Progress Report on Tranche Release

Program Number: 36308 Loan Number: 2141 November 2005

India: Assam Governance and Public Resource Management Sector Development

CURRENCY EQUIVALENTS

(as of 25 November 2005)

Currency Unit – rupee/s (Re/Rs) Re1.00 = $0.0219

$1.00 = Rs45.55

ABBREVIATIONS ADB – Asian Development Bank AGPRM SDP

– Assam Governance and Public Resource Management Sector Development Program

ASEB – Assam State Electricity Board FMU – fiscal management unit FRBM – Fiscal Responsibility Budget Management GOA – government of Assam GSDP – gross state domestic product IGFMIS

integrated government financial management information system

MTFP – Medium-Term Fiscal Plan PSE – public sector enterprise SSN – social safety net VAT – value-added tax

NOTES

(i) The fiscal year (FY) of the Government and its agencies ends on 31 March. FY before a calendar year denotes the year in which the fiscal year ends; e.g., FY2005 began on 1 April 2004 and ended on 31 March 2005.

(ii) In this report, "$" refers to US dollars.

Vice President Director General Director Team leader Team members

L. Jin, Operations 1 K. Senga, South Asia Department (SARD) A. Sharma, Governance, Finance and Trade Division, SARD A. Goswami, Principal Governance Specialist, SARD M.G. Attinasi, Young Professional, SARD E. Glennie, Senior Financial Governance Specialist, SARD H. Mukhopadhyay, Economics Officer, INRM K.N. Shin, Public Sector Resource Management Specialist, SARD V.B. Tulasidhar, Public Sector Resource Management Specialist, SARD A. Mohammed, Counsel, Office of the General Counsel

I. INTRODUCTION 1. The Asian Development Bank (ADB) provided a $125-million loan on 16 December 2004 for the Assam Governance and Public Resource Management Sector Development Program (AGPRM SDP).1 The AGPRM SDP constitutes subprogram 1 of a program cluster concept consisting of two back-to-back subprograms to be implemented during a 5-year program (the Program). The AGPRM SDP will support reform measures under three components: (i) reform of state finances, (ii) reform of fiscal governance, and (iii) reorientation of the role of the state. The following outcomes are expected: (i) enhanced fiscal responsibility, (ii) a broadened tax base and enhanced tax collection, (iii) enhanced nontax revenues, (iv) restructured state debt, (v) containment of state pension liabilities, (vi) improved state budgeting, (vii) enhanced poverty-focused and growth-oriented expenditure, (viii) public sector enterprise reforms, (ix) strengthened public–private partnership, and (x) public administration review. To build institutional capacity of the public financial management institutions and support implementation of the AGPRM SDP, ADB also provided a loan of $25 million for the Assam Governance and Public Resource Management Sector Development Project. 2 2. Subprogram 1 is designed to be implemented within 2.5 years from loan effectiveness. The loan became effective on 17 December 2004. The first tranche of $45 million was released upon loan effectiveness. The incentive tranche of $45 million is to be released upon satisfactory compliance with the tranche-release conditions any time during program implementation. The second tranche of $35 million is expected to be released 24 months from release of the first tranche, subject to satisfactory compliance with the tranche-release conditions. The purpose of this report is to review GOA’s progress in meeting the conditions for the release of the incentive tranche. The report also reviews the implementation of the associated project loan, the good progress of which is essential for timely implementation of the subprogram 1 and for laying the foundation for subprogram 2. 3. Detailed reviews of program implementation were carried out by fielding missions in April, August, and October 2005. These reviews and regular consultations show that GOA took actions to comply with all incentive-tranche conditions and that significant progress has been made toward meeting AGPRM SDP’s overall objectives.

II. RECENT ECONOMIC AND POLITICAL DEVELOPMENTS 4. One of poorer states, Assam is in northeastern India. Although it is rich in natural resources (particularly petroleum and coal) and has good potential for developing agriculture, its economic performance has lagged behind that of rest of the country because of several factors, especially poor infrastructure, remoteness, and inability to minimize crop damage from frequent floods. Assam’s economic growth decelerated even further after the economic reforms in the early 1990s. As against a per capita gross state domestic product (GSDP) growth of 3.63% in 1980/81–1993/94, Assam’s per capita GSDP growth decelerated to 2.63% in 1993/94–2000/01. During the corresponding periods, the growth of all states’ per capita GSDP accelerated from 5.27% to 5.72%. The policy for promoting balanced regional growth through preferential issuance of industrial licenses to backward areas, and various other similar incentives were

1 ADB. 2004. Assam Governance and Public Resource Management Program. Manila. (Loan 2141-IND for $125

million approved on 16 December 2004). 2 ADB. 2004. Assam Governance and Public Resource Management Project. Manila. (Loan 2142-IND for $25 million

approved on 16 December 2004).

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discontinued as part of economic reforms. Poorer states such as Assam, where conditions remained unattractive to private investment, suffered as a consequence. The only way Assam can overcome this handicap is by improving the business environment. This strongly underpins the urgent need to develop a good business climate by promoting fiscal reforms to improve governance and enhance public investment in infrastructure. 5. Assam’s economic growth decelerated to 5.2% in 2004/05 from 6.2% achieved during 2003/04. While this deceleration is in line with the slowdown of the national economy from 8.5% to 6.9%, Assam’s economic performance continues to lag behind the country’s. Agriculture was particularly hard hit in 2004/05 by floods that damaged standing crops in 32% of cropped area and displaced 59% of farming families. Growth came mainly from manufacturing and services. The prognosis for 2005/06 is better than in the previous year, but the state’s performance will lag behind the 7.4% growth forecasted for India. GOA has made significant progress in implementing a number of efficiency-improving measures in the fiscally draining energy sector, notably (i) financial and organizational restructuring of the Assam State Electricity Board (ASEB), (ii) setting up of a regulatory framework, and (iii) de-politicization of tariff setting. A major consequence has been a sharp increase in the fiscal deficit in 2004/05 because of GOA’s assumption of ASEB’s liabilities to its suppliers, equivalent to about 2% of GSDP. Even though revenues increased impressively by over 30%, the fiscal deficit for the year is expected to reach 5.9% of GSDP. GOA introduced new taxes: an entry tax on petroleum products and a land tax on crude oil mining. 6. Elections to the state legislative assembly are expected to be held in March 2006. The Election Commission is expected to announce the dates any time after 15 December 2005. After the election dates are announced, the model code of conduct will come into force, which will prevent GOA from announcing any new policy initiatives or undertaking fresh expenditure commitments that are not already included in the budget. This will effectively put the reform process on hold for about 4 months, though GOA can proceed with its preparatory work.

III. STATUS OF PROGRAM IMPLEMENTATION 7. The progress of implementation of subprogram 13 is reported in section A, and that of the associated project loan4 in section B. A. Subprogram 1 8. The release of the incentive tranche requires compliance with 13 policy actions under six broad policy areas: (i) enhance fiscal responsibility, (ii) broaden the tax base and enhance tax collection, (iii) restructure state debt, (iv) improve state budgeting, (v) reform public sector enterprises (PSEs), and (vi) strengthen public private partnership. Reviews indicated that GOA made satisfactory progress in these areas and complied with all the incentive-tranche conditions. In a few cases, the progress exceeded the requirements for releasing the incentive tranche. The status of compliance is summarized below. A status report on all incentive-tranche conditions of the AGPRM SDP is provided in Appendix 1.

3 ADB. 2004. Assam Governance and Public Resource Management Program. Manila. (Loan 2141-IND for $125

million approved on 16 December 2004). 4 ADB. 2004. Assam Governance and Public Resource Management Project. Manila. (Loan 2142-IND for $25 million

approved on 16 December 2004).

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Achievements Action Implementation Status

1. Enhance fiscal responsibility Update the Medium-Term Fiscal Plan

(MTFP) and introduce a fiscal responsibility bill in the state’s legislative assembly.

Complied with.

Adopt a policy to have no year-end negative cash balances.

Complied with.

Implement a time-bound action plan for the fiscal management unit.

Complied with.

2. Broaden the tax base Approve and notify a composite check post

at Srirampur. Complied with.

Introduce a value-added tax bill in the state’s legislative assembly.

Complied with.

Introduce ad valorem rates of taxation on Indian-made foreign liquor in place of specific excise duties.

Complied with.

Approve and notify objective valuation methods for properties.

Complied with.

3. Restructure state debt Agree on debt swaps/negotiated settlements

of high-interest institutional loans. Complied with.

4. Improve state budgeting Approve the operating guidelines on state budgeting. Prepare FY2007 budget under using MTFP projections.

Complied with.

5. Reform public sector enterprises

The government of Assam (GOA) will approve, issue, and notify the social safety net program designs.

Complied with.

GOA will approve one-time settlements of PSE debts of identified inoperative PSEs to be closed.

Substantially complied with.

GOA will provide the budget for Assam State Electricity Board terminal benefit liabilities.

Complied with.

6. Strengthen public–private partnership

Establish a business incubation unit and a skills development and placement unit, both in the Department of Public Enterprise.

Complied with.

1. Enhance Fiscal Responsibility

9. The main objective of reforms in this area is to create a conducive and binding legal environment and an enabling administrative framework to promote fiscal prudence. To enhance fiscal responsibility, GOA agreed to (i) introduce a fiscal responsibility bill in the state legislative assembly, (ii) update the Medium-Term Fiscal Plan (MTFP), (iii) adopt cash management discipline as part of fiscal responsibility, and (iv) implement a time-bound action plan to strengthen the fiscal management unit (FMU). 10. Fiscal Responsibility Legislation. GOA has enacted the Fiscal Responsibility Budget Management (FRBM) Act, and thereby passed a critical milestone in achieving fiscal consolidation. The FRBM Act’s main objective is to restore the fiscal prudence that had prevailed among Indian states until the early 1980s, when many of them had a surplus on their current (revenue) budgets to finance a part of their capital expenditure. The FRBM Act

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stipulates compliance with specific time-bound fiscal targets, ensures fiscal transparency, places a limit on GOA’s loan guarantees, and seeks to improve cash management. To restore fiscal prudence, the legislation requires GOA to have no revenue deficits5 and bring down the fiscal deficit to a sustainable level of 3% of GSDP by FY2009. To encourage the state governments to cut their revenue deficits, the national Government introduced a scheme of debt write-off linked to the progress achieved in reducing the revenue deficit from 2005/06 onward. In addition to this satisfactory legal framework, other related matters on the MTFP, cash management, and FMU are detailed below. 11. Medium-Term Fiscal Plan. GOA amended the FRBM Act to bring it in line with the eligibility requirements for debt relief under the award of the Twelfth Finance Commission. Accordingly, the target year for eliminating the revenue deficit and reducing the fiscal deficit to 3% of GSDP was shifted from FY2010 to FY2009. To operationalize this legal framework, GOA updated the MTFP to align it with the requirements of the amended FRBM Act. 12. The revised MTFP showed a sharp increase in the fiscal deficit in 2004/05 to 5.9% of GSDP from 3.5% of GSDP in 2003/04. A large part of this increase was due to payment of interest, salary, and pension arrears; expenditure on mitigating the impact of natural calamities; and the settlement of ASEB liabilities. Spending on some social services also increased because of an increase in tied grants from the national Government. Incurring significantly large adjustment costs during the initial phases of fiscal adjustment offers three advantages. First, speedy restructuring of large PSEs and an early settlement of their liabilities will reduce overall interest costs. Second, early resolution of loss-making PSEs would lower overall budgetary support. Third, incurring more adjustment costs during 2004/06 will generate larger reductions in the revenue deficit from 2006/07 onward, which will help GOA obtain more relief under the national Government’s debt relief for deficit reduction scheme. The ASEB restructuring was taken up in the initial stages of GOA’s fiscal consolidation program because it had the largest potential claim on the budget. ADB has been helping to restructure ASEB.6 GOA paid Rs1.1 billion under the current (revenue) budget to clear arrears in ASEB’s current liabilities. Under the capital budget, GOA incurred one-time expenditure of Rs8.5 billion (2% of GSDP) by issuing power sector bonds to the national Government-owned power utility companies to settle the payments due from ASEB. An additional Rs3 billion was spent on relief from natural calamities, and a similar amount was paid to clear arrears in salaries and interest payments. 13. Own tax revenues increased by an impressive 31% in 2004-05, considerably softening the impact of fiscal adjustment. Rationalization of tax rates, imposition of entry tax on petroleum products, and improved tax administration increased sales tax revenue collections by 35%. Recovery of Rs890 million disputed arrears also contributed to tax buoyancy. GOA imposed a new land tax on mines. Nontax revenues were buoyant because of an increase in royalties from crude oil production. Grants devolved from the national Government were larger. These positive developments yielded additional revenues equivalent to 3.6% of GSDP in 2004-05—more than previous projections. The prognosis for revenue in 2005-06 based on collections during the first 7 months is encouraging; receipts from commercial taxes are projected to grow by about 27%.

14. Notwithstanding the significant increase in the fiscal deficit, the trajectory of the revised MTFP shows that GOA is expected to meet the FRBM Act’s fiscal consolidation objectives.

5 The revenue deficit is the excess of current expenditure over current revenue of the Government. The fiscal deficit

is the excess of total (current plus capital) expenditure over current revenues of the Government. 6 ADB. 2003. Assam Power Sector Development Program. Manila. (Loan 2036-IND for $250 million approved in

December 2003).

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Projections for state’s own tax revenues are conservative and adequately cushion the impact of any adverse legal outcome on the disputed new taxes, and a decline in crude oil prices. Expenditure projections are realistic and take into account the impact of repayment of salary and cost-of-living allowance arrears, merger of cost-of-living allowance with basic pay,7 and adjustment costs associated with public sector reforms. GOA showed considerable commitment to reform in not yielding to staff pressure to release salary arrears before the elections in March 2006. 15. Recent fiscal developments and the updated MTFP and its assumptions are attached as Appendix 2. GOA will review and annually update the MTFP. 16. Cash Management. GOA has adopted a policy to avoid recourse to overdrafts with the Reserve Bank of India (RBI) and has kept its Treasury open throughout the year. Because of poor cash management and serious ways-and-means problems, the state ran an overdraft over the prescribed limits, resulting in suspension of payment by RBI on a number of occasions. This problem has not arisen since FY2005. GOA also issued an office memorandum on 28 October 2005 to link cash management to the objectives of the FRBM Act. Consequently, GOA complied with this incentive-tranche requirement.

17. Fiscal Management Unit. A suitable and effective institutional backup is needed to implement the mandate of the FRBM Act. GOA has assigned this task to the FMU, which has five cells, for budget, expenditure, revenue, and pension reform, and for debt management. As required under the incentive-tranche condition, GOA has prepared a time-bound action plan to implement the FRBM Act. While this particular incentive-tranche requirement is complied with, GOA also informed ADB that it had issued an office memorandum on 17 November 2005 to explicitly recognize the role of the Finance Department, including the FMU, in relationship to the FRBM Act, to elevate their importance and role under the Act.

2. Broaden the Tax Base and Enhance Tax Collection 18. GOA has adopted a multi-pronged approach to enhance revenue buoyancy, including reforming the sales tax to eliminate cascading and to improve collection efficiency, improving revenue administration, and introducing new taxes and methods of collection. These measures are beginning to enhance revenue buoyancy (para. 13). Four policy actions were planned under the incentive tranche.

(i) Sales tax reforms. GOA has introduced the national consensus model of value-added tax (VAT) effective 1 May 2005 through the VAT Act.

(ii) State excise tax reforms. The objective of reforms has been to replace

specific duties of taxation on Indian-made foreign liquor with ad valorem duties to simplify administration and improve tax buoyancy. A bill was to be introduced in the state legislative assembly to amend the excise law to this effect. However, GOA informed ADB that under section 21 of the Assam Excise Act, an amendment would not be needed to change the tax rates. The Act has enabling provisions to allow GOA to notify rate changes with the approval of the cabinet and to table the notification in

7 Various payment arrears and staff demands/expectations entail an additional expenditure of Rs20 billion (4.3% of

GSDP). Of these, payment of dearness allowance arrears (Rs3.9 billion) and merger of dearness allowance with basic pay (Rs4.2 billion) are the more pressing demands.

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the next session of the state legislative assembly. GOA, with cabinet approval, notified the ad valorem rates of taxes on Indian-made foreign liquor on 11 November 2005 to replace the specific excise duties levied now.

(iii) Stamp duty and registration fee. The objective of reforms has been to

widen the tax base by levying duty on the market value of properties. A move toward market values will enable GOA to reduce tax rates to improve compliance. GOA has amended the Stamp Duty and Registration Act to enable the determination of “market value of property”. The amendment also authorizes the executive head of the district or a senior civil judge to determine market values. GOA issued policy guidelines, on 28 October 2005, on the methods and procedures to be followed for determining market values of property through surveys and other means. Property values will be determined by a committee of senior district officials, based on annual market surveys

(iv) Measures to improve tax administration. GOA agreed to set up

modern and well-equipped composite check posts at Srirampur (as part of incentive-tranche requirements) and Boxirhat (as part of second-tranche requirements)—two strategic entry points into the state. These check posts, are designed to enable the relevant departments to check vehicles entering the state at one place. This saves considerable time for transporters, improves the transparency of the checking process, and facilitates interdepartmental coordination. GOA has taken preparatory steps such as notification for land acquisition, and obtaining permission for building facilities on the national highway before seeking GOA cabinet approval. The GOA cabinet approved the setting up of a composite check post at Srirampur on 11 November 2005.

3. Restructure State Debt

19. The objective of this requirement is to discharge high-cost debt contracted by loss-making PSEs using the proceeds of AGPRM SDP that GOA receives from the national Government as additional plan assistance. Additional plan assistance from the national Government is given to special category states like Assam as 90% grant and 10% loan under this Program. GOA has already undertaken (i) one-time settlement of debts for PSEs of Rs722.2 million during FY2005, including PSEs that have been identified for closure under the AGPRM SDP, such as Assam Spun Silk Mills Ltd.; and (ii) one-time settlement of debts of Rs468.2 million during FY2006, related to PSEs and financial institutions.

4. Improve State Budgeting 20. The objective of this condition is to adopt operating guidelines to ensure transparency in state budgeting, particularly with respect to off-budget borrowings and contingent liabilities with regard to PSEs, implicit subsidies provided to PSEs and their losses, and salary and pension arrears. The operating guidelines on state budgeting were issued on 27 October 2005. GOA instructed the Finance Department to prepare the state budget for FY2007 in accordance with the updated MTFP. This condition has therefore been complied with. These guidelines will be further strengthened after finalization of the FRBM rules, which are being discussed within GOA.

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5. Reform Public Sector Enterprises

21. By the end of subprogram 1, GOA is committed to undertaking four key policy actions relating to PSE reforms: (i) develop and adopt a comprehensive PSE reform policy for closure, divestment, social safety net (SSN), and corporate governance and accountability; (ii) close seven identified loss-making PSEs through one-time settlement of their government-guaranteed liabilities; (iii) resolve unfunded terminal benefit liabilities of the ASEB, partly through budget support; and (iv) implement in a phased manner an SSN program for the employees of closed PSEs. GOA has complied with all incentive-tranche requirements under this policy area (paras. 22–23). 22. Closure of Public Sector Enterprises. Of the seven nonoperational PSEs8 identified for closure when the loan was negotiated, (i) three9 have been approved for closure by the cabinet, with a one-time settlement concluded for one of them10 (the others having no such debt liability); and (ii) two other PSEs11 have been recommended by GOA administrative departments to the cabinet for closure, and a one-time settlement has been undertaken for them. GOA informed ADB that it was extensively committed to closure of unproductive PSEs and had therefore initiated one-time settlement of PSEs beyond the originally identified list of PSEs. Consequently, noting the significant GOA commitment to PSE closure, ADB agreed that two PSEs12 of the original seven identified would be substituted by three other PSEs,13 which the cabinet had already approved for closure and GOA had already incurred closure adjustment costs. Consequently, this incentive tranche requirement is substantially complied with. 23. ASEB Terminal Benefit Liabilities. The in-principle decision for providing partial budgetary support for ASEB terminal benefit liabilities has already been taken by the cabinet. Provision for this expenditure has been made in the 2005/06 budget. The quantum of budget support to be provided is being determined based on the amount ASEB can collect from the regulator’s earmarked levy on the sale of electricity. Consequently, this incentive-tranche requirement is complied with.

6. Strengthen Public Private Partnership 24. The objective of this component is to establish (i) a task force to review impediments to private sector investment in Assam; and (ii) a business incubation unit and a skill development and placement unit in the Department of Public Enterprises to outsource services, promote self-employment, and provide training as part of the SSN. Both with regard to the SSN program and the related business incubation and skill development units, the necessary policy guidelines/memorandum were submitted to the cabinet, which approved them on 26 November 2005.

8 Assam Conductors and Tubes, Assam Cooperative Sugar Mills, Assam Spun Silk Mills, Assam State Minor

Irrigation Development Corporation, Assam State Minor Irrigation Development Corporation, Assam State Weaving and Manufacturing Company, Cachar Sugar Mills, and Fertichem.

9 Assam Spun Silk Mills, Fertichem, and Assam State Minor Irrigation Development Corporation. 10 Assam Spun Silk Mills. 11 Cachar Sugar Mill Ltd. and Assam State Weaving & Mfg. Co. Ltd. 12 Assam Cooperative Sugar Mills Ltd. and Assam Conductors and Tubes Ltd. 13 Match Splint Factory, Cachar Textile Industries, and Assam Government Construction Corporation Ltd.

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B. Review of Implementation of the Project Loan 25. The objective of the project loan14 is to enhance GOA’s capacity to accomplish the policy and institutional reforms under the AGPRM SDP. Accordingly, the project loan will support (i) assessments, analytical studies, and strategies for key policy reform areas addressed in the AGRPM SDP; (ii) capacity building in key institutions responsible for public finance, fiscal governance, and public administration and service delivery across various activities to improve fiscal performance and enhance governance; (iii) development and implementation of a new integrated government financial management information system (IGFMIS), and information technology support for composite check posts to enhance capacity, efficiency, and effectiveness of public finance institutions of GOA; and (iv) public awareness campaigns about reforms. 26. As the project loan must be implemented on time if the program of fiscal reforms is to be successful, GOA agreed to expedite project implementation. In particular, GOA recognized the urgent need to (i) recruit a consulting firm by early 2006 to provide critical support for the reforms under subprogram 1, and prepare a base for a possible subprogram 2; (ii) recruit an international coordination consultant by mid-December 2005 to support the FMU in various areas, including quality control of all consulting services output; (iii) procure software and hardware for the IGFMIS, which is to be completed in 2006; and (iv) expeditiously carry out a technical assessment of the coverage of the proposed IGFMIS, taking account of GOA’s existing information technology investments. 27. GOA informed ADB that it has invested in a comprehensive treasury management information system (CTMIS), some components of which will overlap with the components of the IGFMIS, which is planned to be procured on a turnkey basis as an integrated system of information and communication technology. To avoid duplication of effort and waste of resources, GOA will recruit technical advisory consultants to find the best approach to integrate CTMIS with the IGFMIS and advise GOA on how to facilitate the planned procurement of the IGFMIS. In addition, these consultants will help finalize bidding documents by assuring their quality pursuant to global best practices, and ADB procurement guidelines. They will also prepare a technical evaluation framework and criteria, and support GOA in procurement. A report on the status of compliance with project assurances is in Appendix 3.

IV. CONCLUSION 28. GOA has made significant progress in implementing reforms under the AGPRM SDP. It has fully complied with 12 of the required 13 actions and substantially with the remaining one needed for the release of the incentive tranche. In certain strategically important areas, such as enactment of the FRBM Act, and implementation of the VAT, progress exceeded the requirements for the release of the incentive tranche. The prognosis for the implementation of remaining fiscal reforms over the next four years is encouraging because (i) the necessary legal and administrative framework is in place; and (ii) the award of the Twelfth Finance Commission, and the ADB-funded AGPRM SDP will provide incentives and capacity. The outcome of the state legislative assembly elections may not adversely impact on the direction of reforms in light of the strong framework that is in place. Irrespective of the political complexion of the new state government, fiscal stabilization efforts are therefore likely to continue, though the pace of

14 ADB. 2004. Assam Governance and Public Resource Management Project. Manila. (Loan 2142-IND for $25 million

approved on 16 December 2004).

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reforms may be an issue. Apart from this political risk, the pace of implementation of reform measures planned under subprogram 1 will depend critically on the timely implementation of the project loan.

V. THE PRESIDENT’S DECISION 29. In view of the significant progress made in implementing reforms and compliance with each of the conditions for release of the incentive tranche, the President has authorized the release of the incentive tranche of the Assam Governance and Public Resource Management Sector Development Program. Accordingly, in accordance with the established procedure, the tranche release will be effected not less than 10 working days after the circulation of this Progress Report.

Appendix 1

10

REVIEW OF THE INCENTIVE-TRANCHE CONDITIONS

Achievements

Action Implementation Status

1. Enhance Fiscal Responsibility GOA will (i) update the MTFP, (ii) introduce an FRB in the state’s legislative assembly, (iii) adopt cash management discipline as part of fiscal responsibility, and (iv) implement the time-bound action plan for the FMU.

MTFP and Fiscal Responsibility Bill: GOA will (i) update the MTFP pursuant to quarterly reviews of the MTFP and remedial action reports on targets; and (ii) GOA will introduce an FRB in the state’s legislative assembly, consistent with the updated MTFP, including targets for deficit reduction, fiscal transparency, GOA guarantees, a prohibition on recurrence of fiscal year-end negative cash balances, and authority of the FMU related to the FRB.

Complied with. The Fiscal Responsibility Budget Management (FRBM) Act has been enacted. The GOA cabinet approved the amendment to the FRBM Act on 26 August 2005 to eliminate revenue deficits by FY2009, provide fiscal transparency, and limit GOA guarantees. GOA revised its updated MTFP in consultation with ADB. GOA issued an operational guideline on 28 October 2005 under its policy (see policy guideline on cash management below), which will link the cash management system to the objectives of the FRBM Act. With respect to the authority of the FMU, to explicitly emphasize that authority in relation to the FRBM Act, GOA issued an office memorandum on the authority of the Finance Department, including the FMU, on 17 November 2005.

Cash Management: GOA will adopt a policy, as of 30 April 2005, of not resorting to overdrafts with the Reserve Bank of India to ensure that there are no year-end negative cash balances.

Complied with. GOA issued a policy guideline on cash management on 20 October 2005. To avoid year-end overdraft, all administrative departments have been advised to plan their draw of funds against the budgeted amount uniformly throughout the year, and closely monitor the draw and use of funds smoothly throughout the financial year.

FMU: GOA will have implemented the time-bound action plan for the FMU.

Complied with. To streamline the functioning of FMU constituted under the Finance Department to act as a focal point for implementing fiscal reforms, GOA approved a time-bound action plan for the FMU and the five cells (for budget, expenditure, revenue, and pension reform, and for debt management) constituted under the FMU on 23 September 2005.

2. Broaden the Tax Base GOA will (i) introduce tax policy reforms on VAT or an equivalent law, excise duty, and stamp duty valuation methods; and (ii) approve a composite check post.

Revenue administration: GOA will approve and notify a composite check post at Srirampur.

Complied with. The cabinet approved setting up the composite check post on 11 November 2005. GOA has taken all preparatory steps to build the check post.

Sales tax policy: GOA will introduce a bill in the state’s legislative assembly to

Complied with. VAT was introduced in the state on 1 May 2005 through

Appendix 1

11

Achievements

Action Implementation Status

amend the VAT bill or to introduce its equivalent in the form of a destination-based multipoint sales tax.

the VAT Act.

State excise policy: GOA will introduce a bill amending the Excise Act in the state’s legislative assembly to convert specific excise duties on Indian-made foreign liquor into an ad valorem levy.

Complied with. The GOA cabinet approved substitution of specific excise rates by ad valorem duties on 11 November 2005 under section 21 of the Assam Excise Act and issued a notification.

Stamp duties and registration fees policy: GOA will approve and notify objective valuation methods for properties.

Complied with. The Stamp Act has been amended by the state legislative assembly. GOA issued a policy memorandum on the assessment methodology of the objective valuation methods for properties on 28 October 2005.

3. Restructure State Debt GOA will agree on debt swaps/debt settlement of high-interest institutional loans (and guarantees given to PSEs).

Debt swaps: GOA will agree on debt swaps/negotiated settlements of high-interest institutional loans (and guarantees given to PSEs).

Complied with. GOA has already undertaken (i) one-time settlement of debts for PSEs of Rs722.2 million during FY2005, including PSEs that have been identified for closure under the AGPRM SDP, such as Assam Spun Silk Mills Ltd.; and (ii) one-time settlement of debts of Rs468.2 millionduring FY2006, with a number of PSEs and financial institutions, and banks. Substantive documentation on all concluded one-time settlement of debt during FY2005 and FY2006 has been provided.

4. Improve State Budgeting GOA will (i) approve operating guidelines on state budget planning, and (ii) start preparing a state budget for FY2007 incorporating revised MTFP projections.

Budget planning, preparation, and presentation: GOA will (i) approve the operating guidelines on state budgeting covering budget presentation and content, charts of accounts, off-budget borrowings, contingent liabilities, arrears, PSE losses, and subsidies; and (ii) start preparing a state budget for FY2007 incorporating revised MTFP projections.

Complied with. The operating guidelines on state budgeting planning were issued on 27 October 2005. GOA has instructed the Finance Department to prepare the next budget based on the revised MTFP projections.

5. Reform PSEs GOA will (i) approve the SSN design, (ii) provide budget for ASEB terminal benefit liabilities, and (iii) approve one-time settlement of PSE loans to inoperative PSEs identified for closure.

SSN program: GOA will approve, issue, and notify the SSN program designs.

Complied with. Policy guidelines for SSN were approved by the cabinet on 26 November 2005.

Closure of PSEs: GOA will approve one-time settlements of PSE debts of identified inoperative PSEs to be closed.

Substantially complied with. See para. 22 of the report.

ASEB terminal benefits: GOA will provide budget for ASEB terminal benefit liabilities.

Complied with. GOA agreed to cover any residual liabilities that arise after meeting the requirements of terminal benefits from the proceeds of the ADB loan and the award of the AERC relative to sale of electricity.

Appendix 1

12

Achievements

Action Implementation Status

6. Strengthen Public-Private Partnership

GOA will approve the establishment of institutional mechanisms to facilitate PSE employment training and PSE outsourcing services.

Business incubation unit and skill development and placement unit: GOA will establish the units in DPE to facilitate PSE job training and PSE outsourcing services.

Complied with. This requirement has been merged with the SSN guidelines. The cabinet approved the policy on 26 November 2005.

ASEB = Assam State Electricity Board, DPE = Department of Public Enterprises, FMU = fiscal management unit, FRB = Fiscal Responsibility Bill, FRBM = Fiscal Responsibility Budget Management, FY = fiscal year, GOA = government of Assam, MTFP = medium-term fiscal plan, PSE = public sector enterprise, VAT = value-added tax.

Appendix 2

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MEDIUM–TERM FISCAL PLAN IN ASSAM

1. Assam’s fiscal condition deteriorated in the recent past and remains fragile. However, the conditions for fiscal correction are at their most favorable. With the passage of the Fiscal Responsibility and Budget Management (FRBM) Act in 2005, a binding legal and administrative framework to guide fiscal correction is in place. ADB’s program loan assistance has provided and will provide the time-bound discipline and incentives to properly sequence and time the reform measures. The generous fiscal award by the Twelfth Finance Commission (TFC), which has provided a special dispensation to poorer states, will provide adequate resources, and a strong motivation to reduce the fiscal deficit. At base-year prices and assumptions, the TFC award envisages a transfer of Rs249.9 billion (53.6% of base year GSDP) to Assam during 2005/06–2009/10 in the form of shared taxes, special grants to improve essential social services and emergency relief, and revenue-gap grants. This is significantly higher than Rs132.8 billion provided by the Eleventh Finance Commission (42.3% of base year GSDP) for the period (2000/01–2004/05). 2. The government of Assam (GOA) has so far demonstrated a strong political will to take difficult measures to restore the state’s fiscal balance. There are, however, risks. Foremost is the continuation of political stability and will during the reform period. Elections to the state legislative assembly are expected in March 2006, which could change the political complexion of GOA. Given the positive gains from fiscal reforms, the new government may not politically sway away from the reform path. Though the national Government and GOA have shown strong commitment to pursue composite dialogue to contain such insurgency, risks may also come from an upsurge in insurgency movements. Besides impacting adversely on the economy, such developments would entail additional spending on law and order and rehabilitation. Another key risk factor is the continued progress in power sector reforms, which is essential for making good progress in fiscal correction. ADB has helped GOA reform the power sector. This appendix presents (i) an assessment of the fiscal performance of GOA, and (ii) the revised Medium-Term Fiscal Plan (MTFP) for 2005/06–2008/09, prepared in October 2005.

Assam Fiscal Situation: A Summary

(% of GSDP) Items 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Pre Act. Proj Proj Proj Proj 1. Total Revenue 19.36 22.97 23.92 23.59 23.54 23.45 Own Revenue 7.52 8.72 8.59 8.60 8.65 8.70 2. Current Expenditure 21.06 24.81 25.54 24.11 23.82 23.38 3. Capital Expenditure (Net) 1.76 4.09 2.30 2.45 2.59 2.74 4. Revenue deficit /surplus (-): [Rows 2-1] 1.71 1.84 1.61 0.52 0.29 -0.08 5. Fiscal deficit /surplus (-): [Rows 4+3] 3.47 5.93 3.91 2.97 2.88 2.66 Act. = actual date, Proj = projections, GSDP = gross state domestic product.

3. The fiscal situation deteriorated sharply in 2004/05 despite a notable increase in revenue, including own revenue. While the revenue deficit increased modestly, the fiscal deficit increased to 5.93% of GSDP, largely because of (i) GOA’s assumption of responsibility for repaying the dues of the Assam State Electricity Board (ASEB) to the electricity utilities owned by the national Government, which sell power to the state;1 (ii) payment of salary and interest arrears; and (iii) settlement of contingent liabilities of loss-making public sector enterprises (PSEs). 1 This was done as part of requirements under ADB. 2003. Assam Power Sector Development Program. Manila.

(Loan 2036-IND for $250 million approved in December 2003).

Appendix 2

14

ASEB was restructured in the initial stages of GOA’s fiscal consolidation program because it has the largest potential claim on the budget. GOA paid Rs1.1 billion under the current (revenue) budget to clear arrears ASEB’s current liabilities. Under the capital budget, GOA incurred one-time expenditure of Rs8.5 billion (2% of GSDP) by issuing power sector bonds to the Government-owned power utility companies to settle the payments due from ASEB.

4. Notwithstanding this slip in performance because of front-loading of fiscal adjustment, projections for 2005-09 are encouraging and GOA is expected to meet its objectives of reducing fiscal deficit close to 3% of GSDP, and eliminating the revenue deficit by 2008-09 as stated in the FRBM Act. Figure A3.1 shows the overall fiscal trajectory for 2004–2009 of the revenue and fiscal deficits of GOA, which are expected to decrease to fully attain the state’s fiscal goal under the FRBM Act. Despite a sharp up-tick in 2004-05 as a consequence of the issuance of bonds for one-time settlement of ASEB liabilities, the fiscal deficit is expected to fall to less than 3% of GSDP by 2008-09.

GSDP = gross state domestic product. 5. The reduction in revenue deficit is to be achieved largely through compression of current expenditures over the projection period. Expenditure projections are realistic and take into account the impact of repayment of salary and dearness allowance arrears, merger of dearness allowance with basic pay,2 and adjustment costs associated with public sector reforms. A major contributor to the reduction in current expenditures will be the expected fall in interest payments. Under the TFC award, the Government, which is the primary lender, will consolidate all its loans to GOA outstanding as of the end of March 2005 into a single loan carrying a lower interest rate of 7.5%. The swap of high-interest loans with low-cost ADB funds will further reduce the average cost of interest to below 9%. The proposed debt relief equivalent to 56% of reduction in revenue deficit from 2005-06 onward is expected to reduce the stock of debt and interest payments. A freeze on the number of posts and the current policy of restricting new recruitments to 70% of attrition because of retirement will gradually reduce the salary bill. Even though GOA’s revenue performance was good in 2004-05 and 2005-06, revenue projection for the state’s own tax revenues are based on conservative assumptions and adequately cushion 2 Various payment arrears and staff demands/expectations entail an additional expenditure of Rs20 billion (4.3% of

GSDP). Of these, payment of dearness allowance arrears (Rs3.9 billion) and merger of dearness allowance with basic pay (Rs 4.2 billion) are the more pressing demands.

Figure A3.1: Fiscal and Revenue Deficits (as % GSDP)

(1.00) -

1.00 2.00 3.00 4.00 5.00 6.00 7.00

2004-05 2005-06 2006-07 2007-08 2008-09

Revenue deficit Fiscal Deficit

Appendix 2

15

the impact of any adverse legal outcome on the disputed new taxes, and a decline in the crude oil prices. Figures A3.2 and A3.3 show the combined impact of fiscal correction, the debt write-off and interest cost reduction schemes on revenue deficit and debt stock.

GSDP = gross state domestic product.

GSDP = gross state domestic product, Rec = receipts. 6. The projections of the revised MTFP vary from those assumed when the loan was prepared, because of (i) a significant increase in shared taxes from the national Government as mandated by the TFC; (ii) a significant increase in grants tied to upgrading expenditures on health, education, calamity relief, and maintenance of roads, buildings, and forests; (iii) debt

Figure A3.3: Revenue Receipt, Revenue Expenditures (as % GSDP) and Revenue Deficit (as % Revenue Receipt)

21.50 22.00 22.50 23.00 23.50 24.00 24.50 25.00 25.50 26.00

2004-05 2005-06 2006-07 2007-08 2008-09 (1.00)

-

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

Total Revenue Revenue Expenditure Revenue Deficit/Revenue Rec

Figure A3.2: Revenue Deficit, Debt Stock, Interest Payment (as % GSDP)

(0.50) -

0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00

2004-05 2005-06 2006-07 2007-08 2008-09 37.00

37.50

38.00

38.50

39.00

39.50

40.00

40.50

Debt Stock Interest Revenue Deficit

Appendix 2

16

relief scheme for promoting cuts in revenue deficit; (iv) reduction in the amount of interest payment as a result of the relief provided by the national Government and as a consequence of (iii); and (v) GOA’s decision to front-load the adjustment costs of reforms, particularly those relating to PSE reforms. All these factors emerged after the national Government accepted the TFC award. The variation between the projections of the revenue deficit and the fiscal deficit made when the loan was prepared and in October 2005 are in Figure A3.4. The original expenditure projections, however, did not adequately take into account arrears in salary, interest, and other liabilities. In addition, GOA’s decision to front-load the cost of fiscal adjustment to take advantage of the TFC’s debt write-off scheme could not be anticipated earlier. Consequently, a large part of the difference in projections is a result of the settlement of ASEB liabilities. Subsequently, however, the revised estimates gradually converged with the original estimates.

GSDP = gross state domestic product, RD = revenue deficit, FD = fiscal deficit.

Figure A3.4: Revenue and Fiscal Deficit: Revised vs Original (as % GSDP)

(1.00)

-

1.00

2.00

3.00

4.00

5.00

6.00

7.00

2004-05 2005-06 2006-07 2007-08 2008-09

RD Revised RD Original FD Revised FD Original

Appendix 2

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Government of Assam: Medium-Term Fiscal Plan (2005-09) as of October 2005

( % GSDP) Items 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Pre Act. 1. Total Revenue (a+b+c+d) 19.36 22.97 23.92 23.59 23.54 23.45 a. Tax Revenue 5.16 6.28 6.31 6.39 6.49 6.61

i. Sales Tax 3.87 4.86 4.88 4.94 5.02 5.10

ii. State Excise 0.32 0.33 0.34 0.35 0.36 0.37

iii. Stamp & Duties 0.15 0.17 0.17 0.17 0.18 0.19

iv. Motor Vehicle 0.35 0.35 0.36 0.37 0.38 0.40

v. Other Taxes 0.47 0.57 0.56 0.56 0.56 0.56 b. Own Nontax Revenue 2.36 2.45 2.28 2.21 2.15 2.08 Own Revenue (a+b) 7.52 8.72 8.59 8.60 8.65 8.70 c. Share of Central Taxes 5.39 5.99 6.30 6.61 6.90 7.16 d. Grants 6.45 8.26 9.03 8.38 7.99 7.59 i. State Plan Grants 4.35 5.21 5.06 4.90 4.72 4.53 (of which ADB Grants) - 0.46 - - - - ii. Centrally-Sponsored Schemes 1.39 1.92 1.78 1.64 1.50 1.37 iii. Finance Commission Grants 0.46 0.88 1.95 1.63 1.57 1.51 iv. Non-Plan Grants 0.25 0.25 0.24 0.22 0.20 0.18 2. Recovery of loans & Advances 0.10 0.09 0.09 0.09 0.09 0.09 3. Revenue Expenditure 21.06 24.81 25.54 24.11 23.82 23.38 a. Interest 3.60 4.39 4.00 3.29 3.19 3.10 b. Salary 11.11 11.12 11.02 10.87 10.67 10.43 c. Pension 2.27 2.46 2.50 2.54 2.56 2.57 d. PSE Restructuring - 0.17 1.03 0.40 0.38 0.29 f. Others 4.09 6.68 6.99 7.02 7.02 6.99 4. Capital Outlay 1.55 1.92 2.06 2.21 2.35 2.49 5. Lending 0.32 2.25 0.33 0.33 0.34 0.34 6. Revenue deficit 1.71 1.84 1.61 0.52 0.29 (0.08) Reduction in Revenue Deficit (-) - - - (0.96) (0.19) (0.34) 7. Fiscal Deficit 3.47 5.93 3.91 2.97 2.88 2.66 8. Debt Stock 35.53 39.26 40.27 39.55 39.05 38.13 9. Revenue Deficit/Revenue Rec.(%) 8.03 6.74 2.22 1.22 (0.32) 10 Revenue Deficit/Own Revenue 67.99 45.57 34.54 33.28 30.55 11. Fiscal Deficit /GSDP 12. GSDP 43,204.89 46,661.28 50,394.18 54,425.72 58,779.78

GSDP = gross state domestic product, Rec. = receipts.

Appendix 2

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Medium-Term Fiscal Framework

The MTFP is based on the following assumptions: • A nominal GSDP growth of 8% in the base year reaching a growth of 9.5% by

2008/2009 • 5% inflation • A fall in average cost of loans from 9% to 8.6% • 7% growth in salary bill; with a 70% replacement rate for retired staff • An increase in capital expenditure to reach 2.5% of GSDP by 2008-09 • 9% increase in operational spending • Debt write-off equivalent to 56% of reduction in the revenue deficit from 2006-07

onwards • Adequate provision of resources for PSE reforms • Reasonable and gradually increasing growth rates for state’s own tax revenues3 • 6% growth in state’s own nontax revenues • Transfers from the national Government based on the TFC award and

assumptions

3 MTFP assumes that the growth rates of taxes accelerate gradually from 2005 to 2009. Growth rates used for

different taxes are as follows: sales tax 8.5%-11.4%, state excise duty 9.8% -12.8%, stamps and registration duties 10%-13%, motor vehicle taxes 7.2%-13.3%, and other taxes 7%-9%.

Appendix 3

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PROJECT ASSURANCES (Conditions not related to tranche release)

Achievements Action Implementation Status

Project Execution and Implementation 1. The Finance Department shall be responsible for the execution of the project.

Complied with. The Finance Department is the focal point and mainly responsible for the execution of the project on behalf of the government of Assam.

2. The fiscal management unit (FMU) as set up in the Finance Department shall be responsible for day-to-day implementation of the Project and its coordination. Save for exceptional organizational requirements, the staff assigned to the FMU shall be retained for the entire duration of project implementation in the FMU and any vacancy in the FMU shall be filled immediately. A project manager shall be appointed to the FMU and shall have the authority to make decisions in relation to facilitating procurement of equipment and recruitment of consultants under the Project.

Complied with. To support assessments, analytical studies,and strategies for key policy reform areas addressed in the AGPRM SDP’s governance and public administration, development and implementation of a modern integrated public financial management information system, recruitment of consultants, and public awareness underpinning required for the sustainability of all reforms, the FMU was set up in the Finance Department and a project manager was appointed to handle all these assignments as a focal point. Five cells were constituted under the FMU to handle budget, expenditure, revenue, and pension reform, and debt management.

3. The program steering committee referred to in the AGPRM SDP Loan Agreement shall also coordinate the Project.

Complied with. The program steering committee was established mainly to provide strategic overview and to ensure effective use of funds under the AGPRM SDP and Project. The committee is headed by the chief secretary and includes all principal secretaries and commissioners of departments concerned, and is also responsible for coordinating the Project as well as the Program.

Progress Reports 4. The Finance Department shall cause the FMU to prepare the quarterly progress reports on project implementation that shall contain a narrative description of progress made during the period, changes to the implementation schedule, problems or difficulties encountered and remedial actions taken, performance of project implementation consultants where applicable, and the work to be carried out in upcoming quarter. The reports shall also include a summary financial account for the Project, consisting of project expenditures to date. The Finance Department shall cause the project consultants to submit (i) an inception report within 2 months after their services start, (ii) a first review report after 18 months, (iii) a second review report after 36 months, and (iv) draft final report at the end of 52 months, with the final report submitted at the end of the assignment.

Complied with. The Finance Department prepared quarterly progress reports for June 2005 and September 2005 and sent them to ADB. The Finance Department is planning to recruit an international coordination consultant by mid-December 2005 to support the project manager of FMU in various areas, including quality control of all consulting services output. The Finance Department is scheduled to recruit technical advisory consultants by the end of November 2005 to provide a technical assessment report to assess the means of accomplishing a proposed integrated public financial management system, taking account of the Government’s existing information technology investments and finalize the bidding documents for the bid.

Program Implementation and Benefit Monitoring

5. The Finance Department shall undertake together with ADB, periodic reviews during the

Compliance ongoing. The FMU will operate a system to monitor and evaluate the results being attained by the

Appendix 3

20

Achievements Action Implementation Status project implementation, to evaluate the scope, implementation arrangements, progress, and achievement of the project objectives. For this, within nine months of the effective date, the Finance Department shall cause FMU to set up a project performance management system.

project using the targets, indicators, monitoring mechanisms, and assumptions and risks in the framework.

Project Review 6. In addition to regular project reviews by ADB, the Borrower, the state, and ADB shall undertake two comprehensive reviews of the Project 18 months and 36 months after it starts.

Compliance ongoing. The Finance Department and ADB will undertake comprehensive reviews focused on the assessment of implementation performance against performance indicators and objectives, and identify any constraints or problems. Project comprehensive reviews will be implemented around mid-2006 and late 2007.

ADB = Asian Development Bank, FMU = fiscal management unit.