World Bank Document · 2016. 7. 16. · South Asia Region This Document has a ... B. Andra Pradesh Vision 2020 ..... 4 C. The Reform Program ... Annex A: Andhra Pradesh Letter of

Document ofThe World Bank

FOR OFFICIAL USE ONLYReport No. P7508-IN

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON

A CREDIT IN THE AMOUNT OF SDR 101 MILLION (US$125 MILLION EQUIVALENT)

AND

A LOAN IN THE AMOUNT OF US$125 MILLION

TO

INDIA

FOR

THE ANDHRA PRADESH ECONOMIC REFORM PROGRAM

February 15, 2002

Poverty Reduction and Economic ManagementSouth Asia Region

This Document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. It's contents may not be otherwise disclosed without World Bank authorization

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CURRENCY EQUIVALENTS

Currency units: Rupees (Rs.) as of February 14, 2002US$1 = Rs. 48.34

Units

1 lakh = 100 thousand1 crore = 10 million

GOVERNMENT'S FISCAL YEAR

April 1-March 31

ABBREVIATIONS AND ACRONYMS

ADB - Asian Development BankAP - Andhra PradeshAPL - Adaptable Program LoanAPDMS - Andhra Pradesh Development Monitoring SystemAPERP - Andhra Pradesh Economic Restructuring ProjectAPFRSHP - Andhra Pradesh First Referral State Health ProjectAPERL - Andhra Pradesh Economic Reform Loan/CreditAPSWAN - Andhra Pradesh State Wide Area NetworkBOT - Build-Operate-TransferBRO - Budget Release OrderCARD - Computer-aided Administration Registration DepartmentCAS - Country Assistance StrategyCDCC - Centralized Documentation and Clearances CenterCDF - Comprehensive Development FrameworkCDT - Commercial Tax DepartmentCGG - Centre for Good GovemanceCSCAR - Cabinet Sub-Committee on Administrative ReformsCST - Central Sales TaxCY - Calendar YearDFID - Department of International DevelopmentDPEP - District Primary Education ProgramDPIP - District Poverty Initiatives ProjectDVD Digital Video DiskERC - Electricity Regulatory Commission (ERC)FD - Finance DepartmentFRA - Fiscal Responsibility ActFRF - Fiscal Reform FacilityFY - Fiscal YearGAD - General Administration DepartmentGDP - Gross Domestic ProductGIS - Geographic Information SystemGoAP - Government of Andhra PradeshGPM - Governance and Public ManagementGol - Govemment of IndiaGSDP - Gross State Domestic ProductHRD - Human Resource DevelopmentHRM - Human Resource ManagementIBRD - Intemational Bank for Reconstruction and Development

FOR OFFICIAL USE ONLY

IDA - International Development AssociationI&CADD - Irrigation and Command Area Development DepartmentIT - Information TechnologyJFM - Joint Forest ManagementLDs - Line DepartmentsM&E - Monitoring and EvaluationMDGs - Millennium Development GoalsMPHS - Multi-Purpose Household SurveyMTFF - Medium-term Fiscal FrameworkNCAER - National Council for Applied Economic ResearchNFHS - National Family Health SurveyNGOs - Non-Govenumental OrganizationsNSS - National Sample SurveyOED - Operations Evaluation DepartmentO&M - Operation and MaintenancePAC - Public Accounts Conmlittee of Legislative AssemblyPEs - Public EnterprizesPEM - Public Expenditure ManagementPSAMU - Poverty and Social Assessment Monitoring UnitPSUs - Public Sector UnitsSC - Scheduled CasteSKIMS - Secretariat Knowledge Information Management SystemSMART - Simple, Moral, Accountable, Responsive and TransparentSPEM - State Poverty Eradication MissionST - Scheduled TribeTA - Technical AssistanceTOR - Terms of ReferenceTWINs/eSeva - Twin Cities Network ServicesUP - Uttar PradeshVAT - Value Added TaxVRS - Voluntary Retirement SchemeWUAs - Water Users' Associations

Vice President Mieko NishimizuCountry Director Edwin R. LimSector Director Sadiq AhmedSector Manager Sanjay PradhanTask Leader Mark Sundberg

This document 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.

INDIAANDHRA PRADESH ECONOMIC REFORM LOAN/CREDIT

TABLE OF CONTENTS

Pane No.

I. THE ECONOMIC SETTING AND RECENT DEVELOPMENTS IN INDIA

A. Introduction .............................................. 1B. The National Context for State Reform .............................................. 1

II. ANDHRA PRADESH: DEVELOPMENT CHALLENGES AND REFORM PROGRAM

A. Development Challenges ................................. 2B. Andra Pradesh Vision 2020 ................................ 4C. The Reform Program ................................. 5D. The Bank's Assistance to Andhra Pradesh ................................ 8

III. ANDHRA PRADESH'S FISCAL AND GOVERNANCE REFORMS

A. Fiscal Reform ................................... B. Public Expenditure Management Reform .................................. 15C. Govemance and Public Management Reform .................................. 17

IV. THE PROPOSED LOAN/CREDIT

A. The Borrower and Amount ............................................. 23B. Actions to Activate APERL ............................................. 24C. Subsequent APERL Operations ............................................. 25D. Implementation Arrangements and Performance Monitoring ............................................. 26E. Loan/Credit Adrninistration ............................................. 27

V. LESSONS LEARNED, BENEFITS AND RISKS

A. Lessons Learned ............. 28B. Benefits ............. 28C. Risks ............. 30

ANNEXES

Annex A: Andhra Pradesh Letter of Development Policy with Policy MatrixAnnex B: Andhra Pradesh Power Sector Reform ProgramAnnex C: Poverty and Social Development in Andhra PradeshAnnex D: Improving Public Financial Accountability in Andhra PradeshAnnex E: Statistical Annex

Map

Task TeamTask Manager Mark Sundberg (Senior Economist)

Peer Reviewers Helen Sutch (Sector Manager, PRMPS); Jeffrey Hammer (Lead Economist,DECRG); Luis Serven (Sector Lead Specialist, PREM)

Fiscal/Public Expenditure Trichur K. Balakrishnan (Senior Financial Analyst); Arindham Das GuptaManagement (Consultant); Priya Mathur (Research Analyst); A. Premchand (Consultant);

V.J. Ravishankar (Senior Economist); Salvatore Schiavo-Campo (LeadSpecialist); Mark Sundberg (Senior Economist)

Administrative Reform Robert Beschel (Senior Public Sector Specialist); Vikrarn Chand (Senior PublicSector Specialist); Edward Mountfield (Economist); Pachampet Sundaram(Consultant)

Legal and Judicial Reform Syed I. Ahmed (Senior Counsel); Richard Messick (Senior Public SectorSpecialist)

Public Enterprise Reform Paramita Dasgupta (Economist); Rajni Khanna (Research Analyst); SunitaAnd Deregulation Kikeri (Lead Private Sector Development Specialist)

Poverty Monitoring & Valerie Kozel (Senior Economist); Reidar Kvam (Senior Social Scientist); PeterSocial Analyisis Lanjouw (Senior Economist); Salman Zaidi (Economist)

Sectoral Inputs Bhavna Bhatia (Senior Energy Economist); Mohinder Gulati (Senior FinancialAnalyst), Rajesh Sinha (Financial Analyst), Sajitha Bashir (Senior EducationEconomist, education); Sumir Lal (Advisor, External Affairs)

Legal Counsel Syed I. Ahmed (Senior Counsel)

FMS/Disbursement Officer Hyacinth Brown (Senior Financial Management Specialist)

Team Assistants Shunalini Sarkar; Jillian Tullet

INDIA

ANDHRA PRADESH ECONOMIC REFORM LOAN/CREDIT

Loan and Credit Summary

Borrower: Government of India.

Implementing Agency: Government of Andhra Pradesh.

Beneficiary: State of Andhra Pradesh.

Amount: Credit: SDR 101 million (US$125 million equivalent).Loan: US$125 million.

Terms: IDA: Standard with 35 years maturity and 10 years grace period.Loan: Payable in 20 years, including 5 years of grace and annuityprincipal repayment; at six-month LIBOR for USD plus variable spreadfor Variable-Rate Single Currency Loans.

Onlending Terms: Standard terms of central resource transfers for state developmentalbudgets.

Description: The Andhra Pradesh Economic Reform Loan/Credit (APERL) supportsthe State of Andhra Pradesh's fiscal and governance reform program.The fiscal reform program aims at fiscal stabilization to reduce the debtburden and restore sustainability to public finances, improve publicresource mobilization, and restructure public spending toward prioritydevelopment areas. This is accompanied by public expendituremanagement reform to strengthen financial management capacity andinstitutions, improve the realism and credibility of the budget, enhancefiscal transparency and accountability, and introduce greater efficiencyto operational management. The program of governance reformincludes strengthening anti-corruption efforts, civil service reform,electronic governance, public enterprise reform, and a program ofpoverty monitoring and analysis. There are fourteen specific "triggers"as upfront actions for completion of the APERL, as detailed in thePresident's Report (MOP), all of which have been completed.

Benefits: Implementation of the APERL program of reforms to date representssubstantial progress in Andhra Pradesh's efforts to achieve its APVision 2020 program and is consistent with efforts by the Governmentof India to stimulate reform in the states. The main development goalsinclude creating an environment in the state conducive to acceleratinggrowth, reducing poverty, and making government simple, transparent,accountable and responsive. The expected benefits are : (i)strengthening of the government's fiscal and financial health; (ii) amore conducive investment climate for private sector growth; (iii) moreefficient and effective public service delivery; and (iv) improved socialoutcomes and reduced poverty.

I

Risks: The major risks arise from: (i) difficulty in adhering to the fiscalframework and budget constraints, including the reduction of powersector subsidies; (ii) slippage in implementation of the power sectorreform program; (iii) possible change in leadership and/or opposition toreform by vested interests; and (iv) shocks external to AP, such as aglobal/India slowdown. Andhra Pradesh's stable political outlook andstrong track record of commitment to reform have contained these risksto date.

Disbursement: The loan/credit would be disbursed in one tranche in an amountequivalent to US$250 million upon effectiveness.

Project ID Number: IN-P073 113

REPORT AND RECOMMENDATION OF THE PRESIDENTOF THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND

THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENTTO THE EXECUTIVE DIRECTORS

ON A CREDIT IN THE AMOUNT OF SDR 101 MILLION (US$125 MILLIONEQUIVALENT) AND A LOAN IN THE AMOUNT OF US$125 MILLION TO INDLA

FOR THE ANDHRA PRADESH ECONOMIC REFORM PROGRAM

I. THE ECONOMIC SETTING AND RECENT DEVELOPMENTS IN INDIA

A. Introduction

I . The state of Andhra Pradesh (AP) is one of India's leading reforming states and animportant state for the World Bank Group under its Country Assistance Strategy (CAS), whichcommits the Bank to support state-level reforms, seen as critical to the acceleration of growth andreduction of poverty. The proposed Andhra Pradesh Economic Reform Loan/Credit (APERL)supports fiscal and governance reforms in Andhra Pradesh. This operation is being preparedjointly by the United Kingdom Department for International Development (DFID), and supportedfinancially by the DFID, for which Andhra Pradesh is a key focus state as well.

B. The National Context for State Reform

2. India is expected to register growth of about 5% in the fiscal year 2001/02, good byglobal standards, but below the average annual growth rate of 6% achieved over the last decade.Causes for the slowdown in growth include the global slowdown, negative investor sentiment dueto the slow pace of reforms at the national level, weak agricultural demand on the back ofsuccessive poor agricultural seasons, and the oil price rises last year. The slowdown in growth hashit the fiscal position hard. Central government's tax revenues for the first eight months of2001/02 were 3% below the figure for the first eight months of last fiscal year, resulting in likelyfiscal slippage in the current fiscal year. Overall, at about 10% of GDP, the size of the combinedcentral and state government deficit is a matter of substantial concern. However, India'smacroeconomic vulnerability continues to be contained by a strong external position, and lowinflation. The current account balance is only about -0.5% of GDP. Reserves are US$49 billionor 9 months of imports (January 2002). The largely closed capital account and low and decliningexternal debt as a percentage of GDP continue to contain India's vulnerability to shocks. Theinflation rate is low at around 5% p.a. or below, and has been declining in recent years.

3. There is an increasing recognition of the importance of state reforms to solve India'snational economic problems, including the large national fiscal deficit (where the states' share isnow close to one-half). Significant progress is being made in a number of important areas tostrengthen the incentives facing states to undertake fiscal reforms:

* The Government of India (Gol)' s Fiscal Reform Facility (FRF) has taken off. Elevenstates have so far received additional funding from Gol on the basis of improved fiscalperformance.

* An effort is being made in the power sector to harden budget constraints, improvegovernance and instill discipline, and prevent states from avoiding power reformsthrough running arrears with central utilities and suppliers (such arrears now constituteover 2% of GDP). Gol has proposed a plan for securitization of overdue payables of theSEBs to the central government owned power and coal companies and an incentive-basedprogram to achieve performance targets, to which states, including Andhra Pradesh, havebegun to sign up.

4. IMF perspective. The May 2001 staff report for the 2001 Article IV consultation notedthat, notwithstanding India's relatively strong growth performance in 2000/01, there remainimportant impediments to achieving the authorities' objectives of higher growth and fasterpoverty reduction. The staff report cited fiscal consolidation and implementation of the CentralGovernment's agenda for structural reform as two critical prerequisites for achieving theseobjectives. On the fiscal front, the staff stressed the need for a clear and time-bound program offiscal deficit reduction, and supported the authorities' stated objective of eliminating the revenuedeficits of the central and state governments. Expenditure and tax reforms to reduce subsidiesand enhance revenue mobilization were recommended. A broad range of structural reforms wasalso seen as necessary to support fiscal consolidation and to enable India to benefit from theglobalization of trade and investment flows. Key measures identified included deregulation ofpower, industrial, and labor markets, liberalization and reform of agriculture, trade liberalization,and continued financial sector reforms. The importance of these key messages has beenreinforced recently, with signs of a further weakening of economic activity and a weaker growthoutlook, difficulty in following through on the structural commitments in the last Budget,evidence that 2001/02 fiscal targets will be missed, and the increasingly uncertain globalenvironment.

H. ANDHRA PRADESH: DEVELOPMENT CHALLENGES AND REFORM PROGRAM

A. Development Challenges

5. Andhra Pradesh is the fifth largest state in India with a population of 76 million people.Per capita income at $380 in 1999, is about 90% of the All-India average. Around 19 millionpeople (one-quarter of the population) live in poverty, depend largely on agriculture, and areoften outside the reach of public services.

6. Poverty and Human Development. Official poverty estimates for AP show significantlylower levels than the national average, with head count rate at 16% in AP compared with 26%nationally in 1999/00 (Table 1). However, there is a great deal of debate around Gol's officialpoverty estimates (Annex C), and other estimates for AP suggest a higher poverty rate, andslower progress in poverty reduction in the 1990s.1 Moreover, evidence suggests that while urbanpoverty appears to have fallen dramatically in AP, there has been less rapid progress in reducingrural poverty. Casual labor in agriculture is the main occupation for more than 40% of thepopulation, many of them poor, and the average size of land holdings in the state is considerablysmaller than in the rest of the country. While the rural economy accounts for over 70% ofemployment, it contributes less than one-third of Gross State Domestic Product (GSDP). The lowrate of agricultural growth over the 1990s, combined with high volatility of output hasundoubtedly slowed the rate of poverty reduction in rural areas. Hence accelerating agriculturalgrowth as well as growth in the rural non-farm sector will be essential for reducing rural povertyin the future.

' Alternative estimates using the official poverty line indicate overall poverty of around 19% in 1999/00, with ruralpoverty down by just 1 percentage point since 1993/94, and urban poverty down by 11%. With a re-estimated APpoverty line, which is also being challenged, poverty incidence is even higher.

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Table 1: Andhra Pradesh: Poverty Per Capita Income and Selected Human Development Indicators

YearState Indicators 1980 1990 2000

All India Per Capita incoame (1993194 Rs.) 5,891 8,266 11,799Infant Mbrtality Rate (per '000 live births) 114 80 71Literacy Rate 44 52 65Female Literacy Rate - 39 54Povery Headcount Rate (HCR) 44.8 36 26.1

Andhra Pradesh Per Capita Incormee(1993194 Rs.) 5,142 7,591 10,886PCI as %AII India 87% 92% 92%Infant Mortality Rate (per '000 live births) 92 70 63Literacy Rate 36 44 61Ferale Literacy Rate - 33 51Poverty Headcount Rate (%/o) 29.9 22.2 15.8

Notes.The date pertains to the years 1980,1990 and 1999 for IMR, 1981,1991 and 2001 for Literacy Rate and Female Literacy Rate, and 1983,1993-94, and1999-00 for poverty headcount rates.Sources: Infant Mortality Rate -Registrar General of India, Sample Registration System; Literacy Rate and Female Literacy Rate -Census of India; Per CapitaIncome -GOP form CSO, and Popula6on from Census of India; Poverty Head Count Rates -Planning Commrission, Gol, based on poverty lines dErivedusing the methodology recomnmended by the Expert Group.Note that on account of differences in survey methodology, estimates of poverty for 1999100 are notstidcy conparable with those for eaier years.

7. AP's human development indicators show a mixed picture, with above-averageperformance on health and fertility indicators, and below-average performance with respect toliteracy. The poor health and education status of AP's population is explained by several factors:large income disparities across regions and population groups, weak public service delivery,particularly in rural areas, and insufficient expenditure on basic services, particularly in poorcommunities with large minority populations. However, progress is being made. There havebeen improvements in all indicators through the 1990s, especially literacy. The 2001 Censusshows AP among India's top performing states in terms of improving literacy through the 1 990s.The gap between literacy in AP and all-India has fallen from 8 percentage points in 1991 to only4 percentage points in 2000 (with literacy in AP at 61%, and nationwide at 65%). Despite thisstrong progress, AP still lags behind several states in terms of schooling achievements.

8. Economic Growth. Real growth in AP has averaged 5.3% over the 1990s, a fullpercentage point below the all-India average of 6.2% (Table 2). Per capita growth averaged 3.7%p.a over the same period. Weak agricultural performance, upon which most rural poor depend,has been a significant constraint on growth. Agricultural growth, which has been highly volatileand affected by repeated drought and flooding, has averaged 2.1-2.7% p.a. in the eighties andnineties respectively, below the all-India average of 3. 1 % p.a. Total investment in agriculture fellby 2% p.a. during the 1990s due to adverse incentives and distortions in agricultural markets(production and marketing controls). In the industrial sector, AP's burdensome regulatoryenvironment and weak infrastructure are seen as constraints to greater private investment:.

2 Andhra Pradesh: Imrproving Business Environment for Sustained Growth, World Bank, draft Jan. 2001.

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Table 2: Growth in Andhra Pradesh and All India, 1980181 -2001101 (%)

Agriculture Industry Services Real GSDP1980s 1990s 1980s 1990s 1980s 1990s 1980s 1990s

Growth*Andhra Pradesh 2.1 2.7 7.2 6.3 8.8 6.5 5.7 5.3All India 3.1 3.1 6.9 6.4 7.0 8.1 5.5 6.2

Share in GSDPAndhra Pradesh 41.2 30.7 21.3 25.2 37.4 44.0 100.0 100.0All India 36.3 28.7 25.1 27.0 38.6 44.2 100.0 100.0*Logarithmic growth ratesNote: 1980s refers to the perod covenng 1980181; 1990s refers to the period coverng 1990191 to 2000101Source: GoAP, Bureau of Economics & Statisics for date on AP; CSO for data on All India

B. Andhra Pradesh: Vision 2020

9. Andhra Pradesh, under the strong leadership of its Chief Minister, Mr. ChandrababuNaidu, was the first Indian state to articulate a comprehensive vision for human and economicdevelopment when it released its Vision 2020 on Republic Day 1999. Vision 2020 is anambitious statement of intent to pursue economic growth, social development and povertyreduction. The Vision is remarkable in that it places equitable human development at its center.The aim is to eradicate poverty, promote human capital development, focus on the welfare of

children, particularly girls, women, the old and infirm, and build an equitable society in whichpeople participate in making decisions which affect their lives and livelihoods. Vibrant economicgrowth, a transparent, accountable and responsive government, and safeguarding theenvironment, are seen as the tools to achieve the state's vision of a "healthy and wealthy society".

10. Vision 2020 has an ambitious scope. On the human development front, the state expectsto achieve full literacy by 2010, infant and child mortality rates of 10 and 20 per 1000respectively, and life expectancy of 68 and 70 years for men and women respectively. To achievethese goals, the state's economy has to grow by an average of 9-10% a year in real terms for 20years, starting at around 7% p.a. and then accelerating to well over 10% p.a. Agriculture wouldneed to grow at 6% annually, industry at 11%, and services, seen as the main engine of growthfor the future, at 13 % annually. The state's growth strategy emphasizes: (i) public sector reformsto enhance economic performance; (ii) privatization to reduce direct government involvement inthe economy; (iii) enhancing the environment for private sector investment through improvingpublic services; (iv) deregulation and improved govemance to reduce red tape and strengthenmarkets; (v) public-private partnerships for major infrastructure development; and (vi) improvedagricultural extension and support for crop diversification.

11. To complement the comprehensive statement of Vision 2020 and in recognition of thefact that poverty eradication is its top development priority, the Government of Andhra Pradesh(GoAP) established in 2000 the State Poverty Eradication Mission (SPEM), and recently issued apoverty reduction strategy paper. The strategy emphasizes the need to: (i) generate more rapideconomic growth; (ii) promote primary health and education services; (iii) enhance social capitalthrough fostering self-help groups; (iv) promote sustainable livelihoods of the poor; (v) focusgreater attention on backward regions and poorer segments of society; and (vi) design theadministrative machinery to improve delivery of services to the poor and promote convergence ofsocial development and other poverty-focused programs in the state. The state's overalldevelopment strategy is consistent with these efforts. Fiscal policy aims to increase resourceallocation to the provision of primary health and education services, and other services ofimportance to the poor. Govemance measures to reduce corruption, broaden access to services,

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improve accountability, and establish grievance procedures, are also important in the state's anti-poverty agenda.

C. The Reform Program

12. A transparent, accountable and responsive government, with the financial means todeploy sufficient resources for social and infrastructure development, is one of the toolsenvisaged to achieve the ambitious targets of Vision 2020. AP has thus embarked on a majorprogram of fiscal and governance reforms. These are described in detail in the following sections(III A to III C), and are sunmmarized below:

* Majorfiscal reform has been launched, with significant increases in own-tax revenue, asharp reduction in food subsidies, and a freeze on civil service hiring. However, a risingpower sector subsidy burden and, related, a large increase in the interest burden, haveprevented the achievement of fiscal stabilization to date. Power sector finances areshowing an improvement, reducing the earlier trend of deterioration, and revenues areexpected to meet operating costs this year. The budget deficit is targeted to decline from5.4% in 2000/01 to 5.0% in 2001/02, and the primary deficit to fall more sharply, by0.9% of GSDP, due to measures aimed at containing budget expenditures.

Box 1: AP's Reform Track Record

Nationally, AP is seen as a pace setter for reform. Under strong leadership, and with a manifest commitment toeconomic and social development, GoAP has initiated some of the most far-reaching reforms in India in theareas of govemance, power sector, and expenditure management:

* In governance, AP is the first state with a major "vision" paper; a pioneer in the use of informationtechnology for streamlining and re-engineering service delivery; first to connect all districts with fiber opticcable for videoconference and long-distance learning; first to set up "one stop shops" for multiple publicservices; first to set up an integrated state-wide database using GIS technology; first to computerize paperflow in the Secretariat; and first to facilitate public access to the Internet through information kiosks.

* In power sector reforms, the state has taken strong measures to halt theft, regularize connections, stiffenpenalties with the establishment of special tribunals, monitor and effectively enforce supply regulationpolicy for agriculture consumers, improve customer service, undertake full census of agriculture pump setsand in implementing tariff rulings of the independent state regulatory agency. Discussions onimplementing multi-year tariff regulation are underway and the license awarded to the distributioncompanies enables direct bulk purchase of power from generators, thereby setting the stage for establishinga multi-buyer-multi-seller market.

* In other sectors, AP is recognized for its strong emphasis on rural development, community empowerment,and support for women's' groups. The state's joint forestry management program has been among the mostsuccessful community-based forest conservation efforts in India, water user associations have beenestablished to assess and collect water fees, and organize irrigation system maintenance. In education nearly100,000 school education committees have been established to make schools more accountable tocommunities, with half of all committee chairs reserved for women.

* In expenditure management, AP has extended budget flexibility under hard budget constraint throughbundling heads of account, authorizing six-month advance budget releases, and granting greaterresponsibility along with accountability to line departments.

* In revenue mobilization, AP is the most advanced state in preparation for implementation of the sub-national VAT.

* Overall budgel management is improving, reflected in the reduction of the budget deficit, excluding powersector subsidies and costs of past debt financing of the power deficit. Power sector subsidies are nowtransparent and directly incorporated in the budget. Use of supplementary budgets has stopped. Amedium-term fiscal framework, which incorporates power sector resource requirements, has been prepared.

* AP faced a budget management crisis in 1999/00, when resource constraints led to asteep build-up of payment arrears. This in turn led to a recognition that much deeper

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fiscal and governance reforms were necessary, and that these would have to be supportedby institutional changes that would transform the government's way of doing business.In light of this, the Government extended its program to incorporatepublic expendituremanagement reform, to improve budget preparation, budget execution and financialmanagement. This aims to restore the realism and credibility of the budget, improvefiscal transparency, and introduce greater flexibility and efficiency in operationalmanagement.

* GoAP has made governance and public management reform a central plank of its reformagenda. Over the last six years, it has built an impressive record of achievement. APinitially pursued significant gains in areas such as e-governance and human resourcedevelopment. It has subsequently expanded its reform agenda to tackle more systemicissues, such as anticorruption, civil service reform, and a broad program of publicenterprise privatization. Furthermore, it has undertaken several pioneering steps toimprove governance in the power sector, as discussed in greater detail below. Withstrong support from senior leadership, a culture of reform is being nurtured andinstitutionalized within the bureaucracy.

13. Power Sector. Reforming the power sector is a key complement to fiscal reform becauseof the sector's major demand on budget resources. The state's power sector reforms aresummarized in Annex B and in the Government's Letter of Development Policy (Annex A).Major milestones achieved to date include the following:

* The Government unbundled the Andhra Pradesh State Electricity Board into six newcorporatized companies during the period 1999/2000.

* The AP Electricity Regulatory Commission (APERC) was established in 1999 to provideindependent oversight of the power sector reform process and its development. APERChas built up a good track record - two tariff orders of APERC have been implemented,customer service quality standards have been set, and a transparent process of regulation,with the participation of stakeholders, has been established. In 2000, the APERC orderraised average electricity tariffs by 15%, and reduced cross-subsidies. The sharp increasefor residential consumers (a doubling of bills in some cases) provoked riots and paralyzedthe state legislature, but the Government stood by the increase.

* To check widespread theft and improve governance, GoAP launched a far-reaching driveto register illegal connections in 2000 (two million residential customers were regularizedin one month), increased penalties/punishment for theft, and cracked down on offendersusing specially constituted tribunals. AP is the first state to enact a new law providingstiff penalties, including mandatory imprisonment, for theft of electricity.

* As a result of the tariff increase, and billing/collections drive, AP's power sectoroperating results have started to improve, reversing the earlier trend of sharpdeterioration. AP's power sector is close to meeting its operating costs (before interestand depreciation) from own revenues this fiscal year, and would have broken even thisfiscal year, but for the drought (Figure 1). The path of projected power sectorperformance is based on the multi-year business plan finalized by GoAP for the powersector, and consistent with the Government's policy decisions and medium-term fiscalframework.

* The Annual Revenue Requirement (ARR) and the tariff filing, as statutorily requiredunder AP's independent regulatory regime, have been completed for 2002/03. Thesehave been based on the business plan, and aim to reduce the subsidy burden on theGovernment.

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Figure 1: Power Sector Financial Performance

30 ;

20__ ___ _ _

10_0

0-Z 1998 _ _ 2000 2001 2002 2003 2Q04

-30 ___ -

-40 - - - --- -- -

Financial year ending March 31

-- rof it after tax (without subsidy) + Earning before interest, depreciation, tax and appropriation(EBIDTA)

14. The state utilities have just completed filing the 2002/03 tariff with the APERC inJanuary 2002, and the final ruling on the application will be made by end-March 2002. Theaverage tariff increase filed for is 7.3%. The proposed tanrff schedule includes a new incentivescheme to increase demand by large industry consumers, with a sliding scale of tariff increasedepending on the level of demand, and the largest consumers facing a tariff reduction by 11.4% atthe margin aimed at winning self-generation consumers back to the grid and encouraging demandgrowth. The tariff filing conforms with the state's multi-year business plan for the power sector.

15. With operational cash break-even largely achieved, the state is well positioned to movetowards privatization of distribution. The medium-term agenda for power sector reform leadingto privatization in 2003/04 revolves around five main issues:

* The predictability of tariff adjustment needs to be enhanced. This is being addressedthrough the development of multi-year incentive-based tariff determination principles.

* To shift agricultural subsidies directly onto the budget to foster commercial operation ofthe distribution companies, and to improve effective subsidy targeting, GoAP has set up aTask Force to design, implement in select areas, and monitor pilot projects of a packageof measures, including alternative subsidy delivery mechanisms for agricultureconsumers and end-use (pump) efficiency improvement. Based on the lessons learned,the Task Force will prepare an action plan for scaling up the pilot projects to the statelevel.

* As stated in the Letter of Development Policy, the Government is committed to universalmetering in accordance with the directives of the APERC. Based on the interim findingsof the Task Force on alternative subsidy delivery mechanisms, the Government willprepare an action plan by October 2002 for compliance with the APERC directive onuniversal metering. In its tariff order for 2001/02, APERC has also directed the powerdistribution companies to meter, with immediate effect, all new agriculture consumers,including unauthorized agriculture connections which have been regularized. The utilitycompanies have requested the APERC to allow extension, up to June 30, 2002, of theperiod for regularization of agriculture connections, and to reconsider the time frame formetering. GoAP and the utilities will ensure compliance with the ensuing directives ofthe APERC.

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* Financial incentives as well as improvements in quality of supply are needed to winindustrial consumers back from captive generation to grid supply and spur growth indemand from new industrial consumers.

* The Government plans to address the accumulated debt overhang in the sector resultingfrom past losses which causes continued, though declining, financial losses in the powersector as shown in Figure 1. For the Government to successfully privatize thedistribution business, it must carry out a financial workout to address the outstanding debtstock. Such a workout needs to entail effective burden sharing among all stake-holders,including the lenders and creditors owned by the Government of India.

* The Government also aims to ensure the independent functioning of the four powerdistribution companies from their parent transmission company in order to improvesector governance, and has initiated steps to provide separate and independent Boards forall of the four distribution companies.

16. Other Sectoral Reforms. GoAP has taken a comprehensive approach to sectoral reformsthrough the public dissemination of strategy papers that aim to provide implementation plansbuilt around Vision 2020. Sixteen sector strategy papers were prepared and disseminated in theLegislative Assembly in March 2001 after consultation and feedback from district officials andcommunity groups. A major 'performance orientation' system has also been launched, aimed atimproving accountability and service delivery (para. 74). Generic features of AP's sectoralreforms include increased community participation, outsourcing, and greater resource availabilityfor priority sectors:

* Irrigation: AP is promoting beneficiary involvement through water user associations toenhance the efficiency and accountability of the surface irrigation system. A graduatedprogram is in place to revise water charges, raise collection efficiency, and achieve fullcost recovery to cover O&M needs.

* Forestry: AP is recognized as a leader in India in shifting towards community-basedresource management in forest fringe communities to enhance incomes, improveenvironmental outcomes, develop community skills, and assist the rural poor,particularly in tribal communities.

* Road infrastructure: GoAP has introduced modern commercial and project managementpractices into the execution of road works resulting in more efficient use of publicresources as well as speedy execution and higher quality of works. The state is extendingthe network of rural roads, developing a performance-based maintenance contractsystem, and implementing Build-Operate-Transfer road projects.

* Primary health: Greater resource allocation to primary health care and health referralcenters is helping to enhance service delivery. A performance monitoring system forfirst referral hospitals and primary health centers has been put in place, and secondaryhospitals and primary health care centers are being ranked by their performance levels,to help target needed improvements in health service delivery.

D. The Bank's Assistance to Andhra Pradesh

17. India Country Assistance Strategy. The India CAS (discussed by the Board on April 5,2001) aligns the Bank Group's assistance program with India's Ninth Five-Year Plan, whichfocuses on strengthening the enabling environment for growth and poverty reduction, andsupporting pro-poor interventions. The CAS highlights three strategic principles, namely,selectivity, adoption of a programmatic approach, and reliance on partnerships. The proposedoperation builds on all three principles.

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18. Based on the selectivity principle, the strategy focuses on reforming states. That startedwith the previous CAS and was endorsed by the recent Country Assistance Evaluation for India.Andhra Pradesh is one of India's earliest reforming states to receive Bank Group support; it nowhas the largest assistance program among states.

19. The CAS reflects an increased emphasis on fiscal and governance reforms, the formerfollowing from India's fiscal deterioration in the second half of the nineties, and the latter from anemerging consensus in India that without better performance, governments will have neither thecredibility to persuade their citizens to pay taxes, nor the capability to convert public resourcesinto growth. The second aspect of the CAS relevant to this operation is an increased reliance onprogrammatic lending. Programmatic budgetary support combines the flexibility necessary in theIndian political environment with a medium-term approach required to implement India's deepand difficult structural reform agenda. It allows for a tighter focus on policies, a better linkbetween Bank support and the budget, and provides important financial backing to state-levelreform programs.

20. The CAS also emphasizes the importance of building partnerships. The Bank Group isworking closely with the United Kingdom Department for International Development (DFID) inAndhra Pradesh, in support of fiscal and governance reform efforts included under this operationas well as sectoral programs (e.g., power sector reforms, urban development, and environment).In 1997 the UK Government published its Intemational Development White Paper, committingDFID to work in partnership with governments to deliver improved development outcomes.DFID has a long history of involvement in AP across a number of sectors. In recent years, it hasadopted a more integrated approach to achieve greater impact on poverty and development,backing action with increased resource flows in areas where there is strong Governmentownership. DFID's assistance strategy identifies five mutually reinforcing priorities: (i)improved human development outcomes, with particular emphasis on the millenniumdevelopment goals and HIV/AIDS; (ii) enhancing livelihood security; (iii) governance reformsand fiscal stabilization; (iv) empowerment of poor women and disadvantaged groups; and (v)strengthening impact assessment for decision-making. Building on complementanties anddeveloping greater convergence in the Bank and DFID's support for AP's reform efforts isexpected to enhance the overall impact of development assistance in the state.

21. Bank Group Assistance to Andhra Pradesh. The Bank's program of assistance toAndhra Pradesh aims to help the Government to reduce poverty by supporting its reformprogram. As outlined in the CAS, power and fiscal/governance reforms are critical to any stategovernment's poverty reduction efforts. Progress with respect to these twin pillars of reform hasdetermined, and will continue to determine, the size and scope of Bank assistance to AP (as inother Bank partner states), including not only adjustment, but also investment operations. Inother words, adequate progress with power sector reforms as well as broader fiscal reforms is apre-requisite for the Bank's entire financial assistance to the state. Therefore, during preparationof this operation, an assessment was made that satisfactory progress in power sector reformswarranted further assistance to the state.

22. The Bank's assistance strategy in AP combines both non-lending services and lending.Beginning with a comprehensive report in 1997 (Andhra Pradesh. Agenda for EconomicReforms), an extensive program of analytic work and technical assistance has informed our statedialogue and helped build consensus for reform. Policy notes have since been prepared on ruralpoverty, rural decentralization, and the state business environment, along with a state povertyprofile and a preliminary financial accountability assessment. In addition, a formal report onfiscal policy was prepared last year, as well as a comprehensive study of the impact of powersupply on the agriculture sector. Analytic work has been complemented by an intensive programof seminars, training sessions, and technical assistance carried out over the last eighteen months

9

as part of the Bank-DFID partnership. This has provided the basis for a more in-depth dialogueon key issues such as power sector restructuring, public expenditure and financial management,including public expenditure analysis in selected sectors, anti-corruption strategy, introduction ofthe VAT, and public enterprise privatization.

23. At the request of the Government, the Bank recently launched a comprehensive programof analytic and advisory support to aid in operationalizing Vision 2020. The aim is to assistGoAP in prioritizing the vision's key goals and targets, formulating realistic strategies andactions, and assessing financing and capacity building needs. The approach taken is to primarilyassess the impact of ongoing interventions and develop a medium-term framework for realizingthe ambitious outcomes set out in Vision 2020. To maximize the impact of such advisory work,the Bank is starting with a few key sectors, namely, education, health, and water resourcesmanagement, but will eventually broaden its advice to cross-cutting issues linked to economicgrowth and poverty reduction.

24. The Bank's lending portfolio in Andhra Pradesh is its largest among India's states.Earlier investments in the rural and infrastructure sectors supported the introduction of improvedbusiness practices, cost recovery policies, and better management of natural resources. Inaddition, mainly through centrally-sponsored schemes, IDA supported improvements in thedelivery of public health services and primary education, in both rural and urban areas. In 1998,the AP Economic Restructuring Project (APERP), followed a few months later by the firstinstallment in a long-term program of investment support to power sector reforms, marked a newphase in our relationship with AP, in that it targeted the root causes of AP's structural imbalances.APERP was an innovative instrument at the time (prior to the availability of sub-nationaladjustment lending instruments). It financed a multi-sectoral investment program in priorityareas, including primary education, health, child nutrition, irrigation and rural roads, to beimplemented within an agreed multi-year fiscal framework. The lessons learned from APERP(para. 92) have been incorporated in the proposed operation. In recent years, in line with GoAP'sgrowing concern with rural poverty, the Bank has increased its support for community-drivenprojects, such as the District Poverty Initiatives Project (AP DPLP) now under implementation. Asecond forestry project and a new rural poverty project are now under preparation.

25. In the power sector, the Bank provides direct support through investment financing,within an APL framework. The Bank's financial assistance to the power sector needs also to helpGoAP address the key challenges it will face during the privatization process, e.g., the need todeal with the significant stock of accumulated liabilities which no private investor will be willingto take on, and the need to project a minimum degree of certainty in the regulatory process andthe general conduct of business. The Bank is therefore carefully examining how best to providefuture support and in particular what instruments to use, such as further investment loans, partialrisk guarantees in support of privatization, a sector adjustment loan, or, most likely, acombination thereof.

III. ANDHRA PRADESH'S FISCAL AND GOVERNANCE REFORMS

26. The proposed AP Economic Reform Loan/Credit (APERL) supports the Government'smulti-year fiscal and govemance reform program articulated in Vision 2020 and related policystrategy papers. Vision 2020 defines a new course for the state, grounded in private initiative andcombined with much greater discipline and efficiency in the public sector. Presenting the Budgetfor 2001/02, the Finance Minister also emphasized the need to operationalize Vision 2020 goalsthrough medium-term and annual performance targets, with clear accountability for eachdepartment. He announced the plan of the Government to place the annual budget preparationwithin a medium-term and annually updated fiscal framework.

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27. The program of reform supported by the proposed APERL rests on three key pillars -fiscal reform, public expenditure management reform, and governance reform - each of which isdetailed in the three following sub-sections. The associated policy matrix and medium-termfiscal framework are appended to the GoAP Letter of Development Policy (Annex A).

A. Fiscal Reform

28. Fiscal Trends. Reducing the fiscal deficit to a sustainable level, while restructuringexpenditure allocation towards priority development outlays, is critical to the success of theprogram. GoAP has finalized its updated Medium Term Fiscal Framework (MTFF) extendingfrom 2001/02 through 2005/06. The MTFF is laid out in the Fiscal Reform Strategy Paper, whichwas published and disseminated in January 2002 (on the GoAP website, andhrapradesh.com).This was published along with, and consistent with, the Annual Fiscal Framework, whichcontains revised estimates for 2001/02 and advance estimates for 2002/03. Table 3 shows thepath of fiscal deficits in recent years. There has been in AP, as in the rest of India, a sharp fiscaldeterioration during the second half of the 1990s when consolidated state deficits roughlydoubled as a share of GSDP. In the early 1990s, the deficit in AP averaged around 3% of GSDP,but by the end of the decade the average was around 6% of GSDP, and reflected both throughbudget and off-budget public spending.

29. Power Sector Financial Deterioration. The main cause underlying the fiscaldeterioration has been the rapidly expanding power sector financing requirement and theexpensive off-budget financing of that deficit by GoAP in the past. The financing requirement ofthe power sector expanded rapidly between 1997/98 and 1999/00, causing major fiscal stress. Tocapture the fiscal impact of the power sector, a key monitoring variable is the consolidateddeficit, which combines the budgetary fiscal deficit with the financing requirement of the powersector. This reached a high of 6.8% of GSDP in 1998/99. The estimate for the current year is5.6%.

30. The Government initially met most of the power sector financing requirement off-budgetthrough borrowing from a special purpose vehicle. It has gradually brought most of its support tothe power sector directly on budget, increasing the transparency of subsidies to the sector.Having nearly reached operating cash-flow break-even (para. 13), the power sector's financingrequirement has started to fall, and is down to 2.2% of GSDP in 2001/02 from close to 2.8% inthe three previous years. The financing requirement is expected to fall further to 1.6% of GSDPin 2002/03.

31. Rising Interest Burden. The other significant cause of the fiscal deterioration has beenthe rising interest burden on account of unsustainably high historical deficits, servicing of powersector liabilities that have been assumed by the Government, and off-budget bond financing('power bonds') of a large portion of power sector financing needs, the debt-servicing of whichreverts to the budget. AP's primary deficit (i.e., deficit before interest payments) declined after1998/99, especially if the underestimation of the deficit in 1999/00 due to a large build up ofarrears - paid off in 2000/01- is taken into account. Moreover, the state's "non-power primarydeficit", i.e., the deficit before interest payments and support to the power sector, has fallen by 1.9percentage points of GSDP since 1998/99, and is now in surplus (Table 3).

32. This improvement in the non-power primary deficit, while not sufficient to bring aboutfiscal stabilization, is based on some real achievements in fiscal management. One of these is therice subsidy, which, through better targeting and reduction in unit subsidies, has fallen from over1% of GSDP in the mid-nineties to only 0.3% of GSDP in 2001/02. Another achievement is onthe tax revenue front - own-tax revenues have increased from around 6% of GSDP in the mid-1990s to 7.8% in 2000/01. Primary social service expenditures (primary health and primary

11

education) have increased by nearlyl% of GSDP, and public investment plus non-wageoperations and maintenance (O&M) have risen by 0.4% of GSDP, since 1997/98.

33. Performance in 2001/02. The consolidated fiscal deficit estimate for 2001/02 is 5.6% ofGSDP, marginally lower than 6.2% achieved last fiscal year, but representing a significantreduction in the primary budget deficit, from 2.2% to 1.3% of GSDP. AP has experienced aserious drought this year which has raised power generation costs, due to a fall in low-cost hydro-electric production, and thus increased the power sector financing requirement above what wasanticipated at the time of the budget. In addition, the industrial slowdown is expected to lead toshortfalls of revenue, both devolved from Gol and from AP 's own tax sources - AP's taxperformance is at 7.8% of GSDP this year, good given the recessionary context, but belowforecast. In the short run, the options for enhancing revenues are limited, and expenditure willbear the brunt of adjustment. GoAP aims to meet the 2001/02 deficit target primarily throughreduced expenditures on net lending (to public enterprises) and lower subsidies and transfers.

34. Expected Performance in 2002/03. As per its recently released Annual FiscalFramework, the Government is anticipating a major improvement in the fiscal position of thestate in 2002/03, with a targeted reduction in the consolidated deficit from 5.6% of GSDP in2001/2002 to 4.6% next year. The budget deficit is targeted to fall from 5.0% to 4.5% of GSDP,and the primary deficit from 1.3% to 0.6% of GSDP. This overall improvement reflects a plannedsharp reduction in the power sector financing requirement (from 2.2% to 1.6% in GSDP) in linewith continued improvement in the financial performance of the sector (Annex B). There aredownside risks to the Government's targets, particularly arising from the power sector (paras.102-104). In the event that these risks materialize in power sector performance, the target range forthe overall deficit in 2002/03 would be 4.6% to 4.9% of GSDP (Rs. 74.6 billion to Rs. 79.6billion).

35. Fiscal performance is also expected to improve with a compression of the non-powernon-interest deficit (by 0.6 percentage points) on the back of a recovery in own-revenue growthand continued wage bill restraint. The interest burden continues to rise, but only by 0.2percentage points, due to the much lower primary deficit. GoAP debt stock (including off-budgetborrowing) is forecast to rise from 33.5% in 2001/02 to 35.1% of GSDP in 2003/04, and fallthereafter (Figure 2), helping to stem the rise in interest payments.

Table 3: Andhra Pradesh: Fiscal Deficits 1998-2002 (/. of GSDP)1998199 1999100 2000101 2001/02 2002103

(AFF)' (AFF)'

(1) Budgetary Fiscal Deficit 5.0% 4.0%b 5.4% 5.0% 4.5%Of Which:

(a)BudgetarySupportforPowerSector 1.1% 1.2% 1.7% 1.6% 1.5%(b) Interest Payments 2.3% 2.5% 3.2% 3.7% 3.9%(c) Non-Power Deficit (1-1a) 3.9% 2.8% 3.7% 3.4% 3.0%(d) Primary Deficit(1-lb) 2.7% 1.5% 2.2% 1.3% 0.6%(e) Non-Power Primary Deficit (1-1a-1 b) 1.6% 0.3% 0.5% -0.3% -0.9%

(2) Power Sector Financing Requirement (2a+2b) 2.9% 3.0% 2.5% 2.2% 1.6%(a) Net LosslProfit excl. Depreciation 1.7% 1.9% 1.6% 1.1% 0.5%(b) Capital Outlay 1.2% 1.2% 0.9% 1.1% 1.1%

(3) Consolidated Fiscal Deficit (Budget & Power) (1+2-1a) 6.8% 5.8% 6.2% 5.6% 4.6%

a AFF is the GoAP 2002/03 Annual Fiscal Framework (Annex B)b Extraordinary accrued liabilities (over 1% GSDP) this year shifted the cash deficit to the next year. Budget Support to power understated due to argovemment servicing of power liabilities in this year.c Defined as power sector revenues (excluding govemment support) minus current and capital expenditures (excluding depreciabon).d Consolidates the Budgetary Fiscal Defict and Power Sector Financing Requirement, netting out Govemment-sector interactions.

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36. Medium Term Fiscal Framework (MTFF). The goal of the MTFF, summarized in theGovernment's Fiscal Reform Strategy Paper (para. 28), is to reduce the budget deficit to 2.5% ofGSDP, and generate a primary surplus of 1.3% of GSDP by 2005/06 (Figure 2 and a SummaryTable in Annex A). The consolidated and budget deficits are approximately equal from 2002/03onwards (reflecting GoAP's extensive budgetary support for the power sector fully reflected onbudget) and fall in tandem.

Andhra Pradesh: Evolution of Deficit (°GSDP) Andhra Pradesh: Evolution of Stock of Debt and Off.kBudget Borrowing (% GSDP)

8.0°h 7.0% 40.0%

6.0% 35.0%

5.0% 30.0% 4.0%3.0% nd 25.0%2.0% - 20.0%

1 0% 15.0% _ _ ,0.0% o, 0 Co o N o O O

-1.0% 0 0 o o o o o r N o 0C O o N o )

-2.0% 1 0 0 o 8 N g N N N N N

- - N N N N N N

-ur- GoAP Fiscal Defict + Consolidated Defica- D-- ebt Stock of GoAP 1- GoAP Primary Deficit D Debt incl. Off-Budget Borrowving

37. The MTFF also aims to protect key development expenditures and in fact, to increaseallocations to primary social services (education and health), operations and maintenance, andpublic investment in essential infrastructure (Table 4). Primary social service expendituresincrease significantly from 2.1% of GSDP in 2000/01 to 2.9% 2005/06, and public investmentplus non-wage O&M increase from 3.7% of GSDP to 4.6% in over the same period.

Table 4: Andhra Pradesh: Trend in Priority Development Expenditures, 1998199 -2005106

1998199 1999100 2000101 2001102 2002103 2003104 2004105 2005106Est Proj Proj Proj Proj

Rs BillionNon-Wage 0 & M 20.6 19.1 23.1 25.8 29.8 35.7 42.1 49.5Capital Outlay 13.9 19.9 27.2 30.5 35.6 40.7 48.1 56.4Primary Education 15.9 18.2 20.3 23.6 27.4 32.4 38.2 45.3Primary Health 6.1 6.8 7.7 8.2 10.8 14.1 17.8 22.2

% GSDPNon-Wage O & M 1.8% 1.6% 1.7% 1.7% 1.8% 1.9% 2.0% 2.1%Capital Outlay 1.2% 1.6% 2.0% 2.0% 2.1% 2.2% 2.3% 2.4%Primary Education 1.4% 1.5% 1.5% 1.6% 1.6% 1.7% 1.9% 2.0%Primary Health 0.5% 0.6% 0.6% 0.6% 0.7% 0.8% 0.9% 1.0%

Memo:GSDP 1130.9 1217.0 1351.1 1489.5 1657.8 1848.7 2065.3 2311.7

Source: GoAP

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38. It is noteworthy that these improvements are expected to occur while fulfilling the targetslaid out in the GoI's Fiscal Reform Facility (FRF) guidelines for states to access resources setaside for the facility. Based on forecasts in the MTFF, the consolidated revenue deficit torevenue receipts (as targeted by the FRF) improves from 26.9% in 1999/00 to -2.7% in 2004/05,falling by more than the 25 percentage point decline that is targeted over five years, and fullyqualifying for facility support.

39. The MTFF, and its targets, reflect the Government's commitment to several key policymeasures:

Implementation of the power sector business plan to reduce the fiscal burden of the powersector. Key policy measures include, inter alia, continued efficiency improvement throughsustained governance improvement; regulation of power supply to subsidized categories ataffordable levels; a program of tariff adjustment progressively reducing cross subsidies,incentives in tariffs to industrial consumers along with imposition of wheeling charges anda special tax on self generation to attract industrial consumers back to the grid; andprivatization of the distribution business to sustain the efficient functioning of the utilitiesover the long term (paras. 14 and 15).Maintenance of a de facto freeze on civil service hiring to gradually reduce the salary bill.Continued cost containment of rice subsidies through the current system of coupons(whereby households must register, thereby removing illicit coverage), and by adjustingprices in line with national rice subsidy levels.Reduction in other subsidies and net lending to public enterprises.Continued budget support to public enterprise closure/privatization for voluntary retirementschemes and social safety net programs consistent with the Phase 11 comprehensiveprivatization program.

40. AP's MTFF incorporates the important lesson from earlier experience in AP as well as inother states and countries, that the strength and relevance of an MTFF is in direct proportion tothe extent of its institutionalization. Making the MTFF a public document is a major stepforward. The Government is also considering measures to strengthen the commitment to, andcredibility of, the MTFF, including through possible fiscal responsibility legislation. In addition,the Government is also committed to annual updating and release of the MTFF, along with semi-annual reporting on performance against targets to help build accountability and to institutionalizethe MTFF. Starting this year, the MTFF has begun to be closely linked to the preparation of nextyear's budget. Next year, GoAP intends to start developing departmental MTFFs to integratesectoral strategies more closely with the aggregate fiscal framework, focusing initially on healthand education expenditures.

41. The AP MTFF is comprehensive as it covers off-budget liabilities as well as budget debt,fully incorporates the power sector into the consolidated accounts, and is consistent with theGovernment's business plan for the power sector. As reflected in the LDP and program policymatrix, the Government is committed to stopping all off-budget borrowing starting 2002/03, withthe exception of unforeseen financing requirements arising from the end-of-year ruling of theAPERC, which cannot otherwise be accommodated.

42. Revenue Mobilization. Revenue reform has focused on improving the performance oftax and non-tax instruments within the confines of India's complex fiscal federalism. The mostimportant and ambitious tax reform in India for the past two decades is the transition to a sub-national Value Added Tax (VAT) to replace the complex and inefficient current sales tax system.The VAT rates are being set in order to be revenue neutral after its introduction, and not to

14

enhance revenues in the first instance. VAT introduction aims to bring major improvements intax administration, including the introduction of self-assessment and risk-based audit.

43. The introduction of a nation-wide transition to the VAT, first scheduled to take place inApril 2002, has been delayed by one year due to the difficulty of finalizing implementationarrangements pending resolution of some key design decisions which need to be taken at thenational level. AP is a leading state in preparing for the VAT transition-it has already designedthe necessary software, drafted the VAT legislation and will shortly be submitting it to theCabinet, initiated major staff training and pilot programs, and has engaged in public awarenesscampaigns. GoAP has already initiated measures to form and staff Large Tax Payer units tominimize any risk of revenue loss during VAT transition.

44. The scope for further broadening of the state's tax base is limited at present toagricultural income tax, and some possible environmental levies. Any broadening beyond thisrequires discussion with Gol on the framework for center-state fiscal relations, where severalissues need to be resolved (e.g., sub-national authority to tax services, adjustment of miningroyalty rights, capping of the professions tax, declared goods restrictions). The main scope forrevenue mobilization lies in improving compliance and reducing the very high levels of evasionfound across India. Reforms of the other taxes are also in the direction of improving enforcementand compliance.

45. Beyond introduction of the VAT, the Government intends to undertake a broad review ofthe tax system, and has constituted a Revenue Reform Committee (RRC) to preparerecommendations for consideration by GoAP. The RRC is expected to complete its review of taxpolicies in AP during the first six months of 2002/03. Further tax reforms are planned or underconsideration to revise tax rates, reduce corruption, improve tax administration efficiency, andexplore options for broadening the tax base. Details are provided in the GoAP policy matrix(Annex A).

B. Public Expenditure Management Reform

46. The second program pillar consists of a package of measures to improve publicexpenditure management (PEM) including budget preparation and budget execution (to restorecredibility to the budget) and financial management (to introduce greater efficiency and financialaccountability). Weak practices in budget preparation had led to inefficient budget execution. Inthe past, unrealistic budgets, derived without sufficient respect to resource availability, have madeachievement of the Government fiscal targets difficult, with expenditure outcomes consistentlydeviating from the budgeted amounts, the emergence of significant payments arrears, fewincentives for operational efficiency, and weak accountability all along the line. The majorimprovements that have been enacted by GoAP in budget preparation have thus opened the doorto better budget execution and cash management. Moreover, specific measures have been takento strengthen financial management directly and increase operational flexibility of budgetmanagers.

47. Reforms in public expenditure management in AP began last fiscal year with a thoroughreview of expenditure programs for the 2000/01 Budget. This was done with a view togenerating savings and containing expenditure, which permitted clearing the substantial arrearsincurred in the previous year. Subsequently, the Government published its strategy for publicexpenditure management in the Fiscal Reform Strategy Paper (para. 28). In the context of thatstrategy, GoAP has taken several steps. It has begun the practice of setting hard expenditureceilings for each Line Department (LD) at the start of the budget preparation cycle, consistentwith realistic resource estimates; and it has introduced a system of mid-year reviews of budgetaryperformance of LDs, in part to establish a broad qualitative link to the next budget.

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48. To give managers greater flexibility in budget execution and operational management,GoAP has initiated several measures. It has begun a rationalization of heads of account and,more importantly, it has initiated the practice of quarterly or half-yearly advance releases ofspending authority to LDs. AP is the first state in India to do this, and it has had very positivefeedback from the LDs themselves. It has computerized pensions and is proceeding tocomputerize payroll along the same lines; it has improved the realism of cash planning, based onseasonality; and to spur stronger performance orientation, it has established an efficiency cell inthe Finance Department (FD) to assist LDs to improve their budgetary operations.

49. In the area of govemment guarantees, GoAP has made a significant initial aggregateprovision against potential govemment guarantee defaults, fully provisioned for selectedguarantees, and intends to elaborate a comprehensive approach to the budgetary treatment ofgovernment guarantees. Non-power government guarantees have been capped by GoAP at 9% ofGSDP, and this cap has been adhered to since its introduction in 1998/99 (non-power guaranteeshave fallen to below 6% of GSDP). GoAP plans to go beyond this, and to implement in thecoming year a comprehensive policy on public guarantees, including, inter alia, setting anaggregate cap on all debt guarantees, loss-sharing provisions, methodology for assessing meritand risk of individual guarantees, including performance guarantees, norms for budgetaryprovisioning for govemment guarantees, and the establishment of guarantee fees. Another typeof contingent liability for GoAP is the pension burden, which is increasing rapidly. GoAP plansto develop next year a pension forecasting model, under the newly constituted Fiscal ReformImplementation Committee, as the first step in the direction of pension reform.

50. Looking to the future, the Government has identified an agenda for further strengtheningexpenditure programming and financial management (Annex A). Strengthening the policy -budget link is central to the govemment's ability to ensure that new policy initiatives areaffordable and adequately budgeted while maintaining budget discipline. Formulating rigoroussectoral inputs to the annual MTFF process is a key step which GoAP intends to initiate nextfiscal year. Future measures to institutionalize fiscal discipline include formalizing cabinetapproval of hard expenditure ceilings, consistent with policy priorities, before the budget cycle.Building capacity for tracking of budget performance and managing mid-term corrections is a keyobjective of the new Fiscal Reforms Implementation Committee, which was set up to oversee thefiscal and public expenditure management reform process, including careful tracking of revenueperformance. The Government also intends to reclassify and group investments of both plan andnon-plan budgets, and integrate public investment programming with the MTFF process, in orderto improve project quality at entry and ensure greater consistency between investment planningand budget resources. This is a major reform over current practices. To strengthen operationalmanagement, additional flexibility and financial power are to be given to managers, but withcommensurate accountability, while formulating relevant and monitorable indicators of budgetmanagement performance. On the financial management side, initial implementation of a cashmanagement system is planned for 2002/03, reducing reliance on personal deposit/ledgeraccounts, and computerization of the payments system is slated to be extended.

51. Public Financial Accountability and Management. A preliminary public financialaccountability assessment was carried out for AP, including review of the state's latest accountsand external audit reports. The results of this assessment are summarized in Annex D, andindicate that although there are weaknesses, the foundations of AP's public financialaccountability system are satisfactory. Major strengths of the system include: (i) the well-established oversight role of the legislature over public finances provided in the Constitution,including legislative approval of annual budgets, and placing of annual accounts and audit reportbefore the Legislature; (ii) regular preparation and compilation of accounting information, andpresentation of annual State Accounts which provide comprehensive information on expenditures

16

and revenues; information on public debts, guarantees, loans and advances, and investments arealso presented, albeit with varying quality; (iii) existence of detailed guidelines for budgeting andmonitoring of the use of public funds, and good procedural controls over expenditures; (iv) thewell established independence of the public auditor (C&AG) from the executive and its broadmandate; and (v) the initiation of a computerization program of key accounting and paymentfunctions, which when completed will help to improve the system. However, there is also a needto strengthen and modernize the system to improve transparency; enable better financial andoperating performance measurement and reporting; have more effective legislative oversight,timely responses and follow-up on audit observations; address identified internalcontrol/accounting weaknesses; clear backlog of accounts and audit (in local bodies, publicenterprises, and other government entities); and improve public financial accountabilityarrangements in local governments.

52. Actions have been agreed to initiate the process of strengthening and modernizing thepublic financial accountability system (Annex D). A State Financial Accountability Assessment(SFAA), covering the State Government (which accounts for the bulk of public funds) will becarried out by GoAP in 2002/03, leading to the adoption of a medium-term action program by theGovernment. To improve budget and accounts transparency, in 2002/03, GoAP plans to provideinformation on major government guarantees and off-budget borrowings in its budgetsummary/overview document, and plans to also publish its half-yearly budget/accountsinformation on the Internet. GoAP has also prepared an action plan to reduce the backlog inaccounts and audits for urban/rural bodies and other institutions in 2002/03. It will developmeasures to address some key identified internal control issues; and improve its responsiveness tothe CAG's Audit Report, focusing on the latest audit report. To streamline and improveprocedures, GoAP is also setting in motion a comprehensive review of financial regulations andrecord-keeping procedures.

C. Governance and Public Management Reform

53. The third pillar of the Government's reform program is governance and publicmanagement. AP has enacted a variety of measures under the rubric of "SMART" governance(Simple, Moral, Accountable, Responsive and Transparent) to enhance service delivery andtransform the public sector into an enabling agent for private sector growth. The Governance andPublic Management Reform agenda consists of five components, detailed in turn below: (i)establishing a framework for the reform process; (ii) simplifying, redefining and rationalizinggovernment; (iii) improving integrity; (iv) enhancing accountability, responsiveness andtransparency; and (v) strengthening poverty analysis and monitoring.

54. Impact of Governance Reforms. Overall, GoAP's governance and public managementreform agenda is expected to achieve the twin goals of reforming core systems and realigningincentives, while gaining some 'quick wins' to sustain political support needed to carry thereforms forward. Efforts to use technology to enhance transparency and re-engineer businessprocesses, as well as to provide managers with greater discretion over inputs while holding themaccountable for results, should help improve service delivery. Greater emphasis on outcomes andpoverty impact should, over time, push policies and services in a pro-poor direction. Efforts toeliminate red tape, and reduce the number of cases going before the courts should create a morefavorable environment for private sector growth.

Establishing a Frameworkfor the Reform Process

55. GoAP produced and submitted a draft Strategy Paper on Governance and PublicManagement to the Legislative Assembly in March 2001, which was targeted at filling the gapbetween the ambitious goals of Vision 2020 and the detailed recommendations of the various taskforces and cabinet sub-committees on public sector reform. The Strategy Paper builds upon

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many themes articulated in these earlier documents, such as e-govemance and human resourcedevelopment. It also proposes new systemic initiatives such as right to information, performancemonitoring, deregulation, anticorruption and decentralization. In collaboration with DFID, GoAPhas recently taken a major step through the creation of its Centre for Good Governance (CGG),which has been tasked with conducting the requisite analytic work in support of reforms andfacilitating their implementation (Box 2). In addition, GoAP has created a high profile unit underthe Chief Secretary to monitor progress on the reforms and resolve implementation problems asthey arise.

Box 2: Establishing The Centre for Good Governance (CGG)

The CGG was inaugurated by British Prime Minister Tony Blair in Hyderabad in January 2002. GoAP has set up theCenter to provide analytic assistance in facilitating its govemance and public management reform effort with theassistance of a three-year grant from DFID. The Center's key priorities are to work with GoAP officials and the generalpublic along six major dimensions: (I) improving the delivery of services to the citizen by simplifying govemment; (2)improving human resource management within the public service; (3) developing systems for accountability, includingperformance indicators; (4) making govemment more responsive to citizens, and particularly to the poor, throughgreater decentralization and the development of participatory processes; (5) increasing transparency and improvingfinancial management; and (6) improving the performance, the focus on core functions, and the development of policycapacity of government departments. The CGG's location at the MCR-HRD Institute (the apex training institute for thestate) will also allow it to play an important role in training AP civil servants.

Simplifying, Redefining, and Rationalizing Government

56. Both Vision 2020 and the Governance Strategy Paper emphasize the need to refocusgovernment priorities and spending towards "doing fewer things better." This task will involvemoving from being a direct provider in many sectors of the economy to a prudent facilitator ofprivate sector activity; it will also involve reorienting the civil service to focus on improving itsdelivery of core goods and services. The realization of this agenda will require progress alongseveral dimensions - public enterprise reform, civil service reform, e-governance andderegulation.

57. Public Enterprise Reform. GoAP launched a Public Enterprise (PE) reform programthree years ago which is among the most advanced in India. It aims to reduce the direct role ofgovernment in the economy, increase enterprise efficiency, and reduce the administrative andfinancial burden of the sector through a combination of closure, privatization and restructuring.The first phase of the program consists of 19 small to medium PEs, covering 14,380 employees.Phase 1 implementation is supported by APERP through financing of severance pay, andprovision of a social safety net for redundant employees, with technical assistance funded byDFID. hnplementation of the PE reform program has been proceeding satisfactorily. Of thePhase 1 PEs, so far 11 have been closed or privatized, with 6 more expected to be closed by end-March.

58. GoAP has also developed a Phase 2 PE reform program, to be implemented from2002/03 to 2005/06. Phase 2 will consist of the privatization, restructuring, or closure of over 60remaining commercially oriented enterprises, and preparatory measures for the two largest PEs,the State Road Transport Corporation and Singareni Mining Corporation.

59. Civil Service Reform. In response to the growth in civil service numbers and upwardpressure on the wage bill, GoAP has put in place a de facto ban on recruitment since 1993. Since1997, GoAP has met the targeted annual net reduction of 1.9% in the total number of civilservants (excluding priority areas of primary education and primary health care). During the nextfive years, attrition rates are likely to significantly exceed this rate, allowing the Government tobring its employment down without resorting to redundancy schemes.

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60. GoAP has also already undertaken a number of innovative initiatives to improve theefficiency and productivity of the civil service. The Chief Minister has used training as a tool forboth capacity building and change management. He and his Cabinet regularly attend trainingsessions, along with the higher civil service. GoAP has developed a series of individual trainingmodules for policymakers, senior managers, administrators and secretarial/support staff. It nowplans to provide annual training to every senior state employee (approximately 10,000 officers)through a series of programs and distance learning techniques utilizing Digital Video Disk (DVD)lessons and training of trainers.

61. GoAP is pursuing a number of other initiatives to improve personnel management. Itshuman resource management effort is currently fragmented, so it intends to consolidate thesefunctions and create a modern Human Resource Management (HRM) function with the GeneralAdministration Department. GoAP will also expand its counseling program for teachers (whichprovides incentives to serve in undesirable posts) to other departments. This program hasproduced promising initial results, improved transparency and reduced political interference intransfers and postings. It will collect, analyze and disseminate regular data on staff transfers,premature transfers, and the average tenure in office for key personnel. GoAP has alsosubstantially completed a civil service census and is establishing a computerized database thatwill facilitate improved human resource management for both core and line departments.

62. Consistent with Vision 2020, GoAP is beginning to systematically review the role ofgovernment and withdraw from peripheral activities in order to better address core concerns. Ithas launched a number of initiatives in this area, such as the recent impact and expenditurereviews supported by DFID for reviewing the efficiency and effectiveness of selecteddepartmental programs.

63. GoAP has recently completed an initial review of over 100 departments with the goal ofeliminating redundancies and functional overlaps between departments identifying performancemeasures, and clarifying reporting relationships. It is also involved in efforts such as theSecretariat Knowledge Information Management System (SKIMS) to streamline informationflows. It is working to reduce administrative layers and to push routine decisions lower in thedepartments, as well as to improve the coordination and utilization of staff and assets at the locallevel. In addition, GoAP is initiating measures for improving policy analysis within theSecretariat.

64. As part of its broader reform agenda, GoAP will continue this effort to rationalize themission, organizational goals and functions, and staffing of key departments. A state-widereserve pool already exists for shifting staff to higher value-added activities, and the GoAPrecently issued a government order allowing District Collectors to create reserve pools forredeploying surplus staff at the district level. To simplify human resource management andfacilitate redeployment, the terms and conditions of various service cadres will be carefullyreviewed and revised. To improve its HRM practices and reduce its legal caseload, GoAP willanalyze its cases going before the Administrative Tribunal and develop a system for the timelyreporting by department of the number of cases fielded, won and lost (including the reasons forlosing).

65. E-Governance. GoAP has already undertaken a number of measures to improve theefficiency and productivity of the civil service (Box 3). GoAP will continue to roll out programs,such as Twin Cities Network Services (TWINS/e-Seva), which creates a "one stop shop" forcitizens to take care of 20 different services, to over 50 municipalities within the state. GoAPwill also give its highly successful Computer-aided Administration of Registration Department(CARD) program greater publicity to improve public knowledge and awareness regarding thisfacility. The Government will establish a blueprint for electronic governance by June 2002

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through a survey of 50 major departments. Among other items, the blueprint will cover financialinformation, procurement, social benefits management, and HRM.

Box 3: Selected E-Governance Initiatives in Andhra Pradesh

Computer-aided Administration of Registration Department (CARD) - Introduced to speed up the process of registeringdeeds from a few weeks to less than one hour. The CARD process has registered around 2.4 million documents, 2.1million valuations and 1.1 million title searches in its first 3 years of operation. There are 239 computerized centers in AP,and the project has been acclaimed by independent examiners as one of the most effective examples of e-govemance inIndia.

Andhra Pradesh State Wide Area Network (APSWA N) - The APWSAN is a dedicated fiber optic network for voice, dataand video communication that connects the Government Secretariat in Hyderabad with 23 district headquarters and thecities of Vijayawada and Tirupati.

Twin Cities Network Services (TWINSIe-Seva) - The TWINS/e-Seva project provides integrated, single window servicefor 20 separate govemment services, ranging from utility payments to the issuance of birth certificates to driver's licenses.It has been expanded to 16 locations throughout the Hyderabad-Secunderabad area, and plans are underway to expand it toover 50 other municipalities by 2005.

Andhra Pradesh Development Monitoring System (APDMS) - APDMS is a geographic based information system that hascreated base maps of all of the 1 ,122 mandals and constituent revenue villages and habitations. Apart from this basic data,a suite of applications is capable of superimposing thematic data on the road network, community infrastructure, basicdemographic data, soil and geomorphologic data. This data is available on the internet and provides support to research,analysis, project design and monitoring.

Multi-Purpose Household Survey (MPHS) - The MPHS has created a computerized database of socio-economicinformation on all citizens. It is comprised of over 100 different fields of information in areas ranging from basic socialand demographic data to legal records and access to the public distribution. It covers all 1,122 mandals in the state.

Secretariat Knowledge Information Management System (SKIMS) - This project was initiated with the objective ofimproving the management of information and knowledge within the Secretariat. The goal is to increase ernployeeproductivity and satisfaction, streamline and speed up the circulation of files and other documents, and facilitate theDlacement of uovernment information on the Internet for oublic access.

66. Deregulation is an important agenda that has seen less concerted reform effort. Manydepartments have yet to initiate a major review that will reduce the regulatory burden ofgovernment and streamline internal procedures. Even in areas where progress has been made,such as the creation of a one-stop window for facilitating investment, significant problems stillexist. Efforts are currently underway to strengthen the legal basis for the single windowclearance process, streamline business inspection procedures, and overhaul the grievanceredressal systems for licensing and inspections. The Government will also provide singlewindow services to businesses through the APonline portal.

Improving Integrity

67. GoAP's strategy for combating corruption is evolving rapidly. Cabinet passed a policypaper on anticorruption in August 2001, which focuses on three key elements - the enforcementof laws regarding corruption, the prevention of opportunities for corruption, and the strengtheningof community education and awareness in the struggle against corruption. The centerpiece of thiseffort will involve enhancing the independence and professionalism of the anticorruption functionby the radical reform and/or rationalization of a number of small, under-resourced bodiescurrently dealing with corruption and mal-administration. GoAP has formed a high-levelworking group chaired by the Minister for Heavy Industry to develop a strategic implementationplan for the policy paper, which will be approved by Cabinet in early 2002/03. Theimplementation plan is being developed in consultation with the public, and GoAP is makingextensive use of survey data for benchmarking progress and identifying priority interventions.

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68. At the sectoral level, GoAP has already completed significant reforms to improve theintegrity and accountability of the public sector. Noteworthy initiatives include a drive to cleanup the power sector through regularizing 2 million domestic consumers; improving collectionefficiency to over 98 percent; and enacting a law to control the theft and pilferage of electricity,along with special courts and police stations for dealing with power theft.

69. GoAP has initiated a review of public procurement processes to: (i) increase thetransparency and accountability of its procedures; (ii) reduce corruption and misuse of funds; (iii)standardize procurement documents; and (iv) streamline decision making and complaintmechanisms. In 2002, it will also initiate a pilot program in e-procurement. Ultimately, all ofthese initiatives aim to achieve better long-term value for money in public procurement.

Enhancing Accountability, Responsiveness and Transparency

70. Right to Information. To achieve responsive and transparent governance, GoAP hasdrafted a Right to Information Bill that is among the best in India. It is implementing citizen'scharters and grievances procedures for govemment departments with a major public interface(completed already for seven departments). The Right to Information draft Bill was submitted tothe Cabinet in January 2002.

71. Management of the Government's Legal Caseload. India has a huge backlog of casespending in the courts, and in many states the government can be responsible for a substantialportion of the cases that come before the courts. The prolonged pursuit of government litigationthrough different levels of the judiciary, irrespective of merit, not only has an adverse fiscalimpact (through delayed resolution of tax liability cases, for example), but it also contributessignificantly to judicial delays and congestion in the courts.

72. In recognition of this problem, GoAP has already pursued a number of actions, includingcreation of a legal cell to manage litigation and monthly reviews of advocate performance. GoAPalso plans to conduct a thorough review of revenue and service related cases, with an eye towardsimproving collection and simplifying its personnel policies and procedures to reduce such cases.GoAP also plans to create an inventory of outstanding litigation, institute a reporting system thatwill allow all new cases to be tracked. It will also analyze the caseload of selected departments toidentify costs incurred from the imposition of interim orders and delays. In addition, discussionsare underway with the State High Court to conduct a study of the dockets of selected courts todetermine the nature of cases being brought, median time to disposition, and reasons for delays.These discussions are the first of their type in India.

Poverty Analysis and Monitoring

73. The ultimate test of the state's reform efforts - and the Bank's and DFID's support forthese efforts - is whether AP achieves major progress in accelerating growth, reducing povertyand improving people's lives. While AP's reforms provide benefits and opportunities for thepoor, they also carry risks. Vigilance on the part of the government is essential to anticipateadverse impacts on the poor and socially-disadvantaged, mitigate these impacts, and promotepotential positive impacts through growth-enhancing reforms. With this end, GoAP is buildingcapacity to better monitor key poverty and development outcomes; strengthen and expand itsprogram of analytic work on poverty and social issues; and is taking steps to ensure that a broadrange of stakeholders in the state, within the government as well as outside, are better informedabout the performance of the public sector and the impact of programs and policies on the poor.

74. Developing Data Resources. Good information is the cornerstone for effective povertymonitoring and impact assessment, and AP is a leader among states in terms of collectingstatistical information. In 1995 and again in 2000, the State Government conducted a Multi-Purpose Household Survey (MPHS), which included a number of welfare and human

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development indicators and covered some 16 million households currently residing in the state.In addition, the Government has developed an extensive GIS system - the AP DevelopmentMonitoring System - that integrates village and habitation development indicators from varioussources (sanitation, land use, access to schools, primary health clinics, etc.) for state-widedevelopment planning and monitoring purposes. Building on this early work and lessons frominternational experience, the state also launched, in 2001, an initiative to implement a system ofperformance indicators. The system is designed to monitor the delivery of public services andimprove the client orientation of public servants and government offices by focusing greaterattention on core development outcomes (literacy, agricultural extension, immunizations, infantmortality rates, etc.), involving over 100 GoAP departments, with 32 core indicators that havebeen agreed to and are being monitored. Evaluation of the first 6 months of the program iscurrently underway. These data are being used to implement a monitoring system down to thevillage level, that looks at core development outcomes (literacy, immunization, infant mortality).However, they have yet to be used for policy analysis or to look at development outcomesspecifically for the poor or socially-disadvantaged groups, nor have the development objectivesof tnis work been widely disseminated outside of government.

75. Future Challenges: Monitoring, Analysis, and Public Information. The challenge nowfacing GoAP is to develop capacity for poverty and social monitoring that builds on existinginitiatives, is coordinated across key government departments, makes better use of the extensivedata base that has been created by various departments (particularly the Directorate of Statistics inthe Planning Department), and responds to the needs and interests of stakeholders, both outsidethe govemment as well as within. Recognizing that its capacity in this area was limited, theGovernment established the AP State Poverty Eradication Mission (SPEM) in 2000, with a broadmandate to address poverty concerns across sectors and across administrative boundaries. SPEMmembership includes govemment Ministers and Secretaries, as well as staff from researchinstitutes and civil society organizations. It has been chosen to lead the state's work on povertystrategy formulation and analysis. With support from the World Bank, the mission brought out arural poverty strategy paper last year, and work on urban poverty is currently underway.

76. The Government recently established a Poverty and Social Assessment Monitoring Unit(PSAMU) to function as a technical secretariat servicing the SPEM. The new unit has a broadmandate to: (i) take overall responsibility for work on poverty measurement, monitoring, andimpact assessment (in coordination with relevant line departments); (ii) play a coordinating rolein developing poverty reduction strategies and pro-poor growth policies; (iii) undertake specificanalyses of policy issues linked to poverty reduction and reforms (e.g., the impact of user fees onthe poor); (iv) more generally, seek to identify adverse impacts of the reform process on the poorand socially disadvantaged and suggest mitigation measures; (v) provide informed policyguidance and inputs to key planning and budget processes in the Government; (vi) keep thepublic better informed about the impact of state reform efforts on the lives of the poor andsocially disadvantaged. The SPEM has been set up outside the Government, albeit with theongoing involvement of senior policy makers. It is the Govemment's intention to developeffective institutional arrangements to ensure that the work of the Unit informs decision makingin the Government.

77. A key task of the PSAMU is to develop a baseline of the core poverty and developmentindicators and to formulate methods to assess where the state stands in achieving its developmentgoals. Poverty has multiple dimensions, requires a range of indicators, and is addressed throughmultiple interventions. Gol has identified a core set development targets for the 10th Plan, similarin many respects to the Millennium Development Goals (MlDGs). These include povertyoutcomes, employment, literacy and enrolments, gender equity, morbidity and mortality, accessto potable water, and the environment. State-level targets will be agreed to as a part of the 1 0t

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Plan preparation. Appealing to these state-level targets, the PSAMU will define a set of coreindicators, develop baseline measures of these indicators, and then set in place a system tomonitor AP's progress in terms of achieving these development targets. It is expected that thecore indicators will be closely aligned with the indicators already included under AP'sperformance monitoring system, and disaggregated, e.g., for poor versus non-poor households, bygender, for backward regions and socially vulnerable groups.

78. Another important task of the Unit is to provide technical assistance in the developmentof a comprehensive framework for poverty reduction that can be used to identify priority areas forfuture interventions and pro-poor policy reforms. The framework would involve inputs frompolicy makers across various sectors and departments, as well as from the research communityand non-governmental organizations.

79. GoAP has requested technical assistance from the Bank and DFID in order to build therequisite capacity in the AP Poverty Eradication Mission to take this work forward.

IV. THE PROPOSED LOAN/CREDIT

A. The Borrower and Amount

80. The Bank proposes to support GoAP governance and fiscal reform program through asingle tranche loan/credit to the Gol of US$250 million (50% IBRD, 50% IDA) to be on-lent toGoAP. In addition, the United Kingdom DFID intends to co-finance the loan with a grant of 65million Pounds Sterling (about US$100 million). The size of Bank and DFID support to AP hasbeen set through reference to both the strength and government ownership of the reform program,and the state's financing needs. With respect to the latter, there are three primary reform-relatedexpenditures:

* The first derives from the need to protect priority development expenditures through thisperiod of intensive reform. Already, there has been significant fiscal compression causedby the increased power sector and debt burden. While AP has been able to protectpriority expenditures to date (Table 4), these expenditures would likely face substantialforced cuts without additional financing.

* While the power sector financing requirement is declining on account of the state'spower sector reforms, there is a limit to the rate at which tariffs can be increased withoutprovoking a backlash, and efficiency improved. Significant budgetary support for thepower sector will continue to be needed over the coming years. If it is not provided, theexperience of other Indian states has shown that power utilities are forced to run largearrears and enter into expensive short-term borrowing arrangements, leading to adeterioration in both the physical and financial health of the sector.

* Third, voluntary retirement payments related to the privatization, closure, or restructuringof public enterprises also place a demand on the budget.

The first of these items is difficult to quantify, but the second and third are together estimated atRs. 32 billion (US$670 million) in 2001/02, compared to the combined DFID-Bank financing ofabout Rs. 17 billion (US$350 million), or approximately half.

81. Table 5 shows AP's borrowing requirement for 2001/02 and 2002/03, consolidating boththe budgetary and power sectors, on the assumption of Bank financing for the state's reformprogram in each year. The overall GoAP borrowing requirement declines sharply in 2002/03 inaccordance with the reduced fiscal deficit and power sector financing requirement in that year.

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Table 5: Andhra Pradesh: Gross Borrowing Requirement and Financing, 1998199 to 2002103

1998199 1999100 2000101 2001/02 2002i03Est Forecast

Gross Borrowing Requirement la 85.9 78.9 91.6 95.0 90.4

Sources of Financing 85.9 78.9 91.6 95.0 90.4On-Budget Borrowing 66.5 57.1 81.3 86.3 88.6

Loans from the Center 23.7 29.9 36.0 41.0 46.6o/w Small Savings 9.9 11.4 17.9 15.2 21.0o/w State Plan Loans (excl. WB Adj Loan) 13.6 18.3 17.7 25.1 24.7

Loans from the MarkeVFIs 19.6 22.2 32.8 22.9 20.4Provident Fund (Net) 3.3 4.9 4.3 4.5 4.8WMA, Reserves, Deposits & Cash Balances (Net) 19.9 0.0 8.2 -2.9 -0.8Extraordinary Financing (incl. WB Adj Loan) 0.0 0.0 0.0 20.8 17.6

o/w IBRD/IDA Adjustment Loan 0.0 0.0 0.0 12.0 12.0Net Financing by Power/b 19.4 21.9 10.3 8.7 1.9

o/w Commercial Loans Serviced by GoAP 10.1 26.0 10.5 8.8 0.0la Gross Borrowing requirement is the sum of Consolidated Fiscal Deficit (incl. Power) and Repayments by GoAP/b Net Financing by Power is the difference between Power Sector Financing Requirement and Gross Support from

GoAP by way of subsidy, capital outlay, and net lending (see Annex 2 for definitions)

B. Actions to Activate APERL

82. There are fourteen key up front actions for the APERL loan/credit. These are listed inTable 6, and include fiscal, public expenditure management, and governance and publicmanagement reforms completed by early 2002.

C. Subsequent APERL Operations

83. This proposed loan/credit is intended as one in a series of loans/credits, to be adjusted tothe strength of the reform program and pace of implementation, with an expectation of annualspacing over a period of 3 to 4 years. Future financial support for the program will be determinedby the Government of India, GoAP, the Bank and DFID on a year-to-year basis. The maininstitutional and fiscal objectives supported by the APERL operations are expected to have beencompleted by the end of 2005/06.

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Table 6: Key Triggers and Actions for APERL

Reform Area Objective First Year Program Key Actions/TriggersFiscal Policy Reform To stabilize * Budget execution in 2001/02 consistent with the corrective

government measures needed to reach the Medium-Term Fiscal Frameworkfinances and (MTFF) targets (1.3% primary deficit, 5.0% fiscal deficit and lessimprove than 5.6% consolidated fiscal deficit) (para.33).resource * Annual Fiscal Framework targets significant deficit reduction formobilization/ 2002/03 (para.34).allocation. * GoAP's Fiscal Reform Strategy Paper (including the MTFF)

finalized and published (para.28).* Tax reforms and cost recovery: sales tax floor rates unified, major

progress in preparation for VAT implementation (para.42-43).Public Expenditure To strengthen * Set hard expenditure ceilings for each line department at the start ofManagement Reform fiscal discipline the budget preparation cycle, beginning in 2002/03 (para. 47).

while improving * Make initial aggregate provision against government guarantees,resource including full provisioning for selected guarantees (para. 49).allocation and a Initial rationalization of heads of account and periodic advanceenabling better releases of spending authority to line departments (para. 48).operational * Computerize pension payments and initiate computerization ofmanagement salary payments (para. 48).

Governance and 'SMART' * Continue de facto civil service hiring freeze in place and conductPublic Management govemance comprehensive civil service census (para.59, 61).Reform (Simple, Moral, * Cabinet approval of anticorruption policy paper (para. 67).

Accountable, * Implement anti-corruption drive in the power sector, including:Responsive and carry out regularization drive, strengthen billing collectionTransparent) to efficiency, enact power theft legislation, implement anti-theft legalimprove public sanctions through special courts (para. 68).service delivery, * Close/privatize 11 public enterprises. Cabinet approval of Phase IIreduce PE reform program, with implementation sequencing and costingcorruption, and (paras.57-58).improve the * Submit Right to Information Bill to Cabinet (para. 70).investment . E-Governance: Implement public service access systemclimate. (TWINs/eSEVA) in Hyderabad; streamline/ computerize deed

registration (CARD) to cut turn around time and public complianceburden (para.65).

84. The evolution and sequencing of reforms supported by the current operation point to keyreform areas to underpin the next APERL, expected to be processed during 2002/03 and builtaround measures taken during that fiscal year. The measures will focus on continued adherenceto the MTFF fiscal program for stabilization and expenditure restructuring, deepening of thepublic expenditure reform program, as well as strengthening key elements of the governance

reform program and continued satisfactory progress in implementation of power sector reforms.Annex A identifies the measures and triggers expected to underpin the second APERL, andmedium-term measures in subsequent years. The main indicative actions for the second operationinclude:

Fiscal Reform

* Fiscal targets: confirmation of 2001/02 fiscal performance (budgetary and consolidated)through the available fiscal data; 2002/03 performance on track to achieve consolidatedfiscal targets for the year; expenditure composition reforms on track through shifting ofresources towards primary social services, non-salary O&M, and capital spending. GoAPto prepare a public report on mid-year fiscal performance.

* Development and implementation of pension forecasting capacity, including selection ofa forecast methodology and staff training in this system, as a first step towards pension

reform.

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* Strengthening of revenue mobilization through preparation measures towardimplementation of the sub-national VAT; preparation of the Revenue Reform Committee(RRC) report on tax revenue mobilization strategy, introduction of statutory requirementsfor periodic revision of specific duty rates.

Public Expenditure Management Reform

* Development of departmental medium-term expenditure plans, focused in 2002/03 onprimary health and education expenditure linkages to the consolidated MTFF to ensureappropriate resource allocation consistent with sectoral policy objectives (universalliteracy, primary health coverage targets, etc).

* Completion of the State Financial Accountability Assessment and related action programcovering the State Goverrnent; satisfactory progress towards implementation of agreedfinancial accountability actions (reducing backlog of accounts and audit of 1999/00-2000/01; responses to audit report of State Govemment; measures to improve someidentified internal control issues).

* Formulation and implementation of comprehensive policy on government guarantees,including, inter alia, setting an aggregate cap on guarantees, loss-sharing provisions,methodology for assessing merit and risk of individual guarantees, norms for budgetaryprovisioning for government guarantees, and establishment of guarantee fees.

* Implementation of an elective government payroll computerization system.

Governance and Public Management Reform

* Establishment of the Poverty and Social Analysis Monitoring Unit, and identification bythe State Poverty Eradication Mission (SPEM) of key poverty monitoring indicators,establishment of a baseline, and implementation of mechanisms for the regular updatingand monitoring of poverty indicators.

* Formulation and implementation of measures to advance deregulation to relax constraintsto business environment and growth, including legislation on enhancing the effectivenessof the single window investment clearance system, and implementation of measures toreform the business inspection regime.

* Initiation of the Phase II program for public enterprise restructuring/ privatization andsignificant progress towards meeting first year targets.

* Completion of a procurement review and action plan, and initiation of recommendedmeasures, including inter alia: strengthening of transparency in the bid process, includingpublication of large tenders on the internet; improving the system for handlingcomplaints; and improving GoAP's value for money in state procurement.

* Implementation of the anti-corruption strategy to reform and/or rationalize existingagencies to strengthen the independence, professionalism and effectiveness of the anti-corruption function.

* Establishment of a computerized human resource management database.

* Submission of the Right to Information Bill to the State Legislative Assembly.

D. Implementation Arrangements and Performance Monitoring

85. Implementation arrangements for the overall loan/credit are detailed in the GoAP Letterof Development Policy (Annex A). To monitor the implementation of its fiscal and publicexpenditure management reforms, GoAP has established a Fiscal Reforms ImplementationCommittee, chaired by the FD and with appropriate participation by LDs and other concerned

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entities. Poverty monitoring will be the responsibility of the recently established AP SPEM (para.75).

86. Performance Monitoring. The Government supports greater transparency andaccountability in government programs, and is disseminating its reform program strategy papersto the public. The MTFF and an assessment of fiscal performance will be presented together withthe annual budget. The following measures are also planned to help strengthen performancemonitoring:

* The poverty monitoring and evaluation system to be established as part of SPEM willimprove availability of data about poverty, and the impact of government policies andreforms on the poor.

* Expenditure and revenue data will be reported monthly on the internet.

* GoAP's new Right to Information Bill will, once enacted, enable the public to be betterinformed about and thus better able to monitor government performance.

* The Government's new system of monitoring indicators (para. 75) is still underdevelopment but should strengthen performance monitoring as it is more fully deployed.

* The Government's extensive e-governance initiatives will greatly improve the flow ofdata within government, and enable customers to get better feedback on their queries andrequests.

* Survey-based monitoring is being emphasized, with regular new surveys planned ofbusiness, households and officials.

87. Performnance indicators for the Government's fiscal and governance reform program areprovided in Table 7. These will be used to assess progress under the program and for preparationof any subsequent operations.

E. Loan/Credit Administration

88. Funds flow arrangements for the Loan/Credit are as follows. Upon effectiveness, GoAPthrough Gol will submit to the Bank a withdrawal application. The US dollar proceeds of theLoan/Credit will be transferred from the Bank to Gol's account held at the Reserve Bank of India,into which all Bank disbursements are deposited. The account is controlled by the Office ofCAAA (Controller of Aid, Accounts and Audit) of the Department of Economic Affairs, Gol, andis part of Gol's general foreign exchange reserves. The Rupee equivalent funds will betransferred promptly by Gol to the Consolidated Fund of GoAP in one tranche on standard termsfor central resource transfers for state developmental budgets (30% as grant and 70% as loan,with Gol bearing the foreign exchange risk). GoAP will confirm to the Bank the receipt of thesefunds within 30 days.

89. Disbursement of the loan/credit will not be linked to specific purchases. However, Golwill not use the loan/credit proceeds to pay for certain expenditures included in the Bank'sstandard negative list which includes expenditures on military hardware, luxury goods as definedin the Standard International Trade Classification, and environmentally hazardous goods.

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Table 7: Performance indicators for Andhra Pradesh's Fiscal and Governance Reforms

Reform Area Outcomes sought Performance Indicators/Monitoring

Fiscal and Reduce fiscal deficit from 5% to 2.5% * Annual publication of the MTFF, and of theExpenditure in four years. budget consistent with the MTFF, reporting onManagement Contain and control off budget fiscal reform performance against targets.reforms borrowing and govemment guarantees. * Filing of the power sector ARR and tariff

Develop pension forecasting and consistent with the power business plan.monitoring system. * Regular monitoring and publication of fiscal andDevelop sectoral linkages to MTFF to power sector performance indicators.fully reflect priority program *Timeliness of audits and follow-up actions onexpenditure requirements. audit observations.Enhanced resource allocation topriority development expenditures.Strengthened public resourcemobilization.

Administrative Monitorable improvements in the * Regular reports on govemance and publicand Civil quality of service delivery in critical management reforms to Legislative Assembly.Service sectors (such as education), as well as * Annual data on the size and composition of theReforms improved access by the poor. civil service, recruitment and attrition rates, and

Measurable efficiency gains through the wage bill.elimination of departmental overlap and * GoAP organizational chart and list of annualredundancies and the termination of revisions/consolidations.ineffective schemes and programs. * Annual list of schemes and programsAccountability and responsiveness eliminated/consolidated.strengthened by improved performance * GoAP performance data on the effectiveness ofmonitoring and enhanced public access service delivery in selected sectors (scope, cost,to information. etc.).Integrity strengthened by strengthening * Number of staff prosecuted or sanctioned forkey institutions (anticorruption) and corruption.procedures (procurement). * Surveys of political leaders, civil servants andPrivate sector investment increases due the general public on the quality of serviceto more favorable and transparent delivery.business environment. * Surveys of business leaders on the business

environment, combined with other publiclyavailable rankings.

Poverty Strengthen the information base and * Establishment of a poverty monitoring, andMonitoring analytic capacity of GoAP for pro-poor evaluation unit within the State Poverty

policy making and program design. Eradication Mission (SPEM).* Development of a program for poverty impactmonitoring and analysis of government programs.* Use of M&E results by the SPEM for policyformulation and reports to Cabinet.

90. The preliminary public financial accountability assessment (para. 52) indicates thatalthough there are weaknesses, the foundations of AP's public financial accountability system aresatisfactory. Actions to strengthen and modernize the system have been agreed to and areincluded in the Policy Matrix and explained in Annex D. A State Financial AccountabilityAssessment (SFAA), covering the State Government (which accounts for bulk of public funds),will be carried out in 2002/03, leading to the adoption of a medium-term action program by theGovernment. The funds flow arrangements for the Loan/Credit (para. 88) are satisfactory toensure that the proceeds of the Loan/Credit are used for the intended purposes.

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V. LESSONs LEARNED, BENEFITS AND RISKS

A. Lessons Learned

91. There are two sources of lessons particularly relevant for this operation: the APEconomic Restructuring Project (APERP), a large multi-sectoral, investment project founded onan agreed fiscal framework (para. 24) and the two other sub-national adjustment loans/credits theBank has made in India to Uttar Pradesh and Karnataka. These are dealt with in turn.

92. Lessons From APERP. APERP was an innovative project, and an important milestonein the Bank's response to the fiscal crisis at the state level. In particular, it was the first case ofstate lending in India based on an agreed fiscal framework. It has also provided several lessons inrelation to the use of fiscal frameworks which the proposed operation incorporates. First, workingon the basis of an agreed fiscal framework is crucial, but it should be revised on an annual basis,as is the usual practice in multi-year budgeting, and not fixed for several years in advance, as isdone in a multi-year investment project. Second, the framework should be public, in order tobuild consensus, and institutionalized into the annual budgetary process. Third, power sectorfinances should be integrated into the fiscal framework. GoAP's new fiscal framework, theMedium Term Fiscal Framework (para.28) which incorporates the above lessons, and which isone of the foundations for the proposed operation, will also replace the existing and now out-dated fiscal framework of the APERP, once this operation is approved as recommended inpara.106.

93. Lessons From OtherAdjustnent Operations. Lessons from the first state adjustmentloan/credit in India (to Uttar Pradesh, approved by the Board in April 2000) are summarized inthe Implementation Completion Report (Report No 22297). First, the programmatic adjustmentlending approach can be an effective instrument for supporting state fiscal reforms. It requiresbroad state ownership of the reforms, and flexibility to withstand political and economicuncertainties. Second, the program should have a well-identified strategic design for a focusedbut deeper policy dialogue, rather than a broad but diffuse agenda. Third, broad reprioritizationof expenditures and improved budget management practices promise more success than detailedauditing and micromanaging of expenditures. Finally, the successful establishment of aneffective poverty and social monitoring system needs early on to focus on systematizing datacollection, analysis, and fostering demand for the use of the data. These lessons have beenincorporated in the proposed operation through the core program triggers, integration of thepower sector in the fiscal framework, emphasis on expenditure management and institutionalreforms, and support to existing poverty monitoring and evaluation capacity in the Government.The main lesson learned from the Karnataka adjustment operation (approved in June 2001) is thevalue of high-frequency monitoring by Government of the state's consolidated fiscal position tohelp internalize and emphasize the state's fiscal targets, and to facilitate early correctivemeasures. Both the UP and Karnataka projects have benefited from close collaboration with theGovernment of India, and integration between Gol and Bank support for fiscal reform is mutuallystrengthening.

B. Benefits.

94. Impact on Poverty. The ultimate test of the state's reform efforts - and our support forthese efforts - is whether the state achieves major progress in reducing poverty and improvingpeople's lives. AP has performed well in urban poverty reduction, and the Governmentrecognizes that its track record in rural poverty reduction needs strengthening, particularly in ruralareas where the Schedule Caste/Schedule Tribe (SC/ST) population is concentrated. Althoughimprovement in state literacy rates over the 1990s was the second highest in India, female literacy

29

and SC/ST literacy remains low. AP's program of fiscal and governance reforms is expected tohave a strongly positive impact on poverty reduction through various channels:

* Fiscal reform will enable a greater share of resources to be focused on poverty-relatedexpenditures. The MTFF seeks to reorient public spending towards priority developmentspending (social sector spending, non-wage O&M and capital expenditure) that willprovide primary education, health, and other basic social services to the poor, includingsupport for improved agricultural performance.

* Increasing cost recovery through user charges for public services is controversial, but inthe case of power it is a progressive policy as the recent study on power subsidies toagriculture makes clear. About 50% of AP's rural households make no use of electricity,and for those who do there is a life-line tariff to protect poor residential consumers. Largeusers of electricity who reap the greatest share of current subsidies are the wealthier,better-off households. Bank research conducted in AP and elsewhere suggests that thenegative impact of tariff increases on marginal and small farmers would remain limited ifmitigated by an improvement in the quality of power supply. For other user charges,analysis is underway (e.g. for irrigation and water services), or will be undertaken by theFiscal Reform Implementation Committee.

* The emphasis being given to improving poverty monitoring and policy analysis will helpthe Government to better track poverty, and to adjust policies accordingly to improvepoverty targeting and program effectiveness. This includes the new poverty monitoringcapacity being developed within the SPEM, as well as AP sector-specific studies such ason power subsidies to agriculture (completed) and on irrigation subsidies (underpreparation).

* The governance agenda aims to reduce government intervention in markets, improve theinvestment climate, ease the regulatory burden on the private sector, especially for smalland medium enterprises, and help generate non-farm employment, of benefit to the poor.These will enhance overall economic growth and generate jobs.

* The fiscal and governance reform program of the Government will increase theeffectiveness of its sectoral anti-poverty interventions, e.g., in health, education, forestryetc., many of which are supported by the Bank. Sectoral expenditure impact reviews,supported by DFID, have been prepared for 8 major departments during the past year,identifying areas of waste, duplication, and recommending measures to strengthenexpenditure efficiency and delivery effectiveness.

* AP's governance reforms also seek to improve the delivery of public services at locallevels (e.g., through citizen charters, user surveys, and performance monitoring system tomake public services 'outcome oriented'). The governance reforms should also reducecorruption and harassment, which tend to disproportionately hurt the poor.

95. AP's broader development program is also supportive of poverty reduction, and attentionin program design has been given to strengthening communities and addressing issues of majorconcern to the poor. The APERP project (para. 24) supports enhanced resource allocation andsector interventions aimed at strengthening the primary health delivery system, expandingprimary education services, child and infant nutrition programs, strengthening rural irrigationsystems and their management through the formation of water users associations, and theconstruction and maintenance of rural roads. Several projects have been initiated by the statetargeted at strengthening communities and self-help groups with a key objective of reducingpoverty, including; (i) the District Poverty Initiatives Project, operating in most districts in thestate, with a similar program under preparation to expand support to all state districts; (ii) theJoint Forestry Management Project, aimed at sustainable use of common resources and targeting

30

marginalized and poor rural families dependent on forest products, which recently receivednational acclaim for its effectiveness; (iii) the DFID supported AP Urban Services Project whichincludes improved provision of services to lower income communities, and (iv) the'Janmabhoomi' program involving local communities in the choice and execution ofinfrastructure projects. AP has also taken measures to improve the targeting of subsidized rice tothe poor to reduce the fiscal burden while improving program effectiveness.

96. Support for Reforms. Bank and DFID backing for the Government's reform programhelps provide support for implementation, and the lessons of international experience. Successwith respect to the Government's fiscal and governance reform program will improve theenabling environment for Bank-supported and other sectoral investments in AP. The additionalfinancing which the Bank and DFID can provide will help ensure that high-priority expendituresare protected and expanded rather than crowded out at a time of fiscal stress, as well as helping tofinance the direct costs of reforms.

97. Impact Beyond AP. AP is in many ways India's first reforming state, and has alreadygenerated enormous competition and reform momentum across Indian states. It is very importantfor the fate of state reforms in India that AP be seen to be rewarded for its reforms, and that itsucceed in the initiatives now underway.

98. Environmental Impact. The Government's fiscal/governance reform program is notexpected to have any major environmental impact. However, environmental issues areparticularly relevant to the public enterprise privatization component of the APERL, building onthe experience under this component of the APERP program. Environmental audits have beenundertaken by the Adam Smith Institute, financed by DFID, for the first set of public enterprisesto be privatized or closed under Phase I of the program, and this has helped build local capacity.This has been reviewed by the Bank and found satisfactory. Under the Phase II Reform Programthe Govemment is committed to continue undertaking environmental audits. Beyond the fiscaland governance program, the Bank and DFID have initiated a dialogue with GoAP on thedevelopment of a broader environmental strategy for the state, which is expected to be undertakenin 2002.

C. Risks

99. The major risks to program implementation are: (i) difficulty in adhering to the fiscalframework and budget constraints; (ii) difficulty in reducing subsidies in the power sector andimplementing the power sector reform program; (iii) possible change in leadership and/oropposition to reform by vested interests, including in the power sector where reform is verycontroversial; and (iv) shocks external to AP.

100. Fiscal risks arise over the Government's ability to deliver on its commitment to maintainhard budget constraints and execute fiscal stabilization measures. As with most Indian states, APhas a history of deviating from the budget and making mid-year changes. Forced year-endexpenditure cuts, or financing through extraordinary arrears, could undermine fiscal reforms. Tomitigate these risks, timely budget releases following regular quarterly monitoring have beeninitiated, and budget constraints facing line departments have been made explicit. Publicdissemination of the Government's Fiscal Reform Strategy Paper (para. 28), including theobjectives and path of the MTFF, should help strengthen fiscal discipline. In addition, theGovernment has agreed to make fiscal monitoring information available to the public (on theinternet) during the year to enhance transparency and accountability to the public. Thecombination of expenditure management reforms to strengthen budget preparation and execution,and enhanced transparency and accountability, serve to mitigate fiscal risk. Delaying theintroduction of the VAT to April 2003 has postponed potential fiscal risk posed by a revenueshortfall during the VAT transition period until the 2003/04 fiscal year, but measures during

31

2002/03 to strengthen the prospects for a smooth transition will be needed. AP's VATpreparations are already well advanced, but a sufficient number of states must move in tandem forsuccessful implementation.

101. Fiscal risks are also posed by the adverse impact on revenue performance at both the stateand central levels, due to the downturn in growth in India. This makes fiscal adjustment moredifficult and intensifies competing demands over resources. AP has taken significant additionalrevenue measures to mitigate the revenue loss, and to adjust to reduced tax devolution from theCenter. Further efforts in this direction are needed. The recently constituted RRC has beencharged with identifying further tax reforms to strengthen revenue mobilization and efficiency,and is expected to complete its report on recommendations this year.

102. Power sector risks. The power sector poses substantial financial risks to the Govemmentbudget. Although the financial health of the power sector has improved this year, and is forecastto continue to improve, large downside financial risks arise from: (i) the difficulty of reducinglarge and politically sensitive power subsidies; (ii) insufficient progress in metering agriculturalconsumers needed to improve revenue collection and support pnrvatization efforts; (iii) the riskthat industrial demand growth projections, including the return of demand to the state grid fromself-generation, do not materialize; (iv) potential excessive expansion of generation capacity thatresults in surplus power, beginning in 2002/03; and (v) failure of power privatization efforts,which would threaten the operational efficiency improvements built into the power sectorfinancial forecasts. Although AP has already significantly improved its billings and collectionsperformance, this may be difficult to sustain in the absence of privatization.

103. Close monitoring of outcomes related to the power sector business plan is important forenabling the Govemment to take timely actions to mitigate these financial risks. The mediumterm framework of the govemment fully incorporates the required budget support to the sector,and a system of regular monitoring of the power sector will provide advance indication of anyfinancial or system problems, should they arise. To mitigate the risk of reducing subsidies toagriculture and the metering of farmers, GoAP has constituted a special Task Force for the designof new subsidy mechanisms, to improve subsidy targeting and effectiveness (para. 15). Both therisks of low demand growth and difficulty in attracting demand back from self-generation to thestate grid, will be mitigated through a new tariff incentive scheme and increased wheelingcharges. To guard against excessive generation plans, the power companies are required tosubmit proposed projects for regulatory review and to demonstrate to the AP ElectricityRegulatory Commission the need for power, and the economy and efficiency of their powerpurchases. Moreover, many of the proposed projects may not reach financial closure. Finally,while the success of any privatization program cannot be assured, AP's conmmitment toprivatization, and to the power business plan, is high. AP's track record in meeting its subsidyobligation to the power sector and towards govemance reforms - the anti-theft drive,strengthening billing and collection enforcement, etc. - provides comfort to potential privateinvestors. Regulatory risk perceived by potential investors is proposed to be addressed throughdevelopment of a multi year tariff regulation framework.

104. To help quantify the magnitude of these financial risks in power, some sensitivityanalysis was prepared, and is summarized in Annex B. It indicates that with more conservativeestimates of growth in sales to industry (4% per annum) and a conservative generation expansionstrategy (with unaltered third party wheeling charges), the additional cost to the budget in2002/03 would be Rs.4.4 billion, or just under 0.3% of GSDP, and would be carried intosubsequent years, although on a declining basis. Monthly monitoring of the financialperformance of the power sector will be undertaken to provide early signs of emerging financialpressures in the sector, and to allow contingency planning to minimize the adverse fiscal impact.

32

105. Political risks will increase as the Government approaches the mid-point in the electioncycle this year, and the introduction of controversial reforms becomes more difficult. Thepolitical system in AP is relatively centralized, placing importance on the top political leadership.There are various interest groups opposed to reform, including some public employees who feelthreatened by restructuring or privatization of loss-making public enterprises and by civil servicereform. Reduced commitment to the reform program could lead to delays or loss of Gol andWorld Bank financial support, which is subject to year-by-year reviews. However, the currentleadership was re-elected to a five-year term in late 1999 on a reform platform, and improvedservice delivery and accountability will help generate greater support for continued reformimplementation. The institutional reforms underway also help to insulate systemic reform frompolitical backsliding, including adoption of fiscal responsibility legislation, which is beingconsidered by GoAP.

106. In addition to the specific mitigating measures mentioned above, AP's track record as aleading reformer over the last 3 to 4 years provides reassurance over continued comnmitment tothe reform program. This operation entails significant risks, but given the importance of theinstitutional objectives of both the Bank and DFID to support poverty reduction and assist theleading reform states in India, this operation is warranted.

James D. WolfensohnPresident

by Zhang Shengman

Washington, D.C.February 15, 2002

33

Annex A

DO.No.F-1776/S(EA)/2002 Page 1 of 19

GOVERNMENT OF INDIAMINISTRY OF FINANCE

SECRETARY Department of Economic AffairsSECRETARY zr4 fl~-R/NEW DELHI

1 gth February, 2002

Dear Mr. Wolfensohn,

I am happy to forward the Letter of Development Policy ofGovernment of Andhra Pradesh describing in detail the policy reformprogramme of GoAP.

While the Government of India, in general, support the reformprogramme contained in the Letter of Development Policy, I would like tostate that approach to subsequent adjustment loans would be decidedannually after discussions between World Bank and Govemment of India.

With regards,

Yours sincerely,

(C.M.Mr. James D. Wolfensohn,President,World Bank,Washington D.C.

Annex APage 2 of 19

HYDERABAD - 500 b22P. V. Rao, I.A.S. {o&NgfSagta Off 3452620

3455340Fax 040-3453700

Res 3548155

CHIEF SECRETARY February 8, 2002

Dear Shri Vasudev,

Letter of Developmnse,it Policy, Governzmjeiiz ofAnjdhlra Pradeslh

1. Andhra Pradesh faces many developmental challenges in its quest to improve the quality oflife for its 76 million inhabitants, over two-thirds of whom live in rural areas and are dependenton agriculture and associated activities. Growth of the AP economy has been somewhat above5% p.a. over the decade of the 1990s, an improvement over earlier years but still modest byIndian standards and well below AP 's potential growth rate, Our state has achieved significantprogress in raising literacy, reducing infant and child mortality rates, and rcducing povcrty duringthe 1990s. However, about one-fourth of the population still lives below the poverty line, literacylevels lag behind national averages, particularly for women and for scheduled tribes andscheduled castes in the state, and infant and maternal health indicators are still very low.Improving the quality of life for all of AP's population, boosting economic perforrmance, andprotecting the environment and quality of life for future generations are the fundamental goals ofthe Government of Andhra Pradesh (GoAP).

2. These goals, as well as the detailed development objcctives of the state, are presented in the1999 report we prepared called Andlzra Pradeslh Vision 2020. This report lays out a broad visionof: (i) accelerating economic growth and eradicating poverty ivhile taking care of the old, theinfirm, and the genuinely needy; (ii) enabling the people to leam, earn, and lead healthful andproductive lives; and (iii) making government simple, transparent, accountable and responsive tocitizens. To do this we must transforn the role of government from one of direct intervention inthe economy towards one of provision of key social services, protection of the environment andcommon resources, and ensuring an effective regulatory regime to protect the interests of citizenswhile not impeding growth and private initiative. A more detailed short term road map fordevelopment has also been prepared in 2001 through a set of 16 Strategy Papers covering themajor policy areas of government, which have been publicly disseminated, debated, andpresented to the state assembly for discussion. Together these documents have provided theinitial basis for our Government reforn programme, while recognizing that reform anddevelopment are evolving, and new ideas and experiences from India and internationally willalways help to achieve greater progress.

The Andhra Pratlesh Reform Programme.

3. The Andhra Pradesh reform programme focuses on both fiscal and governance reforms, andon sectoral reforms. Reforms have been launched across the major sectors and public services,including the power sector, given its very important role in fostering growth and the urgent needto reduce its large drain on fiscal resources. Our sectoral reforms aim to improve the quality ofpublic service delivery to achieve key social and developmeIalu objectives. Fiscal policy is an

Annex APage 3 of 19

important parallel area of reform that is needed to place public finances on a sustainable path,while restructuring expenditures towards priority development needs of the state. Finally,governance and public management reforms are essential to institutional strengtihening, toengender greater transparency and accountability in Govemment, and to improve the quality andeffectiveness of public resource management. All of these initiatives contribute to the objectivesof improved economic performance, growth, poverty reduction, and improving people'slivelihoods. While this Letter focuses mainly.on our core fiscal and govemance reforms (detailsin Annex 1), and their impact on poverty, the sectoral reforms we are undertaking are also offundamental importance, and are summarized briefly below.

4. Reforms are in progress in many sectors, including licalth, irrigation, forestry maniagemnit,education, and infrastrmcture. In irrigation reform initiatives have focused on involving cntd-usersin system support wlile imiproving cost recovery to mobilize resources for operations andmaintenance of canals. The government has developed water user associations into effective usergroups for assessing irrigation use, collecting fees, and organizing irrigation system maintenancewith greater efficiency and less cost than under direct state provision. We are also expanding thejoint forest management programmes which have proven highly successful in organizing andprotecting the common use of community forest resources and halting resource degradation.Modern commercial and project management practices have been introduced to execution of roadworks, including development of a performance based maintenance contract system and Build-Operate-Transfer projects. Expansion of health referral centers is helping to enhance primaryhealth care service delivery, and a new performanlcc monitoring system for prinlary andsecondary care facilities is strengthening outcome orientation. In education, the Govermncilt'sprogramme of Education forAll has become the cornerstone for achieving universal primaryeducation by 2005/06, and implementation plans are underway in parallel with expansion of thecentrally sponsored District Primary Education Project. A key objective of these efforts is toaccelerate progress in improving literacy rates, particularly among women, scheduled castes andscheduled tribes, where literacy is below national and state averages.

5. Power sector reform is a key complement to fiscal reform, due to the sector's major demandon budgetary support, and a necessity for accelerating growth. Andhra Pradesh's power sectorreforms have made the state a leader in India with the achievemrent of major milestones:

* Unbundling of the State Electricity Board into six new autonomously functioning andcorporatized companies (1999 and 2000).

* Formation of the AP Electricity Regulatory Commission (ERC) in 1999 to provideindependent oversight of the power sector reform process and full implementation of twotariff orders, and a third tariff filing has been made with the ERC for FY2003, consistentwith the MTFF and five-year power sector business plan.

* Launching of the most far reaching anti-theft drive in India in 2000/01 to register illegalpower connections, regularizing two million residential customers in one month, andprosecuting cases of theft with specially constituted tribunals. Metering has already beensubstantially completed for non-agriculture consumers in accordance with the ERCdirective.

* Improved billing and collections, and the launch of an extensive anti-tlieft drive andarrears collcction campaign. As a result. billing for clcctricity has incrcased by 34% andcollections have gone up by 44% (while the average tarill increased by 15%) since1999/0).

6. As a result, the sector's operating results have improved, reversing the earlier trend, and hasbegun to meet its operating costs from sales revenues (before interest and depreciation - Table 1).

2

Annex APage 4 of 19

The power sector forecasts are based on a multi-year progranmme that has been fully integratedwith the MTFF discussed above, reflecting the financing requirements from Government toensure success of the programme. Direct support from the budget is high initially, but designedto fall to just 0.3% of GSDP by 2005/06.

Table 1: Forecasts of Power Sector Financing Requirements (in Rs. Billion)

2000101 2001102 2002103 2003104 2004/05 2005106

(I) Earning before Interest, Depr'n,Taxes and Appropriatlon (EBIDTA) -10.7 -0.3 10.1 19.9 25.5 30.8

(11) Net Proflt/Loss cxcl. Depr'n -21.4 -16.8 -8.7 0.2 7.3 14.2and Subsidy

(1ii) Capital Outlay 12.1 15.7 17.9 18.2 14.9 17.6

(iv) Power Sector Financing 33.4 32.4 26.6 17.9 7.6 3.4Requirement (III -11)

7. One key element of the power sector strategy is the privatization of power distribution,targeted for completion in 2003/04. Underlying successful implementation of the privatizationare four specific areas where Government, together with the regulatory authority, is working toidentify clear solutions: (i) enhance the predictability of tariff adjustment through thedevelopment of incentive-based and long-term regulatory principles and guidelines; (ii) improvethe targeting and delivery mechanisms of the subsidy to agricultural consumers; (iii) design afinancial workout to address the accumulated debt overhang from past losses; and (iv) improvethe quality of supply and financial incertives to win industrial consumers back from captivegeneration to grid supply. These are the main challenges for Government in the next two years,.

8. The Government of AP supports electricity subsidies for farmers, but recognizes that suchsubsidies should not prevent the distribution companies from functioning along commercial lines,something which is needed if sectoral efficiency is to be improved. With this goal in mind, GoAPhas set up a special task force to design, implement and monitor pilot projects involvingalternative subsidy delivery mechanisms for the supply of electricity to farmers. These pilotprojects will involve the redesign of supply, billing and collection systems to develop new waysof providing farners with subsidies for the electricity they consume. A package of supportingmeasures, including, for example, better quality of supply, metering, and provision of energyefficient pumps, will also be considered. Based on the lessons leamed, the task force will preparean action plan for scaling up the pilot projects to the state level.

9. The Government is committed to universal metering in accordance with the directives of theAPERC. Based on the interim findings of the Task Force on alternative subsidy deliverymechanisms, the Govemment will prepare an action plan by October 2002 for compliance withthe APERC directive on universal metering. In their tariff order for FY2002, APERC has alsodirected the power distribution companies to meter, with immediate effect, all new agricultureconsumers, including unauthorized agriculture connections which have been regularized. Theutility companies have requested the APERC to allow extension, up to 30 June 2002, of theperiod for regularization of agriculture connections, and to reconsider the time frame formetering. IThe GoAP and the utilities will ensure compliance with the ensuing directives of theAPERC.

10. The Government is also taking action to ensure the financial independcnce and accountabilityof the four newly created power distribution companics. I his is csscntial for improving sector

3

Annex APage 5 of 19

governance. The transfer of staff from APTRANSCO to these c6hnpanies is soon to be completedand will enable the companies to develop their own staff cadre. Action has already been taken toensure separate and independent Boards of Directors for all the companies, and appointment ofprofessionally qualified candidates to these Boards. Institutional development of these companiesis supported by technical assistance funded by DFID.

11. The sectoral reforms noted above, particularly those in the power sector, have majorimplications for the allocation of public funds and for the ability of Andhra Pradesh to achieve thedevelopment objectives of Vision 2020. Prioritizing the sectoral allocation of public resources tomeet development goals, and strengthening the budget process, is a central element of the statereform programme, to which this Letter now turns.

Fiscal Sustainability and Restructuring of Public Expenditurcs.

12. Reducing the fiscal deficit and state debt burden to a sustainable level, while restructuringexpenditures toward priority development areas, and enhancing resource mobilization is central toour efforts at accelerating growth, poverty reduction, and reducing risk. In recent years there hasbeen a build up of state debt and as pressure on public pensions and wages has grown, debtservicing has increased, and the burden of power sector subsidies on the budget has becomesevere. During the last five years government debt has grown from just under 20% of GSDP toreach 29% of GSDP this year. The burden of debt service and subsidies on the budget has growndramatically as a share of total spending, diverting public resources away from criticaldevelopment needs. As set out in the,2001/02 budget speech, GoAP is committed to reversingthis trend and restructuring public spending through a phased medium-term fiscal framework overthe next five years.

13. Fiscal stabilizaliotn. The-major fiscal stabilization goals of the Governmernt are reflected inthe Medium Term Fiscal Framework (MTFF) and used as the basis for preparation of the 2002/03budget, and the Fiscal Reform Strategy Paper of Govemment. The MTFF is based on aconsolidated presentation of the public accounts, which ftilly incorporates thc support providedby the budget to the power sector. Power sector claims o0i the budget are the largest of anysector. Without a solution to reducing the large financial burden of the power sector it will not bepossible to both finance other pressing developmental needs and restore fiscal health to AndhraPradesh.

14. The main goals of the fiscal stabilization programme are set out in Table 2 below (Annex 2provides details). The Government of Andhra Pradesh is committed to reducing the total deftcitof the govemrnment from the 2000/01 level of 5.4% of GSDP to 5.0% projected for 2W00102 andprogressively to 2.5% of GSDP in 2005/06. This is consistent with reducing thie revenue deficitfrom the 2000/01 level of 2.7% of GSDP to 2.3% in 2001/02 and progressively to a surplus of0.5% of GSDP in 2005/06. The consolidated deficit including financing requirements of thepower sector, is expected to decline from 6.2% in 2000/01, to 5.6% in 2001/02, and to 4.6% ofGSDP targeted for 2002/03. These fiscal goals are fully consistent with the objectives of theGovernment of India's Fiscal Reform Facility (FRF), regarding which we have been in closeconsultation with the Gol Ministry of Finance. The MTFF projects that the consolidated revenuedeficit to revenue receipts ratio, as used under the FRF guidelincs, will decline from 26.9% in1999A(X) (the benchmark year) to a revenue surplus of 2.7% in 2004/05, more than fullilling thetarget requirements of the Facility.

15, One key objective of this is to stabilize and reduce the heavy burden of debt on statefinances. During this period the'debt stock, including all off budget borrowing. will initiallyincrease as the state must borrow to pay for the costs of power sector restructuring and otherreforms, and to prevent an unacceptable contraction in vital social service expeniditures. It isimportant to note that the Government of Andhra Pradesh is firmly committed to a complete

Annex APage 6 Qf 19

Hence, debt targets include all off-budget borrowing and control over govemment guarantees.After this year all off-budget borrowing will be eliminated, apart from unforeseen financingrequirements arising from the end of year ruling of the APERC which cannot otherwise befinanced (e.g. through additional revenue measures, electricity supply curtailment, non-powerexpenditure cuts, etc.). The total debt stock (including off budget borrowing) is expected toincrease from 30.6% last year to 33.5% projected for this year, and to stabilize in 2003/04 at 35%before declining to 33.4% in 2005/06. Consistent with recommendations of the Reserve Bank ofIndia, the Government is also committed to preparing a comprehensive policy on govemmentguarantees, including setting an aggregate cap on all debt guarantees, loss-sharing provisions, amethodology for assessing the merit and risk of individual guarantees, norms for budgetaryprovisioning for guarantees, and the establishment of a Guarantee Redemption Fund.

Table 2: Andhra Pradesh: Medium-Term Fiscal Program 2000/01 - 2005/062000/011 2001102 2002t03 2003104 2004105 2005106

% GSUP Actuals LE. Prol Pro) Prol ProJ

Budgetary Fiscal Deficit -5.4% -5.0% -4.5% -3.9% -3.2% -2.5%Of Which:

Revenue Deficit -2.7% -2.3% -1.7% -1.1% -0.2% 0.5%Budgetary Support fo Power 1.7% 1.6% 1.5% 1.0% 0.6% 0.3%Non-Power Deficit -3.7% -3.4% -3.0% -2.9% -2.6% -2.2%Primary Deficil -2.2% -1.3% -0.6% 0.1% 0.85% 1.3%

Power Sector Financing Requirement 2.5% 2.2% 1.6% 1.0% 0.4% 0.1%Consolidated Fiscal Deficit -6.2% -5.6% -4.6% -3.9% -2.9% -2.3%

16. The Government also intends to identify institutional measures that will enhance thetransparency of the MTFF and safeguard against future unforeseen circumstances that could leadto departures from the fiscal targets in the MTFF. To this end, thc Government will hold a forumto examine lessons for intemational and Indian experience, including a examination of the fiscalresponsibility legislation of the Gol and GoK, and will develop proposed measures for publicdebate.

17. Restructuring expenditures. A second major fiscal goal is to restructure expenditures awayfrom non-developmental and low priority items, toward priority development expenditures. Thegovernment succeeded in reducing the cost of rice subsidies from over 0.9% of GSDP in the late1990s to around 0.3% cstimated for this year, and the fiscal burden of power subsidies is likely tostabilize and begin declining over the next two years. At the same time spending on priority areasis growing in primary social services (education and health), operations and maintenancespending. and public investment in essential infrastructure. While the overall deficit falls,spending on primary cducation and health together rise by 1.0% of GSDP by 2006/07, the lastyear of the 10th Five Year Plan. Capital spending and non-wage operations and maintenance riseby 0.9% over the same period. These expenditures are tied to GoAP development objectives;including the achievement of universal primary education by 2005/06 and health targets, as setout in Vision 2020. The Government will be preparing in 2002/03 medium term expenditureplans, starting with health and education, linked to the overall fiscal framework and specifyingscctor allocation priorities. For eight major spending departments, including hcalth andeducation, we have recently had expenditure impact reviews prepared to identify ways in whichpublic spending can be made more efficient, better coordinated, and to improve the quality ofpublic service delivery.

Annex ARage 7 of 19

18. Revenue mobilization. The GoAP is targeting an improvement in total state's own revenuemobilization from 8.9% of GSDP in the current year, to 9.6% of GSDP in 2005/06. There areseveral measures under preparation or planned to achieve this target:

* Introduction of the value-added tax (VAT) in April 2003, including development of largetax payer units to focus implementation on the key sources of revenues. This follows thepreparation of VAT legislation that is near completion, design of special software,training programmes and public awareness campaigns.

* Establishmcnt of a high powered Rcvenue Rerorrm Committee charged with providingrecommendations on system-wide improvement in tax revenue measures. Preparation ofmnajor reports are being planned over the year.

* Abolition of intemal tax checkposts that have been rendered redundant with reform ofsales taxes, started last year and due for completion in the coming year.

* Statutory regulations to be introduced for the periodic revision of specific duty rates,penalty rates, and valuation normns for the purpose of maintaining the real value of taxreceipts.

19. Improvements in the tax system aim to strengthen compliance, reduce evasion, and to reducethe costs of compliance facing tax payers. The VAT introduction is itself intended to heraldmajor improvements in tax administration, including the introduction of self-assessment and risk-based audit. Reforms of the other taxes are also in the direction of improving enforcement andcompliance.

Governance and Public Management Reform.

20. The government is strongly committed to 'people-centcred, growth-oriented governance', totransform the way it does business, and have the govemment do fewer things better. Aspresented in AP Vision 2020, and elaborated in the GoAP Strategy Paper on Govemance reform,GoAP aims to make government an enabler of market-based development by providing a growth-conducive and deregulated policy environment. To achieve this, GoAP is co,mmitted to"SMART' governance (Simple, Moral, Accountable, Responsive and Transparent) to enhanceservice delivery and transform the public sector into an enabling agent for private sector growth.There are several elements of the governance rerorm programme, including expendituremanagement complementary to the fiscal reform agenda, and four elements aimed at improvingservice delivery and accountability through: (i) establishing a framework for the reform process;(ii) simplifying; redefining and rationalizing govemment; (iii) improving integrity, accountability,responsiveness and transparency; and (iv) strengthening budget management and the integrity ofthe budgetary process.

* Establishing a Frameworkfor thie Reform Process. GoAP has established a frameworkfor reform, outlined in the Strategy Paper on Governance anad Public ManagemnentStrategy, which builds upon initiatives launched since the mid-1990s in e-governance andhuman resource development. The Centre for Good Govemance has recently beenestablished and tasked with conducting the requisite analytic work in support of reforrnsand monitoring their implementation. Systemic initiatives in progress include Right toInformation legislation, establishment of a performance monitoring system, marketdcregulation; anticorruption, and deccntralization.

* Simplifying, Redefining, and Rationalizing Gov'ernmnent. The task of government is tomove from directly providing goods and services to a prudent facilitator of private sectoractivity. The realization of this agenda will require progress along major dimensions:public enterprise reform, civil service reform, c-govctnaince and dcrcgulation. The

Annex Apage 8 of 19

Cabinet has recently approved Phase 11 of Public Enterprise Restructuring which involvesprivatization, restructuring, or closure of nearly seventy remaining commercially orientedenterprises, and preparatory measures for restrucluring of major 'labor intensive' PEs.In civil service reform, GoAP aims to provide annual training to all senior stateemployees through distance learning utilizing DVD lessons, training of trainers, andother techniques. Human resource management is being consolidated and a modemHuman Resource Management function created in the General AdministrationDepartment. Among other initiatives is the analysis and publication of data on staffdeployment, a civil service census to establish a computerized human resource database,to assist with HRM and development of a pension monitoring and projection capacity forresource planning. In E-governance GoA_P is preparing to roll out the E-Seva 'one stopshop' system for citizens services to all major cities state-wide. To bolster thederegulation agenda, GoAP is strengthening the legal basis for its single windowinvestment clearance system, streamlining business inspection procedures, and extendinggrievance redressal systems statewide for licensing and inspections.

I Iiproving Iniclgrity, Accountability, Responsiveness atnd Transparency. Theanticorruption strategy of GoAP, as summarized in a 2001 policy paper on anticorruption,focuses on the enforcement of laws regarding corruption, the prevention of opportunitiesfor corruption, and the strengthening of community education and awareness in thestruggle against corruption. We are now formulating a Strategic Irnplementation Plan,which has been developed in consultation with the public, making extensive use ofsurvey data for benchmarking progress and identifying priority interventions. A keycomponent is the reform and/or rationalization of existing agencies to strengthen theindependence, professionalism, and effectiveness of the anticorruption function. GoAP isalso initiating a review of the procurement process, with the goal of: (i) improvingtransparency in the bid proccss, (ii) standardizing tcntdcr documcnts and (iii) strcamliningdccision mnkirig anc comiplaint rncchanisnms. I'lic Cabiniet dccided in Jlanuary 2002 tolormulatc lcgislation on the Right to Information. A draf ltight to Information Bill,which we believe is among the most progressive in India, has been submitted to a CabinetSubcommittee for consideration. Finally, reforms to management of the govemment'slegal caseload are in progress to reduce the enornous burden on time and resources thispresents to both the public and govemment. Several actions have already been taken,including creation of a legal cell to manage litigation and monthly reviews of advocateperformance. We now plan to review service related cases coming before theAdministrative Tribunal (to simplify personnel policies and procedures), and to institute areporting system on outstanding litigation (to allow all new cases to be tracked, analyzed,and costs identified).

* Public expenditure management reformz. GoAP launched reforms in public expendituremanagement in 1999-2000, and followed up last year with a thorough review for the2000/01 budget with a view to generating savings and containing expenditure.Subsequently, a Strategy Paper on Fiscal Reform and Public Expenditure Managementwas published, which extends to improvement in upstream measures to strengthen budgetpreparation, execution, and management, as well as downstream accounting and auditfunctions in order to cnhance financial accountability. I hcsc ainm to build grcatcr realismand credibiliLy in the budgct, improve fiscal transparency, and introduce greaterflexibility and efficiency in operational managemenit. This includes rationalization ofheads of account, advance release of spending authority to line departments within hardexpenditures ceilings, and provisioning towards government guarantees.

Annex Arage 9 of 19

* Improving Public Financial Accountabilit)y. The public financial accountability systemincludes regular legislative approval of the Budget, as well as regular preparation ofannual Accounts and placing these before Legislature. Dctailed guidelines for budgetingand monitoring of public funds are set out in various Govemment Manuals/Codes/Rules.Audit is regularly carried out by an independent auditor (Comptroller ant AuditorGeneral of India). Audit Reports are placed before Legislature, and examined byCommittees of Legislature; and thereafter necessary follow-up actions are taken byGovernment. To further modemize and improve the public financial accountabilitysystem, thc Government has initiated computeri7ztion of key accounting, payment and.payroll-rclated functions. We intend to furthcr cnhance the transparcncy of the budget byimproving the budget overview/summary document, and by publishing summarized half-yearly accounts information on the internet. The Govemment will initiate actions toreduce the backlog of accounts and audit in local bodies and other Govemmentinstitutions; and to improve responsiveness to audit reports. The Govemment will carryout a review of financial regulations and record keeping procedures, with the objectivesof streamlining and improving them. The state will be undertaking detailed assessmentof financial management practices and financial accountability during the coming year,and taking action to improve the timeliness and follow-up to audits, strengthen financialcontrols, and improve capacity in local body accounting.

21. Another core element of AP's public management reform programme is the restructuring,closure, or privatization of state public enterprises. Many public enterprises are loss making andare not cost effective providers of quality goods and services. Many are also providing servicesthat the private sector can provide more competitively. In other cases the enterprises providevaluable public services but need to be restructured to make them more efficient. AP launched itsPE reform programme in the mid-1990s, and in the last two years has successfully closed,restructured or privatized a dozen enterprises. This has provided valuable experience and helpedtrain a core of officers in enterprise evaluation, tendering, and transaction management. It hasalso provided experience in designing voluntary retirement schemes and providing social safetynets to displaced workers. These social safety net programmes help with the retraining and jobsearch needs of displaced workers. In our Phase 1I PE reform programme we aim torestructure/close/privatize a further 68 public enterprises over the next four years, and to continueto provide social safety net assistance.

Impact on Poverty

22. Tangible reduction in poverty rates in Andhra Pradesh is a key objective of the Govemment'sreform programme. Poverty has been steadily reduced in AP, from around one-third of thepopulation fifteen years ago to around one-fifth today by official measures. But this is still veryhigh. It is a priority state goal, as emphasized in AP Vision 2020, "to eradicate poverty andeliminate current inequalities that prevent some social groups from realizing their full potential".The government has established a State Poverty Eradication Mission, charged with bringingtogether govemment and non-govemment civil society groups, cutting across departmentalboundaries, to provide a forum for debate and to inform public policy. It is setting up a specialunit reporting to the Mission responsible for poverty monitoring and evaluation work. TheGovcrnment strategy paper on povcrty eradication, published last year, identifies key strategyelements:

* generating more rapid economic growth,* promoting provision of health and education services,

Annex APage 10 of 19

* enhancing social capital through fostering self-help groups,* promoting sustainable livelihoods of the poor,* focusing greater attention on backward regions and poorer segments of society; and* designing administrative machinery to improve delivery of services to the poor and

promoting convergence with other poverty-focused programmes in the state.

23. Empowerment and participation of the poor in civil society are important to successful effortsto reduce poverty. The state government has accordingly emphasized conmnunity mobilizationand formation of self help groups to give a greater voice to the poor and marginalizedcommunities (watcr user groups, school committees, joint forcstry management groups, etc.).Fiscal policy reformns are also relevant towards poverty reduction. One key goal of fiscal reformis to increase resource allocation to provision of primary health and education services, and otherpublic services of importance to the poor. The government is stressing improved targeting ofservices to the poor, for example through performance of the public distribution system, and thework of the government task force on power subsidy delivery mechanisms. Finally, govemancemeasures to reduce corruption, broaden access to services, establish grievance procedures, etc. arealso critical elements of the state's anti-poverty agenda.

Reform Programme Implementation and Monitoring

24. For more detail on our fiscal and govemance reforms, please see the attached matrix whichcovers reforms in the areas summarized above. It presents the main measures that have beenundertaken through January 2002, and identifies those planned for the 2002103 fiscal year.Implementation of the programme and its monitoring will be done with oversight from the ChiefSecretary's office and all of the major line departments executing components of the programme,in particular the departments of Finance, Revenue, Energy, General Administration, Planning,School Education, and Health. The Govemment is committed to regular monitoring andreporting of progress with the reform programme in all dimensions. Several steps are planneE forthis purpose, among them the following:

* Regular publication on the internet of fiscal performance indicators, detailing budgetexpenditures by major categories, revenue pcrfornmance by major instruments, and ncwgovemment guarantees as they are issued.

* Annual publication of reports on progress with implementation of the MTFF, inconcurrence with the budget cycle, and of progress achieving major govemance reformmilestoncs.

* Regular monitoring and publication of power sector performance indicators (production,revenues, billing rates, losses, etc.) and monitoring of governance indicators(registrations, fines levied, court cases prosecuted, etc.)

* Tracking and analysis of poverty indicators in AP, in parallel with work evaluating theeffectiveness of public social welfare programmes, under guidance of the State PovertyEradication Mission.

Financial Support for Reform

25. The GoAP refonn programme entails medium term costs that will place a major burden onthe state budget during the initial years of the programme. This is due in particular to powersector reforms in progress, with costs incurred through the restructuring of the power sector andgradual reduction of power subsidies. These costs are showvn in Table 3 including both the directcash subsidy to the sector on budget, and the interest payments on power bonds raised by GoAPto finance power sector investments. The costs of restructuring and privatizing public enterprises


also places a significant burden on the budget due to the many thousands of workers expected toopt for voluntary retirement schemes.

Table 3: Mediun-Term Reform Programme Costs (in Rs. crore)

_ 2001/02j 2002103 2003/04 2004/0 2005/06

Budgetary support to powcr scctor* 2438 1792 11921 548

Interest on power bonds (on budget) 768 954 10!0I 961 773

Public Enterprise Rcrorm Costs 80 19( 210 26C 31C

lT'ttl 3286] 2921 2402 1755 10731

* Includes off-budget support (PFC Bonds) in 2001/02.

26. The government is also committed to protecting and reallocating budget resources towardspriority development areas in order to achieve the goals which have been set out in AP Vision2020 as noted above -- significantly reducing illiteracy, improving health outcomes, and sharplyreducing poverty in the state. Additional revenue mobilization efforts, expenditure compressionin non-priority areas, and access to the regular sources of borrowing can all help to offset thecosts of reform and the demand for higher spending on development priorities.

27. In light of this, and with the support of the Govemment of India, GoAP has been workingwith the World Bank and the United Kingdom Department for International Development (DFID)to prepare a Structural Adjustment Loan/Credit to support the state's reform programme.Discussion of the prograrnmre loan began in early 2001, and appraisal of the loan was undertakenin early January, 2002. The programme has been designed to support the costs of the GoAPreform programme in two main areas; the costs on budget of power sector restructuring (cashsubsidy and power related interest payments), and the costs associated with public enterprisereform (including financing voluntary retirement schemes and social safety net expenditures forlaid-off PE employees). Financing from the World Bank of approxinately Rs. 120() crores, andfrom DFID approximately Rs. 470 crore, would help to significantly finance the costs of tilereform programme in the first year (2001/02). Support in the second year of the programme isneeded of a comparable level, and it is anticipated that costs would begin to decline in the thirdyear, when borrowing from the World Bank may be expected to be reduced.

28. The Government of AP requests the Government of India to propose to the World Bankconsideration of a structural adjustment loan called the Andhra Pradesh Economic Reform Loan(APERL), totaling $250 mn on the strength of the AP state reform programme, and to considersupport for subsequent loan/credit operations over the length of the medium term programme tohelp meet the financing requirements of the programme. In addition, the approval of £65 mn ingrant assistance from DFID is also requested. The GoAP is deeply conmmitted to this reformprogramme and to achieving the goals set out in this programme of fiscal stabilization,fundamental restructuring of the power sector, a sharp reduction in state poverty incidence ontrack towards eradication of poverty in the state, and to the major development goals in healthand education. desire to work closely with the Government of India in monitoring andevat ing the prog ss towards these goals.

You sincerel

lChi eretarnd ade

Annex 1: APERL: Program Policy Matrix, 2001-2006February 8, 2002

Prior-acdons by Jan. 31, 2002 2002103 Measures Measures for 2003/04 to 2005/06 Outcomes

I. FISCAL REFORMS * Implement budget allocations limiting the * Reduce primary budgel deficit to no more than * Maintain budgel execution consistent wilh Create fiscal space to maintain financing of

1. Establish a pnmary (non-interest) budget deficit to Rs, 10 billion (0.6% of GSDP); revenue deficit to MIFF program to eliminate the primary deficit priority social services, O&M requirements, andsustainable medium- Rs.19.6 billion (1.3% of GSDP) in 2001-02; Rs. 28 bn (1.7% of GSDP); consolidated fiscal by 2003-04; reduce revenue deficit to below key infrastructure development expenditures,

term Fiscal Framework revenue deficit to Rs. 34.4 bn; the deficit to below Rs.77 billion (4.6% of GSDP); and Rs. 5 bn by 2004/05; achieve a primary surplus through eliminating the revenue deficit,consolidated deficit to Rs. 83.4 billion (5.6% total stock of outstanding debt and guarantees to of at least 1% of GSDP and a profitable power improving expenditure efficiency, and

of GSDP compared to 6.20/6 the previous be contained below Rs. 686 bn. sector by 2005-06. restructuring expenditures within a sustainable

year). consolidated revenue deficit to Provide full budget suppo to the power sector fiscal framework

receipts ratio reduced to below 16.5% consistent with ERC ruling. Eliminate recou se to * Reduce stock of outstanding guarantees to n

Publish revised GoAP Fiscal Strategy off-budget borrowing, except arising from end-of more than 10% of GSDP by March 312 200Paper, including the revised MTFF. year ERC ruling, which cannot be otherwise (from 12.5% in March 2002).Publicize the 2002/03 annual fiscal accommodated. * Provide full budget support to the power sector

framework fully consistent with the MTFF. * Publish a mid-year report on budget execution, consistent with ERC ruling. Eliminate recourse

* Adhere to Rs. 187 billion (1 2.6% of GSDP) and consistency with projected MTFF targets. to off-budget borrowing, except arising fromceiling on the saock of outscanding . . . end-of year ERC ruling, which cannot becguaantheestonackount of poutstanding her * Strengthen public pension expenditure monitoring otherwise accommodatedguarantees on account of power and other and forecasting capacity.public entities. * Contain total debt (including all government

* Develop proposals for insfitutional measures to guarantees and off-budget borrowing) to at or Fiscal support for power sector reforms tohelp enhance transparency of the MTFF, and to below 40% of GSDP by 2005/06. improve sector efficiency, facilitate distribution

* Provide budget support to power sector per safeguard against the failure to meet MTFF company privatization, and substanbally

the APERC ruling. Alt off-budget financing targets. * Table with budget in the State Assembly reduceleliminate the fiscal burden of power

kept within consolidated deficit targets in * Reduce the consolidated revenue deficit to annual reports on fiscal performance and subsidies.

the MTFF. receipts ratio to below 8% consistent with FRF progress with fiscal objectives per the MTFF.

targets, * Prepare and implement pension reformstrategy to address mounting pensionliabilities.

* Meet FRF target with consolidated revenuedeficit to receipts surplus of around 3% by2004105.

2. Improye * Projected budget outturn for 2001102 with * Completion of primary health and pBmary * 3ased on initial sectoral MTFF analysis, Improved development effechveness of state

Compositon, Equity increased prorty expenditures on i. education medium-term expenditure plans, linking elaborate additional MTFF linkages to other expenditures and fiscal discipline; protecbon ofand Efficencn of Public Pnmary educabon and prmary health from sector financing requirements to GoAPs MTFF major spending departments key social and priority development expenditures

Spending (2.1% to 2.2%1; and ii, Capital outlays and program. * Execution of budget consistent with increased in the budget improved targetng of transfernon-wage at 3.7% of GSDP. * Execution of budget consistent with increased support to priority development expenditures programs and subsidies to the poor; improved

* Expenditures on salares and pensions not support to prority development expenditures per per MTFF. maintenance of public assets and infrastructure

to exceed (6.9%) of GSDP. MTFF, raising pnmary education and basic health . Identify options for, and implement shrough sustaining adequate provision of O&M

* Initiate program to eliminate all bogus rice outlays to [2.3%] of GSDP and capital and O&M to improvements in, the efficiency of the public support is the budget

cards. [3.9%]. distribution system. D P

* Implement measures to complete the elimination * Improve targeting of rce and other subsidies to CD

of bogus rice subsidy cards. the poor through linking eligibility to income X

and income proxies. t_ >

3. Refornl Revenue * Issue terms of reference and constitute the * Complete the RRC Report on reforms to the * Implement institutional strengthening of Increased revenue buoyancy; improve the

Systemn mo enhaticn Revenue Refoamns Commi1ee (RRC). structure and administration of APes tax (and non- revenue raising depaments to increase administragton and efficiency of the tax system; O

rSvenum mobilehatnon Commer eoal Taxes: tax) revenue sourcesC and initiate implementation autonomya imprOVe cost accountingc improve reduce tax distortions to improve resource nth

nd eiciency . of accepted recommendations. services and grievance procedures. allocation; improve equity of the tax system; H

Prior-actions by Jan. 31, 2002 2002fO3 Measures Measures for 2003104 to 2005106 Outcones

* Initiate abolibon of internal check posts. * Institute a statutory periodicat revision of specific * Strengthen training arrangements for tax improve voluntary tax compliance and taxpayer

* Prepare draft VAT law and rules lor duly rates, penalty rates and valuation norms for revenue departments. compliance costs.Pevareudaftion. a ndrleo all major taxes in line with inflation. * Reform recruitment policies of ta raising Improve finances while reducing the public cost

* Complete preparabon for establishment of - RRC to prepare a methodology (formula based departrments at the oficer level siof pertionsandmaintenac ofkey publiLarge VAT Taxpayers Units (LTUs). and transparent monthly collecUon monitonng and

Stamrp duties: estmabon system) for forecasts of revenue 0 Develop strategic program to strengthen third-collection by moor revenue eaming departments, tier govemment (PRI and municipal bodies)

* Issue govemrment orders to revise market and implement as feasible. expenditure management capacity and specifyvalue of land and buildings. * Improve reporting of performance by 2003 via their revenue and expenditure assignments.

* Introduce legislation to levy penalty on published and publicly available semi-annual VAT: Strengthen VAT impementation and coveragestamp duty evasion. reports. of services per new laws; dialogue with GOI on

Motor vehIce taxes: abolishing declared goods restrictions; implementVAT: In preparation for introduction of the VAT in ApHl compensation scherme.

* Implement upward revision and 2003; establish and adequately staff and resource Prfessions tax: Simplify professions tax rates,rabonalizabon of motor vehicles tax rates. LTUs in the Commercial Tax Dept.; complete abolibon raise the exempbon limit and improve taxpayer

of intemal check posts; strengthen dealer identificabon identification and tax collection by partiallyand improve commercial tax enfocemnent. outsourcing collectons and dialogue with GOI to

raise ceiling rates, per RRC recommendations

Stamp duties: Rationalizabon of stamp duty and Stamp duties: enhance computerization of propertyregistrabon fee rates; streamline market valuation value/registration data. Develop a proceduralprocedures for properies. manual for post-facto checks. Implement RRC

recommendations.Motor vehide taxes: Implement plot reducton of the Motor vehicle taxes: formulate proposal formonopoly position of the APSRTC by abolition of considerabon of other states for scrapping ofselected existing schemes and liberalizing issue of permits and quotas for goods carriers and inter-permits to bus operators state taxation agreements for contract and stage

carriages.Excise Duties: Examine and rationalize structure and Excise Duties: Rationalize toddy duties with specialfunctioning of excise check posts; strengthen excise regard to major urban areas.duty enforcement Land taxes: Identify options and implement

rationalizabon of water tax rates to reflect water use

Land taxes: Rationalize the structure of the NALA Act.. intensity and land valuaton; establish MIS systemfor land revenues and forecasting, arrears tracking,and irrigabon status.

It. EXPENDITURE * Comprehensive medium-term fiscal * Move to steady state budget system, by * Gradually shift role of Finance Dept. committee Frames annual budgeting in medium-termPROGRAMMING AND projections, to guide budget policy, formalizing Cabinet approval of FD from detailed scrutiny of proposals to perspective and improves altocabive efficiency.FINANCIAL * Publish strategy paper on budgeting and recommendations of hard sector ceilings -to flow monitoring of execution.MANAGEMENT financial management. from MTFF and sector policies.1. Strengthen policy Reduces fiscal risk and makes budget more

bdelikand improve * Establish Fiscal Reformns Implementation transparent. n-rj budgef link Committee, chaired by PS FD and with afiscal discioline. appropnate participation by LDs and other OQ

concemed entties. Strengthen fiscal discipline while empowering Xdepts. to formulate own programs within the

* Budgetary requests brought in line with ceiling and improving efficiency. t. resource availability. Sectoral expenditureceilings are set at start of the budget 0process. Based on rsk assessment and frequency of Permits the growth of consistent linkages Y

* Make initial budget provision for potential * Increase provisioning for government guarantees; default, progressively increase guarantee fees throughout the process of budget formulaton 1-.

Prior-actons by Jan. 31, 2002 2002103 Measures Measures for 2003/04 to 2005106 Outcomes

Government Guarantee (GG) defaults; full introduce aggregate cap on GGs; establish and adjust budgetary provision, with a view to and implementation,

budget provision for select GGs taken on methodology for assessing risk and merit of eliminating the expected lo5s to the budget.

by GoAP. individual guarantees; define burden-shanng in

* Implement measures aimed at containing event of default; adjust guarantee fees.

expenditure increases and prevention ofpayments arrears.

* Revise budget circular, beginning with2002/03 Budget, implementing MTFFobjecfives.

2. Raise aggregate * Review of all schemes, with a view to * Regular monitonng to prevent re-introduction of * Continue monitorng to present re-introduction Permits greater flexibility to achieve performance

efficiency of public clearing payments arrears and contain deleted or lapsed schemes, except where of deleted or lapsed schemes. goals

expenditure and enable current expenditure within available specifically decided otherwise. * Review labor-intensity of major schemes, with Promotes budget implementation.

mana ment resources. * Implement redeployment. a view to additional redeployment without Reduces uncertainty in the provision of funds.management. * Delink staff from speciric schemes, thus retrenchment.

facilitabng staff redeployment out ofobsolete schemes. * Continues review to improve the funding of priority * Introduce approprate elements of ivestment

investment schemes to further rationatize programming; expand non-governmentalinvestment expenditure. feedback mechanisms for monitoring project

mvestnnent expenditure. ~~implementation.B Broader implementation of departmental cost itorereguatiy n i

* Introduce the concept of user charges and recovery efforts, subject to a avoiding adverse * Monitor regulary the financial and distributive

give the flexibility to departments to levy impact on the poor. impaC of user charges

user charges, and retain revenues for their * Formulate a framework for state policy on user

operational purposes. charges, with special emphasis on protectingthe poor.

* Monitor regularly efficiency improvements

* Set up an implementation committee in FD through appropriate indicators.

to facilitate improvements in govt.operations and assist LDs on request.

3. Budget execion, * Initial rationalization of budget heads to * Continue rationalization of budget heads in line * Continue rationalization of budget heads in line Assure compliance with approved budget,

financial management enhance budget managers' flexibility. with expenence. with experience. provide financial predictability to departments.

and accou=ntabihy. * Formulate a new cash management * Implement new cash management system, starting Reduce transaction costs of government activity

system, to assure compliance with budget with 02/03. while enabling greater operational effectiveness

and consistentwith seasonality. * Continue practice of advance release of spending * Continue to strengthen dialogue on visx-v-is the public.

* Introduce release of budgetary spending authority; assess impact on LD efficiency, performance and qualitative link to next Sirengthen financial accountability and integrty

authority on a quartery and hatf-yearty * Computerze payroll. budget. to accounting and audit follow-up processes.

ain . t * Initiate a comprehensive review of fnancial * Consolidate and computerize the entirepeIntrfor ce reviw s-y ste m d rtohenalp regulations, record-keeping procedures, and payments system. O Q

strengthen cash management as well as regulatory streamlining. * Complete the review and regulatory (D

establish a broad qualitative link to * Complete SFAA and related Action Program streamlining, and implementpreparaion of the next years budget. covering State Govemment. recommendations. Keep financial regulations 4

* Review possibilities for consolidating the * Clear backlog of accounts and audits of under continuous review for simplicity and 0

payments systems along the model of urban/rural local bodies and other institutions as . H)

current pension payments, through the per targets in the GoAP Action Plan.introduction of payrolls. * Respond substantially to latest State Audit Report * Verify and expand asset register. __

3

Prior-actions by Jan. 31, 2002 2002/03 Measures Measures for 2003104 to 2005106 Outcones

observations. * Pari passu with computerization, LDs will

* Develop measures to address key intemal control progressively be entrusted with responsibilityissues (reconciliations, loans and advances for accounting.

* Initiate efforts aimed at systemafic provided by govemment, advances charged as * Implement action program based on SFAA for

collection of data on a regular basis on expenditure, and debts and guarantees recording Stale Government.

govemment guarantees. and reporting). * Implement measures to strengthen internal* Publish half-yearly accounts on the Web oentrols, including clearing of suspense

* Improve budget summary by including major accounts and approprate deposit accounts ingovemment guarantees and off-budget borrowings the public account.

* Carry out diagnostic work, and implementactions to strengthen financial accountability, inrural and urban local bodies, and otherinstitutions, as appropriate.

lI1. GOVERNANCE * GoAP to produce a Strategy Paper on GPM * In accordance with its Implementation Plan, the * GoAP to periodically update the Legislative Create a framework and institutional

REFORMS reform strategy for submission to CGG will initiate work along six major dimensions: Assembly on progress made in implementing infrastructure for realizing the goals of Simple,

1. Deveop Strategy for Legislative Assembly. simplifying government, improving human resource the Strategy Paper on Governance & Public Moral, Accountable, Responsive and

Gov nce Public * Establish new wing headed by a Special management, enhancing accountability, Management. Transparent (SMART) govemance.

Afdmngstnt Ror Chief Secretary reporting directy to the decentralizaton, better financial management, andAdmninisdve Reform. Chief Secretary, for coordinating. improved performance and focus on core

monitoring and reporting on governance, functions.public management and administrativerefomns.

Centre for Good Govemance established toprovide support for implementation ofreforms.

Z Civil Servke Reform * Continue 1993 freeze on recruitment, with * Establish a cornputenzed human resource * Based upon the reviews of HRM policies and Performance indicators demonstrate monitorable

specified individual exceptions for prionty database. procedures, initiate comprehensive update of improvements in service delivery in crtical areas

acbvities. personnel regulations, as appropnae (such as primary education and health care, and

* Substantially complete a civit serice * Establish an integrated human resource a potable water), as well as improved access tocensus. management role for GAD. Conduct diagnostic * Based on analytic work by the CGG and services by the poor.

census. ~~~~~~~~review of HRM needs and undertake review ot government departments, reorganize Accountability strengthened by more closelyConduct a review of major departments selected policies and procedures, machinery government to consolidate aligning functions, resources and responsi-

addressing stafing, budget schemes and functions, eliminate duplication and ensure the bilities, and efficiency gains realized through

programs, revenue mobilization, * Drawing upon the initial departmental review, close alignment of portfolios, secretaral imred c nai and reduced throng

operational perormance and computeri- develop formal organizabonal charts for the GoAP assignments and departmental structures. Improved coordiaton and reduced duplcation.

zation. and major departments, clariy reporting The creation of a modern integrated humanrelationships as neeed, and disseminate on the * Strengthen policy analysis capacity in the resource management function with reliable, up-

* Publish citizen's charters, based on Intemet. Secretariat, with particular emphasis upon core to-date information on civil service size and e >

consultabon, for seven departments/ departments. composition. P P

agencies with major public interface. * Analyze the GoAP legal case load and develop a .pmonitonng system, by department, of the number * Implement legal study findings and revamp Modernized personnel regulations consistent (D

of cases fielded and their disposition. Conduct procedures for the selection of govemment with administrative and fiscal reforms. X

detailed analysis of revenue and service-related advocates. Increased revenue collecton and reduced cases ue :V

cases. a~~~~~~~~~~ Strengthen capacity of district training centers .going before the Administrative Tribunal through * Disseminate existing citizen's charters; monitor and establish on-going training for 'change improved management ofatheGoAPleal tnUg

their operation (i.e., by user surveys) and take agents.' agenda..______________________________________ corrective actions; and publish1disseminate Improve the capacity and professionalism of the

4

Prior.acttons by Jan. 31. 2002 2002103 Measures Measures for 2003104 to 2005106 Outcomes

charters for additional departmnents/agencies with civil service by appropriate, cost-effective

public interface, training for different levels and cadres.

* Establish distnct training centers in all 23 districtsfor use by various departments.

* Identify up to 1 0000 change agents' and developspecific training modules for enhancing their

manageral and technical capacity.

3. Decentralization * Strengthen capacity of PRIs to provide effective * Ongoing efforts targeted at. (i) strengthenmng Improve the overall efficiency of fhe civil service

coordination of local functions and services PRI autonomy and financial and human and is responsiveness to the local citizenry.resource capacity, (D) improving the integrationof departmental functions at the district, mandeland village level; and (iii) building the capacityof self-help groups, such as water userassociations

4. Electronic * Streamline deed registration through the * GoAP to streamline and automate paper flow * TWINSle-SEVA program extended to over 50 Use information technology to streamline

Govemnance Computer Aided Adminisration of throughout the Secretariat dunng 2002 through cities. administrative procedures, enhance trans-

Registration Department (CARD), reducing launching the Secretanat Knowledge Information parency and improve service devery

tumaround bme from several weeks to less Management System (SKIMS). * Implementation of blueprint for e-govemance.

than one hour. * TWINSle-Seva program will be extended to

penpheral municipalities surrounding Hyderabad

Implement TWINS/e-Seva, allowing one- and Secunderabad by opening 15 additionalstop bill paymnent for over 16 different outlets.services throughout the metropolitanHyderabad-Secunderabad area. * Establish bluepnnt for electronic governance by

June 2002 through a survey of 50 majordepartments incorporating financial information,procurement, social benefits management and

HRM.

5. Dergulation * Enactment of legislation to enhance the * APonline portal to digitize all relevant laws, An improved business environment, leading to

effecveness of the single window clearance ordinances and regulations for Internet access, an increase in investment and industrial actvity,

system. along with user-fiendly summares. without compromising safety, environmental andother standards.

* Overhaul of business inspection regime (labor,safety, etc.).

* Single window services for business to be providedthrough APonline portal.

* Develop a public relations/outreach strategy for OQ

communicating licensing and inspection X

requirements to various target audiences in a user-friendly fashion.

* Overhaul grevance redressal mechanisms for O

industrial and commercial licenses andinspections.

5

Prtoralctions by Jan. 31, 2002 2002103 Measures Measures for 2003104 to 2005106 Outcomes

6. Right ht Inforrnation * Prepare draft Right to Information Bill and * Submit Right to Information Bill to the Legislative * Index, catalog and computerize government Strengthen accountability and transparency bydisseminate tor public consultation. Assembly for approval. records, train information officers and dissemi- establishing the legal and institutional framework

* Submit Right to Information Bill to Cabinet. nate Right to Information legislation. that wilt allow the public to gain access to officialinformation.

7. Ancornruption * Cabinet approval of an anticorruption * Based on a strategy implementation plan, reform * Strengthen the capacity of the anticorruption Improved deterrence through swifter disciplinary

Sftrateg strategy paper focusing upon prevention, and/or ratbonalize existing agencies to strengthen agency and selcted govemment departments action and a greater sanction and convictionenforcement, and public education. the independence, professionalism and to prevent corrupton by reviewing GoAP rate.

* Constitute a high-level Anticorrupbon Task effectiveness of the anticorrupbon function. systems and procedures. Reduced opportunities for corruption through

Force to develop a strategic * eeo n mlmn omncto taey * Esr fetv rsneIregualaory simplification, proces reengineering,implementation plan. 0 eeo n mlmn omncto Vtg nueefciepeec fat-orpin reduction in inappropriate administrativeDefine termsbof reference and timetable far for engaging public support in the anticosruption agencies at the distfict level, discretion, etc.

* Define terms of reference and bmffetable for effort.review of public procurement process. . * Develop and implement departmental Stakeholder surveys indicate increasing public

* Conduct a procurement review and, if necessary, anbcorruption strategies for key revenue, satisfaction with the anticorruption effort and* Regularize 2 million domestic consumers in introduce legislation, with view to improving expenditure and regulatory departments. decreasing percepbons of corruption.

the power sector. Raise collection transparency in the bid process, standardizingefficiency to over 98%. tender documents, streamlining decision making, * Conduct regular surveys of corruption-related Better value for money and reduced corruption

* Enact a law to control theft of electricity; strengthening mechanisms for handling issues and publish results. in government procurement.

create special courts and police stabons for complaints. * Consolidate and expand the utilization of e- Enhanced revenue collecon in the power

power theft cases. Raise theft case Lanhepoueetpit.rcrmn.registrabon level. * Launch e-procurement pilt, procurement

8. Povety Analysis and * Decision to establish and issue Temts of * Establish the Poverty and Social Monitorng Unit. * Poverty and Social Monitoring Unit to track and Policy formulation which is informed by poverty

Monitoring for Pro-po Reference far a Unit charged with poverty update poverty indicators with particular locus eradication objectives of the government.

Policy Formulation analysis and monitorng to inform * Elaborabon and finalization of the GoAP poverty on key sectors (like welfare, primary health, Better monitoring of efficiency and effectveness

Government policy making. strategy paper. prmary educabon and agriculture), and in service delivery to the poor.

* Initate development by the Sate Poverty disseminate key findings. Improved targeting of government schemes and

Eradication Mission (SPEM) of an overarching * SPEM to effect policy consultation and programs towards the poor.

policy framework for poverty reducbon. coordination arrangements to design and

* SPEM to identfiy key poverty monitorng indicators, implement pro-poor policies.

establish a baseline and implement mechanismsfor regular updating and monitorng of povertyindicators.

9. PE Reform and * Submit to Cabinet Strategy Paper on Public * Continue implementabon of Phase i program and * Privatize/ closeirestructure in batches Reorient govemment away from direct provision

Privatization Sector Reform and Privatization of State initate Phase 2; implement VRS for Phase 2 and PEslCooperatives covered under Phase 2 of goods and services in the economy, enhanceOwned Enterpnses. non-Phase 2. program to complete processing of all 68 public sector efficiency, and reduce fiscal costs

* Close/prvatize/restructure enterprses in * Provide social safety net assistance as per Phase Phase 2 PEs by 2005106 of support to PEs.

Phase I. 11 program to minimize adverse social impact. * Implement VRS and SSN programs consistent

* Finalize and submit to Cabinet for with Phase 2 and non-Phase 2 program.

ratification Phase 2 program coverng PEs * Implement communications program based on D P

and cooperatives (including size and scope stakeholder analysis and participation. aQ

of program, timing and sequencing with * Develop and implement compliance /remediation X

phased targets, methods and procedures, programs for PEs with mqor environmental _ >>

institutional strengthening, VRS estimates liabiities.and social safety net, public awareness O

program, treatment of environmental * Finalize and publish (place on the net) tenderingissues). and bidding procedures.

._ _ xD~~~~~~~~


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STATE GOVERNlIENT

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POWER SECTOR

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CONSOLIDATED ACCOUNTS

Re-etue 179.7 2045 2405 2711 3189 3613 4085 4633

T.t.1 E.Venitooe 256.1 2755 323B 3548 394.7 433.1 4694 517.1Rooonu. Eopend.tur- 225 4 2S.7 2313 306 S 336.6 369.0 4002 437 1Cep, Outl.y &NltLetLd.g 307 36S 423 479 521 641 692 800

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Annex BPage I of 8

Andhra Pradesh Power Sector Reform Program

I. Implementation of Comprehensive Reforms: Achievements during 1999 to 2001

1. A comprehensive program to reform the power sector was launched by the Governmentof Andhra Pradesh in 1998. The foundations of this program, which entails structural, regulatoryand institutional changes, rests on the Electricity Reform Act of 1998, and Government's PowerSector Development Policy Statement (1998)'. During the last two years, impressive progress hasbeen made in implementing reform measures. More specifically, substantial progress has beenmade in restructuring of the power sector, corporatization and commercialization of new powercompanies, establishment of regulatory framework, political and administrative support by thestate government, and efficiency improvements of the power companies.

2. Unbundling of APSEB and commercialization of new companies: The State ElectricityBoard has been functionally separated into one generation, one transmission and four distributioncompanies. These companies are now fully functional and have initiated several institutionaldevelopment and human resource development measures. Commercialization, resulting fromfunctional separation and establishment of commercial contracts between the companies, isbeginning to emerge.

3. Power sector regulation: An independent Regulatory Commission was set up in April1999. In a short span of two and a half years it has implemented several important regulatorydecisions, most notably the tariff order for 2002/01 which linked the tariffs to cost of service,reduced cross subsidies and introduced metered tariff for agriculture consumers. The utilitieshave in January 2002 filed their applications for tariff adjustments for FY2003 to the ERC. TheCommission has set a transparent process of regulation with involvement of stakeholders and thepublic, and demonstrated its ability to take independent decisions. There have been extensivepublic consultation on tariffs, licenses for the companies, and power purchase agreements forpurchase of power from IPPs. Customer service quality standards have been set. TheCommission has directed some far-reaching changes by mandating compulsory metering of allconsumers, and defined the targets for improvement in efficiency, quality of supply and service tothe consumers. Under a recent directive of the Commission about 300,000 agriculturalconnections have to be either regularized or disconnected. The Regulatory Commission hadpronounced in its last tariff order that it will issue a consultation paper on multi year tariff beforeMarch 2002. Amendment to Andhra Pradesh Electricity Reform Act, if required to facilitate thisapproach, may have to be considered by the Government. Another important reform action takenby the Commission has been to allow, through the license awarded to the distribution companies,purchase of bulk power by them directly from the generators thereby setting the stage forestablishing a multi-buyer-multi-seller market. The license also enables the cross holding ofdistribution and new generation business, which will be seen as positive feature by the potentialinvestors.

4. Governance and efficiency improvement initiatives: The most remarkable effort by thestate government in the last one year has been its full commitment and support to improvegovernance and bring transparency in management of the power sector. The government, and thecompanies have implemented impressive measures to control theft of electricity, root outcorruption and improve operational efficiency. Some of the important measures implementedinclude the following:

To control theft of electricity, a new law - the first of its kind in India - has been enacted,providing for stiff penalties for the guilty, including mandatory imprisonment. Several

lThese are also reiterated in " Vision 2020" ( January, 1999) and " Power Sector Strategy Paper " (March 2001)

Annex BPage 2 of 8

new police stations and courts have been set up throughout the state to acceleratesettlement of electricity theft cases. About 2.6 million services have been inspected,20,000 cases booked (including against 87 utility staff and one member of legislativeassembly), 1,800 people arrested.

* More than two million residential customers have been regularized, thereby increasingaccess rate from 68% to 82% in a few months. About 300,000 million agricultureconsumers are in the process of being regularized. About 1.4 million residentialconsumers have been provided with connection and are being regularly billed.

* Power supply to agriculture is being regulated and made more equitable throughmonitoring of all feeders in the state to ensure that the policy of nine hours power supplyto the farmers is implemented and the information is posted on the website on a dailybasis.

* A comprehensive program of metering and energy audit at various voltage levels hasbeen initiated. Statewide checking of consumer meters has been carried out and 1 millionmeters were found to be defective or non-functional.

* An extensive anti-theft drive and arrears collection campaign has been launched. As aresult billing for electricity has increased by 34% and collections have gone up by 44%(while average tariff increased by 15%) since 1999/00.

* A full census of all the agriculture pumpsets through out the state is underway by anindependent organization, to identify the actual number and capacity of pumps connectedto the utility system.

* Pilot projects of computerized "Consumer Care Centers" for addressing consumercomplaints and bill collection started at Hyderabad have been highly appreciated by theconsumers. These pilots will be scaled up for implementation across the state.

5. Improvements in quality and reliability ofpower supply: Investments in the transmissionand distribution system have fallen far short of the requirements during the last decade due to thepoor financial condition of the sector. The situation was further worsened by fast expansion of therural network. Andhra Pradesh was one of the first states in the country to achieve electrificationof all its villages. Consumers' expectation for improved availability, quality and reliability ofpower supply have gone up with the launch of reforms. During the last three years significantinvestments have been made in the transmission and distribution system for evacuation ofadditional power, to improve the quality and reliability of power supply, to reduce technicallosses and in better metering. Investments supported under the Bank loan (APL1) in the last twoyears have focused on critically needed rehabilitation of an overloaded and deteriorating network,reducing transmission bottlenecks, and improving reliability and quality of supply. Based on acomparison of the first five months in 1999/00 and 2000/01, the initial results followingcompletion of part of these investment schemes indicate that: (i) distribution transformer failurerate has declined from 14% to 11% (ii) maximum energy handled by the system has increased by4% from 137 to 142 million units per day and (iii) maximum repair time has decreased by 10%.All these improvements in availability, quality, and reliability of power supply have beenachieved in spite of almost 20% increase in the customer base handled by the power systemduring this period.

6. Further investments in transmission system are planned for evacuation of additionalpower from the new generating stations, augmenting transmission capacity and revamping andstrengthening of the present transmission system to ensure stability of the system, voltageimprovement and reduction of losses. Investments in distribution system, prior to privatization,will be required for purchase and installation of meters to control theft and commercial losses,reduce technical losses in distribution system, and improving quality of supply particularly in

Annex BPage 3 of 8

rural areas for agriculture consumers and also for large industrial consumers by way of providingdedicated feeders for power supply. Deterioration in the reliability and quality of supply due tolack of investments, would not only cause financial losses to the utilities but also reduce publicacceptance of reforms and much needed tariff adjustments.

II. Financial Performance.

7. The financial performance of the sector deteriorated between 1997/98 and 1999/00 withlosses increasing from Rs. 11.3 billion to a level of Rs. 30 billion (Attachment II). During thisperiod coverage of cash operating expenses (EBITDA) 2 deteriorated from a surplus of Rs. 0.5billion in FY1998 to a deficit of Rs. 10 billion in FY2000. This occurred primarily on account ofa decline in sales to industrial consumers, an increase in highly subsidized agriculturalconsumption, and the mounting financing costs of debt financed losses. In response to thefinancial crisis, the Government of Andhra Pradesh and the electricity utilities launched thegovernance improvement drive discussed above. The results of the drive have been remarkablein FY 2002 with both billing and collection improving by over 20% and 35% respectively. InSeptember 2001 monthly billing and collection reached a level of Rs. 5.4 billion and Rs. 5.3billion respectively compared to the corresponding level of Rs. 3.9 billion and 3.5 billion in April2000. Attachment I to the note provides a comparative analysis of the billing and collectionperformance of the sector over the last two years. The loss in the sector in FY 2001 has beenreduced to Rs. 29.7 billion and EBITDA maintained at a loss of Rs. 10 billion. The full impact ofthe improved performance was expected to reduce financial losses substantially in 2001/02 but asevere drought affected the state this year. This resulted not only in reducing availability ofhydro generation but also led to higher electricity demand from farmers to pump groundwater forsaving their crops. The financial impact of this is estimated to be Rs. 3.7 billion over the full yearin increased power costs owing to purchases from expensive sources to compensate for shortfallin state's own hydro generation. Despite the drought and severe hydro failure, the measurestaken by the Government have substantially reduced EBITDA loss to Rs. 1.5 billion at existingtariff level.

8. The Government of Andhra Pradesh intends to pursue a combination of initiatives toimprove the financial performance of the sector rapidly which are highlighted below:

* Industrial consumption has been increasing at a rate of 4% p.a. in Andhra in the last fiveyears though consumption from the utility has shown a reducing trend. To attract industrialconsumers back to the grid Andhra Pradesh intends to follow a strategy of improving serviceand reliability through segregated feeders, and providing incentives in tariffs to industrialconsumers. In addition the Government also intends to levy a wheeling charge of Rs. 1/kWhon wheeling of third party electricity transfers and electricity duty of Rs.1/kWh on electricityconsumption by captive generators.

* Supply to subsidized agricultural customers would be regulated to affordable levels. Supplyto agricultural consumers has been regulated effectively to 9 hours/day in the last 10 months(except during the drought period when supply was increased to 12 hours/day).

* To shift agricultural subsidies directly onto the budget to foster commercial operation of thedistribution companies, and to improve effective subsidy targeting, GoAP has set up a TaskForce to design, implement in select areas and monitor pilot projects of a package ofmeasures, including altemative subsidy delivery mechanisms for agriculture consumers andend-use (pump) efficiency improvement. Based on the lessons learned, the Task Force willprepare an action plan for scaling up the pilot projects to the state level.

2 Earnings before interest, tax depreciation and appropriation

Annex BPage 4 of 8

* As stated in the Letter of Development Policy, the Government is committed to universalmetering in accordance with the directives of the APERC. Based on the interim findings ofthe Task Force on alternative subsidy delivery mechanisms, the Government will prepare anaction plan by October 2002 for compliance with the APERC directive on universal metering.In their tariff order for 2001/02, APERC has also directed the power distribution companiesto meter, with immediate effect, all new agriculture consumers, including unauthorizedagriculture connections which have been regularized. The utility companies have requestedthe APERC to allow extension, up to June 30, 2002, of the period for regularization ofagriculture connections, and to reconsider the time frame for metering. The GoAP and theutilities will ensure compliance with the ensuing directives of the APERC.

* Theft control and efficiency improvements measures are expected to be continued with thesame vigor as demonstrated during the last one year.

* A program of steady tariff adjustment to progressively reduce cross-subsidies is planned.

* The distribution business is proposed to be privatized by 2003/04 to improve efficiency andreduce costs on a sustainable basis.

Figure 1: Power Sector Financial Performance

30

20

100

1998 - "2000 2001 2002 2003 29-10

.S-20

-30

-40

Financial year ending March 31

|+- Profoit after tax (w ithout subsidy) Earning before interest, depreciation, tax and appropriation(EBIDTA)

9. The above measures are expected to improve operational profits of the power sector asshown in Chart I below. In addition the Government has to address the accumulated debtoverhang in the sector resulting from past losses which results in continued, though reducing,financial losses in the power sector as shown in Chart I. At the end of 2000/01 outstanding debtof the sector stood at Rs. 124 billion excluding Rs. 41 billion of bonds taken over by theGovernment. This debt stock includes Rs. 47 billion of bonds issued to employee pension fundswhich had hitherto remained unfunded. For the Government to privatize the distribution businessit is essential for them to carry out a financial workout to address the outstanding debt stock witheffective burden sharing from all stake-holders including the lenders and creditors owned by theGovernment of India. Implementation of recommendations of the Expert Group (AhluwaliaCommittee appointed by the Government of India) would address the debt stock to a limitedextent (about Rs. 20 billion), helping to reduce the debt service burden of the power companies.Past attempts at negotiating such financial restructuring measures have been mixed - over Rs. 40billion have been converted into long term liabilities resulting in reducing immediate cashoutflows but a deeper financial workout could not be negotiated.

Annex BPage 5 of 8

III. Privatization of Power Distribution Business

10. The govemment's desire to ensure long-term sustainability of the efficiency improvementinitiatives and control of theft especially in the wake of political pressures has reinforced itsresolve to privatize power distribution business. Government is committed to privatize the entirepower distribution business by 2003/04 . In the prevailing intensely competitive markets andemerging business opportunities worldwide, minimizing the financial, regulatory and politicalrisks perceived by the potential private investors and offering a viable business is very importantto build investor confidence and for the success of the privatization transaction. Continuedsupport of the government in govemance to enable the utilities to operate post privatization ismost essential for success of the reform program.

11. Substantial preparatory work is underway to launch the privatization of distributionbusiness, with the assistance of international merchant bankers. A cabinet sub-committee onpower has deliberated, through various rounds of discussions, the important issues relating tostructuring of the transaction, criteria of bidding, criteria of qualification and selection of privateinvestor and the role of govemment. The government has decided to privatize the fourdistribution companies through sale of majority shareholding and transfer of management controlto strategic private investor. In order to make the transaction attractive to the private bidders inthe prevailing market situation, the govemment is open to consider sale of more than 76% equitystake to potential investors.

12. To accelerate the privatization process some of the important actions under discussioninclude: (i) appointment of a "Privatization Team" in the state govemment which would provideday-to-day support for policy guidance and implementation of the privatization process, includinginteraction with potential investors once the process is launched:(ii) finalization of the strategy forprivatization and strategy for marketing of the transaction; (iii) finalization of the transfer ofemployees to the distribution companies (at present the employees still belong to APTRANSCOand are on secondment to the distribution companies); and (iv) improvement in the financialviability of the business case, which would need serious consideration of financial restructuringand burden sharing by the central government utilities as well. The efforts towards mitigatingregulatory risks, specifically for developing multi year tariff regulation, is underway.

IV. Financial Risks

13. There are substantial financial risks in the power sector. Although the financial health ofthe power sector has improved this year, and is forecast to continue to improve, there are largedownside financial risks to the sector arising from the difficulties of reducing the large powersubsidy currently flowing to farmers; the risk that demand growth projections, specifically for theindustrial consumers and repatriation of demand from self generation to grid supply, do notmaterialize; and the related risk of excessive generation capacity expansion resulting in surpluspower beginning 2002/03. In addition difficulty in metering agriculture consumers in AndhraPradesh, as in the rest of India, imposes a risk of continued growth in agricultural consumption.Close monitoring of outcomes relative to the Power Sector business plan is important for theGovemment to take timely actions to mitigate these financial risks.

14. A related risk concems the failure of privatization efforts in the power sector, whichwould threaten the operational efficiency improvements built into the power sector financialforecasts: although AP has already significantly improved its billings and collectionsperformance, this may be difficult to sustain in the absence of privatization. While the success ofany privatization program cannot be assured, AP's commitment to privatization is high. Its trackrecord in meeting its subsidy obligation to the power sector will provide comfort to potentialprivate investors. Regulatory risk perceived by the potential investors is proposed to be addressedthrough development of a multi year tariff regulation framework.

Annex BPage 6 of 8

15. Some sensitivity analysis has been prepared and an alternate scenario has beenprepared for the power sector performance in the event of less positive outcomes on thekey risks mentioned above. In particular, the alternate scenario considers a conservative4% p.a. growth in the sales to industry and a conservative generation expansion strategywhile keeping the wheeling charges for third-party sales unaltered at present levels forthe projection period. Under the alternative scenario, the bottom line power financingrequirement in 2002/03 would be around Rs.440 crore higher than the current estimates(around 0.26% of forecast GSDP), and would be carried into subsequent years, althoughon a declining basis. The table below shows these estimates for the base case (used in theMTFF) and the alternative (conservative) scenario.

Forecasts of power sector fina ncing requirem nts (2002/03 to 2006/07) (in Rs. billion)2002/03 2003/04 2004/05 2005/06 2006/07

Earning before Int. Depn. Taxes and appropn.(EIDTA)

- Base case 10.1 19.9 25.5 30.8 30.0- Alternate scenario 5.7 16.2 23.7 30.9 29.8

Net Profit/(Loss) excl. Depn. and subsidy-Base case

- Alternate scenario -8.7 0.2 7.3 14.2 12.8-13.0 -3.2 5.8 14.7 14.3

Capital Outlay 17.86 18.15 14.86 17.58 31.33(same in both scenarios)

Power Sector Financing Requirement- Basecase 26.5 17.9 7.5 3.4 18.4- Alternate scenario 30.8 21.3 9.0 2.8 17.0

Annex BPage 7 of 8

Attachment 1: Billing and Collection Improvements in FY 01 and FY 02

(in Rs. crore)

Improvement from Improvement from1999/00 2000/01 2001/02 FY00 to 01 FY01 to 02

Billing Collection Billing Collection Billing Collection Billing Collection Billing Collection

April 372 327 390 349 502 518 5% 7% 29% 48%

May 395 360 430 410 538 540 9% 14% 25% 32%

June 408 385 425 384 552 544 4% 0% 30% 42%

July 420 396 468 431 569 543 11% 9% 22% 26%

August 399 362 486 406 549 523 22% 12% 13% 29%

September 404 353 507 456 541 524 25% 29% 7% 15%

October 412 378 498 439 545 516 21% 16% 9% 18%

November 397 382 506 506 529 540 27% 32% 5% 7%

December 416 424 518 596 528 603 25% 41% 2% 1 %

January 399 379 503 510 26% 35%

February 402 372 505 534 26% 44%

arch 420 390 536 568 28% 46%

Annex BPage 8 of 8

Attachment Il: Andhra PradeshAimre2ate Financial Performance of the Power Sector

(in Rs. Crores) *

(Financial year ending March 31i 1198 1999 2000 2001 2002 2003 200(act) (act) (est) (est.) (proj.) (pr9.) (proj

Profit and Loss StatementRevenue from Sale of Power 4242 4432 4797 5535 6300 7940 970Non operational Income 122 188 160 393 440 659 691

I Total Power Sector Revenue 4363 4620 4956 5929 6740 8599 1040Purchase of power 3464 3996 4475 5476 5498 5964 675

Repairs & Maintenance 169 181 292 290 304 361 411Salaries and Wages 517 648 668 721 819 923 97Administrative and Misc. Expenses 181 482 583 545 192 347 2

Provision for bad and doubtful debts 0 0 0 0 0 0Electricty Duty Paid 74 74 73 45 87 94 10

Less: Expenses capitalised 96 67 80 80 126 100 811 Total Cash Operating Expenditure 4309 5316 6012 6997 6774 7590 840

IlIl Surplus after cash operating exp. (EBITDA) [I -II] 54 (695) (1056) (1068) (33) 1009 199

IV Interest&financial Charges (incl. Lease Rent) 754 1195 1224 1066 1645 1883 196V Depreciation 435 533 784 832 832 760 90VI Taxation 0 0 0 0 0 0

VIl Profiti(Loss) after tax [il - IV -V -VI] (1134) (2423) (3064) (2967) (2438) (1781) (925

Financing of lossesGoAP Subsidy 1626 2438 1792 106

Bondsmissued 500 2100 2603 1053Other debts including arrears 634 323 462 288

Total 1134 2423 3065 2967

Investment and Financing PlanCapital Expenditure 609 1350 1400 1207 1566 1786 181

nera oeneraon n.a. 522 291 241 185 1 231Transmission n.a. 236 442 362 580 779 620

a Distribution n.a. 376 469 399 649 791 74-Interest Capitalised n.a. 149 118 125 72 129 139-Expenses Capitalised n.a. 67 80 80 80 86 85

Financing 609 1350 1400 1207 1566 1786 181Internal resource generation 0 ° ° ° ° ° 24Consumer contribubons 146 145 175 175 175 179 189Government equity 25 475 101Debt financing 463 1205 1225 1007 1391 1132 1279

Memo Items.Due to severe drought in AP this year an additional expense of Rs. 373 cr. was incurred in power purchase. Excluding theimpact of the same on Profit after tax (without subsidy) and Net surplus after cash operating expense (without subsidy) are:

a . Profit after tax (without subsidy) excl .drought -1134 -2423 -3064 -2967 -2065 -1781 -925b. Net surplus after cash operating expenses 54 -695 -1056 -1068 340 1009 1992

(without subsidy) excluding drought*Rs. 1 00 crorc = Rs. I Billion

Annex CPage ] of 6

Poverty and Social Development in Andhra Pradesh

1. Poverty Levels and Trends: Andhra Pradesh is India's 5th largest state (population: 76million). Nearly three-quarters of the total population of the state lives across 26,500 villages inrural areas. While the rural economy provides over 70% of employment, it is estimated tocontribute less than one-third the Gross State Domestic Product (GSDP). Despite the widespreadattention the state has deservedly received for its achievements in the information technologysector, poverty remains a major issue and concern, with pockets of chronic poverty within thestate affecting specific localities and population groups.

Table 1: Mean Consumption and Poverty in Andhra Pradesh and India: 1999/00

NSS 5 5 th Round (1999/00)Urban Rural Overall

1. Mean per-capita monthly consumption (Rs.)All India: 855 486 591Andhra Pradesh: 774 454 551

2. Gol Planning Commission Poverty Estimate (%):All India: 23.6 27.1 26.1Andhra Pradesh: 26.6 11.1 15.8

3. Alternative Poverty Estimates (%):All India: 12.5 25.3 -

Andhra Pradesh: 11.3 27.9

Source: 1 and 2: NSSO 55a Round Consumer Expenditure Survey, Planning Commission, Govemment of India.3: Deaton (2001) based on NSS data, which tries to correct for cost-of-living differences between AP and theAll-India level.

2. Estimates of poverty incidence in Andhra Pradesh vary quite considerably: while 1999/00Gol Planning Commission estimates (Table 1) show poverty in the state to be considerably lowerthan the All-India average (16% vs. 26%), other studies suggest that poverty differentials betweenAndhra Pradesh and the rest of India are considerably lower than that indicated here.' Alternateestimates (Deaton 2001) suggest that about one-quarter of AP's population still live in poverty.There are also strong grounds for believing that in Andhra Pradesh, the incidence of poverty inrural areas is higher than in urban: mean per capita consumption in rural areas is considerablylower than in urban (Table 1). Other non-income indicators of living standards from other sources(e.g. the 1998/99 National Family Health Survey: NFHS-II), also show rates of infant and childmortality, morbidity, illiteracy, school non-attendance rates, etc. are also much worse in ruralareas compared to urban areas.2

Table 2: Recent Trends in Monthly Per-Capita Consumption

NSS 43rd Round NSS 50 "h Round NSS 55 "h Round A 87-88 to A 93-94 to1987/88 1993194 1999/00 1993194 1999/00

Urban Rural Urban Rural Urban Rural U R U RMean per-capita monthly consumption (Rs.):

Andhra Pradesh 228 159 409 289 774 454 79% 82% 89% 57%Karnataka 223 151 423 269 911 500 90% 78% 115% 86%TamilNadu 245 156 438 294 972 514 79% 88% 122% 75%Kerala 262 209 494 390 933 766 89% 87% 89% 96%All-India 246 158 458 281 855 486 86% 78% 87% 73%

Source: NS_Sdata_, various years.

' For example, World Bank (1997) India, Achievements and Challenges: Reducing Poverty, Deaton & Tarozzi (1999)Prices and Poverty in India, Deaton (2001: draft) Computing prices and poverty rates in India 1999/00.2 For a more detailed discussion of some of these issues, please see Andhra Pradesh Poverty Note. A PreliminaryProfile and Emerging Issues mimeo, World Bank, 2001.

Annex CPage 2 of 6

3. Progress at poverty reduction in Andhra Pradesh in recent years may have been slowerthan in other states. There has been much debate and controversy in India recently around thepoverty estimates released by the Government of India based on the 1999/00 NSSO survey.While it is difficult to ascertain the extent to which poverty in the country has declined in recentyears, NSS data show that growth in mean per capita consumption in rural Andhra Pradesh wasslower than in other states (Table 2). In addition, National Accounts data show that the trendgrowth rate for agriculture in the state declined from over 5% during the 1980s to less than 2%during the 1 990s, a particularly worrying sign given that a large fraction of the rural poor aredepended on wage labor for their livelihoods (para. 5).3

4. Poverty Profde: A profile of consumption-poverty in the state using the 1993/94 NSSshows that a very large percentage of the rural population in Andhra Pradesh has virtually noeducation (Table 3). Some 79% of poor rural household heads (i.e., those in the bottom quintile)are not literate. Another 11% are educated only up to some level below primary. Even for thepopulation as a whole, the comparable figures are as high as 66% and 13%, respectively. Overall,literacy rates in AP are amongst the lowest in the country. These in turn reflect low primaryschool enrollment, the poor quality of education, as well as gender and social inequalities inaccess to education at all levels.4

Table 3: Distribution of Population by Income and Education Level of Household Head

Education level of Household Head (1993/94 NSS)Income Group Not Less than Completed Completed Completed Completed

literate Primary Primary Middle Secondary HigherRURAL AREAS:Bottom Quintile 1 79% 11% 6% 3% 1% -

Quintile 2 75% 13% 6% 4% 2% 1%Quintile 3 68% 14% 9% 5% 3% 1%Quintile 4 62% 13% 11% 7% 4% 3%

Top Quintile 5 47% 15% 12% 9% 9% 9%Overall Population 66% 13% 9% 5% 4% 3%Mean monthly p.c.

Consumption Rs. 255 Rs. 300 Rs. 317 Rs. 377 Rs. 459 Rs. 579URBAN AREAS:

Bottom Quintile 1 58% 16% 12% 7% 5% 2%Quintile 2 38% 19% 16% 12% 8% 6%Quintile 3 29% 17% 17% 13% 12% 12%Quintile 4 19% 12% 10% 14% 18% 27%

Top Quintile 5 11% 5% 4% 9% 21% 49%Overall Population 31% 14% 12% 11% 13% 19%Mean monthly p.c.

Consumption Rs. 292 Rs. 329 Rs.336 Rs. 398 Rs. 512 Rs. 666Source: 1993/94 NSS Consumer Expenditure SurveyNote: Consumption quintiles have been constructed separately for urban and rural households using the NSS MPCE.

5. In Andhra Pradesh, a much higher share of the population report agriculture labor as theirmain occupation (43%) compared to the All-India average (32%). This finding is consistent withthe fact that average landholdings in the state are considerably lower than in the rest of thecountry (about 0.6 hectares per household in AP compared to 0.8 ha. in India overall). NSS dataalso reveal that households in AP that relied primarily upon labor income from agriculture fortheir main source of livelihood had mean consumption levels that were about 20% lower than

3Andhra Pradesh: Draft Report of the Rural Poverty Task Force, 17 th May, 2000.4 Andhra Pradesh State Strategy Paper DFID, India, 2001.

Annex CPage 3 of 6

other households, and tended to be disproportionately represented amongst the bottom incomequintiles (Table 4). Non-farm income shares in Andhra Pradesh are relatively low, compared toneighboring states such as Tamil Nadu, as well as compared to the All-India average.

Table 4: Distribution of Population by Income and Occupation of Household Head

Main Occupation of Household Head (1993/94 NSS)Income Group Self-empl. Agriculture Other Self-empl.

non-agri. laborer laborer Agriculture OtherRuRAL AREAS:

Bottom Quintile 1 9% 59% 8% 18% 5%Quintile 2 15% 52% 8% 23% 3%Quintile 3 14% 46% 7% 27% 6%Quintile 4 17% 33% 7% 34% 9%

Top Quintile 5 18% 26% 4% 36% 16%Overall Population 15% 43% 7% 28% 8%Mean monthly p.c.

Consumption Rs. 303 Rs. 243 Rs. 261 Rs. 325 Rs. 441

Self Regular CasualURBAN AREAS: Employed Salaried Labor Other

Bottom Quintile 1 36% 22% 37% 5%Quintile 2 37% 34% 24% 5%Quintile 3 32% 44% 17% 6%Quintile 4 34% 48% 9% 9%

Top Quintile 5 23% 59% 2% 16%Overall Population 32% 42% 18% 8%Mean monthly p.c.

Consumption Rs. 381 Rs. 486 Rs. 259 Rs. 504Source: 1993/94 NSS Consumer Expenditure Survey.Note: Cases where no occupation was reported were excluded

6. Three population groups who appear to be at some disadvantage in particular are women,tribals, and scheduled caste households. To some extent Muslim households also appear find lessemployment, and earn lower incomes, in the non-farm sector. Not only do these three groupstypically possess much lower levels of human capital, but controlling for these assets, they faceadditional constraints on employment and earnings.5 Prevailing cultural perceptions contribute tosystematic discrimination against these groups. In addition, significant regional disparities inliving conditions persist across different parts of the state.

7. Initial findings from DFID-financed Participatory Poverty Assessments carried out in fivetowns in AP by Action Aid and PRAXIS highlight vulnerability of the urban poor to insecurelivelihoods. Particularly vulnerable to the demands of livelihood were children from poorfamilies. Cycles of impoverishment were found to be perpetuated by severe indebtedness for alarge number of poor, and illnesses in the family. The lack of access to basic services and socialsecurity is often compounded by poor service delivery and corruption. Women have alsoreported violence and drudgery in their daily lives to meet their basic needs such as for drinkingwater.

8. To sum, amongst the main challenges facing policy makers in Andhra Pradesh are to findways to (i) invigorate agriculture and the rural non-farm economy to stimulate the emergence ofvibrant and productive small-scale enterprises and raise rural incomes across the board, (ii)improve access of the poor to opportunities in this growing economy and remove impediments

5 Ibid.

Annex CPage 4 of6

that those of lower social status and wealth appear to face in participating in the growth process,(iii) improve delivery of service to the poor and reduce levels of corruption, and (iv) better targetdevelopment efforts and resources towards regions and social groups with greater need ofassistance.

9. Government Strategy for Poverty Eradication: Acknowledging the tremendouschallenges to be overcome if it is to achieve the standard of living envisioned in the Vision 2020document, GoAP has recently issued a paper outlining the main thrust of the government'sstrategy towards poverty reduction.6 The plan is geared towards (i) generating rapid economicgrowth, (ii) promoting human development, (iii) enhancing social capital through fostering self-help groups, (iv) promoting sustainable livelihoods of the poor, (v) focusing attention onbackward regions and poorer segments of society, and (vi) redesigning the administrativemachinery to improve delivery of services to the poor.

10. More rapid economic growth in the rural sector is envisaged through increased public andprivate investments in rural infrastructure such as irrigation and rural roads, particularly inbackward rain-fed areas, electrification of rural habitations and improved quality of powersupplied to promote the rural non-farm sector, and expanding the service sector though educationand skill development, provision of micro-credit, and through creating a more conducive policyenvironment. The poultry, fishing, dairy, and horticulture sub-sector in Andhra Pradesh havebeen growing considerably more rapidly than the food grain sector. The government plans tochannel the proliferation of self-help groups (SHG) into promoting viable self-employmentventures, to develop partnerships with the corporate private sector to establish marketingplatforms, improve packaging, branding, and value-addition of products, as well as to exploit thepotential of information technology to help bring about transformation in rural and urban areas.

11. The strategy paper highlights provision of basic minimum services to all citizens,particularly the poor, women, and weaker sections as a priority action. These basic minimumservices have been identified as education, health, nutrition, safe drinking water, sanitation,housing, and rural connectivity. The Department of Education has set as its main objectiveuniversalizing primary education in the state. The World Bank and DFID -aided District PrimaryEducation Program (DPEP) is being implemented in 19 of the 23 districts in the state, while theremaining 4 districts will be covered under the GoI Sarva Shiksha Abhiyan (SSA) program. Thechallenge of universalizing Elementary Education in AP is a formidable one: the EducationDepartment estimates that about 3.5 million children from the target population are currently outof school, with the problem of out-of-school children being particularly acute for some regions(e.g., the tribal dominated hilly belt across the Telangana and the coastal regions) and groups(e.g., muslim girls). This challenge is being met through (i) mobilizing out-of-school childrenthrough a variety of initiatives, (ii) in-school process improvements to make schools moreattractive places for attending children, and (iii) systemic reforms geared at removing structuraland procedural barriers that make it difficult for children to enroll in schools.

12. Andhra Pradesh has one of the most vibrant self-help-group (SHG) movements in India,with about 100,000 such registered groups having mobilized total savings of Rs. 2.2 billion in thestate. A recent study conducted for GoAP by ORG using SWOT analysis7 of Women's SHG in 7districts found that in general these groups were homogeneous and cohesive, and exhibitedconsiderable flexibility in management of credit within the group. The SHG were successful inmobilizing savings and provided an alternate source of credit to members who would otherwisehave been forced to borrow from moneylenders instead. On the downside, with three-quarters of

6 Strategy Paper on Poverty Eradication in Andhra Pradesh, 2001, Department of Panchayati Raj & RuralDevelopment, GOAP.' SWOT denotes Strengths, Weaknesses, Opportunities, and Threats.

Annex CPage 5 of 6

the members being illiterate, book-keeping and maintenance of records was found to be deficient,with a high degree of dependence on the leader with regard to maintaining accounts, attendancerecords, etc. Ongoing efforts in facilitating the formation and development of the self-helpgroups will be combined with further capacity-building and training, in addition to which thesegroups will be encouraged both to form federations as well as forge partnerships with Mandal-level and Municipal elected bodies.

13. AP is one of the three states in India where the World Bank-aided District PovertyInitiatives Project (DPIP) - a large community driven development (CDD) project) - is beingimplemented in 6 backward districts. Other projects supporting user groups of different kindsinclude the AP Forestry Project, various irrigation projects, and parents' and communitymembers' groups in education programs. While these groups have had a high degree of success inchanneling funds and resources directly to the poor, they also raise the longer term question ofsustainability and linkages with the elected local Panchayat Raj institutions.

14. Development of sustainable livelihoods for the poor is being carried out with assistancefrom DFID' within a framework of employment and better natural resource management andconservation. In addition, so as to better target resources to poorer geographic regions, GoAP isplanning to select a set of parameters for ranking mandals by their development, the objectivebeing to focus particular attention on backward regions. Finally, GoAP is pursuing wide-ranginginitiatives and administrative reforms aimed at enhancing transparency and accountability ofgovernment activities, and at improving the delivery of services to the poor. Reduction incorruption, in particular, is likely to have a positive impact on the poor, as they sufferdisproportionately from various forms of rent seeking and diversion of funds from targetedprograms.

15. With the objective of bringing backward pockets and regions in the state on par withother more developed localities, GoAP plans to select, through a consultative process, a set ofparameters for ranking mandals by their level of development, and to then use this ranking tofocus efforts to accelerate poverty reduction in these mandals. Finally, the strategy paperhighlights the need to sensitize all government departments to issues concerning the poor, and tomandate them to articulate clearly how their respective programs address poverty. AP hasestablished an overall coordinating body, the Poverty Eradication Mission, to address povertyissues across sectors. The Mission has broad representation from both GoAP as well as civilsociety. Amongst the main recommendations made to GoAP has been to pursue greaterdecentralization and empowerment of local bodies, as well as to work towards convergence ofself-help groups, Panchayati Raj Institutions (i.e., elected local bodies) and government linedepartments.

16. Strengthening Poverty and Social Monitoring and Analysis: Andhra Pradesh has oneof the better databases of both quantitative and qualitative information compared to other Indianstates. The state Department of Economics and Statistics (DES) is one of the best in the country,with various socio-economic surveys conducted by the Department on a regular and matching-sample basis with Gol's National Sample Survey Organization (NSSO). A number ofparticipatory poverty assessments have been carried out under DFID financed Urban Services forthe Poor. In addition, GoAP is currently undertaking an extensive exercise aimed at improvingand refining the existing Management Information System of the various government linedepartments though its Performance Indicators initiative. Finally, an extensive data collectionexercise collecting both qualitative and quantitative information has recently been initiated in 3districts as part of the monitoring and evaluation effort in AP under the District PovertyInitiatives Project (DPIP).

8 Andhra Pradesh Rural Livelihoods Project (APRLP).

Annex CPage 6 of 6

17. Given the good information base available, the main challenge facing AP is (i) to focusefforts at improving quality of the existing system of data collection, and (ii) to try to make bestpossible use is made of the extensive information base by ensuring that the findings from thevarious analytic studies undertaken by different department and agencies inform and influence thedecision-making process. It is also important to gradually move towards greater transparency andaccess to information by the public, in particular the poor, and build feedback mechanisms intothe system. Agreement has been reached that GoAP will take further steps to address these needs,and to strengthen the linkages between the core components of the government's reforms effortswith improved performance, outcomes, and accountability at the local level. The process willfocus on measures to (a) strengthen the capacity in the state to coordinate and analyze differentdata sets and sources of information related to poverty and social development across sectors, (b)discuss and disseminate findings, and (c) provide informed policy guidance and inputs to budgetprocesses and decision-making. A monitoring and analysis unit under the State PovertyEradication Mission is being charged with these responsibilities.

18. Discussions with GoAP have highlighted the need to agree on basic principles of whatindicators are of importance in measuring poverty reduction. These indicators should be acombination of process, output, and outcome indicators using both quantitative and qualitativedata sources. The monitoring system will disaggregate amongst different social groups andcategories on the basis of region, gender, scheduled caste/scheduled tribe, and other relevantimportant factors. Important first steps for the poverty and social monitoring unit entrusted withcoordinating efforts to this end will include (a) agreement on a comprehensive poverty-reductionframework addressing issues of growth, livelihood, empowerment, and security, (b) establish coreindicators for measuring processes and outcomes related to poverty and social development, and(c) determine linkages and relationships with various government line departments and agencies.This process is likely to take some time, as it will be important to involve various stakeholdergroups and build consensus and understanding of the various steps involved.

19. In the medium-term, it is expected that consensus will be established regarding needs,criteria, and location for poverty and social monitoring and analysis. Once this has beenidentified, work is likely to focus on taking stock of existing sources of information, addressinggaps or inconsistencies, and further strengthening the capacity to coordinate and analyze thisinformation. In addition, specific studies are likely to be undertaken in response to issues andquestions of particular interest. Areas proposed by representatives from Government and NGOsinclude: (a) a study of gender in education reform, (b) disaggregated poverty maps, (iii)mechanisms to refine and update the Multi-Purpose Household Survey (MIPHS) database, (iv)benefit-incidence analysis and studies of user charges, (v) expenditure tracking surveys in prioritysectors, as well as (vi) pilot studies of quality of service delivery, for instance through clientsatisfaction surveys, report cards, etc.

Annex DPage I of 3

Improving Public Financial Accountability in Andhra Pradesh

1. A preliminary public financial accountability assessment was carried out for AP,including review of the state's latest accounts and external audit reports. The results of this andother work on fiscal and public expenditure management/accountability indicate that althoughthere are weaknesses, the foundations of AP's public financial accountability system aresatisfactory. Maj or strengths of the system include:

* the well-established role of Legislature in providing oversight over public finances in theConstitution. Legislative approval of the Budget is regularly done, and annual Accountsand Audit Reports are placed before Legislature. Committees of the Legislature examineaudit reports, conduct hearings and provide recommendations, to be acted on byGovernment;

* regular preparation and compilation of accounting information, and presentation ofannual State Accounts. The State Accounts are regularly prepared each year, usuallyabout 7-8 months after the end of the year (Accounts for 2000/01 have been received andplaced before Legislature). The Accounts are prepared on cash basis, and providecomprehensive information on the receipts and payments of the state. The accounts alsoprovide information on some financial liabilities and assets, notably Government's debts,guarantees granted and outstanding, investments, and loans and advances provided, albeitwith varying quality;

* existence of detailed guidelines for budgeting and monitoring of public funds, especiallyat the individual transaction level. The system provides good procedural transactioncontrols over individual items of expenditures and receipts. Accounting for receipts andpayments is done regularly, and monthly accounts are regularly compiled;

* the well established and recognized independence of the public auditor (Comptroller andAuditor General of India - CAG) from the Executive and Legislature, as provided in theConstitution. The mandate of the auditor is also wide. Audits are regularly carried outand the Audit Report for the State is regularly issued, usually about 11-12 months afterthe end of the year. The annual Audit Reports are placed before the Legislature andmade publicly available after receipt from the C&AG, usually within 12 months of theend-fiscal year (as has been the case in the past few years; Audit Report for 2000/01 isexpected to be received soon, and placed before the next session of Legislature inFebruary/March 2002); and

* AP has embarked on a computerization program of all major payment, accounting andpayroll-related functions. This when fully implemented would help to significantlyimprove the quality, timeliness and reliability of accounting and financial information.

2. There is also need to significantly strengthen and modernize the system for the publicfinancial accountability system to be effective and to support the objective of GoAP's medium-term fiscal and governance reform program. Key actions to begin the process of strengtheningand modernizing the system have been agreed and are included in the policy matrix:

* Accounting and Financial Reporting: the Budget and Accounts need to be made morecomplete. Progressively, the major 'off-budget' item viz., government-guaranteedcorporate debt needs to be brought on the Budget and also reflected fully in the Accounts.Major government guarantees need to be disclosed in the Budget and Accounts. Towardsthis end, in 2001-02, GoAP made a significant initial aggregate provision againstgovernment guarantees, and fully provisioned selected guarantees (defaulted) as actualliabilities. Progressively, other useful and important information such as other contingent

Annex DPage 2 of 3

liabilities, accounting changes, summary by type of expenditure, major subsidiesprovided, amounts devolved to local bodies need to be clearly disclosed in the Budgetand Accounts. Presentation of the Budget and Accounts need to be simplified and mademore user-friendly, thereby enhancing transparency. State Accounts, Audit Reports andresponses to Audit Reports need to be disclosed on timely basis, and accessibility needsto be increased. In 2002/03, GoAP plans to publish its half-yearly accounts on theInternet; and to improve its budget overview/summary document by including majorgovernment guarantees and off-budget borrowings. GoAP's accounts are compiled notby the Govermment of Andhra Pradesh but by the Accountant General of the C&AG.Over time, there is need for increased ownership of GoAP for its accounts; forindependent attestation/certification of the State Accounts by the CAG, in accordancewith recognized standards; and for improvement of the accounting system to generate orprovide information that would be useful for performance measurement or monitoring;

* accounting/internal control weaknesses that potentially impact on reliability offiscal/financial information, affect the overall internal control environment, and increasethe risk of misuse of public funds, need to be addressed. These include the need to carryout various reconciliations (numbers in the different accounting/payment offices,accounting records with Bank statements, main accounts with detailed accounts)regularly and in a timely manner, ensure better classification of and controls over loansand advances provided by government, clear appropriate deposit balances in the PublicAccount, clear Suspense Accounts, ensure controls over advances provided which arecharged as expenditure, and a more satisfactory debts and guarantees recording andreporting system. GoAP (through its Fiscal Reforms Implementation Committee and/orCenter for Good Governance) will develop measures to address some of these keyinternal control weaknesses. There is also need to strengthen budgetary controls,including on supplementary appropriations, over commitments, improved budgetestimates, and Government responses to the Appropriation Accounts;

* responses to Audit Reports of the State Government need to be provided on timely basis.Quality of responses also needs to be improved. Regular follow-up actions need to betaken based on the Audit Reports. In 2002/03, GoAP will strengthen its follow-upmechanisms with Departments to ensure more timely audit responses, and will focus onthe latest audit report (in contrast to the earlier approach which dealt with the earliestyears first), with the aim of substantially responding to the CAG's latest audit report ofthe State Government;

* there is scope to ensure more effective legislative oversight, including taking promptfollow-up action on the recommendations of the Public Accounts Committee (PAC) andthe Committee on Public Undertakings (COPU);

* GoAP needs to progressively develop its institutional arrangements for responsibility andcoordination of internal controls systems, accounting, financial reporting, internal audit,liaison with external auditors and with the Legislative Oversight Committees;

* the backlog of accounts and audit in various Departmental Undertakings (including theState Insurance Department which handles significant employee Funds) needs to becleared. The backlog of accounts and audits in rural and urban local bodies, and PEs alsoneeds to be cleared. GoAP has prepared an action program to reduce backlog of accountsand audit in 2002/03.

* there is need to substantially improve accounting and financial management systems inlocal government institutions (rural and urban). Capacity-building and improving local-level accountability mechanisms are also important priorities. In 2002/03, GoAP plans tosubstantially clear the backlog of accounts and audit of local government institutions;

Annex DPage 3 of 3

following this, further diagnostic work on the financial accountability arrangements inrural and urban local bodies would be carried out, to help develop an improvementprogram.

3. A State Financial Accountability Assessment (SFAA): GoAP will carry out in 2002/03 theSFAA covering the State Government (which account for bulk of public funds). This is expectedto be carried out by GoAP's Fiscal Reform Implementation Committee (FRIC) and its Center forGood Governance, with the assistance of consultants as needed, and in consultation with theBank. This would draw on analytical/diagnostic work already carried out such as the Impact andExpenditure Reviews in major Government Departments, on public expenditure management,and the preliminary financial accountability assessment; and more detailed in-depth work inselected Govemment Departments (including primary health and primary education) would becarried out as needed. The SFAA would focus on budgeting, accounting and financial reporting;management/internal controls; public auditing; legislative oversight; and transparency and publicaccess to information on public finance aspects of the State Government. Major aspects such asthe Concept Note/terms of reference, methodology, and reports, would be discussed with theBank. Government will also prepare an action program in 2002/03 to address the major issuesand findings of the SFAA, for implementation during 2003-2006. In 2003-06, GoAP will carryout diagnostic work on public financial accountability in rural and urban local bodies, and otherinstitutions through which public funds flow as appropriate, to help develop an improvementprogram, after more progress is made on clearing backlog of accounts and audits in theseinstitutions. The SFAA prepared by GoAP will be used by the Bank for its fiduciary purposes; ifconsidered necessary, the Bank with GoAP's cooperation will carry out any additional workrequired to meet these fiduciary requirements.

Amnex EPage I of 7

Statistical Annex

India at a Glance 2t14102

POVERTY and SOCIAL South Low-India Asia Income Development diamond*

2000Population, mid-year (mi/lions) 1,015.9 1.355 2,459 Life expectancyGNI per capita (Atlas method, US$) 450 460 420GNI (Atlas method, US$ billions) 454.8 617 1,030

Average annual growth, 1994400

Population (%) 1.8 1.9 1.9 G \Labor force (V.) 2.3 2.4 2.4 GNI Gross

per primaryMost recent estimate (latest year available, 1994-00) capRta enrollment

Poverty ('A of population below national poverty line) 35Urban population (OA of total population) 28 28 32Life expectancy at birth (years) 63 63 59Infant mortality (per 1,000 live births) 71 74 77Child malnutrition (% of children under 5) 45 47 .. Access to improved water sourceAccess to an improved water source (% of population) 88 87 76Illteracy (% of population age 15+) 43 45 38Gross primary enrollment (% of school-age population) 100 100 96 -/ndia Low-income group

Male 109 110 102Female 90 90 86

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1980 1990 1999 2000Economic ratlos'

GDP (USS billions) 182.9 316.9 445.2 457.0Gross domestic investment/GDP 20.9 25.2 24.3 24.0 TradeExports of goods and services/GDP 6.1 7.3 12.0 14.0Gross domestic savings/GDP 17.3 22.5 21.2 21.4Gross national savings/GDP 18.9 22.0 23.2 23.4

Current account balance/GDP -1.9 -3.2 -1.1 -0.6 Domestic InvestmentInterest payments/GDP 0.3 1.2 0.8 0.8 savingsTotal debt/GDP 11.3 26.4 22.0 22.0 svnTotal debt service/exports 9.8 32.4 15.3 12.7Present value of deWGDP .. .. .. 15.5Present value of debtlexports .. .. .. 91.2

Indebtedness1980-90 199040 1999 2000 200044

(average annual growth)GOP 5.8 6.0 7.1 3.9 5.4 - India Low-income groupGDP per capita 3.5 4.1 5.2 2.0 3.8Exports of goods and services 5.9 11.7 6.0 5.0 7.3

STRUCTURE of the ECONOMY1980 1990 1999 2000 Growth of Investment and GDP (%)

(% of GDP) NAgricuiture 38.6 31,3 26.2 24.9Industry 24.2 27.6 26.0 26.9 1S

Manufacturing 16.3 17.2 15.2 15.8 _

Services 37.2 41,1 47.8 48.2 95 t 97 ~~98 99 017

Private consumption 72.7 65.9 65.9 65.4 -1S 9

General government consumption 10.0 11.6 12.9 13.2 GDI 0 GDPImports of goods and services 9.7 9.9 15.1 16.6 __G

1980-90 1990-00 1999 2000 Growth of exporta and Imports (%l(average annual growth) 4Agriculture 3.1 3.0 1.3 -0.2 4

Industry 6.9 6.4 4.9 6.3 30

Manufacturing 7.4 7.0 4.2 6.7 20

Services 7.0 8.0 9.5 4.8 107

Private consumption 5.8 4.8 2.8 4.2 oGeneral govemment consumption 4.2 6.9 12.0 6.5 -10 f 9 97 59 99 05

Gross domestic investment 6.6 7.9 15.7 2.0 -E rts . mporsImports of goods and services 5.9 9.5 6.0 5.0

Note: 2000 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with Its income-group average. If data are missing, the diamond willbe incomplete.

Annex EPage 2 of 7

India

PRICES and GOVERNMENT FINANCE1980 1990 1999 2000 Inflatlon .%)

Domestic prices 15(% change) 1Consumer prices 12.8 3.4 3.8 10Implicit GDP deflator 11 6 10 4 3.5 4.1

Government finance s I(% of GDP, includes current grants) o -.-- t--t--

Current revenue . 18.9 199 9s 96 97 97 99Current budget balance -4.4 -4.2 GDP deflator 2CPOverall surplus/deficit -10.6 -10.6

TRADE

(US$ millions) 1980 1990 1999 2000 Export and import levels (USS mill.)Total exports (fob) 8,501 18,477 37,542 44,894 75.000

Tea . 535 1,183 1,394Iron .. 970 916 1,158 s0oo0Manufactures 5,105 12,996 29,714 34,511 45000

Total imports (ciF) 15,862 27,914 55,383 59,264 000Food 1,348 557 2.417 1432Fuel and energy 6,669 6,028 12,611 15,650 15000Capital goods 2,416 5,836 8,965 8,785

94 95 96 97 99 99 00Export price index (t995=100) 28 S1 116 122Import price index (1995=100) 27 46 150 162 nExports *importsTerms of trade (1995=100) 105 109 77 75

BALANCE of PAYMENTS1980 1990 1999 2000 Curn a u ln o P

(US$ millions) Current account balance to GDP I%)Exports of goods and services 11,249 23,028 53,251 63,764 oImports of goods and services 17,821 31,485 67,028 75,656Resource balance -6,572 -8,457 -13,777 -11,892

Net income 325 -3,753 -3,559 -3,821Net current transfers 2,693 2,068 12,256 12,798 1 I I I I " 'Current account balance -3,554 -10,142 -5,080 -2,915

Financing items (net) 2,564 7,650 11,482 8,771 IChanges in net reserves 990 2,492 -6,402 -5,856 -s

Memo:Reserves including gold (US$ millions) 6,823 5,834 38,036 42,281Conversion rate (DEC, local/US$) 7.9 17.9 43.3 45.7

EXTERNAL DEBT and RESOURCE FLOWS1980 1990 1999 2000

(US$ millions) Composition of 2000 debt /USS mill.)Total debt outstanding and disbursed 20,695 83,717 98,158 100,367

IBRD 827 7,685 7,816 7,063 G: 3,464 A: 7,063IDA 5,142 13,312 18,930 20,804

Total debt service 1,426 8,191 10,108 9,862 1IBRD 137 1,087 1,389 1,421 B:20,804IDA 50 211 469 554

Composition of net resource flows F. 40,376 !

Official grants 750 461 382 336Official creditors 908 2,334 1,068 589 D4541Private creditors 789 1,606 -1,658 4,340Foreign direct investment .. 97 2,093 1,828Portfolio equity .. 6 3,024 2,760 E 24,119

World Bank programCommitments 2,503 2,186 817 2,064 A -IBRD E -BilateralDisbursements 826 1,981 1,460 1,742 B -IDA D -Other multilateral F -PnvatePrincipal repayments 86 586 1,228 1,392 C -IMF G -Short-temNet flows 739 1,395 232 350Interest payments 101 712 630 583Net transfers 639 683 -398 -233

Development Economics 2/12/02

Annex EPage 3 of 7

India Social IndicatorsLatest single year Same regionlincome group

South Low-1970-75 1980-85 1994-00 Asia income

POPULATIONTotal population,mid-year (millions) 613.5 765.1 1,015.9 1,354.7 2,458.7

Growth rate (% annual average for period) 2.3 2.1 1.8 1.9 1.9Urban populalon (% of population) 21.3 24.3 28.4 28.4 31.9Total fertilty rate (births per woman) 5.3 4.4 3.1 3.4 3.7

POVERTY(% of population)National headcourt index .. . 35.0

Urban headoDunt index .. . 30.5Rural headcountindex .. .. 36.7

INCOMEGNI per capita (US$) 190 290 450 460 420Consumer price index (1995=100) .. 40 142 136 142Food price index(1995=100) . 38 134

INCOMEICONSUMPTION DISTRIBUTIONGini index .. .. 37.8Lowest quintile 16 of income orconsumption) 5.9 8.1Highest quintile (96 of income or consumption) 49.4 .. 46.1

SOCIAL INDICATORSPublic expenditure

Heakh (% of GDP) .. .. 0.8 0.9 1.2Educaton (% of GNI) 2.7 3.5 3.2 3.1 3.3Social secirity and welfare (% of GDP) .. ..

Net prlmary school enrollment rate(% of age group)

Total 81 96 100 100 96Male 96 111 109 110 102Female 64 80 90 90 86

Access to an Improved water sourceQ'/l of population)

Total .. 54 88 87 76Urban .. 80 92 92 88Rural .. 47 86 85 70

Immunization rate(% under 12months)

Measles .. 1 60 63 64DPT .. 41 78 75 70

Child malnutrtion (% under 5 years) .. .. 45 47Life expecbncy at birth(years)

Total 52 57 63 63 59Male 52 57 62 62 58Female 51 57 64 63 60

MortalityInfant (per thousand live binths) 130 97 71 74 77Under5 (perthousand live births) 206 177 90 99 116Adult (15.89)

Male (oer 1,000population) 324 261 218 223 288Female (per 1,000 populaton) 353 279 206 212 258

Matemal (per 100,000 live births) .. .. 440Births attended by skilled health staff (%/6) 30 49 49

CAS Annex B5. This table was produced from the CMU LDB system. 02112102Note: 0 or 0.0 means zero or less than half the unit shown. Grss enrolment ratios exceeding 100 indicatediscrepandesbetween the estimates of school-age popubtion and reported enrollment data.

Annex EPage 4 of 7

India - Key Economic Indicators

Estimate ProjectedIndicator 1997 1998 1999 2000 2001 2002 2003 2004

National accounts (as % of GDP)

Gross domestic producta 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Agriculture 28.0 27.7 26.2 24.9 24.5 23.7 23.1 22.3

Industry 27.1 26.5 26.0 26.9 27.1 27.0 27.0 27.0

Services 44.9 45.8 47.8 48.2 48.4 49.3 49.9 50.7

Total Consumption 80.5 80.0 78.8 78.6 78.7 78.9 77.9 78.0Gross domestic fixed investment 21.7 21.4 21.6 21.9 23.3 23.2 24.2 24.1

Government investment 6.4 6.3 6.4 6.8 6.5 6.7 6.7 6.7Private investment 15.4 15.1 15.2 15.1 16.7 16.5 17.5 17.4

Exports (GNFS)b 11.0 11.5 12.0 14.0 13.6 13.4 13.9 14.2Imports (GNFS) 14.5 14.1 15.1 16.6 16.5 16.5 16.9 17.2

Gross domestic savings 19.5 20.0 21.2 21.4 21.3 21.1 22.1 22.0

Gross national savings' 21.5 21.6 23.2 23.4 26.0 25.6 26.7 26.1

Memorandum itemsGross domestic product 409718 414064 445233 456990 477555 515408 557893 606742(US$ million at current prices)GNP per capita (US$, Atlas method) 420 420 440 450 459 488 520 558

Real annual growth rates (%, calculated from 1993 prices)Gross domestic product at market prices 4.4 6.0 7.1 3.9 4.5 5.5 5.5 6.0Gross Domestic Income 5.2 4.9 6.2 4.8 5.1 6.0 5.7 6.2

Real annual per capita growth rates (%, calculated from 1993 prices)Gross domestic product at market prices 2.6 4.1 5.2 2.0 2.7 3.8 4.0 4.6Total consumption 1.8 -0.1 2.4 2.7 -13.6 5.0 1.8 5.0Private consumption 1.6 -2.1 1.0 2.4 -16.9 6.0 1.8 5.9

Balance of Payments (US$ millions)

Exports (GNFS)b 45109 47484 53251 63764 65025 69242 77288 86022Merchandise FOB 35680 34298 37542 44894 44835 47093 52210 57817

Imports (GNFS)b 59297 58565 67028 75656 78915 84888 94076 104344Merchandise FOB 51187 47544 55383 59264 61234 65121 71989 79656

Resourcebalance -14188 -11081 -13777 -11892 -13890 -15646 -16788 -18322Net current transfers 11830 10280 12256 12798 13396 13786 15520 15237Current account balance -5879 -4345 -5080 -2915 -3493 -4841 -5113 -7166

Net private foreign direct investment 3557 2462 2093 1828 3300 3000 5500 6000Long-term loans (net) 1816 5918 4781 8133 2680 3012 -960 2605Official -406 979 1068 589 1097 643 254 172Private 2222 4939 3713 7544 1583 2369 -1215 2434

Other capital (net, incl. errors & ommissions) 5017 187 4608 -1190 3450 3710 3941 4372

Change in reservesd -4511 -4222 -6402 -5856 -5937 -4881 -3367 -5811

Memorandum itemsResource balance (% of GDP) -3.5 -2.7 -3.1 -2.6 -2.9 -3.0 -3.0 -3.0Real annual growth rates ( YR93 prices)

Merchandise exports (FOB) 2.5 2.8 16.7 20.9 1.1 4.0 9.7 9.2Manufactures 6.2 1.9 19.2 24.9 1.5 2.8 10.2 9.0

Merchandise imports (CIF) 11.3 3.1 12.7 10.6 5.4 9.5 12.8 10.6

(Continued)

Annex EPage S of 7

India - Key Economic Indicators


Public finance (as % of GDP at market prices)'Current revenues 19.8 19.1 18.9 19.9 20.3 21.1 21.5 22.1Current expenditures 22.6 23.8 23.4 24.1 23.9 23.9 23.8 23.7Current account surplus (+) or deficit (-) -2.8 -4.7 -4.4 -4.2 -3.6 -2.8 -2.3 -1.6Capital expenditure 7.8 8.8 6.2 6.4 7.0 7.2 7.2 7.2Foreign financing 0.4 0.3 0.8 0.4 0.3 0.3 -0.3 0.2

Monetary indicatorsM2/GDP 53.9 56.2 55.7 59.5 60.1 60.6 61.7 63.2Growth ofM2(%) 17.0 19.2 9.9 15.6 11.8 15.0 15.0 15.0Private sectorcredit growth/ 57.6 52.2 25.7 61.9 37.3 56.0 61.5 63.7total credit growth (%)

Price indices( YR93 =100)Merchandise export price index 103.7 96.9 90.9 90.0 88.9 89.8 90.7 92.0Merchandise importprice index 130.4 117.5 121.4 117.5 115.1 111.8 109.6 109.6Merchandise terms of trade index 79.5 82.5 74.9 76.6 77.2 80.3 82.8 83.9

Real exchange rate (US$/LCU)f 76.6 72.4 71.0 75.5 ..

Consumerprice index (%change) 7.2 12.7 3.4 3.8 5.9 7.7 7.5 6.3GDP deflator (% change) 7.0 7.9 3.5 4.1 6.0 8.0 7.0 6.0

a. GDP at factor costb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Consolidated non-financial public sector.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

Annex EPage 6 of 7

India - Key Exposure Indicators


Total debt outstanding and 94320 97639 98158 100367 102936 105782 104822 107427

disbursed (TDO) (USSm)d

Net disbursements (USSm)4 850 3319 519 2209 2568 2847 -960 2605

Total debt service (TDS) 4864 5121 3782 3741 3979 3691 4969 5773

(USSm)a

Debt and debt service indicators

(%)TDO/XGSb 164.4 166.3 148.2 129.1 129.8 126.1 111.4 103.9

TDO/'GDP 23.0 23.6 22.0 22.0 21.6 20.5 18.8 17.7

TDS/XGS 8.5 8.7 5.7 4.8 5.0 4.4 5.3 5.6

IBRD exposure indicators (%)

IBRD DS/public DS 12.2 12.5 16.4 15.9 15.7 14.6 10.7 16.2

Preferred creditor DS/public 24.0 23.6 30.0 32.1 29.6 28.1 20.6 31.5

DS (%)C

IBRD DS/XGS 2.5 2.3 2.1 1.8 1.6 1.6 1.5 1.3

IBRDTDO(US$m)d 8138 7990 7816 7062 7137 7305 7609 8228

Share of IBRD portfolio (%) 7.6 7.2 6.5 5.8 5.9 5.8 6.0 6.6

IDA TDO (US$m)d 17912 18562 18930 18886 19899 20570 20817 20814

IFC (US$m) 855.4 801.7 686.3 677.7 ..

Loans 662.8 569.1 436.0 411.9 .. ..

Equity and quasi-equity /c 192.6 232.6 250.3 265.8 .. ..

MIGA

MIGA guarantees (US$m) 9.6 9.6 .. .. .. ..

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-

term capital.

b. "XGS" denotes exports of goods and services, including workers' remittances.

c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for International Settlements.

d. Includes present value of guarantees.

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

Annex EPage 7 of 7

Evolution of the Public Sector Deficit ', 1990-02 (% of GDP at Market Prices)

90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01 01-02Prov. BE

Actuals

Central GovernmentFiscal Deficit 2 6.6 5.2 5.1 6.4 5.3 4.3 4.1 4.9 6,7 5.4 5.4 5.3

PrinaryDeficit' 2.8 1.1 0.9 2.1 1.0 0.1 -0.2 0.6 2.3 0.8 0.9 0.7Outstanding Debt 61.6 65.4 64.2 65.0 62.2 59.2 56.4 58.1 57.6 58.7 59.6 59.7Interest Payments/Revenue 39.1 40.2 41.9 48.7 48.4 45.4 47.1 49.0 52.1 49.7 51.0 48.5

State GovernmentFiscal Deficit 3.2 2.8 2.8 2.5 2.6 2.6 2.7 2.7 4.2 4.6 4.3 3.8Primary Deficit 1.6 1.1 1.0 0.6 0.7 0.8 0.9 0.7 2.1 2.3 1.7 1.2Outstanding Debt 19.4 19.3 19.0 18.6 18.2 17.9 17.8 18.5 19.4 21.5 23.2 24.4tnterestPayments/Revenue 13.0 13.6 14.4 15.0 15.7 16.0 16.7 17.9 20.5 21.1 22.5 23.1

General GovernmentFiscal Deficit' 9.3 7.3 7.3 8.3 7.5 6.5 6.4 7.1 9.2 9.2 9.2 8.9Primary Deficit 4.9 2.6 2.4 3.3 2.4 1.6 1.3 1.9 3.9 3.5 3.6 3.0Outstanding Debt 67.9 71.9 70.9 71.8 68.9 66.0 63.3 65.2 65.4 68.1 70.5 71.2InterestPaysnents/Revenue 21.5 22.1 23.2 25.1 25.8 25.2 26.5 27.3 30.5 29.7 29.9 30.1

Consolidated Non-Financial Public Sector Deficit5

11.2 9.4 9.2 10.4 9.0 8.1 8.7 8.0 9.8 10.8 10.3 10.1

Notes: For States 1999-00 = RE; 2000-01= BE; 200i-02= Estimate1: All definitions pertain to World Bank defnitions unless otherwise specified.2: Fiscal Deficit (Govt.of India new defh.) excluding disinvestment from revenues.3.: Fiscal deficit minus interest payments4: General Govt. comprises Central (excl. divestment revenues), States Governnents and excludes net lending from Center to States5. : Consolidated Public Sector includes General goverrnent, oil pool balance and market financed central public enterprise deficit (on-lendingfrom central government to central public enterprises is netted out)Source : Budget Documents, RBI State Bulletins, RBI Annual Report 1998-99, Staff Estinates, IMF, RBI Annual Report 2000-01

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