CHIAPAS PROGRAMMATIC ECONOMIC DEVELOPMENT LOAN (PEDL)

Initiating Memorandum

Contents

I.          Background and Project Concept

II.                   The Challenges for Economic Development and Poverty Reduction and the State Government's Program

A.      Governance

B.     Social Sectors

C.     Economic Planning and Development

D.     Public Finance and Management

III.                  The Program's Outcomes

A. Poverty Impact

B. Social Impact

C. Fiscal Impact

IV.                The proposed Programmatic Economic Development Loans (PEDL)

A. Content, Loan Amount, Conditions and Disbursements

B. Risks

V.         The CAS Bank Strategy and the proposed PEDL

VI.        The National Macroeconomic Framework

Annex  1. Policy reform program

CHIAPAS

PROGRAMMATIC ECONOMIC DEVELOPMENT LOAN (PEDL)

Initiating Memorandum

I. BACKGROUND AND PROJECT CONCEPT

Background

1. Although the State of Chiapas has abundant natural resources-water for agriculture and hydroelectricity, rich agricultural land and seacoast it has been the poorest state in Mexico for the past thirty years. In GDP per capita the state has fallen farther behind the national average. The 4 million inhabitants are less urbanized and suffer from low economic growth, high poverty rates, low health outcomes and education enrollment, with lower than average access to basic infrastructure and social services. [1] Although adult illiteracy has declined since 1.990, it is still almost one-quarter, twice the national average.

2. This poverty ultimately reflects the failure of productive sectors in Chiapas-agriculture, rural industry, urban industry, tourism-to generate enough-well-paying jobs, small enterprises, and farms. The reasons for failure include cultural conflicts, poor education, inadequate transport and communications, and alleged "lack of entrepreneurial spirit." One-fourth of the population is indigenous and speak indigenous languages at home-a share four times larger than elsewhere in Mexico-and almost one-tenth does not speak Spanish at all. The state faces a special challenge to provide them with opportunities both to participate in the nation's growth and to advance their own cultural tradition.

3. The Zapatista uprising, starting in 1994, has marked the politics of the state, bringing into the open conflicts that are present to some extent in most of Mexico. As a result, a. number of dispersed rural communities, with up to 300,000 in population, have rejected the authority and the resources of the formal government and instituted to varying degrees their own social programs and public security. While there are many problems with the isolationism and disruption of governance and regular social services, the movement does indicate a sense of local responsibility and willingness to pay for services that could inspire more accountability and true decentralization in the traditional public sector.

4. The traditional state economy rest on three legs-agriculture for self-consumption, coffee and cattle for market sale (mostly from large farms), and the public sector. The rest of the economy is local services, plus a little tourism. The world coffee market has collapsed, other markets in agriculture stagnate, and rapid population growth in rural areas is making subsistence agriculture unsustainable. Spending by the state and municipalities is over 20 percent of state GDP, which is 95% funded by federal transfers. Direct federal spending adds another xx percent making the public sector by far the largest source of external purchasing power for the state. This large economic presence has not, however, resulted in good public services or economic infrastructure. Quality and coverage in education and health services are among the lowest in the nation; producers lack good transport connections within the state, to the rest of Mexico, and to the world.

5. Partly this failure of the public sector, was political-a lack of accountability of the government to the people. As everywhere in Mexico, no one can be reelected, so politicians in office, and with career ambitions, pay attention to the party bosses who will decide their next job.

Furthermore, in Chiapas more than most places, those elected to offices rarely stay their whole term and are replaced by appointees. For instance, almost none of the governors of Chiapas has stayed for the full term of six year, and over the last century there has been a change of governor on average once a year. Hence, patronage more than public service has been the norm for the state government in the past. These problems in the private and public sector are hardly unique to Chiapas, although they are more extreme than in most other states.

6. Patronage politics of a corporate type largely account for weak management and administration in the public sector and under-provision of basic public services. Although usually short-lived, every new state administration brought along a new crop of cabinet members and high level administrators. Changes at the highest levels were followed by rotating positions all the way down to the lowest paid echelons. Nevertheless, rotation from one position to the other disguises the influence of special interests that persist in their control of important parts of the state administration, including labor and procurement contracts. The state developed widely diversified and highly stratified compensation and social security systems for public employees. State assets are poorly maintained and often abandoned. The state has tolerated practice of discretionary donations of real estate and other state assets to special interests, municipalities, and NGOs.

7. Distorted public administration practices are not only at the core of inefficiencies in resource allocation and production but are partially responsible for distrust among levels of government as well. Weak state management capacity and clientele-dominated administrative culture have not only affected state resources but federal and municipal as well. Federally funded subsidies for rural development, for instance, end up distributed by state authorities following the same clientele-based criteria, lack of transparency and discretionary decisions other state resources are. Although municipalities have become as important recipients of federal transfers as the states, lack of transparency and accountability has made it difficult for the state to lead local governments towards coordinated investment and service operation.

8. The state government of Chiapas is starting to reverse this situation. The current governor was elected in 2000 as part of the break with one-party rule in Mexico, and his government is committed to reforming the state administration, advancing social services and developing the productive sectors to replace the public sector as the engine of growth and poverty reduction. This was reflected in the comprehensive agenda of state-level reforms envisioned in the Plan de Desarrollo Chiapas 2001-06. This Programmatic Economic Adjustment Loan (PEDL) for US$ [40] million will be the first stage of the Bank's response to the Chiapas state government's commitment to reform its programs to support poverty reduction through economic development. The ambitious policy agenda that the operation will support-to be elaborated in the government's Letter of Development Policy-has been discussed and designed over a series of technical missions starting in early 2002. [2]

Project Concept

9. Primary Objective.- This program of reforms in Chiapas aims to improve the quality, quantity and targeting of public services, toward the ultimate objective of promoting poverty reduction through economic growth. The program will include strong attention to problems with governance that have subverted public sector activities in the past, and will address the problems in the specific sectors that, are most relevant for poverty reduction and growth. The measures to strengthen sector programs and reform public administration will have fiscal as well as political costs, so it is important to include in the program the necessary reforms of fiscal management to assure sustainability.

10. Secondary Objective.- The objectives of the loan go beyond Chiapas, as all state governments in Mexico need to enhance their fiscal position and improve service delivery. This is an essential condition for the federal government's decentralization policy to work in the long run. In this context, Chiapas fulfills an important role since it is the poorest state of the Mexican federation. By showing the other states of the Mexican federation that structural adjustment is possible and rewarding, even in the state that is often regarded as the most backward, the Chiapas program will constitute an unprecedented example. Other states will possibly imitate and follow a similar path.

This will further add to the Mexican experience of successful structural adjustment on subnational levels, as is currently the case with the states of Mexico and Puebla. So this, loan carries a nation-wide significance and provides "good example for states to be able to improve their fiscal position despite an adverse economic context. The federal Secretary of Finance (SHCP) anticipates covering a maximum of four state with programs similar to the one carried out with the state of Mexico and now proposed for Chiapas.

11. Rationale.- The underlying rationale that unifies these reforms is -to install, for the first time in the modern history of Chiapas, a state administration that provides basic social and infrastructure services with enhanced transparency and efficiency, utilizes effectively the potential public-private partnerships for mobilizing community resources, and creates a positive overall environment for business and investment. [3]   For these new management principles to work, this project addresses four broad reform areas: (i) Governance: transparency and social participation create conditions for legitimate government and help direct spending where it can be most effective; (ii) Social Sectors (health and education): it is expected that better spending in these two areas will contribute significantly to the reduction of poverty by giving people access to knowledge and by improving their well-being; (iii)' Economic Planning and Development: reforms in this area will create the framework conditions in which the private sector constitutes the engine for growth; (iv) Public Finance and Management: the reforms that the state government envisions must be financially sustainable; consequently, increasing own revenue, reforming state-municipal relations and adjusting the internal working of the public sector in Chiapas are crucial conditions for the success of this operation.

12. Conditions for application.- The authorities' ownership of the program is strong and widespread, as evidenced by discussion with the Governor and all secretariats as well as major independent agencies. Private capital, NGOs and communities have also been consulted as part of project preparation -and have generally reacted positively to policies actions to be supported by the project. The program supported by this operation will also facilitate citizen participation in helping the state identify where and how spending should be carried out. Participatory reforms are a central component in each of the sectors and will reveal citizens' preferences and raise the efficiency of spending. In municipalities with better knowledge of the local situation, the state will decentralize responsibilities or engage in close coordination with lower levels of government, especially for health and rural roads. Taken altogether, the private sector, has big expectations for the new state government and overall political environment. World Bank support is generally welcome since the Bank is expected to bring along know how and credible, technically independent opinions. [4]

13. The Project ^-and the CAS goals. The Country Assistance Strategy Report (CAS) discussed by the Bank's Board in May 2002, gives priority to poverty reduction, human capital development, and public sector reform. The proposed PEDL will directly contribute to achieving several important CAS Objectives. (See section V for elaboration.) The CAS also calls for this type. of state-level adjustment loans as most appropriate for states that_. need to undertake_ substantial reform for consolidation of fiscal balances, public sector capacity and basic services before going to development banks or financial markets for investment financing.

14. Operational Aspects. This extraordinarily difficult economic development program will take several years and require a series of reforms, some of which can only be designed fully after seeing how the initial steps proceed. To support this process, the government has requested a series of up to three adjustment operations in a programmatic framework. The first proposed operation, for the equivalent of US$[40] million, would mainly cover the actual costs of adjustment and transition-retraining, paying severance for redundancies, recapitalizing the pension fund, investing in capacity building to reach isolated communities with health services, providing one-time financial incentives for the creation of a new fee-for-services water culture at the local level, etc. The subsequent operations would cover other such reform costs in the future and perhaps the eventual expansion of the public investment program if the state chooses to do so, with strong public support and adequate increases of resources to support it.

15. Structure of the Initiating Memorandum.- The next section (11) of this report summarizes a diagnosis for each of the most pressing problems and challenges in Chiapas and describes the program of the state government to address the problems. Section III describes the outcomes of this program and Section N deals with the content, loan amount, conditions and disbursements. Section V discusses the relation between the CAS and the proposed PEDL. Section VI describes the national macroeconomic framework in which this operation takes place.

Il          THE CHALLENGES FOR ECONOMIC DEVELOPMENT AND POVERTY REDUCTION AND THE STATE GOVERNMENT'S PROGRAM

16. Even though growth will be stimulated mainly from policies of the national government and developments in the national and international economy, the Chiapas government recognizes that the state-level public sector needs many reforms in order to do what it can in support of economic growth and reduction of poverty. The inadequate provision of public services, including those administered by the state, have contributed to low economic growth and poverty. Table l, below, shows the problem of Chiapas in terms of the gaps relative to the Millennium Development Goals. Weak service delivery is not just a result of inadequate funding, for indeed, Chiapas has more than the average funding per capita for Mexican states. The problem is more in the inefficiency in the provision service and targeting of spending. As these problems are resolved, the state will still need more funding in order to make up the social and economic deficits relative to the rest of Mexico.

17. There are four broad areas of reform: (i) Governance, (ii) Social Sectors, (iii) Economic Development and (iv) Public Finance and Management. In each specific area, the next section presents the main challenges as well as the Government's program to address them.

Table I. Chiapas and the Millennium Development Goals

* For 3 Mexican Southern States (Chiapas, Guerrero, Oaxaca), of which Chiapas is presumed to have the highest poverty index.

** Basic education covers primary and lower secondary levels. Census 2000.

*** The target is for primary education.

(A) Governance - Social Participation And Transparency

18. Reforming the relationship between the state government and its citizens is fundamental to achieve better governance in an environment of social exclusion and civil unrest. Every sector of the state public administration has traditionally managed its own budget, its own contracts, its own payroll system. Fragmentation prevents evaluation and control and facilitates corruption. Until very recently, the legal and regulatory framework for procurement provided special protection to local suppliers of goods and services and had no effective safeguards against rent-seeking and corruption. Social participation and transparency would help restore and consolidate the electorate's confidence in the state government but first and foremost contributes to deliver better services to the people_ Therefore, the current administration has decided to work toward a more open and transparent approach to public policy.

19. Diagnosis and Challenge. State policy making in Chiapas, like the rest of Mexico, has traditionally happened behind closed doors, often with the participation of privileged corporate interest groups, or at the federal level. This concentration is particularly: noticeable in Chiapas, where more than 30% of municipalities have less than 20,000 inhabitants that are often dispersed in communities of no more than a few tens or a few hundred people. Many of those communities are hard to reach and have had little contact with state services or state authorities. It is unlikely that the state government can detect and respond to preferences of its citizens unless it seeks their direct support in all stages of service delivery-planning, execution and evaluation of results. Incorporating civil society into policy making would also help to increase the relevance and efficiency of public services, as well as to empower the marginalized population whose frustration has peaked in Chiapas. Given that Chiapas is still largely rural, with relatively low population density and a history of mutual distrust between governments and many communities North and' East of Tuxtla, the capital, participation and empowerment will demand trustworthy mechanisms with which the electorate can both participate iii public affairs and hold politicians accountable for their actions, thus contributing to more efficient allocation of resources.

20. Transparency and accountability and social participation require disclosure of information in all the areas of interest to citizens, making the information necessary for dialogue accessible to different audiences. For a more participatory practice to evolve, new and creative ways of participation have to be opened up; organizations of the civil society need to be trained in their new rights and obligations; and the state government needs` to commit itself openly  to deliver a certain quality and standard of services to all citizens. Reaching the marginalized and the poor with these new ways of policy making poses an exceptional challenge for the state government of Chiapas, but one that it aims to meet. As it has been demonstrated so far in Chiapas, outsourcing through NGOs and other civil society organizations may prove more effective to reaching marginalized communities that have inherited decades of distrust for government and have opted to assert their isolation.

21. Government Program. The state government has recognized the need to enhance transparency, through social participation, information disclosure and clear rules for contracting. As a first step, the state will develop and adopt new laws for procurement. All solicitations would accept electronic bid and the selection process will be monitored by a team of non-governmental organizations and citizens. In addition, to guarantee a certain level of services, the state government commits itself to publish -in connection with the annual budget and revenue package submitted to the state congress-- service standards for education, health, water/sewerage, rural development and roads; the definition of such targets has been developed with the participation of citizen-clients and monitored by them. Following best regional practice, the state budget will be moving to the second phase of participatory budgeting. [5] Additional reforms. to this new approach of transparent government consists of state agencies publishing and committing themselves to codes of conduct.

The state has plans to train citizens in their new rights and obligations; current programs for civil society involvement and training for non-governmental organizations will be extended to rural and remote areas.

(B) Social Sectors

22. The social sectors constitute the core of the reform program of the Chiapas government. This is because poverty can be addressed best through better spending: that is, by targeting services to the most needy. The education and health sectors are especially important to achieve this goal.

Education

23. Diagnosis and Challenges. Improving the education sector is critical to achieve long-term reduction of poverty, given that in the three southern Mexican states (Chiapas, Guerrero and Oaxaca) close to seventy percent of the population lives below the, poverty line. The overall educational level of the adult population in Chiapas is now only 5.6 years - compared with a national average of 7.2 years - and 50 percent of the adult population has not completed primary education. Chiapas also has 23 percent adult illiteracy,:-Worse than any other state in Mexico. At the basic education level, 22 percent of 6-14 year-olds cannot read and write. In the last decade, however, the state has made notable progress in reducing the education deficit. For example, literacy among the adult population rose by more than 7 percentage points between 1990 and 2000, and primary education enrollment increased by almost 12'permtage points. In the last five years, primary-education completion rates improved significantly. The school-age population is changing rapidly, with the number of 6-14 year olds projected to decline 0.7 percent annually in 2000-2005, while the number of 12-16 years olds will grow at 0.6 percent annually. [6] This poses an additional challenge for maintaining coverage and quality, in order for Chiapas to catch up with the rest of Mexico and share in the benefits of global technological progress and economic growth.

24. Low education quality in Chiapas has a variety of causes, in addition to the broader socio-economic situation.

25. (i) Academic reasons. There are limited learning opportunities in the classroom and too little time on task. Teachers, especially with indigenous students, employ old-fashioned teaching practices that follow the `frontal model' that emphasizes rote learning and unproductive repetition exercises. In addition, most school principals do not supervise effectively or provide academic leadership. They usually have a conflict of interest between ensuring compliance with school regulations and being a member of the teachers' union. Without adequate supervision for a widely dispersed school-age population, and with the collusion of supervisors, teachers are frequently absent, especially in rural areas.

(ii) School management. In Chiapas, schools have little autonomy and resources to analyze, plan and carry out school improvement activities; and they lack discretionary resources to implement them. For example, they may not adjust the content of teaching and learning materials and thus cannot respond to the interests of students in different localities and circumstances. Also, schools are not recognized and rewarded for good performance. Parents, businesses and other education stakeholders have little chance for participation in school affairs, thus minimizing accountability.

(iii) Investment priorities. Low education quality also results from misaligned investment priorities in the sector: Resources are wasted on redundant teacher training courses and duplication of services; staff and programs throughout the state. For example, 97 percent of all education spending in the State goes for wages and salaries, largely because of the influence that powerful stakeholders such as teacher unions exert on budget allocations.

As a consequence, almost no resources are left for improving infrastructure, which is badly deteriorated. Since 62 percent of the State budget goes for education, making more efficient allocation in that sector has top priority.

26. All together, the main challenges for the education system in Chiapas are: increasing access to education in disadvantaged communities, increasing completion rates for primary education in a cost-effective manner, and improving the teaching-learning process and the quality of education throughout the system. Meeting these challenges is especially important for improving the educational attainment of the poor, marginalized, and indigenous population.

27. Government Program. The state government has given top priority to improving the education system, in order to promote equity and diversity. To this end, a number of initiatives have been designed and are executed, for a large part, with the help of the federal government. Yet because these programs are often centralized and impede ownership on behalf of the state, their real impact remains uncertain. This points to the need to design and implement education reform that is led by the state of Chiapas; it should focus on transformational activities that have their motivation and at least some of the direction coming from the level of the individual school. This will require an improved regulatory environment and support from education authorities outside the school and from the Chiapaneca society. [7]

28. Improving access and quality of education requires up-dating the State Education Law to use resources more productively, since the sector already gets the largest share of state resources. Reforms should focus on reforming the teacher management system. The excess Normales Estatales and their staff should be converted to other uses, such as secondary schools; directors, supervisors and sector chiefs should be selected competitively through a system of examination; the appointment of new primar17 and lower secondary teachers (where there is now excess, supply) should be halted for a certain time to ease fiscal pressure on the state budget and to reduce future rigidities. Another important reform is to introduce programs that schools themselves can manage and thus contribute to quality improvement. One of these programs is Escuelas en Movimiento which the state has begun to develop. School performance should be evaluated periodically, which the state plans to do. An independent Institute of Education Evaluation and Innovation will be established -following a recent federal precedent, as well as a schedule for the production and dissemination of a Education Performance Report Card. The Institute will gather information to monitor developments in the sector, down to the level of individual schools, and_. to allow more informed decision-making. This includes defining a baseline data for agreed indicators and a reliable system for collecting those data subsequently. The government will also implement the federally-recommended SIASEP system to improve the administrative capacity of SECH-SE regarding payroll control and performance evaluation.

29. On the institutional side, adjustments to the organization and working of the Education secretariat are also needed. Selected areas of the SECH-SE systems should be fused and better educational development planning needs to be introduced. In all these reforms it is crucial to strengthen the role of parents and civil society in education policy decisions and oversight, for example, through a parents association with perhaps even -the authority to approve salary discounts for teachers. The state expects that these measures taken together will help elevate the quality of education and improve access, especially for students from low-income families.

Health

30. Diagnosis and Challenge. Health is the second largest, sector for state spending, after education, and an equally critical area for reform. Much remains to_. be clone in health to raise. people' s welfare. Life expectancy at birth remains considerably below the national, average, and Chiapanecos suffer more from disabling illnesses. In 1998, for example; disability-free life expectancy at birth was only 56.7 spurs compared to the national average of 61.1. Also, the state is in the middle of an epidemiological transition due to rising life expectancy, falling birth rate, and less traditional lifestyles (more rich food and less exercise). Thus, Chiapas presents an epidemiological mosaic, with new patterns of mortality and morbidity existing alongside the traditional ones. Yet disease control and provision of health care services are poor-especially in isolated areas. The state government can hardly change structural conditions that contribute to the problem-including population growth, geographic dispersion, and isolation of communities. Yet, the state has committed itself to reverse the current trend through improved education as well as infrastructure, communication, water and sanitation services.

31. The most important reason for poor health services is the scarcity of resources for serving a highly disadvantaged population. Per capita public health expenditure in Chiapas is half the national average. Mexico's fiscal federal system, still evolving rapidly, puts undue pressure on the state budget for health. For example, salary increases are determined at the federal level without participation by the state. Thus the main challenge is to extend coverage and improve quality of services despite this adverse financial context. Problems with institutional coordination and lack of social accountability also contribute to the poor health services. For example, IMSS-Solidaridad reports to a federal agency and coexists with the states Institute of Health. Although a variety of health institutions operate in the state, a considerable part of the population is excluded from these services. And within this dispersed institutional environment there is no referral system to facilitate coordination and more efficient service delivery.

32. Government Program. In response to the challenges in the health sector, the overnment seeks to improve the quality and coverage of the state' s health services through four reforms: increased financing; a program for strengthening public health and provision of health services to isolated communities; institutional development, local planning and decision-making; and special attention to indigenous population.

(i) Increased financing. In contrast to other social sectors such as education, lack of financing is a major cause of the problems in health. This requires a radical shift in the funding of the sector. To this end, the state government will redirect resources over the next [4] years, so that the health budget grows by [3] percentage points as a share of the total state budget.

(ii) Improved public health aid health services to isolated communities. This program will emphasize prevention in order to control diseases such as malaria, dengue and. cholera. Also, health coverage would be increased through mobile health units and use of alternative health services to communities that otherwise cannot be reached properly. The state government will set performance targets and monitor improvements at frequent intervals.

(iii)               Institutional development, local planning and decision-making (Regional Health Care Model). The state government has designed a Regional Health Care Model based on local planning and involving municipal governments, micro-regional units and civil society. This model needs to be strengthened in order to mobilize additional public and private resources. As first step, all health providers in the state-which currently operate separately-would be made accountable to the municipalities. This includes the federal IMSS-Solidaridad as well as municipal governments, which would be committed to reach certain performance targets. Other reforms include establishing citizen oversight at all levels and publishing a Health Performance Report Card for the evaluation of state performance relative to published targets. Another key component of reform consists of the state participating in the federal government's Seguro Popular on a pilot level; this program provides subsidized insurance coverage to families of independent and informal-sector workers.

33. (iv) Development of indigenous health. The situation of the indigenous population is especially severe in the health sector. T o tackling these problems the state plans to adopt policies such as medical scholarships for the indigenous population; the provision of interpreters in hospitals; and the reintroduction of traditional medicine into government health services. This shift in focus also requires a series of institutional strengthening programs that would put health workers into position to advocate and oversee health policies beneficial to the indigenous population.

(C) Economic Planning And Development

34. In a context of increasing competitiveness-both within Mexico and internationally-it is critical to adopt policies that help prepare Chiapas and its many small-scale producers to address these new challenges. Four areas are essential: improved road and water infrastructure as well as reforms that are directed towards the private sector as a whole and the rural population in particular. Systematic support in these areas will contribute to the poor having better access to markets and thus opportunities to participate in economic development.

Private Sector Development

35. Diagnosis and Challenge. Obviously the lack of economic development is at the core of Chiapas's problems. Much of the responsibility for development rests with the entrepreneurs in the productive sectors-rural and urban. The state can contribute with human capital development as discussed above and with economic infrastructure as discussed below. They are probably the most important areas for state activity, because the physical isolation of the state and business’s inability to find a well-qualified labor force are the severest handicap of the state. Public sector reform will also contribute to uniform, predictable procurement practices and reduced transaction-costs. Beyond that, however, the state government can do a little more and aims to do so with the programs of the Secretariats of Economic Development, Tourism; and Fishery, and the Agency for Export Development. Despite isolated successes-a maquiladora, a new hotel-these programs have failed as a whole.

36. While further investigation is needed in this area, a few areas for improvement are already evident. First, the state lacks a coherent plan for economic development and the responsibility for this goal `is now scattered -among at least four dependencies reporting to the governor: Second; the-state is not well promoted to the outside. Third, the targeted credit programs. are going to established industries, which should be able to obtain market credit if they are viable, and this is perhaps excluding (crowding out) possible new sectors. Also, possibly fourth, the regulatory framework for business may still discourage new entrants.

37. Government Program. [The details in this area remain to be discussed with the government.]

Rural Development

38. Diagnosis and Challenge. Chiapas economy remains largely dependent on agricultural and cattle activities. Traditional small farmer agriculture co-exists with large landholdings for commercial plantations and cattle raising activities. The state has been for decades a supplier of primary products for domestic and -to a much lesser extent international markets. Discretionary allocation of federal agricultural subsidies -often based on political patronage ties- has further protected traditional agriculture. However, traditional rural activities have been threatened for some time and those threats will likely materialize in a dramatic way when the NAFTA provisions further open the primary sector to competition from the United States and Canada. Coffee prices have already been in sharp decline for some time; corn will hardly survive the imminent flood of higher quality and lower priced grain from the Northern countries. Although the state appears to keep a competitive edge in tropical fruits, much has to be done to add processing value and enhance marketability.

Lack of timely and accessible information on markets or technological changes are keeping most rural producers away from the necessary signals for technological modernization, flexibility to adjust production and further specialization. Weak planning and project preparation capacity are also preventing small, isolated farmers to access federal subsidies on a competitive, transparent basis. State top-down technical assistance has neither inspired ownership nor capitalized on the accumulated know-how of traditional farmers.

39. Government Program. The primary objective of the state program is to enable rural producers to receive and take advantage of signals from national and international markets and to access federal subsidies in a competitive way. This is essentially a cultural-change objective that will probably take several years to achieve, By-identifying this objective as the state priority for rural development, the government of Chiapas is assuming that the public sector is called to play a role in bridging the information gap that handicaps local producers in national and international markets.

40. The state government has already planned several programs and is taking some actions to achieve the above objective. First; the state is putting together relevant market information currently kept at 5 different sub-secretaries. The state is also putting together a strategy to ensure information sharing and networking among the more than 90 public organizations that are currently operating in a given state region. second, the state will organize and disseminate market information through the internet and, through the Delegaciones Regionales (regional delegations or deconcentrated units of the state Secretary of Rural Development). Market information will be linked to the inventory of land use currently under preparation. Third, the state is already undertaking a training program for capacity building in community participatory planning for integral regional development. Although 20 NGOs have already, been certified as trainers, there is a need to rapidly increase the number of certified NGOs to cope with increasing from the communities. By putting regional participatory planning at the center of rural development planning the state government expects to introduce bottom-up planning at an adequate scale to combine community action with the coordinated actions of the three levels of government [8] Regional participatory planning will also provide a reference point for those community and local development projects that are being required to access some of the federal rural development programs. [9] Fourth, the current administration is committed to allocating state and federal resources for rural development in a transparent way, on the basis of the merits of each project rather than discretionary decisions -as it has been traditionally the case in Chiapas. Fifth, the state intends to authorize a floating credit to the Secretary of Rural development with a view to eliminate the seasonality of the transfer of rural subsidy funds from the federal government.

Roads

41. Diagnosis and Challenge. Better roads are an essential but still missing condition for economic development in Chiapas, which suffers from geographic isolation from the rest of the country (and the NAFTA boom) and geographic fragmentation within the state. Located strategically at the border to Guatemala, Chiapas could capture significant trade flows with a better road system. Two of the most important missing roads for overall economic development in the state the highway to Mexico City and the highway between the capital Tuxtla-Gutierrez and San Cristobal-are largely complete and are expected to be in operation soon, when a couple of missing bridges are built at last.

The existing alternate routes, winding and circuitous, slow down car and truck traffic and subject them to the dangers of accidents and even crime. Many communities in marginal areas have no road connection at all,. which contributes to their extreme poverty. Investments in these areas have been declining over the past few years, leaving a considerable number of communities without access to roads and thus with only marginal possibilities to participate in economic exchange. Plans to improve infrastructure facilities such as the harbor Puerto Madero and a number of regional airports, included in the Central-American Plan Puebla-Panamá; make only sense if they are connected properly with an efficient road network that links local and regional economic centers.

42. Much of the problem with roads results from an inappropriate division of responsibilities among levels of government. Feeder roads, constructed in the federal network have not yet been adopted by the state government due to legal ambiguity and insufficient investment and maintenance, which has further contributed to the deterioration of 400 km of highways. In addition, rural roads would best be managed by municipalities since they are more efficient than the state in operating on the micro level. In some cases, paving and maintaining roads will cost less than restoration and maintenance of dirt roads. Unfortunately, the state has long emphasized the construction of new roads over maintenance-a common problem-with the result today that almost half of the state's roads are in bad condition. Reversing this current trend requires both mobilizing additional resources from the private and public sectors across different levels of government and investing them in such a way as to increase coverage and quality.

43. Government Program. To address these challenges the structural reform program of the state government has three main components: First, the state will decentralize rural roads (and corresponding funding) to the municipalities that are responsive to local priorities and work closely with rural communities. Second, the state will increase its budget allocation for maintenance and will incorporate micro-enterprises in the maintenance of roads. As a mid-term goal, 70% of the state resources in the road sector should be employed for maintenance. Also, international experience shows the value of local participation, as that population is able to realize close surveillance and has a proper interest in good maintenance. Third, paving access roads to municipalities will improve services and protect against further deterioration. This reform program will be feasible if the state implements flexible arrangements of public-private cooperation; puts emphasis on institutional strengthening; and contracts for and monitors annual results with the municipal governments.

Water

44. Diagnosis and Challenge. Good water service contributes importantly to economic growth as well as improving public health and the quality of life. However, the main problem with water and sanitation sectors in Chiapas is the top-down (cascading) transfer mechanism which does not require matching financial contributions from the recipients of funds. This is the case with the state government, municipalities, water supply agencies and users; since users rarely pay for water services, transfers work in practice as non-targeted subsidies. As a consequence, the water and sanitation authorities in Chiapas have financial deficits; they do little or no proper investment, and assets depreciate quickly, which causes low coverage and poor quality of services, which finally exposes the population to considerable health risks. Also, since financing relies exclusively on transfers and subsidies, mostly ex post and de facto when participants do not, pay what they owe, municipalities and the state have no accountability to users. Water becomes like a common good for which no participating agent faces the incentives to pay for services received. This creates a vicious circle in which users refuse to pay for poor services, and consequently state and municipal governments are financially unable to improve service delivery. Thus, the main challenge is to introduce policies to make services financially sustainable, at least, in covering operational cost and depreciation.

45. The rural part of Chiapas receives at least some attention through the PROSAPPYS  project, which has increased investment and provided some institutional strengthening. Problems are especially pressing in urban areas, but both urban and rural municipalities lack adequate managerial capacity. The state water authority CEAS (Comision Estatal de Agua y Saneamiento) needs to improve its performance and to become a supervising agency rather than a direct provider of investment, maintenance or operation services. To do this it will need to supplement the recently adopted water law with new regulations that-clearly define new rules for the establishment of water agencies (organismos operadores, now required by the new law), the participation of the private sector, or the determination of user charges-deficiencies that have contributed to the current financial problems. The state will also need to provide conditional incentives that stimulate municipalities and organismos operadores to gradually promote a fee for services water culture.

46. Government Program. The main challenge in the water and Sanitation sectors is to mobilize additional financing from the private and public sectors, to improve services on a sustainable basis. Reforming the water sector is especially complex because no level of government can achieve much on its own; the current reform effort of the state government of Chiapas recognizes this constraint. It has repeatedly stressed that it will only initiate reforms in coordination with others levels of. Government but is willing to commit itself to the individual actions and results it can control.

47. This reform effort requires commitments among the state, municipalities and user or participating agents in the form of performance agreements. Such agreements can be signed among state and municipal governments and lay out a path/gradual strategy in which (i) municipalities are committed to charge for water services, collect revenue, and reinvest these resources; (ii) the state reduces gradually its current transfers (from its own disposable resources) to municipalities; and (iii) the state in turn increases investments in the localities that perform well. These agreements also need sanctions for non-compliance in the form of a holding back of transfers to municipalities. This gradual and phased-in approach is best suited to reach the long-term goal of 95% coverage in the water sector for the year 2010, which, in turn, will require investment of 5 to 6 million USD annually.

48. These reforms will be complemented by a new regulatory framework for the water and sanitation sector, which should help attract private investment to the sector and improve its financial sustainability. Also, the state water authority (CEAS) needs to change its role from service provider to become an agency for planning, monitoring, and regulation. For this CEAS will need comprehensive institutional reforms to its structure and operation. In addition, municipalities will also require technical assistance from CEAS to improve their performance and contribute to reform of the sector.

(D) Public Finance And Management

49. The state will only be able to sustain the improvements to the provision of public services, outlined above, if it strengthens its public finances. To some degree this will depend on decisions at the federal level, particularly the level of transfers, the degree of earmarking of transfers (legal and de facto), and the transfer of additional taxation authority to the states. Nonetheless, the state has considerable scope for action. In particular, it remains responsible for maintaining is overall fiscal balances; it can increase its own revenue within the present and future limits; management of physical assets and personnel in the civil service offer many opportunities for improvement: the social security programs for public employees need reforms to reduce their current fiscal burden and contingent liabilities; and improving state-municipal relations are essential to implementing many proposals for service delivery and transparency. By improving its performance in these areas, the state government will save financial resources that can be redirected towards expenditure categories that contribute the most to alleviate poverty.

State Fiscal Framework

50. Diagnosis and Challenge. Over the past decade, sub-national governments in Mexico have rapidly increased their participation in the responsibility for and management of public goods and service delivery as a result of the country's on-going decentralization process. This decentralization has resulted from the desire for broader political participation and from the expectation of benefits and efficiency gains from bringing decision makers in the areas of spending and service delivery closer to the beneficiaries and taxpayers. The impact of this process is clearly reflected in the fiscal accounts of the government of Chiapas, which saw its total revenue as a proportion of state GDP rise steadily -to an annual level of US$ 2.3 billion or about 23 percent of the state's GDP in 2002- and with the greatest part of this increase coming from rising federal transfers rather than from own revenue resources. Federal transfers, similar to other states in Mexico, account for more than 90 percent of total revenue for the state government of Chiapas.

Table 2. Allocation of State Public Spending, 2000 (percentage of total

spending)

Note: Table 2 includes total transfers received from the federal government, including federal transfers targeted to municipal governments. Table 3 (below) separates transfers to the state from transfers to municipalities. This explains why percentages for the state earmarked/unearmarked (discretionary) resources differ between Table 2 and Table 3.

51. Federal transfers have increasingly become rules-based and any discussion on the distribution and level of resource transfer is supposed to take place in a federal framework rather than through ad-hoc, discretionary negotiated solutions as in the past. The state government should continue to present its case for further reform of the federal framework in particular in view of its limited level of economic development and the high prevailing levels of poverty. However, at the same time, in order to increase the amount and quality of public goods and services delivered to the state's population the state government also has the ability to broaden its own revenue base and to increase the efficiency with which public expenditure is taking place. Also, an increase in the efficiency of public expenditure not only refers to programs financed with its own, un-earmarked resources, but also in the area of programs financed with federal transfers.

52. The state has the authority to borrow to finance the transition to delivering a higher quantity and quality of public goods and services, and it has the financial space to do so, with low levels of public debt and debt ratios, compared with most: other sub-national governments in Mexico. The state has set a prudential limit on the level of debt, equal to 25 percent of disposable revenue (own revenue and participaciones). Such a debt limit, in terms of disposable revenue rather than in relation to state GDP, is appropriate in view of the state's extremely limited authority to tax and the earmarking of most of its revenue coming in transfers. At the moment, the state's public debt is about US$ 100 million, equivalent to 13 percent of disposable revenue and well within the prudential limit.

53. Government Program. The fiscal reform program of the state government of Chiapas aims to increase the level and improve the quality of public goods and services delivered to the state's population, particularly the poor. This implies an increase in the budget allocation in some areas, for example health, or a shift of expenditures in others involving transition costs, for example retraining teachers from primary to pre-primary education.

Fiscal sustainability of the program should be warranted by a combination of increases in own revenue and cost savings obtained. A detailed multi-annual fiscal impact analysis will be part of the design of the overall program and commitments regarding the contracting of public debt and the maximum allowable primary deficit during the program implementation period will be part of the overall program. An initial indicative estimate of the size of the program puts the external financing needs at US$40 million annually between 2003-2005. At this level of external finance, the state government remains within its prudential limit of debt-to-disposable revenue of 25 percent (see Table 3).

Table 3. Chiapas Fiscal Reform Program

*Three loans of US$40 millions each (debt contracted in pesos, final maturity 20 years without grace period).

Revenue

54. Diagnosis and Challenge. Federal transfers provide roughly 93 percent of the state's revenue-35 percent from tax sharing participaciones, that the state can spend where it chooses and 60 percent in aportaciones that are earmarked for particular uses, mostly education and health at the state level. [10] Twenty percent of the participaciones received has to be passed on to municipalities, and the total amount of participaciones largely depends on the federal tax collection. Federal aportaciones have been the fastest growing revenue category on- the state budget. Besides die participaciones and the aportaciones, the federal government funnels through states and municipalities a number of poverty alleviation programmes that often require matching contributions from subnational governments. [11] As a result, nearly two-thirds of the resources in the state government's budget are earmarked, limiting the state's ability to decide on the allocation and application of those resources. The state's own revenue is low even by Mexican standards as well as in international comparison. The advantage of own revenues is that the state has some control over the amount of inflow as well as its use. With such a small share, however, people may only see the connection between the tax they pay and the benefits of public services if the state revenues are earmarked for some priority areas that the earmarked federal transfers (aportaciones) do not cover.

55. The small share of own revenues in Chiapas has two basic causes. [12] First, federal law gives the states little tax authority-only the payroll tax, hotels, medical services) and annual fees on old automobiles, plus the right to collect and keep all of the federal taxes on sales and annual licensing of new cars. In the medium term, a reform of the fiscal pact at the federal level could put additional taxes bases at the disposal of the state-such as a tax on final sales, a gross income tax on individual entrepreneurs, an optional surcharge on the federal VAT or income taxes, and a gasoline tax. (The first two options were put in the 2002 Federal Revenue Law, but the states including Chiapas, are waiting for these options to be put into regular laws, with more than one year of application, before they would pass their own laws to utilize these options.)

56. Second, the tax base in Chiapas is smaller than in any other state, because the state has the lowest per capita GDP and the smallest share in the formal sector where taxes are paid. Chiapas has implemented essentially all the taxes at its disposal, and although there remain a few significant loopholes, closing them and raising rates to their effective maximum would increase own revenue by only about 15 percent and not significantly raise total revenue. The state traditionally weak tax administration, perhaps more than most states, has made considerable progress during the last two years: Continued improvements in the current Legal framework, while not affecting total revenue much, would give the state more resources for its free disposition. Still, the best option to raise own revenue is to change the federal law to give the state more tax authority.

57. Government Program. The state is taking advantage of the available policy options for strengthening its own revenue:' It will extend the payroll tax to the public sector as in Veracruz's new payroll tax. Although the state would pay much of this itself, there would be a net gain from the-tax on federal` and municipal levels: Administratively it will strengthen the payroll tax by w ltihold ng a presumptive payroll tax payment from all public sector construction contracts, which typically do not pay the tax now. Second, the state will extend the tax on private sector medical services (imposed because that sector does not pay the federal VAT) to withholding at private hospitals. Third, it is passing as series of administrative reforms, the most important of which starts with a "sweep of all streets" (door-to-door identification of taxpayers) to get a good record of urban business that should be paying federal as well as state taxes. [13] It is also taking steps to increase collection through banks and by Internet, allow payment of the tenencia (car tax) at offices in shopping centers, coordinate information with IMSS to assure better coverage with the payroll tax, and shift personnel resources to enforcement (fiscalizacion). In the future, the state plans to take advantage of federal laws extending their tax authority and, if that is not forthcoming, to raise some rates on their existing taxes, as a follow-up to extending their bases.

Asset Management

58. Diagnosis and Challenge. Proper asset management is central to maintaining and increasing the value of goods owned by the state as well as regular access to quality access to goods and services needed by the state. Proper asset management is also a way to further define the role of the state and the goods and services essentially needed to fulfill the core mission of the public sector. Last but not least, proper asset management will generate additional revenues, reduce maintenance or restoration costs; it will also liberate resources that have remained under-utilized for higher efficiency in resource allocation and production and will invite transparency in public-private partnerships for economic development and poverty alleviation. Chiapas, however, has accumulated a vast array of goods and properties, with unclear legal status and undetermined economic value. Registry, control, maintenance and accounting are dispersed and weak. There is a tradition of free 'transfer of assets to municipalities or the private sector. These practices have depreciated the value of assets, undermined accountability, and induced corruption and patronage:

59. Three challenges lie ahead for improving asset management by the state: first, to know precisely which assets it actually owns; second, to keep only those assets that are productive and contribute to budget surplus; and third, to manage these assets with much more efficiency and transparency. As demonstrated by Mexican and international experience, the state transition from asset negligence to modern asset management has to be phased-in in such a way that substantial revenue gains from asset management help overcome political resistance and justify additional spending, in asset identification, valuation and commercialization.

60. Government Program. The state government recognizes the importance of improving asset management, based on market principles and transparency: As an essential first step, the state should generate reliable information on its assets-clarifying what properties it- actually owns (versus what has been given to other governments or private owners). assessing the real value of the properties, and verifying their actual use. This information must go into an organized data bas-- and b up-dated regularly.

61. Training a specialized unit for asset management would be an important component of institutional strengthening. In turn, the actual operation would be decentralized to each of the administrative units of the state government. The private sector plays a potentially important role in this area and should be given priority provided it is more efficient in fulfilling these tasks. For example, leasing by means of competitive bidding will be part of the reform; cattle should be privatized; and vehicle and equipment maintenance should be outsourced, since they are typical non-governmental activities.

62. To increase transparency, the state will publish a list of the main assets it owns and will announce commercialization policies for [20] real estate properties during the first six months of implementation of first loan. To facilitate control and monitoring by civil society, the state should consider the introduction of an ombudsman of public assets. Finally, a series of legal reforms would complement this new concept of asset management in critical areas: it is them that often impede that the state can get rid of unproductive assets and focus clearly on those that contribute to the overall efficiency of service delivery.

Civil Service

63. Diagnosis and Challenge. The state government faces an especially complex challenge in reforming its civil service. Like other subnational governments in Mexico and elsewhere, technical capacity varies widely within the state administration; typically very professional leadership coexists today with a majority of public servants who lack commitment and technical capacity. I,n addition, the often redundant assignment of tasks to administrative units and individual' public servants has lead to an over-sized bureaucracy. Current compensation packages depend heavily on bonuses and reflect inequities in pension conditions. At the same time, an informal career system has emerged, largely owing to political factors that have historically determined the development of the public sector. These factors together explain and contribute to poor services in the state of Chiapas.

64. To reform its civil service the state government faces a number of constraints to overcome: how to improve technical capacity in a tradition of political and clientelistic appointments; how to down-size the public sector when it fulfills an important social function, with over a third of. regular employees on the State government's payroll; and how to sequence the different components of the civil service reform so as to avoid misalignments and new inefficiencies.

65. Government Program. Chiapas has embarked on a program to reform its civil service, with the strong commitment of the Governor and his cabinet and with support of a cross-party agreement.

As an important signal and preliminary step, the new state government did not turn over as many positions as did predecessor governments. It has wisely decided to apply the new regime initially only to the most critical posts for the efficient operations of government and to implement it as a gradual and phased-in approach. Central to this approach is a political strategy to manage the short-term costs of reform. Establishment of a Committee for Public Sector Reform would help ensure that stakeholders have a voice and can participate in the design and implementation; the committee would' also include key ministries like finance, planning and administration, to assure the technical and political capacity to fill the mandate.

66. Reforming the civil service will require reliable and comprehensive information, for which the government is creating three inter-linked databases: on public servants, posts, and payroll. (i) Registry of public servants: Work has already begun on a census for higher-level posts but it needs developing in two directions. First, it needs to be enshrined in a centralized and regularly up-dated data base containing personal data, personal history, education, training, and post held. Second, it needs extendin