactor services *See Annex B6 for a complete list of economic indicators.

6 Guatemala: Country Assistance Stratenv Progress Report

20. The last decade also witnessed important structural reforms, particularly in the areas ofcommunications, infrastructure and trade. The liberalization of the power andtelecommunications sectors in the mid-nineties has led to a significant increase in the coverageof these services. The economy has also gained from the dynamism of increased trade andintegration; today Guatemala's economy is fairly open and with low levels of protection.Exports account for more than 18 percent of GDP, and are increasingly more diversified, bothgeographically and by product.

21. Despite some fluctuations, fiscal policy has also been relatively stable, with centralgovernment budget deficits averaging about 1.5 percent of GDP over the last ten years. Theperennial shortcoming of fiscal policy, however, has been the very low levels of taxation, whichhave inhibited public investment in much needed infrastructure and social programs.Guatemala's main challenge has been to raise tax revenues, which were around 8 percent of GDPin 1995 and have been gradually raised to an estimated 9.7 percent of GDP in 2001.

22. The Peace Accords called for an important increase in government spending on socialservices. As a result, in recent years budget deficits increased as tax revenues did not keep pacewith increases in spending: the Central Government budget deficit rose from 0.6 percent of GDPin 1996 to 2.8 percent in 2001. During the same period, expenditures as a share of GDP rosefrom less than 10 percent to 13.8 percent of GDP, with the bulk of the expenditures in the socialsectors and for investment.

23. Economic policies have also been subject to fluctuations during the political cycle. In therun-up to the 2000 Presidential election, the Government pursued expansionary monetary andfiscal policies resulting in a widening of the current account deficit, a depreciation of thecurrency and the loss of foreign exchange reserves. Macroeconomic conditions were aggravatedby adverse terms of trade movements, particularly due to depressed coffee prices, andunprecedented weather related conditions, including the impact of Hurricane Mitch in late 1998.

24. Recent Developments. The first two years of the Portillo Administration were markedby some important accomplishments. Faced with a deteriorating macroeconomic situation uponassuming office, the Government assigned high priority to stabilizing the economy. It pursuedinitially a policy of restraining expenditures and liquidity through aggressive open marketoperations. As a result, the Central Government deficit was lowered to 2.2 percent of GDP in2000, interest rates on bank loans declined sharply from an average of 27 percent in late 1999 toless than 20 percent a year later. Capital began to flow back to the country and internationalreserves increased sharply to $1.8 billion at the end of 2001 (close to 5 months of imports).

25. A relaxation of fiscal policy at the beginning of 2001 led not only to a higher budgetdeficit for the year (2.8 percent of GDP) but prompted increased domestic and foreignborrowing. The Government in November 2001 successfully issued Eurobonds, after receiving aBB risk rating from two of the major rating agencies. Inflation also rose slightly during 2001reaching 9 percent (e.o.p.), in part because of the price effects of an increase in the value addedtax rate, as described below.

26. Despite improvements in macroeconomic management, the growth rate has beendeclining over the last two years (Table 2). The economy has been affected adversely by a seriesof shocks, particularly from external sources, and by an uncertain investment climate. The sharp

Guatemala: Country Assistance Strateev Progress Renort 7

decline in international coffee prices, of close to 50 percent over the last two years, has had adevastating impact on the coffee sector. Coffee has been the country's main export for manyyears, accounting for 18 percent of total exports and generating $549 million in revenues in2000. In 2001, the value of coffee exports declined to $304 million, a loss in revenuesequivalent to 1.2 percent of GDP. As a result, the value of Guatemala's total exports declined by11 percent in 2001 and the trade balance widened to $2,290 million (11 percent of GDP). Coffeeexports and production are expected to decline further in the near term, posing a major constrainton economic recovery.

27. The slow down in global economic activity has also contributed to the decline in growth.In the short run, Guatemala's overall economic performance is correlated closely to theperformance of its main trading partners, particularly the United States. Estimates show that adecline of one percentage point in quarterly GDP growth in the US leads to a similar reduction inthe index of economic activity in Guatemala. Finally, investment was also lower in 2001 (Table2), in part due to economic conditions but also due to the business climate. Uncertaintyregarding the Government's position on tax policy-clarified with the adoption of the taxpackage described below--and public campaigns by business associations questioningGovernment policies fueled doubts regarding business conditions and led to a postponement ofinvestments.

28. In the midst of these difficult conditions, the Government introduced some importantstructural reforms. Perhaps the most significant has been in the area of tax revenues. Sincetaking office, the Government has taken measures to raise revenues by increasing the income taxrate from 25 to 31 percent, by widening the coverage of the Value Added Taxes, and byeliminating some exemptions. It subsequently took additional measures by increasing the ValueAdded Tax (from 10 to 12 percent), and introduced important reforms to the tax and penal codes,enhancing the powers of the tax administration by allowing closure of establishments in arrears,remnoving banking secrecy on tax related information and allowing electronic tax payments. Inaddition, with Bank support the Government introduced joint inspections of customs and taxinlbrmation, increased the number of audits, and improved the number and operations of theLarge Tax Payers Unit. These measures are expected to raise tax revenues from 9.7 percent ofGI)P in 2001 to an estimated 10.6 percent of GDP in 2002.

29. The Government has also taken important action to start address weaknesses in thebanking sector. Guatemala's financial sector grew considerably in the last two decades, but hasbeen under some stress in the last few years due to a deteriorating portfolio. Some small bankshave confronted liquidity and solvency problems and remained in operation in part with supportfrom emergency loans from the Central Bank (Banco Central del Guatemala - BANGUAT) anddqposits from the public sector, including the social security institute. In recognition of the longterm costs of such strategy and the inability to sustain it, the Government intervened, paid offfully the depositors, and is in the process of closing three small banks. The initial cost of theseinterventions (close to $200 million) was absorbed by the Central Bank in 2001.

30. Congress recently approved four important laws that modernize financial sectorlegislation (some of the laws dated back to the 1940s). These laws establish a new legalframework for the operation of banks and financial groups, as well as conduct of monetarypolicy and the operation of the Central Bank. The Bank and Financial Groups Law introducesmodem rules for the formation, operation and the closure of banks, new methods for

8 Guatemala: Country Assistance Strategv Pro-aress Report

consolidating the balance sheets of financial groups (including off-shore operations), a newlimited deposit insurance mechanism, and risk-based capital requirements. The new CentralBank Law enhances the autonomy of BANGUAT, clears its balance sheet, makes its operationsmore transparent and establishes price stability as the main objective of monetary policy. Thenew Banking Supervision Law gives stronger powers to a more independent and professionalSupervisory Board and establishes the concept of consolidated supervision. The new MonetaryLaw eliminates restrictions on capital flows and certifies the concept of convertibility. Togetherwith legislation approved last year to control money laundering, these laws constitute acomprehensive and far reaching set of sectoral reforms.

Box 1 - PROGRESS ON ANTI-MONEY LAUNDERING

As part of its financial sector reforms, the Government of Guatemala approved a new Anti-MoneyLaundering Law in December 2001. This new legislation aims to prevent, control, supervise and sanction thosetransactions deemed to be carried out with illicit funds. The new law has gone into effect, and already theBanking Supervisory Agency has obtained several reports of suspect transactions, which it is investigating.

The Govermnent has requested technical support from the World Bank and other international agenciesto implement the reforms under this new law. The Bank's assistance is included in the Financial SectorTechnical Assistance Loan that is being presented to the Board with this Progress Report.

As a result of this progress, the Government is hopeful that Guatemala will be removed from the list ofnon-cooperative countries and territories when the Financial Action Task Force on Money Laundering nextmeets to review the list.

31. The Govermnent has also pursued other structural reforms. Under the auspices of theILO, important changes aimed at reinforcing worker's rights were introduced to the labor code.These reforms strengthened the collective bargaining process, the role of minimum wages in theagricultural sector and the right to strike. The Government also continues to pursue free tradepolicies, including negotiations of trade agreements with Mexico and other Central Americancountries. The Government is now negotiating a Free Trade Agreement with Canada and theUnited States, jointly with other Central American countries. In preparation for negotiations, theGovernment has begun to harmonize trade policies and improve product certification and healthinspections.

II. THE GOVERNMENT'S POVERTY REDUCTION STRATEGY

32. President Portillo plans to pursue several initiatives during the remainder of hisadministration to further the process begun with the Peace Accords. The Government's programis anchored in its Poverty Reduction Strategy and macroeconomic program which is aimed atmaintaining macroeconomic stability and improving social expenditures. The Governmentrecognizes that Guatemala's key long-term challenge is to sustain the peace process by endingthe exclusion that led to the conflict and by reducing the levels of poverty, especially extreme

Gu atemala: Country Assistance Strateev Progress Revort 9

poverty. As a result, poverty reduction has been placed at the center stage of the Govermment'spolicy agenda.

33. Recently, the Government completed a comprehensive Poverty Reduction Strategy(PRSP), Estrategia de Reducci6n de la Pobreza, to make operational its commitments under thePeace Accords. The Government views the PRSP, which was presented at the CG Meeting inFebruary 2002, as a blueprint to improve the social conditions of the poor. The PRSP wasdeveloped to provide a framework that could focus the Government's and country's efforts andassociated support from the international community. The PRSP establishes clear targets to beachieved in many areas between 2002 and 2005. Details of the Government's program and thepolicy content of the PRSP are presented in Annex I; a brief summary of the main points isprovided below.

34. The PRSP and the Government's economic program are built on three main pillars:

* economic growth with equity;

* investment in human capital; and

* investment in physical capital.

Growth with Equity

35. Guatemala must raise its level of economic growth if it is to make significant progress inre(lucing poverty. Recent growth performance has been disappointing, particularly in the thosesectors that employ the poor, such as agriculture. The PRSP establishes clear social indicatorsfor the next few years that can only be met if there is a strong economic recovery and growthreaches at least 4 percent per annum. The Government plans to achieve stronger economicgrowth in the near and medium term by: a) maintaining macroeconomic stability; b) reformingand strengthening the financial sector; c) reorienting public expenditures to the social sectors andinirastructure; and d) promoting agricultural and rural development.

36. Macroeconomic stability is expected to be achieved by reducing the public sector deficitto 1.5 percent of GDP in 2002, by pursuing monetary policy consistent with a rate of inflation inthe 4 to 6 percent range for the year, and by maintaining a competitive and flexible exchangeral:e. Macroeconomic stability will be key to growth prospects since sharp policy fluctuations inthe past, particularly prior to elections, led to a boom and bust cycle of credit and investment thatwere detrimental to long run economic growth.

37. The financial sector reforms (para. 30) should strengthen commercial banks' ability toexpand credit to new sectors and customers, particularly to smaller and medium enterprises thatheretofore have not been widely served. The reforms should make the sector more competitiveand better poised to confront the challenges of global and regional integration. Moreimportantly, they should improve capital and financial positions, prevent a deterioration in thebanks' portfolios, and thus help to fend off a possible crisis that could have detrimental effectson growth.

10 Guatemala: Country Assistance Strategv Progress Report

38. The Government plans to increase and improve investment in power and transportinfrastructure by offering concessions to the private sector. These investments would includeamong others hydroelectric plants, roads, maritime port services, and airports, and theconcessions are to be complemented with new laws governing some of the sectors, especially intransport. The other component is the National Competitiveness Program that is being launchedwith Bank support, and is designed to improve product promotion and help develop newmarkets.

39. Finally, the Government is attempting to address the plight of the agricultural sector,which has been affected adversely by several shocks recently. In order to give coffee producers,particularly the small and medium farmers, time to confront the crisis in the sector, theGovernment has created a $100 million fund designed to help with diversification and debtrescheduling. For subsistence farmers, who are mostly indigenous and rely on small familyplots, the Government is providing subsidized seeds and fertilizers to ensure food security.

40. The Government has already moved ahead by announcing a complementary program ofeconomic reactivation policies including plans to: accelerate the process of infrastructureconcessions to the private sector, adopt new laws to liberalize transport, promote standards andmarket development, and deal with problems in the agricultural sector.

41. Investment in Human and Physical Capital. While recognizing that macroeconomicstability and economic growth are important prerequisites for tackling poverty, the PRSP alsonotes that growth must be accompanied by deliberate efforts to accelerate social development.Thus, the PRSP's second pillar relates to increasing public investment devoted to human capital,especially targeted at the poor. The Goveriunent's strategy proposes that these investmentsshould concentrate in food security, education, especially preschool and primary, and in health,emphasizing preventative primary health care. To ensure that public resources are directed at theneediest, the poverty map-prepared using information from the 2000 LSMS carried out withsupport of an IDF grant--will be used as the basis of targeting of expenditures.

42. A major contribution of the PRSP is to identify the resources required to reach targetgoals for expanding the coverage in education and health. The Government estimates that toreach the goals for education, including the expansion of coverage, 200,000 new scholarships forgirls and improvements in feeding programs and literacy, it will require increasing annualallocations that reach approximately $160 million per annum by 2005. Similarly, the expansionof health services in rural areas, along with broader preventive services to reach the goalsestablished in the PRSP, would require increasing annual allocations that reach an estimated$110 million per annum by 2005.

43. The PRSP's third pillar is investment in physical infrastructure, particularly in thepoorest and most remote areas of the country. Actions to extend coverage of basic infrastructurewill be focused on water supply, basic sanitation, roads and energy. Most of the investments areto be carried out by social funds, and priority will be given to areas with limited or inefficientservices. The social funds in Guatemala currently invest close to $200 million annually. Theneeds identified in the PRSP to improve water and sanitation alone would amount toapproximately $60 million per year.

Guatemala: Country Assistance Stratea'v ProRress Report 11

44. The Government's strategy to improve service delivery and empower communities relieson decentralization as an objective and a mechanism for implementation. Three new lawsrec,ently approved by Congress (a new Municipal Code, the Law on Regional and LocalCouncils, and a Decentralization Law) have established a new institutional framework fordecentralization. The Government intends use these laws to begin transferring gradually greaterresponsibility for local services to the municipalities. The main objective is to improve servicedelivery and make the operations more responsive to community needs. The Government is alsoconsidering a reform of its social funds to complement the decentralization process and make theoperations of the funds more community demand driven.

45. The PRSP also incorporates four general implementation principles. First, it assignspreferential attention to the rural areas, using the poverty map to prioritize investments in poorerareas. Second, it emphasizes the need to modernize further public administration, in order toincrease the effectiveness of public expenditures and to strengthen tax collection capabilities.Third, it identifies decentralization as the primary vehicle for coverage expansion and forimprovement in supervision and monitoring of public social expenditures. Finally, it highlightsthe role of consultations with affected groups as the means to gauge better the needs of thepopulation and to obtain suggestions in the design of priority investments. The PRSP alsoidentifies three cross-cutting themes for the design of specific actions: multi-culture and inter-culture, gender equality, and the reduction of vulnerability to natural disasters.

Box 2: THE MILLENNIUM DEVELOPMENT GOALS

The Poverty Reduction Strategy Paper establishes clear goals for the next few years for the mostinportant Millennium Development target indicators. The PRSP identifies the irmprovements in 5 of the 8indicators expected to be achieved by 2005. This is an important development since it helps to focus publicpolicy towards achieving the MDGs. While Guatemala had been making some progress towards achieving theMDGs, the progress had not been fast enough and had not been part of a concerted effort by the Government.Now the PRSP targets will provide the basis to measure the success of the Government's program with respectto achieving the MDGs.

Poverty reduction in Guatemala has been slow. Although comparable numbers are not available,estimates reveal that since 1990 the poverty rate has been reduced from 62 to 56 percent of the population. ThePRSP identifies a target for reducing extreme poverty from 16 percent of the population at present to 13 percentby 2005.

The second most important goal is to expand net primary school enrollment from 82 to 88 percent by2005. This will require an increase in public spending of $180 million. The Bank is supporting this goal withan ongoing operation of $62 million. The goals of the program also call for improving the attendance of girlstirough a scholarship program for 200,000 primary school-aged girls.

The PRSP also identifies programs and fmancing requirements to reduce child mortality from thecurrent 45 to 35 per thousand by 2005, and maternal mortality from the current 190 to 100 per 100,000 livebirths by 2005. Achieving both of these targets might require an increase in health expenditures for the nextfour years of $134 million.

To complement the health goals and improve environmental sustainability, the PRSP also proposes toincrease access to potable water and sewage to 60 percent of the rural households (from the current 44 percent).

The PRSP identifies goals that are specific to Guatemala's needs but not explicitly included in theMDGs, such as expanding the rural electrification coverage to 90 percent of the rural households (from today's70 percent), and expanding the network of rural roads. Finally, it also sets targets for expanding the transfer ofLund to grouvs of landless Door farmers

12 Guatemala: Countrv Assistance Strateyv ProEress Report

46. The Government sees further development of the Poverty Reduction Strategy as aparticipatory process, where not only key sectors of society will be asked to provide additionalinputs, but will also be called to develop similar regional and local development strategiesconsistent with the goals and approach of the PRSP. The Government is now proposing to usethe PRSP consultations and discussion also as a tool to assist regional and local councils inpreparing their own plans.

47. Finally, the Government has used the PRSP to raise public awareness about theMillennium Development Goals (Box 2), as there had been until very recently little discussion ofand attention to these goals in Guatemala. With the PRSP, there is a greater focus on the actionsthat might be needed to reach those goals. As noted in the Box 2, the PRSP has established theframework necessary to achieve the MDGs, but unless growth is accelerated on a consistentbasis Guatemala will also have difficulties in reaching them.

HI. PROSPECTS, FINANCING REQUIREMENTS, AND RISKS

Medium Term Outlook

48. With the successful implementation of the PRSP and the Government's economicprogram, Guatemala's economic outlook should improve. The macroeconomic program signalsthe Government's commitment to maintain macroeconomic stability and to ensure a stable andsmooth economic transition to a new Government in 2004. It also identifies policies that couldcontribute to growth, such as the financial sector reforms, improvements in public investment,support for a rural development strategy, and movement towards free trade arrangements andplaces the country in a position to benefit in the near term from the expected recovery in worldgrowth and trade. Thus, in the next two years, GDP growth is projected to return to the averagerate of the last decade, around 4 percent per annum. Still, this projected growth is rather modestand not sufficient to reduce sharply the country's high poverty rates, and there are severalconstraints, such as the crisis in the coffee sector, limited increases in Government spending, anda possible reductions in bank credit growth that may likely restrict Guatemala's growthperformance.

49. Implementation will be key to the program's success. Continued compliance with thecommitments and continued support from the IFIs should help enhance the credibility of theGovernment's program and improve the investment climate. Investors should be encouraged bythe prospect of a stable transition and the reduction of policy fluctuations that have beenprominent in previous political cycles. Thus, the resurgence of investment from the current levelof around 16 percent of GDP to more than 17 percent of GDP by 2004 is expected to be one ofthe principal contributors to the projected increase in economic growth.

50. The expected recovery of the global economy should also improve Guatemala'sprospects. Exports are projected to increase by approximately 2 percent in 2002 and thenresume a growth pattern more consistent with projected world trade flows. The Government iscommitted to preserving a market based exchange rate system, which should contribute to exportcompetitiveness. Non-traditional exports are likely to benefit the most from the economic

Guatemala: Country Assistance Strateev Progress Reyort 13

recovery of Guatemala's main trading partners. With imports rising along with domesticdemand, the current account balance should decline sligfitly over the next few years. In 2002,the current account deficit will still be close to 5 percent of GDP, with most of the financingexpected to be provided by private flows. The high current account deficit, however, remains asource of concern and makes the economy vulnerable to shifts in capital flows. Finally, in theshort run, plans to provide financial support to poor farmers through subsidized seeds andfertilizers should ameliorate temporarily their situation and ensure the maintenance of thesubsistence fanning.

TABLE 3: MEDIUM TERM MACROECONOMIC SCENARIO*

(as % of GDP, unless otherwise indicated)Estimate Projected

2001 2002 2003 2004

National Accounts and PricesReal GDP (% change) 2.1 2.3 3.3 4.0

Consumer price index (% change, average) 7.3 6.5 7.3 6.6

Real exchange rate, % change, (Us/Qz) 5.5 1.1 1.3 0.6

Gross Domestic Investment (as % of GDP) 16.2 16.2 16.6 17.1

GrossNational Savings (as %ofGDP) 10.9 11.3 11.8 12.7

Central Government financeTotal revenues 11.0 11.5 12.0 12.3

Total expenditures 13.8 13.0 14.0 13.8

of which, Social expenditure 5.5 5.2 5.6 6.4

Deficit (-) Surplus (+) -2.8 -1.5 -2.0 -1.5

of which, Net Foreign financing 0.9 1.0 1.2 0.7

Balance of PaymentsExports of GNFS 18.4 17.9 17.8 17.8

Imports of GNFS 27.7 26.7 26.3 26.0

Current account balance -5.3 -4.9 -4.7 4.4

Reserves as months of imports of GNFS 4.8 4.2 4.1 4.1

Public and Publicly Guarantee DebtTotal Debt 22.3 22.2 22.6 22.6

Domestic Debt 5.4 5.0 5.0 5.1

External Debt 16.9 17.2 17.6 17.5

External Debt Service / Exports of GNFS 22.5 19.9 20.7 20.8

Memorandum items

Gross domestic product (US$ million) 20,573 21,751 23,294 24,928

Source: Bank of Guatemala, IMF and World Bank Staff estimates.GNFS = goods and nonfactor services *See Annex B6 for a complete list of economic indicators.

51. In the medium term, growth could benefit from the Government's recently announcedreactivation program and the implementation a comprehensive program to improve productivityand develop new markets through the National Competitiveness Program (PRONACOM). This

14 Guatemala: Countrv Assistance Strateev ProEress Report

joint partnership between the public and private sector is designed to help attract new investmentand promote non-traditional exports, and should help improve the business climate andopportunities. The reactivation plan to open infrastructure for concessions and to increaseinvestments in infrastructure will at best yield results in a few years, and it is not expected tohave a large impact during the projection period.

52. The Government intends to redirect spending towards the social sectors to ensure thateconomic growth benefits the poor during a period of fiscal restraint. Under the program, totalsocial spending is expected to rise from 5.2 percent of GDP in 2002 to 6.4 percent of GDP overthe next two years. The efficiency of these expenditures should improve marginally as theGovernment proceeds with its intended program of social investment reforms in the socialinvestment areas. The Government is also committed to introduce tax policies that will raise taxrevenues over the next two years closer to the Peace Accords target of 12 percent of GDP.

Financing Requirements

53. The program's success depends in great part on the Government's ability to secure therequired financing. Guatemala's 2002-2003 financing gap is approximately $225 million. Theserequirements arise from an expected current account deficit of close to $1.06 billion per year, asmall budget deficit of the consolidated government (which includes the losses of the CentralBank), the amortization of some $1.14 billion of loans, and also the contingent financing neededto support the financial sector modernization process (including the initial contribution by theGovernment to the Deposit Insurance Fund). As shown in Table 4, Guatemala is expected toattract considerable financing from the private sector. Besides the expected capital flows and, inparticular, remittances from Guatemalan expatriates (currently the country's largest source offoreign exchange earnings), Guatemala anticipates receiving as much as $175 million of foreigninvestment per annum. Even with these expected inflows, the Government will need to useapproximately $200 million of foreign exchange reserves and will need to rely on the support ofthe IFIs in order meet its financing needs.

54. More broadly, Guatemala is looking forward to continued support from its bilateraldonors and other multilateral agencies for a successful implementation of the PRSP. TheGovernment has estimated that more than $2.9 billion will be required over the next three yearsto finance additional programs and the expansion of existing programs identified in the PRSP.More than half of these expenditures will be covered by internal financing. The rest would haveto be complemented by foreign financing. At the CG Meeting last February, the Governmentwas able to secure commitments from the international community amounting to $1.4 billion forthe next three years. Thus, if the Government is able to fulfill the commitments made at theConsultative Group Meeting, it should be able to raise sufficient funds to finance its program.

Guatemala: Country Assistance StrateRv Proeress Report 15

Table 4: Guatemala - Financing Requirements and Sources(in mnillions of US$)

2000 2001 2002 2003

Combined Public Sector and Banking SystemFinancing Requirements -375.7 -856.5 -474.0 -584.1

Central Govermment Deficit -413.8 -566.3 -327.8 -459.8RestoftheNFPS 114.4 123.4 108.8 116.5Central Bank Deficit -76.3 -164.6 -130.5 -139.8Banking Sector Requirements ... -249.1 -124.5 -101.0

Financing Sources 375.7 856.5 349.5 483.1Net External Borrowing 171.7 190.8 217.9 288.0NetInternalBorrowing 74.5 304.4 74.7 195.1Privatization Proceeds 129.5 361.3 56.9 0.0

Financing Gap 0.0 0.0 -124.5 -101.0

Memorandum itemsAnnual average exchange rate (Qz /US$) 7.77 7.88 8.12 8.40

Source: Bank of Guatemnala, IMF and World Bank Staff estirmates.

Rtisks

55. The program faces several external and internal risks. A possible delay in the recoveryof the global economy could postpone the resumption of faster economic growth in Guatemala.UJnder such conditions, the burden on the financial sector could grow as both enterprises andhouseholds continue to have difficulties servicing their loans. Under this scenario, tax revenueswould also be lower than expected and the Government might be faced with the need to reduceexpenditures further or to increase taxes during a period of a slow growth.

56. One possible risk is the reduction in credit growth that could take place as a result of thecapitalization needs of the banking sector. Under the new financial sector laws, commercialbanks will have to increase their capital, particularly as their operations are consolidated with theinclusion of the off-shore facilities. Total capital requirements are still unknown and couldrestrict the availability of bank credit to the private sector, thus reducing expected growth rates.

57. Another risk is that political pressures for higher public spending may emerge aselections approach next year. This risk is heightened by ongoing difficulties in the rural sectorcaused by depressed coffee prices. A continued deteriorating trend in the rural sectorprecipitated by a further decline in coffee prices would not only constrain the Government'spoverty reduction efforts but also put additional pressures on the Government's budget,especially during a pre-electoral period. Already in 2002, the budget approved by Congress iscoming under significant pressure, since planned expenditures for some programs are notsufficient to cover their needs. The program will test the Government's ability to maintain itsfiscal position. Failure to adhere to the budget deficit targets for the next two years would placeupward pressures on interest rates, the exchange rate, and inevitably on inflation. Guatemala haswiritnessed the consequences of lax fiscal and monetary policies in the run-up to presidentialelections, and any sign that the Government is loosening its stance could lead quickly to capitalflight. The Government could attempt to contain the impact of such development by using the

16 Guatemala: Countrv Assistance Strateev Proeress Reort

foreign exchange reserves accumulated through the sale of public sector assets (such as thetelecommunications and power companies). Such response, however, would place the countryin a more vulnerable position. Guatemala is susceptible to natural disasters, such as earthquakesand hurricanes, and thus needs to preserve sufficient foreign exchange reserves in order to copewith the unexpected costs of a possible natural disaster.

IV. THE BANK GROUP'S COUNTRY ASSISTANCE STRATEGY

58. This Progress Report presents the Bank's FY02-03 assistance program for Guatemala,while the new Country Assistance Strategy is being prepared. The assistance program is alignedwith the priorities that have been established in the Government's program as outlined in thePRSP, and consistent with the analytical input provided in the draft Poverty Assessment.

59. The Government recently accelerated the implementation of important reforms in thefinancial sector, and has requested Bank assistance for these reforms and its program. TheGovernment also reached an agreement with the IMF on a Stand-by program. Bank support willbe provided by the Financial Sector Adjustment Loan and the Technical Assistance Loan that arebeing submitted for consideration together with this Progress Report. The schedule of the CASwas not advanced to ensure adequate consultations on the Government's PRSP and the Bank'sPoverty Assessment that are considered critical inputs for the design and the development of afuller and more participatory World Bank assistance program. This Progress Report will providean additional input for discussions with civil society and donors that will be held in parallel withconsultations on the Poverty Assessment and the Government's consultations on the PRSP.

Evaluation of FY99-01 Assistance

60. Bank assistance to Guatemala expanded considerably over the period of the last CAS.The signing of Peace Accords in 1996 paved the way for increased lending and non-lendingassistance by the Bank, as well as by Guatemala's other external donors. With increasedlending, coordination efforts intensified. The IDB has taken the lead in organizing CG meetingsat regular intervals. The Bank's participation in this process has been guided by the last CAS,where the Bank Group committed to work with many partners-the Government, the PeaceCommission, civil society, international lenders and donors-to solidify the peace process. Bankassistance supported programs designed ultimately to reduce the exclusion that has longcharacterized Guatemala's dualistic society and economy, and its focus was on: building socialcohesion and strengthening participatory decision processes; reducing poverty; improvingeconomic management to maintain stability and foster growth; and modernizing the public sectorto make it more effective at essential tasks.

G'uatemala: Country Assistance Strateev Proe'ress Report 17

Box 3: Operations Evaluation Department's Country Assistance Evaluation

The Operations Evaluation Department has recently carried out a Country Assistance Evaluation (CAE), whichreviews the Bank's assistance to Guatemala over the last fifteen years. The CAE highlights the significantincrease in the efficacy of Bank assistance during the period. It notes that assistance was satisfactory during the1990s as a result of Government ownership of the program and its sharper focus in supporting the Peace Accordobjectives of eliminating poverty, inequality, and social exclusion and in assisting people in rural areas-mainlyindigenous-gain access to education, land, rural and urban markets, and access to the legal system. Adjustmentlending and support for the improvements in the Government's system of public financial management werealso important aspects of Bank assistance. The report also highlights the improvements in the Bank's analyticalcapacity and country dialogue in recent years. The CAE rates the outcome of the Bank's assistance asunsatisfactory for the 1985-90 period and satisfactory for the 1991-2000 period. Institutional developmentimpact is rated as modest and the sustainability of the Bank's assistance program is rated as likely.

The Recommendations of the CAE will be taken into account in the preparation of the FY93-95 CAS.In fact, most of the recommendations are consistent with the thrust of the ongoing and future assistance program,as presented in this Progress Report. The reconmmendations include:

* Growth with stability: The Bank should focus on strengthening the financial system by improving theregulation and supervision of financial institutions.* Reduction in poverty and exclusion: The Bank should support programs for primary education, rural roads,and basic infrastructure for rural communities, titling of land to the poor, and strengthening of the judiciary. Thedesign of Bank-supported programs should ensure that the benefits also reach indigenous people.* The Bank should support redirecting Government expenditure in education, health, electricity, water supply,and sanitation towards the poor.* The Bank should support the Social Investment Fund (FIS) if: (i) FIS is made more accountable andtransparent; (ii) the communities have more power to select and manage projects; and (iii) the Governmentstreamlines the various social funds currently in operation.

61. The last CAS had identified three criteria for judging the success of the Bank'sassistance. They were: achievement of the broad socioeconomic targets established in the PeaceAccords; sector specific indicators in the context of project implementation; and the effects onliving standards in San Marcos, a region where three innovative projects were beingirnplemented and where the Bank was to open a domestic regional office.

62. What worked well. Bank assistance provided direct support in many areas establishedwader the Peace Accords, and had its greatest impact on education for poor indigenouscommunities, public sector modernization, and the delivery of basic services to the poor. Ineducation, the Bank supported the creation and has financed PRONADE - a community basedp]rimary education program, which has been responsible for a sharp increase in primary schoolcoverage. The program now covers 10 percent of primary education (all in rural areas not servedby the regular programs of the Ministry of Education). The schools are run by parentcommittees, and greater community participation has led to better student attendance andperformance. Financing for PRONADE has focused on teachers' training, scholarship for girls,and development of teaching materials in Mayan language.

63. In the area of public sector modernization, Bank assistance has been key to improvingthe public sector financial management, tax administration and the judicial sector. The Bank hassupported through a series of operations the introduction and development of the Integrated

18 Guatemala: Country Assistance Strateev Progress Report

Financial Management System, which introduced new budgeting, accounting and cashmanagement systems in the Central Government. The financial management system has beenrecognized for its contribution to increasing efficiency and improving transparency. The Bankhas also helped improve tax collections through the modernization of the now autonomous taxadministration agency, and has supported Judicial Sector reforms aimed at modernizing many ofthe processes in the court system, at improving efficiency and general access to justice.

64. Bank support for the delivery of basic services to poorer communities has been channeledprimarily through social funds and the rural roads programs. The social funds (FIS andFONAPAZ) have financed a large number of small scale infrastructure projects that contributedgreatly to the expansion of coverage in poor rural areas. But experience has shown that the basicoperations of these funds need improvement, particularly in fostering a more decentralized andcommunity demand driven approach. A pilot road program has used this decentralized approachand demonstrated the merits of community involvement in project design. The Rural RoadsProject helped create an unique and effective regional association of mayors who contributed tothe financing and maintenance of the roads in consultations with their communities that hasbecome model for other municipalities, and is now being replicated country wide.

65. Bank assistance also benefited from concentrating support in one region of the countryand opening a small satellite office in San Marcos. This northern region is one of the poorest inthe country, and the synergy created by a multi project approach located in one place has shownimpressive results. The office today houses the executing units for one of the social funds(FONAPAZ), the staff of the Rural Roads Project, the Institute of Municipal Development, theregional association of Mayors, and CARE, which has an important presence in the area. Thepresence of multiple groups involved with community development in a single place has createda thriving regional center for development where clients can present projects, enquire aboutsources of financing, and obtain support and advice. The office has also provided on the groundproject implementation support.

66. Some Lessons Learned. The Bank's experience has also yielded some lessons ondealing with changing priorities. The only project currently rated as unsatisfactory, PrivateParticipation in Infrastructure Project (Loan No.4149-GT), has shown that when Governmentpriorities change to the point where there is no longer strong commitment to project objectives,implementation will suffer, even though the Bank may be willing to restructure the loan to meetthe Borrower's revised objectives.

67. The Bank's experience with the social funds has also revealed areas for further work.Many of the projects should now take fuller advantage of the growing participation and interestby civil society and local communities in the preparation and execution of projects. While theactivities supported by the more conventional social fund supported by the FIS haveimplemented quickly in expanding basic services, the evolution towards a more communitydriven development mechanism has taken longer than expected because of the additional timeneeded to build capacity at the local level and the limited availability of counterpart resources.The current process of decentralization and self determination highlight the need to designprojects that are community demand driven and more responsive and tailored to local needs.The Bank is currently working with the Government to develop a more community demanddriven approach for future assistance, including possibly direct support to municipalities andcommunities through greater decentralization to the local level.

Guatemala: Country Assistance Strateev Proeress ReDort 19

68. The FY98 CAS noted weaknesses in project implementation capacity, especially the slowpace of project execution caused in part by effectiveness delays. While project execution hasbeen generally good, implementation continues to be affected by approval to effectivenessdelays, counterpart funding constraints, and staff turnover. The Bank has worked closely withthe Executive to streamline the authorization process for Bank loans, but delays in thesubmission of loans to Congress to control the timing of their consideration and of Congressionalconsideration and debate of loans continue to cause delays in signing and effectiveness. To sorneextent this is an issue that affects most countries that require Congressional approval of externalfinancing-and more so in countries reestablishing democratic institutions where Congressprovides a live forum for the discussion and debate of national priorities. Recognizing that thisprocess of debate is healthy and desirable, the Bank is trying to work with the Government tofacilitate this process by promoting discussions with key actors earlier in the project preparationprocess. Tight fiscal constraints have affected occasionally the assignment of counterpartresources to Bank-financed projects. While funds are assigned eventually to permit continuity inproject implementation, the budget allocation process is often lengthy and the Bank has tried toassist by working with the various Government agencies. Finally, several projects were affectedby staff turnover shortly after the change in Presidential Administration in early 2000. This, insome cases, affected the pace of execution.

Portfolio Performance

69. The Guatemala portfolio, which had only nine projects under implementation at the timeof the CAS, grew rapidly since then as ten new projects were approved from FY98 to FY01. Asof March 31, 2002, the portfolio contained 13 projects for a total net commitment of $435.9million, of which $258.7 million remained undisbursed. The undisbursed balance reflects theage profile of the portfolio and the increase in lending following the Peace Accords. TheGuatemala portfolio is relatively new, with an average implementation period of only 3.3 years.Despite sporadic implementation issues-which have mostly been project-specific--irnplementation has been quite good. Only one of the projects in the portfolio (PrivatePalrticipation in Infrastructure) is now rated U for Implementation Progress.

Lending During the Previous CAS Period

71). The FY98 CAS proposed base-case lending of $310 million over three years (FY99-01).This amount represented a slight increase over the high case proposed in the previous CAS, andwas justified on the basis of the signing of the Peace Accords and the introduction of acomprehensive program to address long-standing development needs. The distribution of theproposed $310 million was considered indicative, given the need to retain flexibility, to be abletco complement other donors, and to respond to Government priorities, especially if they reflectedgreater progress in achieving, certain targets of the Peace Accords.

7L. Actual lending over the CAS period totaled $249.5 million, marginally below theproposed base case scenario. The shortfall was the result mostly of adapting the Bank's lendingto areas of assistance that were eventually supported by other donors (Low Income Barrios-anurban project was financed by the IDB), or a slower phasing of the program to reflect longer thanexpected transition following the change in Government in January 2000. There were also some

20 Guatemala: Country Assistance Strateia Progress Report

delays in project preparation, primarily because of their broad participatory approach. Asexpected, Bank lending was heavily front-loaded-five loans totaling $167 million wereapproved in FY99. Mirroring the political transition, no new loans were approved in FYOO-anda proposed follow-up Rural Roads Project was delayed until FY03 to reflect actual needs givenimplementation of an ongoing project. Lending in FY01 was generally in line with CASexpectations.

IFC and MIGA Experience

72. Since the last CAS, IFC has approved three projects for Guatemala: a $7 millioninvestment in a banana producer; a $1 million risk management facility to an independent powerproducer; and, most recently, an $8 million investment (including $2 million in syndications) in asustainable forestry company. IFC also approved several regional investments that can benefitGuatemala, including a $10 million investment in a private equity fund targeted at medium-sizedcompanies that, in particular, have regionally focused strategies; a $8.3 million equity investmentin a regional provider of high speed data and internet services, a $15.0 million investment in aregional power development company that will invest in small to medium sized renewable andco-generation projects; and an $8 million in a Salvadoran bank with a regional focus.

73. IFC has also provided support to the private sector through regional technical assistanceprojects. One, financed by Italian and IFC Trust Funds, sought to provide assistance to small andmedium enterprises in Central America in the areas of (a) project development, (b) training,technical assistance and skill development, and (c) identifying sources of funding for projects.IFC also held training courses in banking and leasing aimed at the management of banks andleasing companies throughout Central America.

74. Following priorities under the last CAS, IFC's strategy is expected to continue to focus onsupporting (i) industries and services, infrastructure and the financial sector in Guatemala; and(ii) the development of regional financial and physical infrastructure in Central America. Giventhe importance of a stable financial sector for private sector development in Guatemala, IFC iscurrently supporting the government efforts in financial sector reform. In tandem with theBank's assistance to the sector, IFC is supporting a bank with a proposed investment of $10million; IFC's first investment in the Guatemalan financial sector that, after a long period, isfaced with an opportunity for significant reform and much needed consolidation. The projectwill strengthen the capital base of the bank and help it play an important role in supporting theconsolidation process. The investment will also help prepare the institution to meet the stricterrequirements of recently passed financial sector legislation, the implementation of which will besupported by the Bank's FSAL. This investment should also provide a strong signal to themarket that well managed Guatemalan financial institutions can attract long term externalresources. Going forward, IFC is also looking at a $37 million (including $22 million insyndications) in an independent power producer and a $5 million investment in a privateuniversity.

75. In April 2001 MIGA began a comprehensive 24 month technical assistance program toassist the Ministry of Economy in developing institutional and promotional capacity to attractforeign direct investment through the establishment and development of a new investmentpromotion agency: Invest In Guatemala ( IIG). Working closely with the executing agency of

Guatemala: Country Assistance Stratery Pro_are.ss Report 21

the World Bank-financed National Competitiveness Program (PRONACOM), IIG wasestablished in May, 2001 and is already operational. MIGA's assistance has focused on thedesign of HG, its internal structure and functions, as well as the determination its of budgetaryreqluirements. MIGA has provided assistance in the development of program objectives andtargets, as well as critical local and international networking.

Bank Group Assistance Strategy

76. The Bank's country assistance strategy objectives for FY02-03 remain consistent withthose presented in the FY98 CAS. On a broader level, they continue to focus on assistingGuatemala to reduce poverty and accelerate the implementation of the Peace Accords. The fourinterlinked development priorities outlined in the previous CAS continue to be the fundamentalobjectives of Guatemala's economic and social development. These are to: a) reduce povertyand. promote inclusion; b) maintain macroeconomic stability and raise economic growth; c)strengthen participatory decision making; and d) improve governance. The Country AssistanceMatrix (Annex BI) follows the priorities in the PRSP and indicates how the Bank's program isaddressing these strategic priorities, and complementing the work of other donors. The Bankwill continue to function as one of many partners within a CDF-like framework-withGovernment, donors and civil society-in support of the peace program and the implementationof the Government's PRSP.

77. Reduce Poverty and Promote Inclusion. Reducing poverty and promoting inclusionhave been the central objectives of the Bank's assistance strategy. Sustained progress in this areawill. require a broad-based approach that should include: economic growth and incomegenerating opportunities, particularly in the rural areas; an increase in spending on socialprograms; more effective delivery of social services that are targeted to the poorest; rapidimprovements of infrastructure; and better functioning markets and rural financial systems.

78. As identified in the previous CAS, the largest share of ongoing Bank assistance has beendevoted to poverty alleviation projects that address efforts to: (i) expand delivery of basicservices, with emphasis on education; (ii) target the social safety net to the poor; and (iii)improve access to sustainable productive opportunities.

79. Bank assistance for the expansion of basic services delivery continues to focus heavily oneducation. - Following on the success of the recently-completed Basic Education ReformProject (Loan No. 3003-GT), the recently-approved Universalization of Basic EducationProject (Loan No. 7052-GT) will provide continued support for expansion of the communitybased PRONADE program, by bringing schooling to an additional 40,000 rural and mostlyindigenous students, and by introducing of a non-formal pre-primary education program attachedto PRONADE schools. It will also contribute to the Government's education reform initiativethrough the development of a new curriculum and the adoption of new text books.

80. Bank assistance for financing of schools, health and small rural infrastructure is alsobeing provided through social funds operations--Social Investment Fund Project (Loan No.35341-GT) and Reconstruction and Local Development Project--PDL (Loan No. 4379-GT).PDI, is a community demand driven project focused in an area with one of the highest povertyinci(lences and some of the highest concentrations of indigenous population. The approach used

22 Guatemala: Countrv Assistance Strategv PfoLress Report

in PDL is serving as basis for discussions on how to make the social funds more responsive tothe community needs and to promote decentralization'.

81. The ongoing Rural Roads Project (Loan No. 4260-GT) is supporting continuedexpansion of Guatemala's rural road network to ensure that physical barriers to transport do notconstrain access of the rural poor to markets and basic social services such as education andhealth. The Bank is now finalizing the preparation of a proposed follow-on project, Rural RoadsII (FY03, $90 million), which will extend the pilot program (where communities andmunicipalities actively participate in the construction and maintenance of the roads) in the regionof San Marcos to the entire country.

82. Transforming the traditionally skewed land distribution pattern and clarifying land tenurerights are necessary preconditions for improving access to sustainable productive opportunitiesfor the poor. Two ongoing Bank-financed projects are supporting the Government in its effortsin this area. The Land Administration Project (Loan No. 4415-GT) is supportingregularization of land tenure and conflict resolution mechanisms in the northern province ofPeten, and the Land Fund Project (Loan No. 4432-GT) is supporting the operation of a LandFund that was established to finance land purchases (financed by the Government). Bankfinancing complements the purchases by supporting investments to improve land productivity,and by providing legal and technical assistance for the beneficiaries.

83. Raising Economic Growth and Maintaining Stability. Sustained poverty reduction inGuatemala cannot be achieved without a period of consistent economic growth. To generatehigher economic growth, the Government will need to act decisively to attract foreign anddomestic investment, diversify its agricultural production, further the potential for non-farmincome, develop access to new markets, and continue to integrate its economy to both regionaland global associations.

84. World Bank Group assistance to promote employment and income generating growth isfocusing in three areas: a) maintaining a stable macroeconomic environment; b) creating theconditions to attract foreign and local investment; and c) designing targeted programs to increasethe participation of the rural poor in economic growth. Unquestionably, this remains one of themost challenging areas for the Bank Group, and the forthcoming CAS consultations will be of

The Bank and other donors are engaged in a dialogue with the Authorities on possible reforms of the social funds.The objective is to modernize their operations and make them an instrument for community driven development.The Bank is considering the possibility of supporting this process with a follow on Social Investment Fund Project.A decision would depend on the reform efforts and the establishment of such priority during the forthcoming CASconsultations. Preliminary thoughts are that the project could help transform the funds into an engine for localdevelopment by empowering poor communities, strengthening their self-reliance, and improving coordination at thelocal level. Given the continued high need for basic social infrastructure and services in the country, and especiallyin rural areas, the project could fund community-based subprojects (including infrastructure and services) for whichprioritization, execution, operation and routine maintenance would be carried out by communities in accordancewith the principles of decentralization and community-driven development. The project might also pilot a financingmechanism to foster private-public partnership in the delivery of social assistance for vulnerable groups (e.g.,migrant workers and their families, exploited children, displaced people) and/or against specific social risks (e.g.,domestic violence, HIV/AIDS).

,uatemala: Country Assistance Stratefev Profress Report 23

great value for determining how the Bank can best support these efforts to achieve highereconomic growth, especially in the rural areas.

85. In the interim, support for efforts to maintain macroeconomic stability is being providedthrough several assistance vehicles, including lending, both adjustment and technical assistance,supervision, economic and sector work and other non-lending services. The Bank is carrying outa. high-level policy dialogue and has developed a program of analytical work, in closecoordination with the IMF and other donors, to monitor and provide advice on the economicprogram, especially in the pre-electoral period. Already key inputs in this area, such as theFlublic Expenditure Review and the FSAP, have proven to be of value to the Government. Anupdate of the Public Expenditure Review is planned for FY03. Its primary aim will be toimprove the efficiency and focus of social public spending (in line with the recently completedpoverty map). Macroeconomic stability will also require continued efforts to increasegovernment revenues, in part through the strengthening of revenue collection and administration.The Bank is supporting these efforts through the ongoing Tax Administration Project (LoanNo. 4225-GT), which is providing technical and analytical support to the Tax AdministrationSecretariat.

86. The financial sector is an area of high vulnerability for the Guatemalan economy.Following joint IMF-Bank technical assistance for the design of the reforms and relevantlegislation under the FSAP, the Government has requested the Bank and the IDB to support itsfinancial sector reforms through both a proposed Financial Sector Adjustment Loan (FY02,$150 million) and a proposed Financial Sector Technical Assistance Loan (FY02, $5 million)that accompany this Progress Report

8'7. The proposed Financial Sector Adjustment Loan would support the creation of amodem, stronger and better functioning banking sector, able to improve and expand itsintermediating functions and to withstand shocks. The technical assistance loan would help theBank of Guatemala and the Banks' Supervisory Agency to prepare the regulations needed toimplement key legislation, and strengthen and adapt these institutions to carry out their newmandates. Bank assistance would also support efforts to implement the recently approvedM oney Laundering Law and its relevant regulations.

88. The Government will need financial assistance to carry out it financial sector reformsbecause recent legislation has now limited the Central Bank's ability to continue providing fundsto distressed banks (either to re-capitalize or restructure them). The financial burden of dealingwith troubled banks will now be partially transferred to the Deposit Insurance Fund program,wlhich the Government will have to finance initially. Over time, the banks in the system willcontribute to the fund, but at the outset the Government will have to provide sufficient contingentresources. Bank financing will also assist with the mergers and acquisitions required tostrengthen the banking system.

89. The reforms of the financial sector are also important for raising the level of investmentand economic growth in the medium tern. The structural changes contemplated under the legalreforms will allow the banks and financial intermediaries to expand lending to the private sectorand will also open access to groups and enterprises that today are largely excluded frorncommercial financing (micro, rural and small and medium enterprises). The limitations on

24 Guatemala: Country Assistance Strategv Progress Renort

connected lending will now create conditions for banks to explore lending to new costumers andto new areas of the economy.

90. The FSAL also has important linkages to the Government's PRSP and to povertyreduction. Experience in other countries show that banking crisis have a significant impact onthe poor and often require public resources that could have been used to fund poverty reductionprograms. The proposed operation will help the Government strengthen the banking sector andreduce the chances of a possible banking crisis that would divert funds from the Govemment'spoverty reduction agenda. The single greatest threat to the peace process would be to notaddress the issues of the financial sector, since a crisis would have a damaging impact onmacroeconomic prospects and would preclude the Government from following its povertyagenda.

91. In the area of private sector development, the Bank's assistance is being providedthrough the ongoing Competitiveness Project (Loan No. 7044-GT), now in its initial stages ofimplementation. This project supports the Government's National Program for Competitiveness,a partnership between the public and private sector to improve the productive capacity. of thecountry, expand its exports, promote the development of small and medium enterprises, create asystem of clusters, extend financial and technical assistance support to small producers of non-traditional producers, and establish a system of market and product development information.

92. The promotion of income generation and economic growth in the rural areas are criticalto Guatemala's development. The ongoing Land Administration Project (Loan No. 4415-GT)and the Land Fund Project (Loan No. 4432-GT) are supporting agricultural productiveinitiatives through financing of investments designed to increase the productivity of landbeneficiaries. The Bank intends to deepen its efforts in the rural areas with the proposed RuralRoads II Project (FY03, $90 million), which will improve road transport access in the poorerareas of the country, and will provide better access to markets and to social and other publicservices. Lack of infrastructure is still a major impediment to the growth in rural areas, and ruralroads in particular are considered necessary to stimulate economic activity and improvecommercialization of non-traditional agricultural products. The project would also generate ruralemployment through an intensive roads rehabilitation program and will promote the creation ofmicro-enterprises that could participate in the contracts for rural roads construction.

93. Complementing these initiatives, a proposed Integrated Management of NaturalResources Project (FY03, $35 million), currently under preparation, would provide targetedsupport for the development of sustainable productive investments in rural areas, includingactivities to promote small-scale productive activities and natural resource management by usinga decentralized approach in which the identification of specific activities and theirimplementation are carried out by community groups. The project would also strengthen naturalresource management to address the high level of environmental degradation taking place in thehighlands. The sustainability of growth in rural areas requires an appropriate and balanced useof natural resources. Several ongoing local and regional projects, some financed by the GlobalEnvironmental Fund, are dealing directly with the issues of sustainable use and conservation ofnatural resources., including the Laguna del Tigre (GEF $750,000), Bio-Itza (GEF, $1.47million), Mesoamerican Biological Corridor (Regional), and the Mesoamerican BarrierReef (Regional) projects.

Guatemala: Country Assistance Strateev Progress Report 25

'4. Non-lending channels are also being used to further policy discussions and dialogue inthe area of growth and economic stability. The use of the newly-established Global DistanceLearning Network, in association with University Rafael Landivar, provides local access toseminars and courses on macroeconomic topics. Additionally, the Country DevelopmentGateway, under development with the a local NGO and the Chamber of Commerce, will providebetter information on attractiveness of the country for foreign investment.

95. Strengthen Participatory Decision Making. Guatemala will not be successful inreducing poverty without the participation of rural and indigenous communities who have beenso far marginalized and have not benefited from the country's economic and social development.This requires, among other things, better targeting government spending and programs to poorercommunities, and empowering the communities to take greater control of their own developmentneeds.

96. The Bank is promoting efforts to build and strengthen community participation throughprojects and programs that: (i) foster decentralized decision-making and implementation; (ii)support reforms to make the social funds more demand driven; (iii) strengthen communities andlocal levels of Government; (iv) improve coverage and responsiveness of the judicial sector inthe rural areas; and (iii) expand the Bank's outreach program, including social communicationsstrategies.

97. Ongoing Bank assistance for strengthening communities and expanding beneficiaryparticipation focuses primarily in the rural areas. Many of the projects place rural communitiesat the center of the decision making. The Universalization of Basic Education (Loan No.7052-GT), Reconstruction and Local Development (Loan No. 4379-GT), and the RuralRoads (Loan No. 4260-GT) respond essentially to community demands. Support for thisapproach would expand with the proposed Rural Roads II (FY03 $90 million), which will helpcreate municipal associations that will be responsible for the identification, construction, andmaintenance of the roads. Preliminary work is underway to prepare a possible operation thatwould support the modernization and operations of the social funds. The Government isinterested in making the funds more responsive to community needs, and be an instrument topromote the process of decentralization.

98. Improving Governance and Public Sector Management. In recent years, Bankassistance has provided broad support for public sector modernization in all three branches ofGovernment. At the center of this modernization process is the Government's integratedfinancial management system, which was developed with Bank assistance through a series ofIntegrated Financial Management Loans (IFML). The system is widely recognized as a case ofbest practice, and has been instrumental in introducing greater transparency and efficiency inpublic sector finances. The ongoing Tax Administration Project (Loan No. 4225-GT) hasalso assisted in the creation of the Superintendencia de Administraci6n Tributaria, anautonomous tax agency, and has helped to improve the professional capacity of its personnel andoperational assistance. The ongoing Judicial Reform Project (Loan No. 4401-GT) issupporting efforts to improve the functions, and services of the judicial system, expand theaccess to justice, strengthen the administrative management, improve the professional capacityol'judges, and combat corruption.

26 Guatemala: Country Assistance Strategv Progress Renort

99. The recently approved IFML III Project (Loan No. 7104-GT) will provide continuedassistance for the Government's efforts to modernize its financial management sub-systems.The focus will be on: (i) expanding the financial management reform effort to decentralizedagencies and the 330 municipalities; (ii) extending the management information systems to lowerlevels of the ministries and agencies; and iii) reforming the central Government's humanresources function. The project will also strengthen the role of the Comptroller General's Office,will update the system of public audits, will modernize the public contracting rules andprocedures, and will begin introducing E-Government applications to many contracts and otheractivities that could benefit from the available new technology.

100. Recently, the Government has requested Bank assistance for the development andimplementation of its National Program to Combat Corruption (Box 4). The World BankInstitute is assisting the Government with the design and implementation of the analytical worknecessary to identify the sources and causes of corruption, as well as to help the Government putin place an effective institutional arrangement to review the required changes in policies tocombat corruption. This effort will complement several operations and initiatives of the BankGroup that already address the issues of corruption. The IFML operations have improvedtransparency and the Judicial Reform Project (Loan No. 4401-GT) has a specific anti-corruption component that include assistance for development of an ethics code for judges,training on ethics, transparency in judicial procedures. The WBI is also sponsoring long distancelearning program on justice reform and the combat of corruption.

Box 4 - GOVERNANCE ISSUES

Issues of governance and corruption have become a major source of concern and public debate inGuatemala over the last few years. Despite improvements in public sector financial management and transparency,there have been several highly publicized cases of misuse of public funds. There have been also an array of reportsof influence peddling, mismanagement in banks that have been intervened, and failures to prosecute suspects ofcorrupt activities. This has reduced public confidence in some institutions and diminished the credibility of somepublic officials.

The public clamor for improvements in governance has led to many new initiatives and policy changes.President Portillo announced in February 2002 the launching of a National Anti-Corruption Plan and asked forWorld Bank assistance to implement the plan. The World Bank Institute has already begun to provide support,and a high level Anti-Corruption Commission is being formed. The Congress has approved several new laws todeal with corruption and transparency, and is considering further legislative measures. An important new lawgiving greater powers to the Comptroller General was enacted in May 2002. A law reforming Public SectorProcurement is expected to be approved in June, along with a new code of ethics for public employees under a newProbity Law. Finally, a proposed law on transparency has been presented and is likely to be approved by Congressin its next session in August.

Civil society groups have also organized and have prepared proposals to deal with corruption and toinprove governance. These are being widely debated and have become important inputs to the development of theGovernment's plans. The International Donor Community has also re-affirmed its intention to provide greatersupport for programs to eradicate corruption, and during the most recent Consultative Group Meeting in February2002, highlighted the importance of progress on this front for their continued assistance to Guatemala.

Guatemala: Country Assistance Stratefv Prostress Report 27

]Lending

[01. Bank lending is expected to amount to up to $310 million for the FY02-03 period.Adjustment lending would account for $150 million (the proposed Financial Sector AdjustmentLoan, being presented with the Progress Report). Approximately $35 million is in support oftwo technical assistance operations (Integrated Financial Management III, already approvedby the Board and the Financial Sector TA, being presented with this Progress Report). Plannedlending for investment operations in FY03 would include the Rural Roads Project ($90 million),end the Integrated Natural Resource Management Project, ($35 million). Besides the proposedoperations, the Bank is discussing with the Governnent possible support for increasing theefficiency, effectiveness, and responsiveness of the social funds, as well as for improving healthservices, which were identified as priorities in the Poverty Assessment. If during the CGSconsultation process these priorities are confirmed, these possible operations could be includedim the Bank assistance program for FY03-05.

102. Lending in FY02-03 is predicated on: a satisfactory macroeconomic framework, asevidenced by compliance with the IMF Stand-by program; progress towards strengtheningrevenue administration; implementation of the four financial sector laws recently approved byCongress; the execution of the poverty reduction program identified in the PRSP; andsatisfactory progress with the implementation of the projects in the Bank portfolio.

Exposure

103. Guatemala has a relatively low level of external debt compared to countries in similarstage of development. As shown in Annex B7, even with the projected increase of indebtednessresulting from the proposed sector adjustment loans from the Bank and the IDB over the nexttwo years, total debt will remain below 18 percent of GDP. Total debt service is expected to bearound 20 percent of exports of goods and services, primarily because of scheduledamortizations. Interest payments account for approximately one quarter of total debt service.

104. The structure of Guatemala's external debt is tilted heavily towards preferred creditors.They account for slightly over 50 percent of the country's total debt. This structure is the resultolf the surge in official international financial support that took place following the signing of thePeace Accords, and also to Guatemala's historical low access to financial markets. Guatemalaonly recently began to tap the international financial markets. Last year it successfully floated$325 million of Eurobonds after receiving a BB rating from Standard & Poor's. Debt service topreferred creditors is approximately 25 percent of total service, reflecting the maturity ofstructure of official debt and also its lower average interest rates. While the exposure indicatorsto preferred creditors may be a concern, they should be measured against the country's low levelof extemal indebtedness and the changing structure of its debt.

Amalytical Work

1(15. The Bank's non-lending assistance has been extensive and has taken many forms,including economic and sector worlc (ESW), project preparation support, institutionaldevelopment under IDF grants, knowledge management and a program of seminars, and aprogram of civil society outreach.

28 Guatemala: Country Assistance Strategy Progress Report

106. Although constrained in recent years, the Bank's economic and sector work (ESW) hasfocused on important areas in the Government's agenda. The two main pieces of formaleconomic and sector work carried out during the CAS period were a Public ExpenditureReview (PER) (FY01) and a joint IMF/World Bank Financial Sector Assessment Program(FSAP) (FY01). The PER assessed the costs and effectiveness of programs needed to reach thePeace Accord targets, thereby providing important inputs to the debate about the levels of taxrevenues needed to fund those programs. The solid dialogue established in the process ofcarrying out the joint FSAP, has led to the preparation of financial sector legislation and arequest for support of the FSAP's key recommendations under the proposed adjustment andtechnical assistance operations. IDF support has been useful in providing institutionaldevelopment assistance to provide the Guatemalan Congress with increased access to legalinformation and data bases. ESMAP is currently completing an extensive analysis of the healthimpact of indoor air pollution and the need to promote the use of improved stoves and alternativesources of fuel to wood.

107. Analytical and advisory services, both formal reports, informal policy notes, and just-in-time advisory services continue to be an important component of the Bank's assistance program.Building upon updated information provided through IDF support for a Living StandardsMeasurement Survey, a highly participatory Poverty Assessment (FY02) is being completed,which has already provided valuable inputs into the formulation of the Government's PRSP, andinto the design of Bank assistance. The Country Financial Accountability Assessment (FY02)analyzes and builds upon the assistance provided under the Integrated Financial ManagementProjects. The report has just been reviewed by the Government and is being updated with theofficial comments. The CFAA complements the Country Procurement Assessment Report(FY99) that has already provided inputs to the preparation of a Procurement Law, now underconsideration in Congress, and related institutional components that are being supported underthe Integrated Financial Management Projects. In other studies, the Bank completed animportant report on violence titled Violent Conflict and the Transformation of Social Capital(FY01).

108. A number of regional Central America studies under preparation are addressing issues inGuatemala, including those on the coffee crisis and its social impact, growth, trade, e-Government and education. Work on a Central America Gender Review (FY02) is nearingcompletion, and other studies are to be completed during the FY03 period. There are threestudies contemplated for Guatemala in the near future. The Social Expenditure Review (FY03)will build on the findings of the Poverty Assessment Report. An Education Sector Strategy(FY03) will provide an overview of the effectiveness of sector resource allocation, will carry outan assessment of student achievement and will identify interventions to improve quality. Aplanned Country Economic Memorandum (FY04) will analyze the challenges that remain foreconomic policy, the reform agenda, and the promotion of growth. These studies will serve asimportant inputs into a possible set of policy notes for the incoming government in January 2004and to respond to requests for "just-in-time" advisory support by the Government.

Role of other Donors

109. Donor activity in Guatemala increased considerably following the signing of the PeaceAccords. The UN has played an important role in coordinating and overseeing implementation

Guwitemala: Country Assistance Strateav Proeoress Report 29

of the Accords, and the Bank has worked closely with UN agencies in several areas. The mostrecent activities involve working with the UN Resident Coordinator in identifying thoseactivities and responsibilities currently being carried out by the Special UN Mission foirGuatemala (MINUGUA) that should be transferred to the agencies once Minugua's term expiresin 2003.

110. The Inter-American Development Bank (IDB) is the largest multi-lateral lender toGuatemala, followed by the IBRD and Central American Bank for Economic Integration(CABEI) both with programs of approximately equal size in recent years. The IDB's strategy isveiy similar to that of the Bank, focusing on poverty alleviation, public sector modernization.,and infrastructure development and improvement. The IDB has taken the lead in health care,disaster mitigation, large-scale urban infrastructure and housing and development of thc:productive sectors, but coordinates closely with the Bank in the areas of the FIS, roads, educationand, now, financial sector. CABEI's assistance has focused on decentralization, ruraldevelopment and environmental management, along with the construction, improvement andexpansion of roads and highways.

11.. The bilateral donors and the European Union combined provide the largest annualfin.mcial support to Guatemala. The United States and Japan are the two single largest donors,with disbursements of around $60 million annually, but combined the countries that comprise theEuropean Union and the EU itself provide a higher volume of assistance. Bilateral assistance notonly supports public sector programs, but increasingly are directed at NGOs and civil societyorganization, including the areas of humani rights.

112. Finally, the Bank is an active participant in the Dialogue Group, which was formedamong the major donor countries and international organizations to coordinate assistance andestablish a more unified dialogue with both the Government and Civil Society. This provides anexcellent forum for close consultations with bilateral donors, and also serves as basis forcocrdinated work to follow up on the agreements reached at the most recent Consultative GroupMeetings.

Monitoring and Evaluation

113. The Peace Accords have provided the overall framework that has been used formoaitoring compliance with key output and outcome targets in the Government's program. ThePRSP now has built on the Peace Accord targets and has further refined the indicators that willbe 'used to monitor its progress. The PRSP, as noted in Box 2, has established clear linkageswit]l the Millennium Development Goals. Thus, the progress in assistance efforts will bemeasured by progress in meeting the targets set in the Government's PRSP.

114. The Bank has provided assistance to develop Guatemala's monitoring and evaluationsystems, particularly through advisory services provided during the preparation of the PRSP.This involved continuous cooperation, technical assistance and training with three maincounterpart agencies: INE, the Planning Secretariat (SEGEPLAN), and the University of RafaelLandivar (URL). The process has already generated several outputs, including the ENCOVI andits dlatabase, which will serve as a baseline for monitoring the progress in poverty reduction andother MDGs. This effort is being complemented by the monitoring and evaluation system being

30 Guatemala: Country Assistance Strateev Progress Report

created under the Integrated Financial Management 111 Project, which includes assistance foranalysis of the incidence of government expenditures and investment programs on the MDGtargets, and systems to follow physical implementation of government projects.

V. CAS RISKS

115. The short term risks to the Bank's country assistance strategy stem mostly from theGovernment's possible inability to carry out its macroeconomic program because of internal orexternal factors. To be successful, the program requires strict fiscal and monetary policies,particularly during the transition to a new Administration. Guatemala's experience, however,suggests the possibility of pressures to ease the fiscal stance before elections. Failure to maintainmacroeconomic stability would place the objectives of many Bank operations in jeopardy,particularly thosz in the financial sector.

116. There are other internal and external risks that could affect the compliance with theeconomic program. One source of concern is a delay in economic recovery or less than robusteconomic growth, particularly as a result of the global economic environment. The country'snear term prospects are highly dependent on the recovery of the global economy. A shortfall inglobal growth by one percentage point could generate a similar reduction in Guatemala'seconomic growth. A failure by the major trading partners to boost their demand for Guatemalanexports would not only increase the country's financing needs, but could also lead to a shortfallin domestic revenues making it more difficult for the Government to assign the necessary fundsfor the poverty reduction programs.

117. Perhaps the most immediate threat to the success of the economic program would be anyfurther decline in the price of coffee and the continued difficulties in the rural sector. Revenuesfrom coffee exports declined by more than $250 million (1.2 percent of GDP) in 2001 due to a50 percent fall in prices, and projections are that these revenues will fall further in 2002. Thishas had a dramatic impact on the rural economy in Guatemala. Prices are not expected torecover and close to 40 percent of the area in production may have to be diverted to other uses.There are indications of another El Nino, a climatic occurrence that sharply reduces precipitationin Guatemala. Under these deteriorating conditions in the rural sector there could be pressureson migration to the cities and other countries, on the environment and on the Government'sbudget. The goals of reducing rural poverty could be difficult to achieve if recovery in the ruralsector is not forthcoming.

118. Besides economic developments, the strategy could also be placed at risk if there are setbacks in the Peace Process, a deterioration in governance and corruption, and growing concernsabout public safety. The Bank's assistance could suffer if the Government fails to make progressin complying with important commitments under the Peace Accords, particularly those related tohuman rights, violence, and security in general. While reported urban violence is on the rise, thismust be weighed against the level of violence prevailing before the Peace Accords. Overall, thePeace process is holding in Guatemala, and the society is now more open to debate, freedom ofexpression and the press, and protests. The sense of growing lawlessness stems in part fromgreater media scrutiny and reporting of human rights cases and crime. Still, the Government willhave to redouble its efforts to stem violence, which is one of the Peace Accords' main objectives.

Guatemala: Country Assistance Stratee-v Proeress Renort 31

119. Another source of risk 4to the strategy would be delays in enacting the policies necessaryto improve govemance and combat corruption. Credibility is key to the success of the overallprogram. Ongoing reports of mismanagement of public funds are eroding public confidence,damaging the Government's credibility and making the task of increasing revenues increasinglydii:'ficult. Without the proper policies to improve governance, confidence will not be restored,the expected increases in investment and growth might not materialize, and support for furtherrevenue increases-which is never easy-will disappear.

120. There are several measures being taken to reduce some of these potential risks. Theinvolvement of key donors and the clear understanding at the highest level,of the need topreserve stability and address financial sector issues, provides some assurances that commitmentto a comprehensive program is strong. The Government has recognized the importance ofinitiating a broad-based national program to combat corruption, and has requested the WorldBank for support in this effort. The Government's commitments were announced to the donorcommunity at the recent CG'Meeting, and the Government agreed to have the internationalcommunity monitor the implementation of its programs.

James D. WolfensohnPresident

By:

Shiengman Zhang

Washington, D.C.May 31, 2002

Guatemala: Country Assistance Strateev Proeress Report ANNEX IPage I of 11

THE GOVERNMENT'S POVERTY REDUCTION PROGRAM

1. This Annex provides a summary of the Government's economic and poverty reductionprogram. As noted in the text, the program is based on three main pillars: economic growth withequity; investment in human capital; and investment in physical capital.

Economic Growth with Equity

2. The PRSP highlights that Guatemala must raise its level of economic growth if it is tomake significant progress in reducing poverty. Despite the country's historically reasonablegrowth rates and macroeconomic stability, recent growth performance has not been sufficientlyfast to benefit greatly the poor. Growth has slowed overall and has been almost non-existent inthose sectors that primarily employ the poor (such as agriculture). Unless growth is accelerated,Guatemala will have difficulties reaching the Millennium Development Goals (MDGs). Astrong economic recovery will be needed for Guatemala to meet the 2005 targets for socialindicators established by the PRSP, which presumes economic growth of no less than 4 percentper annum.

3. The Government's plans to achieve stronger economic growth include actions to: a.)maintain macroeconomic stability (supported by an IMF Standby agreement); b) reform andstrengthen the financial sector; c) reorient public expenditures to the social sectors andinfrastructure; and c) promote agricultural and rural development.

4. Macroeconomic Stability. During the initial years of the current administration, theGovernment has focused on reestablishing a stable macroeconomic environment. TheGovernment aims to ensure macroeconomic stability, supported by an IMF Standby for 2002-20,03.

5. The Government's economic program supports policies aimed at generating a strongerfiscal position and redirecting an ever increasing share of public expenditures towards the socialsectors. The program aims to reduce inflation to a rate of 4 to 6 percent in 2002 (from 8.7percent in 2001), to narrow the external current account deficit to 4.6 percent of GDP (from 5.5percent in 2001), and to maintain the level of international reserves at close to 4 months ofimports. Guatemala is confronting a difficult external environment this year and the Authoritiesbelieve that by consolidating recent macroeconomic gains with the support of the internationalorganizations, the climate for trade and investment will improve. Its policies will also enjoygreater credibility and will prepare the domestic economy to benefit from the expected recoveryof the international economy. With the adoption of its economic program, the Governmentexpects the Guatemalan economy to grow by more than 2.0 percent in 2002, and 3.0 percent in2003.

6. Fiscal policy will be the main instrument used by the authorities to maintainmacroeconomic stability. The 2002 budget--already approved by Congress--is austere and willrequire concerted efforts by the Government. It has established as the cornerstone of theprogram a halt in the nominal growth of expenditures which had increased by more than 22percent in 2001. With tax revenues projected to increase by 1 percentage point of GDP (to 10.7

Guatemala: Country Assistance Stratee'v Proeress Report ANNEX IPage 2 of 11

percent of GDP), the public sector deficit is expected to be reduced to 1.5 percent (after havingreached 2.8 percent in 2001). The improvement in tax revenues reflects the full effects of the taxrate increases approved in July 2001 and continued improvements in tax administration. ThePeace Accord target for tax revenues of 12 percent of GDP by 2002 is now expected to befulfilled by 2004.

Annex Table 1: Medium Term Macroeconomic Scenario*(as % of GDP, unless otherwise indicated)

Estimate Projected2001 2002 2003 2004

National Accounts and PricesReal GDP (% change) 2.1 2.3 3.3 4.0Consumer price index (% change, av.) 7.3 6.5 7.3 6.6Real exchange rate, % change, (Us/Qz) 5.5 1.1 1.3 0.6Gross Domestic Investment (as % of GDP) 16.2 16.2 16.6 17.1Gross National Savings (as % of GDP) 10.9 11.3 11.8 12.7

Central Government financeTotal revenues 11.0 11.5 12.0 12.3Total expenditures 13.8 13.0 14.0 13.8

of which, Social expenditure 5.5 5.2 5.6 6.4Deficit (-) Surplus (+) -2.8 -1.5 -2.0 -1.5

of which, Net Foreign financing 0.9 1.0 1.2 0.7

Balance of PaymentsExportsof GNFS 18.4 17.9 17.8 17.8Imports of GNFS 27.7 26.7 26.3 26.0

Current account balance -5.3 4.9 -4.7 -4.4

Reserves as months of irnports of GNFS 4.8 4.2 4.1 4.1

Public and Publicly Guarantee DebtTotal Public Debt 22.3 22.2 22.6 22.6Domestic Debt 5.4 5.0 5.0 5.1External Debt 16.9 17.2 17.6 17.5

External Debt Service / Exports of GNFS 22.5 19.9 20.7 20.8

Memorandum itemsGross domestic product (US$ million) 20,573 21,751 23,294 24,928

Source: Bank of Guatemala, IMF and World Bank Staff estimates. GNFS = goods and nonfactor services

*See Annex B6 for a complete list of economic indicators.

7. The Government has adopted complementary measures to reinforce its fiscal policyposition. It has restricted possible increases in budgetary appropriations to priority expendituresthat have identified external financing, has frozen public sector salaries for 2002, and hascommitted to expand public sector employment only in priority areas, such as health andeducation. The Government also adopted strict budgetary norms that will govern the actions ofministries and other public sector agencies. All public sector investments will be evaluated andmonitored by the Ministries of Finance and Planning. The Integrated Financial ManagementSystem established with Bank assistance under a series of technical assistance operations will be

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extended to a greater number of executing agencies (including the social funds) and to keymunicipalities. Also, stricter controls will be placed on advances payments and commitments tocontractors.

8. The fundamental objective of monetary policy will be to maintain low and stableinflation rates and an adequate level of foreign exchange reserves. An improved fiscal position,along with measures to strengthen the banking sector (through implementation of the financialsector laws now in Congress) should allow the Central Bank to pursue a firm stance on monetarypolicy without the need for domestic financing. The important change in the management ofrnonetary policy is that the program does not contemplate the need for the Central Bank to issuehigh levels of internal domestic debt, which were required in the last two years in order tosterilize the effects of several sources of liquidity. While the program envisions a continuedinflow of foreign capital and remittances, the exchange rate is expected to depreciate slightly inreal terms. The policies identified in the Government's program should provide the basis forcontinued stability and help the country solidify its position during what could be a difficult year,especially on the external front. The program would help ensure that latent problems (such ast:hose present in the banking sector) do not emerge as possible crises. More importantly, itreveals the commitment by the Government to maintain a path of prudent economic managementduring a difficult pre-electoral and political transition period next year.

9. Financial Sector. The Government's PRSP acknowledges that a healthy, solid andefficient financial system is prerequisite for achieving macroeconomic stability. Recognizing thepast piecemeal financial sector reforms had not achieved the intended modernization of thefinancial sector, the Government decided to address the issues in a comprehensive basis, andrequested IMEF and Bank diagnostic support under a Financial Sector Assessment Program(FYO1). With subsequent analytical support from the IMF, the Bank and the IDB, theGovernment has designed a financial sector reform program that addresses: (i) reform of themonetary policy legal framework for the conduct of monetary and financial policy, including thecapitalization of the Central Bank; (ii) reform of the financial sector legal framework aimed at:strengthening the regulation of financial groups and create an orderly market exit mechanism,enhance credit risk management, and increase access to financing; (iii) reform of banksupervision legal framework aimed at strengthening the autonomy of the SB and its legal andinstitutional capacity to supervise financial groups, and rise banking sector regulation towardsinternational standards; (iv) enactment of legislation to prevent money laundering therebyreducing illegal activities and complying with international norms; and (v) consolidation of thebanking system through the restructuring or closure of insolvent banks, and through mergers andacquisitions. Congress recently approved four laws to improve regulation, supervision andforeclosure procedures in the financial sector. These include the: Central Bank Law, Law ofE,anks and Financial Groups, Monetary Law, and Supervision Law.

10. Public Investment. Sustained and high growth will require increased investment, bothpublic and private. The Government aims to continue to create the conditions for attractingprivate sector investment that can generate employment opportunities. At the same time, theCrovernment aims to increase public investment in basic infrastructure in order to reduceoperational costs, to increase efficiency and to attract private investment. The PRSP proposesthat priority be given to infrastructure investment in rural areas, especially water supply,sanitation, rural roads and electricity.

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11. Private Investment. A sustained annual growth of four percent will require privateinvestment, and the Government intends to continue its efforts to attract foreign investment andto open the economy to increased competition. Trade policy will play a fundamental rolethrough: a) consolidation of customs tariffs with low levels of protection and little dispersion;and b) creation of a new integral export and foreign investment system, adapted to internationaltrade regulations, security and incentives for exporters. The Government is committed to fulfillits obligations to the Central American Common Market and the other bilateral free tradeagreements recently concluded. The commitment also includes maintaining an exchange ratesystem free of restriction (which is being further codified in the new Monetary Law). At thesame time, the PRSP acknowledges that improving safety conditions, increasing the clarity andstability of investment policies and modernizing the judicial system will all be important toattract increased investment.

12. Agriculture and rural development. Agricultural and rural development will be criticalfor sustained growth and poverty reduction in Guatemala. Agriculture accounts for a quarter ofGDP and 60 percent of the country's exports. It is the source of employment for six out everyten poor. More than 70 percent of the population lives in the rural areas, with heavyconcentration in the highlands, where most subsistence farming takes place.

13. Improving the agricultural and rural economy will be particularly challenging. Recentgrowth in agriculture production has been lower than growth in other sectors of the economy.Factor productivity has been low, and investment in agriculture has lagged, accounting for only10 percent of total investment. The four traditional export crops--coffee, sugar, bananas andcardamom---account for 35 percent of agricultural production. The recent fall in coffee prices,which has had far-reaching effects on the rural economy (where coffee is the source ofemployment for more than 500,000 workers) clearly indicates the need for diversification.Given the patterns of land use, however, there limited scope for expanding existing areas ofproduction. Also, soil erosion and environmental degradation (through deforestation, andinefficient use of natural resources), specially in the mountainous highlands, preclude theconsideration of more intense farming in the region.

14. In the PRSP, the Government has identified a set of policy priorities for the agriculturalsector. The main objectives of the program are to intensify efforts to increase food security,through actions that will strengthen the productive capacity of small farners. This is to beaccomplished with programs of technical assistance, fertilizer and seeds distribution, as well ascrop diversification. Efforts to promote private investment, together with infrastructureinvestment in rural areas are also important to stimulate agricultural development. Together,these are expected to increase agricultural productivity, reduce input costs, and increase theprices of agricultural products at the local level.

15. Also, in response to the deteriorating conditions in the rural areas resulting fromdepressed coffee prices, the Government has complemented its poverty reduction strategy with amore focused emergency program to deal with food shortages and malnutrition in 102municipalities (one third of the total). The program has three basic phases: the first, involvesdistribution of basic food with the support of the World Food Program; the second, is gearedtowards ensuring the planting and harvest of basic food grains for next year; and the third is alonger term process of agricultural restructuring away from subsistence crops and those

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adversely affected by international conditions to those with greater potential of exports. I'heGovernment plans to continue food assistance through school breakfast and lunch programs, andother similar programs that target the needy.

L6. There are sub-sectors with future potential in agriculture. During the last 10 years, thenon-traditional agricultural sector has grown rapidly, multiplying by four in value terms, mostly(due to crops from temperate highland valleys and tropical coastal plains. Not only does thisemerging sector generate significant foreign exchange earnings, accounting for more than 15percent of exports, it also provides income and employment for over 105,000 small-scale, oftenindigenous producers. Estimates suggest that non-traditional agricultural exports could be(loubled and employment increased 50 percent over the next decade or less. There are otherlypes of rural development activities with the potential for high returns, employment generation,or incentives for wise use and conservation of natural resources (e.g., eco-tourism, small andmedium enterprises, improved management of local and national protected areas for provision ofwater and other environmental services).

iL7. Finally, government efforts to improve rural infrastructure, access to services, titling,land purchases and rural credit will encourage the expansion of non-traditional agriculture andrural development more broadly. The Peace Accords commit the Government to promoteagricultural development through the delivery of land, and the delivery of inputs to smallfarmers. The Land Fund, created with Bank assistance, is promoting access to land withproductive potential. Its goal is to deliver at least 35,700 hectares annually to benefits 6,300families over the PRSP period. The Government also has parallel programs providing technicalassistance to support Land Fund beneficiaries in agricultural technologies.

18. Because rural indigenous populations have strong cultural ties to the land and naturalresource base, access to land and appropriate livelihood strategies are extremely important notonly to subsistence and income generation, but also to quality of life and cultural identity andsustainability. However, the scope for increased incomes and productivity of subsistencefarmers in the highlands will remain limited by their isolation and small fragmented landlholdings. Many of these farmers will continue to rely on seasonal migration to work on thelarger commercial estates in the coastal plains. Also, with peace and a revitalized sense ofcultural identity, the ex-conflict areas have potential for the development of ecologically andculturally sensitive tourism, which could be an important source ofjobs and markets.

][nvestment in Human Capital

19. The second pillar in the PRSP relates to increasing public investment devoted to humnancapital, targeted at the poor. The Government plans to concentrate investments in the areas offood security (discussed. above), education, especially preschool and primary, and in health,emphasizing preventative primary health care. To ensure that public resources are directed at theneediest, the poverty map--prepared using information from the 2000 LSMS carried out withsupport of an IDF grant--will be used as the basis of targeting of expenditures.

20. Education. Because of the close correlation between education and poverty, the PRSP]'lighlights investment in education as one of its highest priorities. Improving education is central

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to both the Peace Agenda and the poverty agenda as it is a crucial determinant of poverty,inequality and earnings, and influences health outcomes, malnutrition and fertility rates.

21. There have already been significant improvements in education since the signing of thePeace Accords: (a) the sector has undergone important institutional and structural reforms(including some decentralization and deconcentration): (b) public spending on education hasincreased significantly since 1996, with the bulk going to the primary level; (c) literacy andeducational attainment are increasing over time, with important reductions in disparities betweengender, ethnicities, and the poor versus the non-poor; (d) coverage has accelerated at all levelssince the Peace Accords, particularly at the primary level, and the expansion has been well-targeted to the poor (largely through the Bank-supported PRONADE program); and (e) officialstatistics on internal efficiency suggest improvements.

22. Nonetheless, significant coverage gaps and disparities remain, particularly for the poor,girls, rural and indigenous children. Very few poor make it to the secondary level, where thehighest potential for increased earnings due to education are, attained. Despite progress,indicators of internal efficiency suggest serious structural deficiencies in the educational system.Moreover, low returns to primary school suggest shortcomings in the quality of schooling.Demand-side factors, particularly the direct costs of attending school, are the main constraints toincreased coverage at the primary level. Secondary enrollment is constrained by both supply-and demand-side constraints, particularly the direct costs of attending school and opportunitycosts (work and domestic duties). The targeting of public spending on education is neutral atbest, and highly regressive at the secondary and university levels. PRONADE is the exception,since it is essentially targeted to the poor. Other programs (e.g., school feeding and schoolsupply program) are slightly better targeted, but mainly benefit the middle quintiles of thepopulation. The Government plans to use the school feeding programs to achieve some of itsfood security goals mentioned above.

23. The PRSP includes three goals related to education: to increase the net enrollment rate inpreschool and primary schooling to 40 percent and 88 percent, respectively, and to reduce theilliteracy rate to 20 percent. To extend coverage while improving the quality of preschool andprimary education, the Government aims to provide school lunches, textbooks and supplies, aprogram of scholarships for children in rural areas, and promote further community participationas well as rehabilitation and expansion of school infrastructure. Several of these measures areseen as necessary for guaranteeing student attendance by reducing the opportunity costs ofattending school. Efforts to improve quality will focus on programs of teacher training, greateravailability of textbooks, and strengthening and expanding bilingual education.

24. Health. While Guatemala has made progress in the health, significant challengesremain, especially in trying to improve health outcomes. Progress has taken place primarily inpolicy reforms and new delivery methods (e.g., particularly through decentralization and use ofnon-govemment providers). In spite of these, key health outcomes--malnutrition, infantmortality, matemal mortality, and morbidity--have not improved as much as desired, andGuatemala remains among the worst performers in LAC. As expected, health outcomes areworse among the poor, the indigenous, and rural residents, suggesting a need for better targetedinterventions since a significant share of the population lacks access to affordable healthservices, particularly the poor and rural and indigenous residents.

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2:5. A combination of supply and demand-side factors appears to be blocking improvedhealth access. On the supply side, services are fragmented; insurance coverage is minimal; wastein public funding is generated by use of highly-subsidized public facilities by the few who areinisured (virtually exclusively the non-poor); and even when facilities are available, they oftenlack medicines, doctors, or staff. Public spending on health has not increased sufficiently andpublic spending is not well targeted to the poor. On the demand side, economic barriers (directcosts of health care) present the main constraint to improved access. Although public health careis highly subsidized, patients still have to incur certain costs, particularly for medicine. Privatehealth care is relatively expensive. As such, in situations in which only private services areavailable, disadvantaged groups lack access due to economic constraints. Cultural barriersfLrther constrain access of the indigenous population to health care.

26. The PRSP proposes extending coverage of basic health services, strengthening healthpromotion and disease prevention services, with an emphasis on prenatal and neonatal care,nourishment education and vaccination programs. A key element in extending coverage of thebasic health system will be promoting further decentralization and de-concentration of healthservices at different levels, incorporating where necessary traditional indigenous medicine.Municipal and community participation is to be promoted.

liivesting in Physical Capital

27. Investment in physical infrastructure in the poorest and most remote areas of the countryis the PRSP's third pillar. Actions to extend coverage of basic infrastructure will be focused onwater supply, basic sanitation, roads and energy. Most of this investment will be carried out bysocial funds, and priority will be given to areas with limited or inefficient services based on thepoverty map.

283. Infrastructure. There has been significant progress in expanding the equitable provisionoi basic utility services since the signing of the Peace Accords: (a) sectoral reforms haveinmproved competition and efficiency; (b) the volume of resources channeled towards theexpansion of rural service provision has increased substantially through a variety of new andexisting institutional mechanisms; (c) overall coverage of basic services has acceleratedconsiderably since 1996; and (d) this expansion has been well targeted, with new connectionsgoing disproportionately to traditionally disadvantaged groups. Despite improvements, however,significant coverage gaps and disparities in access remain. A significant share of those withoutaccess to basic services live in communities where the services are present but do not connectdue to demand-side barriers, such as the direct costs of connecting to and using services.Furthermore, Guatemala needs to extend. the road network and public transport to the poor,particularly in rural areas. Rural residents and the poor are relatively more isolated in terms ofrcad and transport access, which significantly constrains their access to health services,opportunities and institutions, further exacerbating their isolation.

29. The PRSP aims to increase access to safe water and basic sanitation to 60 percent ofrnral homes by the year 2005 (coverage was 48 percent in 2001). Within the context of theGovernment's decentralization process, it is expected that municipalities will be responsible formanaging and maintaininig water and sanitation services.

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30. The PRSP acknowledges that a good system of rural roads is a necessary preconditionfor agricultural development, both by reducing transport costs for raw materials and agriculturalproducts and by increasing the access to basic services such as education and health. As aninitial step, the Government has carried out an inventory of over 12,000 kilometers of rural roadsto facilitate the development of a maintenance strategy based on municipal and communityparticipation. The PRSP aims to build 100 kilometers of new rural roads and pave 60 kilometersof dirt roads each year.

31. Less than half of the poor in Guatemala have access to electricity, impacting not onlypoverty levels, but also leading to adverse environmental consequences by promotingdeforestation to obtain needed firewood. The Govermnent has designed a Rural ElectrificationProgram that aims to extend coverage of electricity in rural areas to 280,000 new users in 2,600communities over the 2000-2004 period, benefiting an expected 1.5 million inhabitants.

Public Sector Modernization

32. One of the areas where Guatemala has made the most significant improvements since thePeace Accords has been in modernizing some of the institutions in the public sector. With Bankassistance, the Government has introduced a integrated financial management system in all of theministries, thus improving budgetary management and increasing transparency. It has alsoestablished an autonomous tax administration agency, with new systems and more professionallyqualified personnel. Finally, it is in the midst of a major reform of the administration of thejudicial system, aimed at improving access to the courts, accelerating the process of cases,improving transparency, and reducing corruption.

33. Despite recent efforts, Guatemala still scores poorly on most governance indicators,particularly those for corruption, the rule of law and the justice system, and political instability,all of which damage the climate for growth and investment. The PRSP acknowledges that it isnecessary to promote new systems of public administration that incorporate criteria of solidarity,efficiency and effectiveness of public expenditures and strengthen further the tax collectioncapability to respond more dynamically to changes in social conditions. It also proposes thatmechanisms that promote transparency at all levels of Government will be necessary to avoidcorruption and mismanagement in the use of public funds. Finally, transparency and efficiencyin public expenditures are necessary to support the Government's plans to increase further thetax burden, since mismanagement and the need for seeking greater efficiency in the use ofexisting revenues has often been cited as a justification for not increasing taxes.

34. - Governance. The aim of public sector modernization has been to enhance its publicservice delivery capacity, with a focus on alleviating poverty and improving social conditions.The Government realized early on that its efforts to modernize the public sector needed to startby improving the way the public sector manages its own finances. Thus, at the core of theGovernment's modernization effort is the adoption of an integrated financial managementsystem, not only to increase the efficiency of financial management but also to improveaccountability. The Integrated Financial Management System has made an outstanding start butit requires continued effort to ensure it becomes sustainable, especially in terms of extending itscoverage, and strengthening its underlying legal and institutional framework. Over the mediumterm, efforts need to focus on: expanding horizontally to integrate all ministries, social funds

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and most municipalities, which remain outside the budgetary and the Comptroller's auditingprocess.

35. Civil service reform is a key priority in the Peace Accords, and is critical to sustaineconomic modernization and expenditure reform in the medium-term. Although the Governmenthas not been able to carry out a comprehensive reform in this area, it has begun addressing somekey issues that are already contributing to improved efficiency and flexibility in the publicsector. As in other countries, salaries to public employees are the largest Government operatingexpenditure, but in Guatemala there is presently no system to handle properly such payments, ormaintain in an integrated manner the most basic information on the Government's humanresources. Moreover, in view of the lack of personnel information the Government has onlylimited ability to carry out rationally staff reorganizations, to evaluate the impact of alternativesalary policies, or to even evaluate staff (in terms of skills, previous experience, education, etc.)to carry out specific activities. This affects the Government's capability to manage the publicsector human resources. And consequently, to achieve its goals in terms of improved servicedelivery in an efficient, cost effective, and transparent manner. Development of a public sectorhuman resource system will be a key component of the Integrated Financial Management LoanIr:, recently approved by the Bank.

36. The Government's program includes actions to combat corruption and improvetransparency. The expansion of the Integrated Financial Management System to all levels ofGovernment will help, but is not enough. Realizing that decisive action is needed, theGovernment has created a Transparency/Anti Corruption Commission that will be charged withinvestigations and establishment of norms, and has requested World Bank support to assist withthe design and implementation of the National Plan to Combat Corruption. The World BankInstitute is already engaged and has started providing technical support for the design of a anti-corruption strategy. The Government has already sent several draft laws to Congress, includingthose on probity, on oversight and controls, and public procurement.

37. Decentralization and Participation. The PRSP establishes that decentralization will bethe key process for expanding coverage, improving targeting and reducing the expenditure biastoward large urban areas. It will also serve to empower communities that until now have beendisenfranchised. It will allow communities and affected groups to take ownership in the designol their programs and it will strengthen the oversight of expenditure management.

313. The Government's decentralization strategy is based on the reforms of the system ofcouncils (Regional, Departmental, Municipal and local), a new Code for Municipalities, a newlaw establishing the basis for the decentralization of service delivery, and the reforms of thesocial funds to create more community based development. Several of these laws, recentlyapproved by Congress, would transfer greater powers to the local communities and would alsoensure greater participation by local associations, the church, the private sector, and non-government organizations.

319. Guatemala is a unitary state with essentially two levels of government -central andmunicipal. The 330 municipal governments are locally elected and of increasing importance inthe delivery, operation and maintenance of basic services. The Government has made progressirn its decentralization effort, through some de-concentration of functions and especially in

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increasing the transfers and financial autonomy of municipalities. Since 1988, the CentralGovernment has transferred an automatic 10 percent of general revenues to municipalities basedon population and other considerations. While this program has led to a major and practicaldecentralization of political power and responsibilities, the full benefit of this effort in terms ofgreater response to basic needs has been undermined by the weak institutional capacity of mostmunicipal governments. The deconcentration effort has focused on pilots in a few ministries,transfer of investment execution to the social funds, decentralized programs in education(PRONADE), and health, and pilot programs to transfer responsibility for rural road maintenanceto selected municipalities.

40. Now the Government intends to build on the existing structure, particularly bystrengthening the system of councils. The system was established in the 1986 Constitution buthas not be operating effectively, especially since the Constitutional court determined that thelocal councils were unconstitutional. The new approach, embedded in a new law approved inFebruary 2002, recreates the community councils within the municipal structures and broadensthe participation of civil society. The council structure will be used for the consultation anddissemination of the Poverty Reduction Strategy Paper. The new system of councils, along withthe reforms of the social funds, could be the most fundamental set of reforms undertaken by thecurrent government.

Cross-cutting Themes

41.- Culture. Because of Guatemala's cultural and linguistic diversity, the PRSP incorporatesthe concept of culture throughout. Community participation will be promoted in the process ofdesigning, executing, monitoring and evaluating investments proposed in the PRSP to ensure thatcultural and linguistic issues are addressed. Bilingual education will be strengthened andtraditional indigenous medicine will be taken into account in designing health programs. Theseactions are seen as fundamental towards reducing cultural exclusion.

42. iGender. There are important gender inequalities in Guatemala. These have a strongimpact on poverty by limiting family incomes and by providing fewer opportunities for womento participate in decisions regarding household spending. Women participate less in the labormarket (35.2 percent) than men (66.8 percent), and when they do, their salary is 53 percent lowerthan that of their male counterpart. Recognizing the magnitude of the problem and the need for aconcerted mechanism to address it, the Government created the Presidential Women's Secretariatcharged with coordinating the formulation of public policies that allow the integral developmentof women. The Government's policies with respect to gender have the following objectives: a)to assign priority to actions for the female population of every age group in the different ethnicalgroups and areas of the country; b) to adapt policies, legislation, plans, programs and projects toincorporate women's needs; c) to increase participation of women at the different levels of publicadministration; and d) to adapt the legal base, institutional budgets and mechanisms to ensure theinstitutionalization of women's issues.

43. Vulnerability. Because of its geographic and topographic characteristics, Guatemala hasbeen prone to natural disasters. The poor are more subjected to the impact of natural disastersthan their non-poor counterparts. The lack of adequate assets makes the poor especiallyvulnerable to shocks, including not only natural disasters, but economic shocks, as well. The key

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sources of vulnerability include: (a) worsening terms-of-trade and job loss associated with thecrisis in the coffee sector; (b) lost remittances from the global economic slowdown; and (c)natural disasters. Certain sub-groups of the population are inherently or structurally vulnerableto shocks, especially young children, school-aged children, the working poor, particularly thosein agriculture, seasonal migrants and poor, rural households living in disaster prone areas. Thepoor are less equipped than the non-poor to fight shocks, and are more likely to reduceconsumption or use existing assets. Indeed, existing social protection programs are poorlytargeted and inefficient. Social assistance programs are scattered across many agencies, with.many gaps and duplications in coverage, and are generally regressive.

44. The PRSP recognizes that actions must be taken both to mitigate the impact of naturaldisasters and to increase the effectiveness of programs aimed at protecting vulnerable groupswhen natural or economic shocks occur. Guatemala signed the "Strategic Setting for theReduction of Vulnerabilities and Disasters in Central America" with other Central AmericanGovermments in 1999. It contains policies and measures for the prevention and mitigation ofdamages, as well as policies and actions for the administration of emergencies and preparation toface them. An essential part of that strategy is the development of a prevention and mitigationculture that allows the population to organize and be prepared to face all types of contingenciesat ihe local and national levels. This will require full participation of society in the tasks toreduce vulnerability and risk management and implies that special attention will be given to themost vulnerable population groups and sectors, and that gender aspects will be incorporated.The strategy also contemplates that sector development plans and programs will incorporateprevention and mitigation measures reduce the vulnerability of the social and productive sectors,infi-astructure and the environment, at local, national and regional levels.

Annex Al

Guatemala CASKey Economic & Program Indicators - Change from Last CAS

Forecast in Last CAS Actual Outcome Current CAS Forecast

Economy (CY) 1998 1999 2000 2001 1998 1999 2000 2001 a 2002 2003 2004Growth rates (%)

GDP 5.0 5.0 5.0 5.5 5.0 3.8 3.6 2.1 2.3 3.3 4.0Exports of#GNFS,b- 12.7 18.1 18.1 18.0 8.9 -0.6 13.3 -2.6 2.9 6.3 6.7Imports of GNFS b 10.4 16.3 14.5 14.5 20.1 -0.9 12.1 2.0 2.0 5.3 5.8

Inflation, average (-%) 8.5 8.1 8.1 8.0 6.6 5.2 6.0 7.3 6.5 7.3 6.6

National accounts (% GDP)Current account balance -4.0 -3.8 -3.5 -3.4 -5.4 -5.6 -5.5 -5.3 -4.9 4.7 -4.4Gross domestic investment 14.8 15.2 15.8 16.3 17.4 17.4 18.1 16.2 16.2 16.6 17.1

Public finance (% GDP)Tax Revenues 9.5 9.7 10.2 10.5 8.7 9.3 9.5 9.7 10.6 11.0 11.3NFPS Fiscal balance -0.7 -0.8 -0.6 -0.4 -1.5 -2.8 -1.9 ..

Net Foreign financing 1.1 0.4 0.2 0.3 1.5 2.4 0.9 0.9 1.0 1.2 0.7

Intemational reserves 2.8 2.8 2.8 2.8 2.9 2.6 3.9 4.8 4.2 4.1 4.1(months of imports of GNFS)

Program (Bank's FY FY99 FY00 FY01 FY99 FY00 FY01 FY028 FY03 Total FY02-FY03

Millions of US$Lending .. 160.0 65.0 85.0 167.0 0.0 82.5 185.0 125.0 310.0Gross disbursements .. 66.3 66.0 70.8 40.3 61.7 54.6 53.8 163.3 217.1

a. Estimated yearb. GNFS = Goods and Nonfactor Services.

5/29/2002

Annex A2

Guatemala at a glance 5/30102

Latin Lower-POVERTY and SOCIAL America middle-

Guatemala & Carib. Income Development dlamond2001Population, mid-year (millions) 11.7 516 2,046 LIfe expectancyGNI per capita (Atlas method, USS) 1,700 3,680 1,140GNI (Atlas method, US$ bilions) 19.9 1,895 2,327

Average annual growth, 199541

Population (%) 2.6 1.6 1.0 GNI GrLabor force (%) 3.4 2.3 1.3 per Grimar

per ~~~~~priMaryMost recent estimate (latest year available, 1995-OI capita enrollmentPoverty (% of population below national poverty line) 58 c eUrban populatlon (% of total population) 39 75 42Life expectancy at birth (years) 65 70 69Infant mortality (per 1,000 live births) 45 30 32Child malnutrtlion (6 of children under 5) 44 9 11 Access to improved water sourceAccess to an Improved water source (96 of population) 92 85 80Illiteracy (96 of population age 15+) 31 12 15Gross primary enrollment (% of school-ago population) 88 113 114 Guatemala

Male 93 116 Lower-middle-income groupFemale 83 114

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1981 1991 2000 2001Economic ratlos

GDP (US$ billions) 8.6 9.4 19.1 20.6Gross domestic Investment/GDP 17.0 14.3 18.1 16.2Exports of goods and serviceslGDP 17.1 18.0 19.9 18.4 TradeGross domestic savings/GDP 10.5 10.7 10.3 7.0Gross national savIngslGDP 10.6 11.9 13.6 10.9

Current account balancelGDP -6.7 -2.7 -5.5 -5.3 DomesticInterest payments/GDP 0.7 1.2 0.8 0.9 savlngs InvestmentTotal debt/GDP 14.9 32.9 17.2 16.9Total debt service/exports 8.7 15.3 17.0 18.2Present value of debtGDPPresent value of debtexports

Indebtedness1981-91 199141 2000 2001 200145

(average annual growth)GDP 1.4 4.1 3.6 2.1 3.4 GuatemalaGDP per capita -1.1 1.3 0.9 -0.6 0.7 Lower-middle-lncome groupExports of goods and services 0.1 6.2 3.9 -2.6 5.9

STRUCTURE of the ECONOMY1981 1991 2000 2001 Growth of Investment and GDP (%)

(96 of GOP) 6Agriculture 25.0 25.7 22.8 22.8 60Industry 21.7 19.6 19.8 19.7 o

Manufacturing 16.0 14.9 13.2 131 20Services 53.3 54.7 57.4 57.7 5

Private consumption 81.6 83.9 83.4 87.8 -20 97 Oa 99 00 01

General govemment consumption 7.9 5.4 6.3 5.2 GDI e GDPImports of goods and services 23.6 21.6 27.8 27.7 7

(average annyal growth) 1981-91 199141 2000 2001 Growth of exports and Imports (%)

Agrkcufture 1.7 2.7 2.6 1.1 30Industry 0.7 4.1 1.5 1.6 20

Manufacturing 0.7 2.7 1.9 1.6 _0Services 1.6 4.6 4.6 2.7

Private consumption 1.7 4.1 2.9 3.6 - 97 Oa 90 o General govemment consumption 2.6 5.5 14.5 10.2 -10Gross domestic Investment 0.1 4.9 4.2 -6.3 -Exports * tInpoftImports of goods and services 0.8 8.5 6.1 2.0

Note: 2001 data are preliminary estimates.

The dlamonds show four key Indicators in the country (in bold) compared with ts income-group average. If data are missing, the diamond willbe Incomplete. Source for Social Indicators: Guatemala Poverty Assessment, 2002.

Annex A2

Guatemala

PRICES and GOVERNMENT FINANCE

Domestic prices 1981 1991 2000 2001 Inflation (%)

(% change) 12 TConsumerprirs 11.4 33.1 6.0 7.3 Implicit GDP deflator 8.5 33.0 5.7 7.2 6 .

Central Govemment flnance(% of GDP, includes current grants) oCurrent revenue 9.0 10.5 11.0 ss 97 98 99 0o 01Current budget balance 1.5 1.8 1.4 -G DP deflator oCPI

Overafl surplus/deficit -0.5 -2.2 -2.8

TRADE _

1981 1991 2000 2001 Export and Import levels (USS mill.)(US$ millions)Total exports (fob) . 1,298 3.082 2,980 E,OOO

Coffee 281 569 335Sugar 141 180 212 .000.Manufactures 692 1,907 1.805

Total imports (cif) 1,851 5,171 5.272 3,00 I *i IFood .. 284 1,085 1,182Fuel and energy 311 540 561 a oo_Capital goods 430 1.417 1.404 e

Exportpriceindex(1995=100) 11 71 139 144 95 as e7 9e OD o Import price index (1995=100) 13 76 128 137 *Exports *ImportsTerms of trade (1995=100) 85 93 108 105

BALANCE of PAYMENTS

(USS millions) 1981 1991 2000 2001 Current account balance to GOP (%)Exports of goods and services 1,446 1,727 3,893 3,791 0Imports of goods and services 2,024 2,030 5,585 5.698 -1Resource balance -578 -302 -1.692 -1.907

-2Net Income -86 -174 -225 -166Net current transfers 90 220 868 981 -3

Current account balance -574 -256 -1,049 -1.093 4

Financing items (net) 273 812 1.784 1.535 4 Changes in not reserves 301 -556 -735 -442 40

Memo:Reserves induding gold (USS millions) 172 419 1,818 2.260Conversion rate (DEC, locaW'US$) 1.0 5.0 7.8 7.9

EXTERNAL DEBT and RESOURCE FLOWS1981 1991 2000 2001

(USS millions) ComposMton of 2001 etobt (USS mill.)Total debt outstanding and disbursed 1.278 3,092 3,285 3,476

IBRD 171 279 296 330IDA 0 0 0 0 G:471 A: 330

Total debt service 136 290 786 855 \IBRD 16 31 34 34IDA 0 0 0 O 0

Composition of net resource flows F: 719Official grants 12 72 87 88Official creditors 169 46 94 84 D 1,342Private creditors 110 -7 33 106Foreign direct investment 127 91 230 470Portfolio equity 0 0 0 0 E: 614

Wodd Bank programSigned Commitments 0 0 54 46 A -IBRD E -BilateralDisbursements 35 4 51 46 B - IDA D- Other mulUlateral F -PrivatePrincipal repayments 7 21 13 12 C-IMF G-Short-termNetflows 28 -17 38 35Interest payments 9 9 21 22Net transfers 18 -26 17 12

Development Economics 5/30/02

Annex B I

Guatemala: CAS Program Matrix, FY02-03

DEvELopmENT GovERNETnsz's PovERTY REDucrIoN PRSP'sEcrnBjE vE DLDcN STRATEGY (PRSP) PROGRESS BENciMmUe PARTNRS

Proposed: Integrated Mgmt of UN, CABEI,Natural Resources (FY03) UNDP, EU

To reduce extreme 16% of the population living Increase the share of public expenditure Reduce extrame poverty index by Ongoing: FIS H; Reconst andpoverty. in extreme poverty in 2000. dedicated to poverty reduction. 3 percentage points by 2005. Local Development

Non-lending: Poverty Bilateral DonorsAssessment (FY02); Social

_ ______________ Expenditure Review (FY04)

Economic growth of 3.6% in Reduce fiscal deficit as a percentage of Economic growth of no less than Ongoing: Tax Administration IMF2000. the GDP. 4% per annum, while maintaining TAL; Competitiveness

macroeconomic stability. Enhancement Loan; JudicialReform Project; IFML m

To accelerate Accelerated annual growth of exports Non-lending: Public Expenditureeconomic growth and foreign investments. Update (FY03); Country

Development Gateway UN

Banking system under stress, Modernize and strengthen the financial Enacting of Financial Sector Proposd: Financial Sector TAL IDB and IMFoutdated laws, weak sector. legislation. (FY02)supervision. Creation of a new Deposit Provo : Financial Sector

Insurance Fund, to operate under a Reform Loan (FY02)more consolidated banking sector.

In 1999, the net primary Increase share of public expenditure Increase rate of net primary school Oneoine: Basic Education IDBschool enrollment rate was dedicated to primary and preschool enrollment to 88% and that of Reform; Universalization of88%, while the net preschool education, as a percentage of total preschool enrollment to 40%/e by Basic Education

To increase access to enrollment rate was 31.0o/o expenditure in education. 2005.preschool and Expand availability of bilingual schoolsprimary education. and increase percentage of schools that Non-lendin : Public Expenditure

have a school board. Review (FY03) KFW

Literacy rate 40G/o in 1999 Increase share of expenditures devoted to Increase literacy rate to 80% by Non-lendin: Global Distance IDBliteracy programs, as a percentage of the 2005. Learning Network KFWpublic expense infeducation.

Average life expectancy of 64 Increase health expenditure as a Increase life expectancy to 67 Ongoink. FIS 11; Reconst. and CARE

To improve access to years in 1996-2000. percentage of total public expenditure. years by 2005. Local Development UNDPhealth care. Increase preventive health expenditure as EU

a percentage of total health expenditures.

Page of 2|IDB

Page I of 2

Annex B I

Guatemala: CAS Program Matrix, FY02-03

DEvFLopmENT GovERNMENT's POVERTY REDUCnON PRSPs I B ExTERNALOBJECTtVF ~sIsSTRATEGYNSTRMENSP)PoRs Ec RsPARNmERS

Maternal mortality rate of Increase percentage of pregnant women Reduce maternal mortality rate to Ongoing: FIS H; Reconst. and CARE190 per 100,000 live births in that have at least three prenatal 100 per 100,000 live births by Local Development1998. consultations. 2005. EU

Increase percentage of deliveries assisted IDBby health personnel.

As of 2000, infant mortality Increase percentage of children under 5 Reduce, by end-2005, infant Ongoing: FIS II; Reconst and CARErate was 40 per 1,000 live years with access to the basic health mortality rate to 35 per 1,000 live Local Developmentbirths and under 5 mortality service package. births and that of children under 5

To improve access to rate was 52 per 1,000 live . years of age to 48 per 1,000. IDBhealth care. births. Increase percentage of children under

one year of age vaccinated againstmeasles and polio.

In 1998, only 44% of rural Raise expenditure in water services and Provide access to piped water and Ongoing: FIS II; Reconst. and IDBhouseholds had access to sanitation as a percentage of total public basic sanitation to 60% of the rural Local Developmentpiped water and only 1.4% expenditure. households by 2005.had access to a sewagesystem.

In 2000, 4,977 km of rural Increase expenditure in rural roads Expand the rural road network by Ongoing: Rural & Main Roads IDBroads were paved and 9,300 construction, as a percentage of total 500 km, of which 300 km will be Proposed Rural Roads 11 (FY03)km of dirt roads. expenditures in transportation paved.

infrastructure. Proposed: Integrated Mgmt. of CABEINatural Resources (FY03)

To increase In 2000, more than 10,000 Raise share of public expenditure in rural Provide maintenance services to Ongoing: Rural & Main Roads IDBproductivity in rural rural roads lacked adequate roads maintenance, as percentage of total 100% of rural roads. Prooosed: Rural Roads II (FY03) CABEIareas. maintenance. expenditure in transportation

infrastructure.

Currently, only 70% of rural Built new distribution and transmission Expand rural electrification Oneoine: Social Investmenthouseholds has adequate lines. coverage to 90% of the rural Fundelectric coverage. households by 2005.

In 1994, 37% of rural Increase number of hectares delivered To benefit 6,300 new peasant Ongoing: Land Fund and Landhouseholds had no access to through the Land Fund. families annually through delivery Administration projectsland. of land by 2005.

5/30/2002

Page 2 of 2

Annex B2

Guatemala CASSelected Indicators* of Bank Portfolio Performance and Management

As of March 31, 2002

Indlcator 1999 2000 2001 2002Portfolio Assessment

Number of Projects Under Implementation a 11 10 12 13Average Implementation Period (years) b 2.1 2.3 2.8 3.3Percent of Problem Projects by Number ac c 0.0 20.0 0.0 7.7Percent of Problem Projects by Amount c. c 0.0 12.7 0.0 3.0Percent of Projects at Risk by Number a, d 0.0 20.0 0.0 7.7Percent of Projects at Risk by Amount a, d 0.0 12.7 0.0 3.0Disbursement Ratio (%) e 23.8 20.8 23.3 14.2Portfolio Management'CPPR / CSIR during the year (yes/no) Yes Yes Yes NoSupervision Resources (thousands of US$) 597.7 886.4 690.0 659.2Average Supervision (thousands US$/project) 54.3 88.6 57.5 50.7

IMemorandum Item Since FY 80 Last Five FYsl'roj Eval by OED by Number 17 4Proj Eval by OED by Amt (US$ millions) 514.8 73.0YO of OED Projects Rated U or HU by Number 25.0'YO of OED Projects Rated U or HU by Amt 31.9

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.

5/29/2002

Annex B3

Guatemala CASIBRD Program Summary

P osed IBRD Base-Case Lending ProgramFi lyar mS$ (M) Strategic Rewards' ImplementationFiscal year Project Name Us$ (M) (HIMIL) Risks (HIMIL)

2002 Integrated Financial Management III 29.8 H MFinancial Sector Adjustment Loan 150.0 H HFinancial Sector TAL 5.0 M L

2003 Integrated Mgmt. of Natural Resources 35.0 M MRural Roads III 90.0 H L

Total Period FY02-FY03 309.8

a/ For each project, the table indicates whether the strategic rewards and implementation risks are expected to be High (H),Moderate (M) or Low (L).

5/30/2002

Annex B4

Guatemala: Summary of Non-lending Services

Cost or GrantProduct Completion FY Amounta Audience b Objective

ECONOIIC SECTOR WORKRecent completionsPIR- Investing for Peace FY98 168 G, D, B KG, PSRural Financial Markets FY99 30 G, B, KGCountry Procurement Assessment Report FY00 50 G, B KG, PSPER: Expenditure Reform in a Post Conflict FY00 69 G, D, B, PD KG, PD, PS

CountryFinancial Sector Assessment Program FY01 188 G, B KG

UnderwavCountry Financial Accountability Assessment FY02 66 G, B, KG, PSCentral America Urban Review (Regional) FY02 189 G, D, B, PD KG, PD, PSRegional Coffee Study FY02 65 G, D, B, PD KG, PSPoverty Assessment FY02 589 G, D, B, PD KG, PD, PS

PlannedPublic Expenditure Review FY03 226 G, D, B, PD KG, PD, PSSocial Expenditure Review FY04 58 G, D, B, PD KG, PD, PSPolicy Options Notes FY04 50 G, B, KG

IDFANDPHND GRANT,Small-scale Rural Enterprise Support Services FY98 148 G, D, PD KG, PSInstitutional Development of Congress FY98 239 G, D, PD KG, PSDevelopment Household Survey System FY00 499 G, D, PD KG, PSAfro-Descendant Communities (Regipnal grant) FY03 500 G, D, PD KG, PSBasic Health for Vulnerable Groups PHRD FY03 1,000 G, D, PD KG, PS

WRIACT!I TIESEconomic Globalization and Sustainable FY97-98 .. G, D, PD PDDevelopment Seminar (Regional)Municipal Govermments Workshops FY98-99 .. G, D, PD KG, PSPartnerships for Poverty Reduction FY98-00 .. G, D, PD KG, PSBank Supervision and Fin. Markets (Regional) FY99 .. G, D, PD KG, PS

OTHERLaguna del Tigure Mid-sized GEF FY99 750 G, D, B KG, PSFIAS Advisory Services FY99-00 .. G, B, PD PSRUTA Agricola Implementation Support FY99-01 .. G, D, B PSCentral America Emergency Trust Fund FY99-02 1,400 G PSItza Maya Community Management-GEF FY02 1,474 G, D, B KG, PSWestem Altiplano Natural Resources GEF FY03 8,000 G, D, B KG, PS

a. Direct Cost Only. Expressed in thousands of US dollars. b. Government, donor, Bank, public dissemination.c. Knowledge generation, public debate, problem-solving.

May 30, 2002

Annex B6Page 1 of 2

Guatemala - Key Economic Indicators

Estimate Projected

Indicator 1997 1998 1999 2000 2001 2002 2003 2004

National accounts (as % of GDP)

Gross domestic product' 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Agriculture 23.7 23.4 23.0 22.8 22.6 22.4 22.2 22.0

Industry 20.0 20.0 20.2 19.8 19.7 19.6 19.5 19.4

Services 56.3 56.6 56.8 57.4 57.7 58.0 58.3 58.6

Total Consumption 92.0 90.7 91.1 89.7 93.0 92.6 91.9 91.1Gross domestic investment 13.7 17.4 17.4 18.1 16.2 16.2 16.6 17.1

Govemment investment 3.1 4.3 5.5 4.2 4.2 4.0 4.5 4.2Private investment 10.6 13.1 11.9 13.9 12.0 12.2 12.1 12.9

.Exports (GNFS)b 17.8 17.8 18.8 19.9 18.4 17.9 17.8 17.8.[mports (GNFS) 23.5 25.9 27.2 27.8 27.7 26.7 26.3 26.0

Gross domestic savings 8.0 9.3 8.9 10.3 7.0 7.4 8.1 8.9

Gross national savings' 9.8 12.1 11.8 13.6 10.9 11.3 11.8 12.7

Memorandum itemsGross domestic product (US$ million) 17,768 19,306 18,225 19,070 20,573 21,751 23,294 24,928GDPpercapita(US$) 1,689 1,788 1,644 1,675 1,760 1,811 1,889 1,967

Real annual growth rates (%, calculated from 1958 prices)Gross Domestic Product 4.4 5.0 3.8 3.6 2.1 2.3 3.3 4.0Gross Domestic Income 4.8 6.4 3.3 4.4 2.0 2.3 3.1 3.8

Real annual per capita growth rates (%, calculated from 1958 prices)Gross domestic product at market prices 1.7 2.3 1.2 0.9 -0.6 -0.4 0.6 1.3Total consumption 1.8 2.2 1.1 1.4 1.6 -0.8 -0.2 0.4Private consumption 1.1 2.1 1.5 0.2 0.9 0.0 -1.0 1.6

l3alance of Payments (US$ milllons)

Exports (GNFS) b 3,175 3,456 3,435 3,893 3,791 3,900 4,148 4,426Merchandise FOB 2,598 2,847 2,781 3,082 2,980 3,053 3,233 3,438

Imports (GNFS) b 4,188 5,028 4,984 5,585 5,698 5,812 6,120 6,474Merchandise FOB 3,519 4,249 4,181 4,794 5,272 5,383 5,677 6,016

Resource balance -1,013 -1,572 -1,549 -1,692 -1,907 -1,911 -1,972 -2,049Net income and current transfers 327 536 534 643 815 840 867 946

Current account balance -686 -1,036 -1,015 -1,049 -1,093 -1,072 -1,105 -1,103

Foreign direct investmentd 85 673 357 230 .470 150 180 200Long-term loans (net) 222 234 294 116 191 268 366 264Other capital (net inel. errors& ommissions) 612 372 238 1,438 874 446 591 750Change in reserves - -232 -243 126 -735 -442 208 -31 -111

Memorandum itemsC(urrent Account balance (% of GDP) -3.9 -5.4 -5.6 -5.5 -5.3 -4.9 -4.7 -4.4

(Continued)

51291'2002

Annex 86Page 2 of 2

Guatemala - Key Economic Indicators(Continued)

Estimate Projected

Indicator 1997 1998 1999 2000 2001 2002 2003 2004

Public finance (as % of GDP at market prices)'Total revenues 9.4 9.7 10.5 10.5 11.0 11.5 12.0 12.3

Tax revenue 8.8 8.7 9.3 9.5 9.7 10.6 11.0 11.3Nontax revenue and transfers 0.5 0.9 1.1 0.9 1.3 0.9 1.0 1.0

Total expenditures 10.1 11.9 13.3 12.4 13.8 13.0 14.0 13.8Current expenditure 6.2 7.3 8.1 8.6 9.6 9.0 9.8 9.4Capital expenditure and net lending 3.9 4.6 5.2 3.7 4.2 4.0 4.2 4.4

Deficit (-) Surplus (+) -0.4 -2.2 -3.3 -2.2 -2.8 -1.5 -2.0 -1.5

Net Foreign financing 2.0 1.5 2.4 0.9 0.9 1.0 1.2 0.7Net Domestic financing. -1.6 0.7 0.9 1.3 1.8 0.5 0.7 0.8

of which, privatization proceeds 0.0 3.1 0.6 0.7 1.8 0.3 0.0 0.0

Monetary indicatorsM2/GDP(%/.) 27.2 26.8 27.0 30.4 31.3 31.8 31.8 31.8Growth of M2 (%) 15.5 13.4 9.8 23.3 12.5 10.9 10.8 10.8Private sector credit growth (%) 19.9 27.5 14.4 10.0 34.7 17.8 12.2 10.7

Price indices( YR58 =100)Exports of GNFS price index 2362 2647 2906 3253 3380 3309 3497 3843Imports ofGNFS price index 3831 3896 4429 4661 4989 5141 5320 5507

Terms oftrade index 61.6 67.9 65.6 69.8 67.8 64.4 65.7 69.8

Annual average exchange rate (Qz /US$) 6.07 6.42 7.42 7.77 7.88 8.12 8.40 8.70Realexchangerateindex(US$/Qz)f 153.6 157.3 143.2 145.5 153.4 155.1 157.2 158.1Consumer price index (% change, ave.) 9.2 6.6 5.2 6.0 7.3 6.5 7.3 6.6GDP deflator (% change) .8.3 9.5 5.0 5.7 7.2 6.5 7.3 6.5

a. GDP at current market prices.b. "GNFS" denotes "goods and nonfactor services."c. Gross Domestic Savings plus net current transfers and net factor income.d. Includes privatization proceeds, if any.e. Includes only Central government operations.f. An increase in the index denotes appreciation.

5129/2002

Annex B7

Guatemala - External Debt Exposure Indicators

Actual Estimate Projection1997 1998 1999 2000 2001 2002 2003 2004

Total debt outstanding (US$m)a 2,619.7 2,900.5 3,274.0 3,285.1 3,475.9 3,743.8 4,109.3 4,372.9

(TDO)

Net disbursements (US$m)a 252.1 264.2 391.2 127.2 190.8 267.9 365.5 263.6

Total debt service (US$m) 523.1 499.8 483.2 786.4 854.7 775.5 857.8 919.8

(TD:S)

Debi and debt service indicators (%)TDO/ExportsofGNFSb 82.5% 83.9% 95.3% 84.4% 91.7% 96.0% 99.1% 98.8%

TD'O/GDP 14.7% 15.0% 18.0% 17.2% 16.9% 17.2% 17.6% 17.5%TDS / Exports of GNFS 16.5% 14.5% 14.1% 20.2% 22.5% 19.9% 20.7% 20.8%

Preferredcreditordebt/TDOC 39.0% 42.7% 45.6% 48.2% 48.1% 51.1% 51.5% 49.6%

Pnrferred creditor DS/TDS (%)C 20.3% 22.7% 26.7% 17.3% 19.7% 24.6% 25.1% 26.0%

IBRI) exposure indicatorsIBRD DS/ TDS 4.9% 5.3% 6.5% 4.3% 4.0% 4.5% 5.0% 6.3%

IBRD DS/ Exports of GNFS 0.39% 0.41% 0.42% 0.34% 0.31% 0.34% 0.42% 0.65%

IBIRD TDO (US$m) 187.6 202.9 258.4 295.7 330.4 422.3 581.1 623.3

Share of IBRD portfolio (%) 0.17% 0.17% 0.21% 0.24% 0.27% 0.34% 0.46% 0.50%

IFC 4US$m, by Fiscal Year)Loans 0.0 19.0 0.0 19.2 ... ... ... ...

Equity and quasi-equity d 0.0 0.0 0.0 1.2 ... ... ... ...

MIGA (by Fiscal Year)MlGAguarantees(US$m)' 12.9 12.9 7.2 18.7 114.1 113.5

a. Irtcludes only public and publicly guaranteed debt.

b. "GNFS" denotes exports of goods and non factor services services.c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the BIS.

d. Includes equity and quasi-equity types of both loan and equity instruments.

e. IDncludes present value of guarantees.

5/29/2002

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Annex B8-2

CAS Annex B8 (IFC) for Guatemala

Statement of IFC's Held and Disbursed PortfolioAs of 4/30/2002

(In US Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1993 Vigua 2.1 0.0 0.0 0.0 2.1 0.0 0.0 0.01994 Fabrigas 1.5 0.0 1.0 0.0 1.5 0.0 1.0 0.01996 Pantaleon 8.8 0.0 0.0 0.0 8.8 0.0 0.0 0.01998 La Fragua 17.9 0.0 0.0 0.0 17.9 0.0 0.0 0.02000 Frutera 7.0 0.0 0.0 0.0 7.0 0.0 0.0 0.02000 Orzunil 10.9 1.2 1.2 12.7 10.9 1.2 1.2 12.7

Total Portfolio: 48.1 1.2 2.2 12.7 48.1 1.2 2.2 12.7

Approvals Pending CommitmentLoan Equity Quasi Partic

2002 Interforest 6.0 0.0 0.0 2.0

5/30/2002

IMAGING

Report No.: 24235 GUType: OAS