el salvador: country strategy with the idb (2010-2014)

DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

EL SALVADOR

IDB: COUNTRY STRATEGY WITH EL SALVADOR 2010-2014

JUNE 2010

This document was prepared by the team consisting of: María Carmenza McLean, Anabella Lardé de Palomo, Karen Munguía (CID/CES); Santiago Castillo, Mario Castañeda (PDP/CES); Germán Cruz (ENE/CES); Guillermo Villacorta (MIF/CES), Jean Eric Theinhardt (ICS/CES); Alfonso Salazar (TSP/CES); Héctor Morena, Gabriela Inchauste, Sebastián Ugarte VásquezSolís (CID/CID); Hubert Quille (WSA/CNI); Nelson Estrada (WSA/CES); Beatriz López, Alberto Barreix (ICF/FMM); Néstor H. Roa (INE/TSP); Luis R. Tejerina (SCL/SPH); Antonio Giuffrida (SPH/CBR); and Marisela Alvarenga (FMK/CGU).

CONTENTS

EXECUTIVE SUMMARY AND RESULTS MATRIX I.

CONTEXT .......................................................................................................................... 1

II.

THE IDB IN EL SALVADOR ............................................................................................... 2

III.

THE BANK’S COUNTRY STRATEGY WITH EL SALVADOR 2010-2014 ............................. 2 A. B. C. D. E. F.

Public finance ......................................................................................................... 3 Social protection ..................................................................................................... 4 Urban environment................................................................................................. 6 Water and sanitation ............................................................................................... 7 Transportation......................................................................................................... 8 Energy ..................................................................................................................... 9

IV.

LENDING FRAMEWORK................................................................................................... 10

V.

IMPLEMENTATION OF THE STRATEGY ............................................................................ 12 A. B. C.

VI.

Safeguards and fiduciary systems........................................................................ 12 Other country systems .......................................................................................... 13 Coordination with other donors ........................................................................... 14

RISKS .............................................................................................................................. 14 ANNEXES Annex I: Selected Macroeconomic and Social Indicators, 2002-2009 ..................... 16 Annex II: Dialogue and Consultation.......................................................................... 17 Annex III: Lessons Learned......................................................................................... 19 Annex IV: Analysis of Macroeconomic Risks ........................................................... 21 Annex V: Incorporation of Recommendations of the Country Program Evaluation: El Salvador 2004-2008 ................................................................................................ 28 Annex VI: Actions of Other Donors ........................................................................... 32 Annex VII: Development Effectiveness Matrix of the Country Strategy ................. 36

- ii -

ELECTRONIC LINKS

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

Diagnostic assessment of growth in El Salvador Independent macroeconomic assessment Debt sustainability analysis Tax revenue challenges in El Salvador Government expenditure Social protection in El Salvador Public safety and citizen security as a State Pact El Salvador’s health sector: Challenges and opportunities for 2010-2014 Education strategy in El Salvador Labor markets in El Salvador Housing sector in El Salvador Water and sanitation Transportation sector in El Salvador Challenges and options for development of the electricity sector El Salvador: Fiduciary technical note El Salvador: Portfolio

- iii -

ABBREVIATIONS

ANDA CABEI CNE EHPM FISDL FMLN FUNDE GDP IFMS IMA IMF LPG MIF MOP MSMEs MSPAS NFPS OMJ OVE PBL PPP PRODEV SCF SEM SSMA STP SFW UNDP USPS VAT

Administración Nacional de Acueductos y Alcantarillados [National Water and Sewer Authority] Central American Bank for Economic Integration Consejo Nacional de Energía [National Energy Council] Encuesta de Hogares de Propósitos Múltiples [Multipurpose Household Survey] (EHPM) Fondo de Inversión Social para el Desarrollo Local [Social Investment and Local Development Fund] Frente Farabundo Martí para la Liberación Nacional [Farabundo Martí National Liberation Front] Fundación Nacional para el Desarrollo [National Development Foundation] Gross domestic product Integrated financial management system Independent macroeconomic assessment International Monetary Fund Liquefied petroleum gas Multilateral Investment Fund Ministry of Public Works Micro, small, and medium-sized enterprises Ministry of Public Health and Social Welfare Nonfinancial public sector Opportunities for the Majority Office of Evaluation and Oversight Policy-based loan Public-private partnership Program to implement the external pillar of the Medium-term Action Plan for Development Effectiveness Structured and Corporate Financing Department Sistema Nacional de Emergencia Médica [National medical emergency system] San Salvador Metropolitan Area Secretaría Técnica de la Presidencia [Technical Secretariat of the Presidency] Spanish Cooperation Fund for Water and Sanitation in Latin America and the Caribbean United Nations Development Programme Universal Social Protection System Value-added tax

EXECUTIVE SUMMARY

In its recent history, El Salvador has enjoyed macroeconomic stability and has made significant headway in the area of liberalization and open trade practices, rooted in structural reforms introduced in the 1990s. Yet despite that progress, El Salvador has been one of the countries of Latin America with the lowest rates of growth and investment. The low growth is explained mainly by human capital and infrastructure deficiencies, along with rising fear for personal safety in the country.

The food crisis and international financial crisis in recent years have reversed gains made in poverty reduction in the last decade. Today, the poor are concentrated in the main urban centers, characterized by overcrowded and poor quality housing and limited access to basic services. The economic downturn has exacerbated the lack of opportunities to access formal employment and social services for the population in general, and for young people in particular. Recent studies highlight the fact that fear of crime and the rise of gangs are tied to the deprivation in underprivileged areas and the lack of access to formal employment, quality education, and other services.

Against this backdrop, the new authorities have begun implementing the Global Anticrisis Plan (known by its Spanish-language acronym, PGA) for 2009-2010, the core objective of which is to protect the most vulnerable sectors from its effects and to create jobs. The PGA is part of the Five-year Development Plan, whose main pillars are to deepen democracy and contribute to an economic and social model that is efficient, competitive, and inclusive. The goals under this framework are the strengthening of public finances, social development, investment in basic infrastructure, and productive development. These efforts are underpinned by a stand-by arrangement with the International Monetary Fund (IMF) for the period 2010-2012.

In support of the new administration’s priorities, the Bank’s country strategy for the period 2010-2014 will focus on six priority areas: public finance, social protection, urban environment, water and sanitation, transportation, and energy. The Bank’s activities will be geared toward strengthening public finances by increasing tax revenue collected and the efficiency of public spending, as well as greater transparency and prevention and control of corruption; fostering greater coordination and consistency between the programs of the Universal Social Protection System (USPS) and integrated violence prevention programs; improving the living conditions of urban settlement dwellers; expanding access to and coverage of water and sanitation services; improving the rural road system and making the mass transit system more efficient; and expanding access to rural electrification with more diversified energy sources.

The Bank will support the country through policy-based loans (PBLs), investment operations, technical assistance, and knowledge transfer. Sovereign guaranteed loans in the period 2010-2014 are anticipated to be around US$1.08 billion, which will cover approximately 10% of the country’s financing needs. In order to help meet those needs in a timely manner, the strategy envisages approval of a high proportion of the funding in the first two years.

Executive Summary

Page 2 of 2

Implementation of the country strategy entails four main risks: first, a macroeconomic risk associated with the consequences of a slow international economic recovery; second, a political risk derived from the process of authorization and approval of loans and discussions on reforms in the Legislative Assembly; third, the risk of natural disasters, which are a common phenomenon in the Central American region; and fourth, a risk that historically weak institutions and coordination difficulty could mar the effectiveness and impact of operations. The Bank will take actions to mitigate those risks.

RESULTS MATRIX

Substantially increase tax revenue intake, use those resources efficiently and transparently, and reduce the level of external debt

IDB sectors of intervention

IDB strategic objectives Increase tax revenue intake

Expected outcomes Increase in the net tax ratio Elimination of the drawback on exports

A. Public finance

Five-year Development Plan

Increase the efficiency of public Reduction of subsidies expenditure Improve transparency in public administration

1

B. Social protection

Reverse the rising poverty trend recorded in recent years and expand coverage of basic social services

Introduction and use of the master registry of beneficiaries as a tool to identify the poor and vulnerable population Expand the Increase in the coverage and Comunidades scope of the Comunidades Solidarias program Solidarias program in the most to urban areas impoverished urban areas

Improve access to, and the quality of public health services

Baseline (Source)

Tax revenue (net of refunds) as % of GDP FOB value of the drawback on exports

2009: 12.1% of GDP (Ministry of Finance) 2009: 6% of the FOB value of exports (Ministry of Finance) 2009: 1.8% (Ministry of Finance)

Subsidy spending as percentage of GDP

Citizens can access reliable Percentage of projects information on public investment monitored by Observatorio Ciudadano de la Obra Pública 1 Improvement in country’s score on the Open Budget Index

Coordinate the social protection system

Indicators

Open Budget Index

Percentage of municipios using the master registry of beneficiaries to identify the system’s beneficiaries Percentage of the most impoverished urban municipios addressed by the Comunidades Solidarias Urbanas program

2009: Base level being prepared (Fundación Nacional para el Desarrollo (FUNDE)/Transparency International) 2008: 37% International Budget Partnership (IBP) 2009: 0% (Technical Secretariat of the Presidency, STP)

2009: 4% (2 municipios / 50 municipios) (Urban Poverty Map of the United Nations Development Programme, UNDP) Reduction of the mortality rate in Mortality rate due to external 2010: the National Medical Emergency causes (injuries and accidents) In preparation System (SEM) in the first 48 hours after the (Ministry of Public Health event in the 16 hospitals and Social Welfare, included in the SEM MSPAS) Increase in coverage of the new Population covered by the new 2006: 0 primary care services model health care model in the (MSPAS) (Departments of San Miguel, Integrated Health Care Chalatenango and Sonsonate, Services and Primary Care and the entire San Salvador Services Networks Metropolitan Area, SSMA)

Indicative targets 2014: 16% or higher 2014: 0% of the FOB value of exports 2014: 0.9% or less

2014: To be determined

2014: 45%

2014: 48% (125 municipios / 262 municipios) 2014: 50% (25 municipios / 50 municipios)

2014: To be determined

2014: 2.5 million people (39% of the Salvadoran population in 2014)

The Salvadoran chapter of Transparency International is managed by Fundación Nacional para el Desarrollo (FUNDE), which under an agreement with the Ministry of Public Works (MOP) is responsible for monitoring the physical and financial management of large public works projects.

- ii -

Five-year Development Plan

IDB sectors of intervention

IDB strategic objectives

Expected outcomes Decrease in the infant/child mortality rate

Improve informal urban settlements and access to housing for vulnerable households

C. Urban environment

Improve the capacity of the Ministry of Labor and Social Security to execute active employment and risk prevention policies Improve housing conditions and access to housing for households living in makeshift circumstances

Increase in the coverage of job placement programs

Reduction in the number of workplace accidents

Increase in the number of households living in dwellings with basic infrastructure (water and sanitation) in municipios addressed by the Comunidades Solidarias Urbanas program

Indicators

Baseline (Source)

Under-5 mortality rate per 1,000 live births

2008: 19 per 1,000 live births (Fundación El Salvador, FESAL) Percentage of the unemployed 2008: 14% who receive job placement services (RENACEMPLEO, a national job network) Number of workplace 2008: 20,147 workplace accidents each year accidents (FUNDE)

Indicative targets 2014: 17.3 per 1,000 live births

2014: 30%

2014: 15,110 workplace accidents (25% reduction)

Percentage of households in poor and extremely poor informal urban settlements with residential water service

2014: 71% 2009: 60% (48,955 households / 81,231 (57,955 households) households) (UNDP Urban Poverty Map)

Percentage of households in poor and extremely poor informal urban settlements with residential basic sanitation service

2009: 32.3% (26,267 households / 81,231 households) (UNDP Urban Poverty Map)

Reduction in the quantitative and Number of dwellings without qualitative housing deficit for floor, walls, or roof households living in makeshift circumstances

Quantitative housing deficit

2014: 43% (25,267 households)

2009: 315,918 dwellings (2007 Census)

2014: 255,918 dwellings

2009: 44,383 dwellings (VMVDU)

2014: 34,383 dwellings

- iii -

Five-year Development Plan

IDB sectors of intervention

IDB strategic Expected outcomes objectives Improve the Greater operational and financial coverage and efficiency of the National Water management of and Sewer Authority (ANDA) water and sanitation services in urban areas

Increase water coverage in poor municipios

D. Water and sanitation

Expansion of the basic sanitation system in urban areas

Indicators

Baseline (Source)

Unaccounted-for water from ANDA in the San Salvador Metropolitan Area (SSMA) Revenues from ANDA billings as a percentage of costs associated with providing water and sewer services Residential basic sanitation coverage in urban areas

2009: 41.4% (ANDA)

2014: 37.4% or less

2009: 88% (ANDA)

2014: 96.8% or more

Percentage of rural households in municipios with high extreme poverty that have residential access to water 3 Percentage of rural households in municipios with high extreme poverty that have access to basic sanitation 4 Percentage of rural water boards benefitted by the SFW 08 program that are able to cover their operation and maintenance costs

2009: 62.1% (Census and Fondo de Inversi贸n Social para el Desarrollo Local, FISDL) 2007: 81.4% (Population and Housing Census)

2014: 66.9% or more

2009: 0% (FISDL)

2014: 100%

2009: 66.1% of urban homes are connected to the system (ANDA) Increase in treatment coverage for Percentage of domestic 2005: 3% urban sewage 2 wastewater treated according to Country-level data Salvadoran standards (World Bank) Improve the Households have access to coverage and drinking water and basic sanitation management of in rural communities water and sanitation services in rural areas

Water boards supported by the program are able to cover their operation and maintenance costs with revenue

Indicative targets

2014: At least 75% of urban homes are connected. Final figure to be determined when the intervention is designed.

2014: To be determined when the intervention is designed

2014: 86% or more

2

Treatment: Up to Salvadoran standard NSO 13.49.01:09 on solid waste, grease, etc. in water to be discharged.

3

Drinking water: 80 to 125 liters/person/day with a minimum pressure of 10 cubic meters of water up to Salvadoran standard NSO 13.07.01.04 on water quality.

4

Improved sanitation: disposal of sewage and greywater from households through latrines, pits, and drainage ditches with grease traps.

- iv -

Expand rural electrification coverage and increase renewable energy sources

E. Transportation

Modernize the port system and mass transit system and expand/improve the country’s road system

IDB sectors of intervention

F. Energy

Five-year Development Plan

IDB strategic Expected outcomes objectives Improve the quality Improvement in the rural road and management of system the rural road system Implement the new mass transit system in the SSMA Access to better ports

Urban and intercity routes for SSMA buses are redesigned (eliminate excess supply and shorten travel time) Increase in the operating capacity of La Unión port

Implement a Increase in the installed capacity regulatory for electricity generation framework that permits investments to align energy supply and demand in the medium term

Increase renewable energy sources Increase rural electrification coverage

Indicators

Baseline (Source)

Indicative targets

Percentage of the rural road 2009: 0% (MOP) system improved with an average International Roughness Index of at least 3 m/km Travel time for the Santa Tecla- 2009: 50 minutes San Martin corridor

2014: 7%

Number of twenty-foot 2009: Not operating equivalent units (TEUs) moved through La Unión port

2014: 148,000 TEUs/year

Installed capacity to meet peak demand and cover the probability of system outages (MW)

2014: 1,697 MW This installed capacity covers peak demand and outage probability.

2009: 1,472 MW This installed capacity covers peak demand and outage probability.

(Superintendencia General de Electricidad y Telecomunicaciones) [General Superintendency of Electricity and Telecommunications] (SIGET) Increase in renewable energy Installed capacity of renewable 2009: 676 MW generation capacity in the energy sources in the country’s (Renewable energy sources country’s electric power system electric power system represent 46% of total) Increase in the number of people Percentage of homes in rural 2009: 79.8% in rural areas that are connected to areas with electricity the power grid connections

2014: 35 minutes

2014: 823 MW (Renewable energy sources represent 48% of total) 2014: 84%

-v-

Establish a responsible, efficient, effective, modern, deconcentrated, and decentralized public sector that provides quality services to the population

5

IDB sectors of intervention

G. Institutional capacity of the State in the area of financial management and government procurement

Objectives Five-year Development Plan

IDB strategic objectives

Expected outcomes

Use the country’s integrated financial management system (IFMS) (including the budget, cash management, accounting, and reporting subsystems) to monitor and render accounts for loan operations financed by the Bank

Use of the IFMS by Bank loan operations to monitor and render accounts

Strengthen the structure and functions of the country’s government procurement system

Improve the efficiency, effectiveness, and transparency of the country’s government procurement system

Indicators

Baseline (Source)

Financial management system Percentage of Bank loan 2009: 0% operations that use the IFMS to monitor and render accounts

Government procurement system Transparency - Percentage of 2009: 5% of projects projects that publish procurement publish their procurement plans, procurement notices, and plans in COMPRASAL award notices in the Dissemination Module COMPRASAL Dissemination (MODDIV) Module (MODDIV) Efficiency - Percentage of loan 2009: 0% of loan operations financed by the Bank operations financed by the that use standard bidding Bank use standard documents 5 for their bidding bidding documents processes Effectiveness - Percentage of loan operations that use electronic tools for procurement planning and monitoring processes to increase the reliability of information

2009: 0%

Indicative targets

2014: 80%

2014: 50% of projects publish their procurement plans in COMPRASAL Dissemination Module (MODDIV)

2014: 100% of loan operations financed by the Bank use the standard price comparison document for works, goods, and nonconsulting services developed by the country 2014: 80% of loan operations plan and monitor procurement processes using electronic tools

Standard bidding documents are documents prepared by the country and agreed upon with the Bank for bidding processes for works and/or goods and/or nonconsulting services; shopping for works and/or goods and/or nonconsulting services; and selection of consulting firms and/or individual consultants for operations financed by the Bank.

I. CONTEXT 1.1

In 2009, a new political cycle began in El Salvador with election of the candidate backed by Frente Farabundo Martí para la Liberación Nacional [Farabundo Martí National Liberation Front] (FMLN) and the first party handover of the presidency in 20 years, since the signing of the Peace Accords in 1992.

1.2

The new administration took office in a context marked by the international financial crisis, which had a strong impact on El Salvador. In 2009, GDP shrank by an estimated 3.5%. In addition, growth performance in the last two decades has been below the average for Latin America, accompanied by declines in gross fixed capital formation and savings rates. 6

1.3

Recovery and a rapid transition to higher rates of sustained growth depend, in part, on the growth of the U.S. economy, 7 but also on structural factors that have caused low growth in El Salvador. Human capital and infrastructure deficiencies, along with problems of insecurity, are the main factors behind the country’s low growth. 8

1.4

In the social sphere, the food crisis and international financial crisis have eroded the gains made in poverty reduction in the last decade. Between 2006 and 2008, the proportion of poor households climbed from 31% to 40%. Today, the poor are concentrated in squatter areas of the main urban centers, characterized by overcrowded and poor quality housing and limited access to basic services.

1.5

The recent economic downturn has exacerbated the lack of opportunities to access formal employment and social services for the population in general, and for young people in particular. Violence in El Salvador has been intensifying since early this decade, especially from 2008 onward. 9 Recent studies highlight the fact that fear of crime and the rise of gangs are tied to the deprivation in underprivileged areas and the lack of access to formal employment, quality education, and other services.

1.6

Against this backdrop, the new authorities have begun implementing an anticrisis program to protect existing jobs and create new sources of work. At the same time, the administration is considering measures to increase tax revenue intake and better target public spending. Both are necessary to create fiscal headroom and to enable investments in works with a high impact on employment, without compromising

6

In the period 1990-2007, El Salvador’s GDP per capita, measured in terms of purchasing power parity, grew by 0.8% annually, while Latin America as a whole averaged 1.4%. The growth rate for national gross fixed capital formation slid from 10% (1991-1998) to 2% (1999-2008), and national savings fell from an average of 16% to 12% of GDP in the same period.

7

The U.S. is El Salvador’s main export destination and the origin of nearly 80% of family remittances sent to that country. There is about a 76% correlation between the U.S. and El Salvador economic cycles, with a two-quarter lag.

8

Other notable problems are institutional and political weakness and failures in coordinating policies that promote productivity through technological advancements with policies geared toward training a skilled and qualified labor force. See Growth Assessment and Assessment of Productive Development Policies, 2009.

9

In January 2010, the homicide rate reached 72 per 100,000, one of the highest in the world.

-2-

public debt sustainability. These efforts are underpinned by a stand-by arrangement with the International Monetary Fund (IMF) for the period 2010-2012.

1.7

At the same time, the authorities have drafted a Five-year Development Plan with the objective of overcoming economic, social, and political inequality as a government priority. Its main pillars are to deepen democracy and contribute to an economic and social model that is efficient, competitive, and inclusive. 10 The goals under this framework are the strengthening of public finances, 11 social development, investment in basic infrastructure, and promotion of productive development.

II. THE IDB IN EL SALVADOR

2.1

The Inter-American Development Bank (the “Bank,” or the IDB) is considered an important partner for the country’s social and economic development, both for its financing resources—historically accounting for more than 60% of multilateral loans—and for knowledge transfer through investment loans, policy-based loans (PBLs), and technical assistance.

2.2

During the country strategy 2005-2009 and through end-2008, the Bank’s capacity to assist financially with implementation of the strategy was seriously limited by political polarization, which resulted in no loans being approved by the Legislative Assembly. The Bank’s support activities were limited to providing technical assistance for project preparation and execution of an ageing loan portfolio (see Annex II). It is worth noting that the technical assistance provided was particularly important for the design of the Red Solidaria Rural program.

2.3

Since 2008, the Bank has been intensifying its efforts to create opportunities for dialogue with the Legislative Assembly, think tanks, and opinion leaders. This enabled the Bank to approve two operations for a total of US$900 million at the end of that year. The loans were supplemented by an extensive program of studies and a special effort to use technical cooperation projects to lay the groundwork for a new project portfolio.

III. THE BANK’S COUNTRY STRATEGY WITH EL SALVADOR 2010-2014 3.1

The Bank’s country strategy will focus on six main areas: (a) public finance; (b) social protection; (c) urban environment; (d) water and sanitation; (e) transportation; and (f) energy.

3.2

Those areas have been agreed upon with the Government of El Salvador after sharing the numerous studies and technical notes prepared by the Bank as the basis for the country strategy 2010-2014 with the new administration and conducting the

10

For more information on the Five-year Development http://190.5.132.123/Presidencia/tecnica/rokdownloads/Documentos/PQD.pdf

11

El Salvador has signed and ratified the Inter-American Convention Against Corruption and the Follow-up Mechanism for its Implementation (MESISIC).

Plan,

see:

-3-

policy dialogue. The consultation with the new administration started before, and continued after, it took office. The areas mentioned are covered by the administration’s Five-year Development Plan, respond to the challenges identified in the research, and were agreed upon in view of the administration’s priorities and the value-added that the Bank can provide, given its experience (in the country or in the region) in nearly all areas of the strategy, and its ability to offer knowledge and innovative solutions. 12 The Bank will evaluate how best to support the “Productive Development Strategy” set out in the Five-year Development Plan, once the government has implemented it. 13 3.3

In addition to supporting the areas of social protection, urban environment, and infrastructure (paragraph 3.1, items (d) to (f)), the non-sovereign guaranteed windows will help to address market defects that limit access to financing by El Salvador’s entrepreneurs, particularly micro, small, and medium-sized enterprises (MSMEs).

A.

Public finance

3.4

Fiscal headroom to increase spending in the country’s key areas is limited by the low net tax ratio (12.3% of GDP in 2009) and the inflexibility of spending derived from high subsidy levels—LPG, electricity, transportation, and water—and debt servicing. The economic slowdown intensified this situation, 14 causing a 10% decline in revenue intake compared to 2008—mainly due to the reduction in the value-added tax (VAT) on imports—and an increase in subsidies to offset the effects of the crisis. The weakest points in the tax area are related to tax legislation that limits tax collecting capacity (particularly in the case of income tax, VAT, and tax administration powers), and limited coordination among the various collection agencies, which facilitates tax evasion. In addition, the Central AmericanDominican Republic Free Trade Agreement (CAFTA-DR) and agreement with the World Trade Organization (WTO) mean that the State has lower revenue from customs duties and limited leeway to give tax credits to exporters. On the spending side, subsidies represented 1.8% of GDP in 2009, but the poorest were not the main beneficiaries.

3.5

The administration is seeking a fiscal pact that would enable it to raise the tax ratio and improve spending efficiency. As a first step, it approved a tax reform in December 2009, and has begun making changes in tax administration to ensure better interagency coordination among tax collection agencies. On the trade policy

12

A summary of the dialogue and consultation for this strategy is found in Annex III. The alignment with the administration’s objectives is presented in the Results Matrix. Annex IV details the lessons learned, while Annex VI indicates how the recommendations of the Office of Evaluation and Oversight (OVE) have been incorporated into this document.

13

This country strategy will be updated if that evaluation (or any other diagnostic assessment performed by the Bank in coordination with the government) results in the inclusion of a new shared priority area between the Bank and the government.

14

It is estimated that the fiscal deficit and debt of the nonfinancial public sector (NFPS) will amount to 4.8% and 50.6% of GDP in 2010, respectively.

-4-

side, it approved a new strategy to promote exports that, rather than granting tax incentives, encourages export diversification, innovation, the participation of MSMEs, investments in export development, and interagency coordination.

3.6

Dovetailing with the program of the Government of El Salvador, the Bank’s support in this area will be geared toward achieving the following strategic objectives: (a) improvement in tax and customs policy and administration; (b) targeting of spending on the neediest sectors; and (c) support for transparent fiscal management. 15 In line with the administration’s plans to improve economic growth and debt sustainability, the Bank will also support productive development, the promotion of exports, implementation of free trade agreements, nurturing of MSMEs, and technological innovation. The expected outcomes by the end of the strategy period are: an increase in tax revenue intake, a significant reduction in nontargeted subsidies, and greater access to information on the main aspects of public administration.

3.7

The main risk is macroeconomic and would be associated with the consequences of a slow international and domestic economic recovery. There is also a possibility that the required tax reforms will not be approved, that they will be significantly modified by the Legislative Assembly, or that the targeting of subsidies will be ineffective due to pressure exerted by certain social groups.

B.

Social protection

3.8

Historically, the different programs to reduce poverty have been disjointed, which increases their cost while reducing their effectiveness. In an attempt to solve this problem, in 2005 the Government of El Salvador introduced the Red Solidaria [Solidarity Network] program, which combined the traditional method of conditional cash transfers with other modes of social development. Despite the program’s efforts so far, certain challenges remain, such as: (a) coverage is low (41% of poor rural households), and improvements remain to be made in the targeting mechanism and monitoring and evaluation system; (b) urban areas, where 58% of the poor are concentrated, are still not covered; (c) the social services network that should support social welfare efforts is still poorly developed; and (d) there is a high level of youth unemployment and a low level of job training.

3.9

Specifically with respect to education and health services, coverage is low and quality is poor. In the case of health, public services—used by the majority of the population, particularly the poorest segments—are characterized by low coverage of health outreach services, limited response capabilities of primary health care establishments, fragmentation in the supply of services, and shortages in the network of laboratories responsible for epidemiological surveillance and quality control. In terms of education, only 75% of children who enter first grade finish the sixth grade, while kindergarten and middle and high school enrollment is low, particularly affecting children and youths from the poorest households. In addition, education quality is still lackluster, based on the results of international

15

This work will be done in coordination with the IMF and the World Bank.

-5-

standardized tests. With respect to labor, unemployment has a greater impact on young people ages 15 to 24 and on the very poor. Informal employment in El Salvador has averaged 55%, while the underemployment rate was 32.1% 16 in 2008, a figure much higher than in the country’s peers of the region. Coverage of the main employment, job placement, and job training programs is very low, reaching less than 14% of the unemployed population.

3.10

The current administration has set out to address these challenges as a key part of its Five-year Development Plan, in order to lay the groundwork for the Universal Social Protection System (USPS), which includes: (a) strengthening of the Red Solidaria program (now the Comunidades Solidarias Rurales [Rural Solidarity Communities] program); (b) development of a new component for urban areas (Comunidades Solidarias Urbanas [Urban Solidarity Communities]) that includes violence prevention at the community level; (c) improvement of the health care system and strengthening of primary care; and (d) a temporary employment program and job training and placement to increase the coverage of those services, particularly targeting youth and vulnerable women heads of household. The government has already defined the strategies for these sectors and is structuring its programs with technical assistance from the IDB. In education, the authorities are in the process of setting strategy for the sector.

3.11

The Bank’s support will focus on the following strategic objectives: (a) strengthening of the central elements of the USPS (targeting mechanism, benefits structure and incentive system, monitoring and evaluation system, and institutional arrangement for implementation); (b) expansion of the Comunidades Solidarias program to urban areas, which will encompass nutrition and integrated violence prevention programs; (c) in health, strengthening of primary care, giving it a high level of response capability and laboratories for quality control and epidemiological surveillance; and (d) expansion of job training and creation of a skills system. Support for the education sector will be defined by the Bank once the strategy to be approved by the administration is analyzed. The Bank will also evaluate the gender perspective in the social programs cited above and explore actions to improve conditions for migrants.

3.12

The Bank’s intervention in the social sector is the result of its prior experience with programs in the different relevant areas and the government’s request for assistance.

This area will be supported mainly by sovereign guaranteed operations, supplemented by the non-sovereign guaranteed window, specifically the Multilateral Investment Fund (MIF). The MIF will finance youth job training activities and the expansion of services through the communities. The Opportunities for the Majority (OMJ) program will promote private sector participation in the production of goods and services tied to Comunidades Solidarias Urbanas at affordable prices.

16

Underemployment rate in urban areas, Multipurpose Household Survey (EHPM), 2008 Office of Statistics and Census (DIGESTYC).

-6-

3.13

The expected outcomes at the end of the strategy are: better coordination and consistency among USPS programs, an efficient and effective Comunidades Solidarias Urbanas program under way, increased coverage of the new primary care services model, reduction in mortality in the SEM, decrease in the infant/child mortality rate, and improvements in the capacity of the Ministry of Labor and Social Security to implement active employment policies.

3.14

The main risks derive from the difficulty of coordinating multiple agencies with different outlooks and interests, and the weakness of certain institutions in implementing their programs, which could result in slow execution.

C.

Urban environment

3.15

The country’s high population density (306 inhabitants/km2) and internal migration processes have led to urbanization of the poor. The rapid growth of cities 17 has resulted in the proliferation of informal settlements lacking basic infrastructure, with limited access to public services, poor housing conditions, social exclusion, and high levels of violence. This situation is particularly critical in the San Salvador Metropolitan Area (SSMA), which occupies 3% of the national territory and where 27% of the population lives. There has been uncontrolled growth of unregulated settlements in the SSMA. Fifty percent of homes are overcrowded and 13% of the population lives over eroded ravines, which puts them at high risk in the event of natural disasters and contributes to pollution of the country’s rivers. Moreover, the poorest families have little access to mortgage financing because of their limited ability to pay.

3.16

In order to help the government improve the urban environment, the Bank will focus its efforts on achieving the following strategic objectives: (a) improve living conditions in informal urban settlements under the Comunidades Solidarias Urbanas program, which combines investments in comprehensive neighborhood improvement—infrastructure works, drinking water, sewage disposal, road infrastructure, electricity and street lighting networks, property titling, and strengthening of the social organization of settlements—with investments to expand social services; and urban facilities such as markets, parks, and recreation sites; (b) prevent the occurrence of disasters in settlements located over ravines in the SSMA and in other high risk areas; and (c) facilitate access to housing for low- and middle-income families by providing subsidies to improve and purchase housing— which would otherwise be unaffordable for many households—supplemented with family savings and loans from financial institutions. The Bank’s intervention in these areas is the result of its prior experience in the country and the administration’s express request. Sovereign guaranteed operations will be complemented by the OMJ initiative, which will support access to housing finance for low-income segments of the population, while the Structured and Corporate Financing Department (SCF) will be used to strengthen housing finance through financial institutions and the possible securitization of mortgages.

17

Between 1992 and 2007, the urban population grew from 50% to 63% of the total population.

-7-

3.17

The Bank’s actions to improve the urban environment will be underpinned by assistance to strengthen management of ANDA, clean up ravines, manage solid waste, and improve the urban mass transit system (see paragraphs 3.22, 3.24, and 3.30).

3.18

The main expected outcomes of the Bank’s interventions under this strategy are improvement in urban settlement conditions, reduction of the risks for the population living in urban settlements located over ravines and in other high risk areas, and reduction of the quantitative and qualitative housing deficit for families with incomes less than four times the minimum monthly wage.

3.19

The main risks could stem from institutional weaknesses and coordination problems between public agencies with roles in multisector programs, which could slow the pace of execution and reduce the effectiveness of the Bank’s support in this area.

D.

Water and sanitation

3.20

Access to water and sanitation is very limited in El Salvador. In 2007, only 44% of rural households had access to tap water—of which not all had regular service— and 18% had no type of sanitation services. In urban areas, water and sanitation services are limited by ANDA management inefficiencies. Despite urban water coverage of 81%, uninterrupted water supply in most localities served by ANDA ranges between 16 hours and less than 4 hours a day. In 2007, 32% of water was unaccounted-for, and billing receipts covered only 74% of costs associated with providing water and sewer services.

3.21

Sanitation coverage is low due to the lack of investments to expand the networks as the population has grown. ANDA’s financial position has not enabled it to finance the required investments due to inadequate levels of user charges and their lack of correlation with the costs of providing services. With respect to solid waste management, the country currently has a small number of final disposal sites, which has created a monopoly for this service. In addition, there are no mechanisms to regulate the quality of services and their costs.

3.22

The administration’s objective is to improve access to water and sanitation through larger investments in rural areas and improvements in ANDA’s indicators of operating efficiency and financial sustainability.

3.23

In rural areas, the Bank will support expansion of water and sanitation coverage in small communities, together with strengthening of management and the creation of external units to support program sustainability. The sovereign guaranteed operations in this area could be complemented by operations under the OMJ initiative to finance solutions through local water boards, and the MIF to develop small public-private partnership (PPP) projects. In urban areas, the Bank will support comprehensive strengthening of ANDA with the purpose of improving its operating efficiency and financial sustainability; ANDA’s infrastructure program to reduce production costs and physical losses; and a plan to finance priority

-8-

investments in wastewater treatment and the cleanup of ravines and rivers in the SSMA. 3.24

With respect to solid waste management and in support of the government’s strategy, the Bank will focus its assistance on institutional and operational strengthening of municipal providers of collection and final disposal services; modernization of the current legal and institutional framework, including support for creation of independent management units at the municipal level; cleanup of critical areas, emphasizing regionalization of final disposal sites and the incorporation of different management modalities, including PPPs; and, recycling and use of biofuels from urban solid waste.

3.25

The main expected outcomes of the Bank’s interventions in this area are: improvements in ANDA management, expansion of the sanitary sewer system and increase in sewage treatment coverage in urban areas, greater access to water and sanitation for the rural population, and better solid waste management.

3.26

The main sector risk would result from the low institutional capacity, which could affect the impact of the programs, particularly with respect to ANDA reforms. The risk for rural programs is the risk of sustainability of the systems, if a long-term plan is not designed and executed.

E.

Transportation

3.27

In the past 10 years, the country has built a paved road network with reasonable service levels. However, distribution throughout the territory is not uniform, particularly in rural areas where there is a significant need to improve the road network. 18 The condition of the rural network becomes critical during the six months of the rainy season each year, reducing accessibility, limiting productive activities or access to basic social services, and increasing transportation costs and travel times.

3.28

Urban challenges arise from a transit system characterized by high levels of congestion, due in part to poor planning of the mass transit system, which in turn has adverse environmental impacts. Currently the only port in operation is the old Acajutla port, which is multimodal but not very efficient at handling containers. It also does not have the capability to accommodate ships with a deep draft. The port of La Unión was built to compensate for that but has been unable to start operations due to a shortfall in government funding.

3.29

The administration aims to develop a logistics services platform in El Salvador that includes consolidation and distribution of international cargo. It is limited by diffuse institutional management of the transportation sector and the lack of an integrated intermodal policy and coordinated actions. Progress needs to be made towards improving and coordinating the road, port, and airport subsectors so as to

18

The Bank has supported construction of rural roads in the country. However, the Departments of Cabañas and Morazán have the smallest number of paved roads, with densities of 75 km/1,000 km2 and 90 km/1,000 km2, compared to 307 km/1,000 km2 in San Salvador.

-9-

facilitate cargo transportation and connectivity with centers of activity and potential logistics development.

3.30

In this setting, the Bank’s strategic objectives are to: (a) strengthen planning of the transportation sector, offering support for the creation and implementation of strategic planning systems by the MOP and of an urban mass transit plan; (b) improve the rural road system; and (c) improve ports and airports. In all cases, environmental risk management mechanisms will be bolstered. The requirements of the road infrastructure, port, and airport sectors may be supported through sovereign guaranteed loans and financing from SCF, through investments and possible port concessions and lines of credit for small fleets. By the end of the strategy period, these actions are expected to bring about improvements in the quality and management of the rural road system, improvements in the SSMA mass transit system, and opening of the port of La Unión.

3.31

The main sector risks derive, on the one hand, from the possible lack of political support, which would lead to a shortage of funds allocated for investments and, on the other hand, from institutional limitations in management capacity.

F.

Energy

3.32

Access to electricity remains limited in rural areas, where 20% of the population is still without service. Moreover, in recent years, sustainable development of the energy sector has been threatened by high and volatile international oil prices. This is more pronounced in El Salvador due to its high dependence on thermal generation with oil derivatives; failures of an advanced market model unsuited to a very small electricity market; and the lack of long-term contracts that curb the natural price volatility in spot markets.

3.33

In 2003, changes were made to the Ley General de Electricidad [General Electricity Act] (LGE) to correct market deficiencies and ensure sufficient supply to sustainably meet growth in demand. 19 However, the process of regulation and application of this new market model suffered setbacks and implementation did not begin until 2009. Likewise, a new apex agency for the electricity sector was created in 2007 in the form of the CNE, which makes and monitors sector policies, strategies, and plans and began operation in early 2010.

3.34

The Bank will give priority to support for the government in supplying energy to the rural population in the country’s poorest 100 municipios, with innovative solutions and sustainable systems.20 It will also foster the strengthening of the sector regulatory framework and apex agency, helping the CNE to develop a National Energy Strategy and to implement a new market model. It will also support

19

Noteworthy among those changes are strengthening of the regulatory authority to monitor market competition and the obligation to sign long-term contracts with distributors, which facilitates the financing of new competitive generation projects in the market, and strengthening of the regulatory authority’s powers.

20

Studies conducted by the Bank that served as a model for the programs financed by the Millennium Challenge Corporation will be used.

- 10 -

investments to diversify the energy mix by financing new sources of generation with renewable energies (hydroelectric and geothermal). These requirements may be considered in future programming of Bank operations to be supported by sovereign guaranteed financing, the Inter-American Investment Corporation (IIC)—which could finance cogeneration in sugar refineries—or SCF—which could look for investment opportunities in hydroelectric and geothermal generation, learning from the Bank’s innovative experiences in other countries.

3.35

The expected outcomes of the strategy include better access to electricity services in rural areas and a more diversified supply of energy capable of meeting the country’s needs.

3.36

The main risks in the sector are derived from the limited institutional capacity of the sector’s apex agencies, which could lead to poor use of the Bank’s support in this area.

IV. LENDING FRAMEWORK

4.1

Fiscal position and external financing. To cope with the economic contraction in 2009, the Government of El Salvador will implement countercyclical fiscal measures aimed at achieving 1% growth in GDP in 2010, and up to 4% growth starting in 2013. 21 Although the nonfinancial public sector (NFPS) deficit stood at 5.6% of GDP in 2009 and should be 4.8% in 2010, it is projected to fall to 3.6% of GDP starting in 2011, owing to the recovery of economic growth and structural measures to be introduced by the Government of El Salvador in tax policies and administration. This improvement in the economic outlook and NFPS fiscal performance will allow the country to stabilize its levels of debt from 2011 onward, and to begin producing a primary fiscal balance consistent with the fiscal sustainability analysis. In this scenario, the NFPS debt will peak at 50.6% of GDP in 2010, and then fall to 46.3% of GDP in 2014. 22 Medium-term financing needs.

Given the amortization profile, countercyclical fiscal policy, and structural adjustments proposed by the Government of El Salvador, the country’s mediumterm gross financing needs 23 are estimated to be on the order of US$10.526 billion in the period 2010-2014, of which 36% is expected to come from external sources and the remainder from internal sources. The greatest financing needs are anticipated to arise in 2010 (11.6% of GDP) and 2011 (11.4% of GDP) due to maturing Eurobonds placed in 2001 and the effects of the global financial crisis on the country’s fiscal position. However, financing needs are expected to fall to 7% of GDP in 2014.

4.2

IDB financing. The lending framework for approvals of sovereign guaranteed operations in the period 2010-2014 is around US$1.08 billion for the base scenario

21

All GDP figures (in real and nominal terms) correspond to the latest projections made by the Central Reserve Bank in May 2010.

22

See Sustainability Analysis, Independent Macroeconomic Assessment (IMA), and Annex V.

23

Fiscal deficit plus amortization payments.

- 11 -

(see Annex V). During the strategy period, this lending framework would allow sufficient resources to be disbursed to meet the objective of covering an average of 10% of the country’s financing needs. In order to help meet financing needs in the peak years when lower growth and greater needs are anticipated, the strategy is frontloaded, with more than 65% of approvals occurring in the first two years. The program’s year-on-year distribution is intended to ensure stable financing equivalent to 7% to 12% of total annual financing needs. Therefore, new policybased loans (PBLs) are anticipated under this lending framework; 24 however, the risk is higher that the unrestricted PBLs may not be ratified. At the same time, an investment portfolio will begin to be built in the priority areas of this strategy, which would be reflected in increasing disbursements in the medium term. This level of approvals will make it possible to reduce the IDB’s share of the external debt and the total NFPS debt from the historical averages for the period 2005-2009 of 25.9% and 20.7%, respectively, to 24.5% and 18%, respectively, in 2014. In the case of multilateral debt, the IDB’s share would fall from a historical average of 66.5% to 50.7% in the strategy period. In addition, the ratio of multilateral external debt would rise from a historical average of 39% to an average of 47% in this period, assuming that the Legislative Assembly continues to approve the operations. Financial instruments will be accompanied by the technical cooperation projects and knowledge products needed to structure operations and support institutional strengthening and the dissemination of knowledge and best practices.

4.3

The transition from the base scenario to other scenarios will be determined by macroeconomic and fiscal triggers: (a) economic growth; and (b) progress of fiscal reforms. The triggers are established in Annex V. In the high scenario, if the economic recovery is slower and the profile of financing needs changes, the Bank could provide slightly higher PBLs to ensure a countercyclical response and help preserve the continuity of the necessary reforms in a less favorable environment. In the low scenario, if the planned fiscal reforms do not materialize and the economic recovery is slower, the Bank would have difficulty approving PBLs and the size of the program would be reduced. Annex V also details both possibilities and proposes modifications to the program’s size and composition.

4.4

In terms of knowledge generation and technical cooperation, the Bank’s country strategy with El Salvador envisages simultaneous programming of this type of products with the loan operations program to ensure consistency and relevance with the country priorities and the Bank’s operations cycle. For the period 2010-2011, technical cooperation resources on the order of US$4.5 million are expected to be mobilized. This program will be updated annually to ensure that interventions are timely and dovetail with the Bank’s work cycle with the country.

24

Regarding the likelihood of approval of PBLs, see the section on risks (paragraph 6.2).

- 12 -

V. IMPLEMENTATION OF THE STRATEGY A.

Safeguards and fiduciary systems

5.1

In terms of financial management, the public expenditure and financial accountability (PEFA) study 25 completed in 2009 determined that the level of performance in public finance management is high in most key aspects, but also reported weaknesses in some areas that affect the overall quality of the system. The Integrated Financial Management System (IFMS), 26 through which all loan operations are channeled and executed, is not used by the Bank for project monitoring and financial accountability because it is not nimble enough to accommodate typical information requirements by component, investment category, and sources of financing, making monitoring and control difficult. The Bank will continue providing support for diagnostic assessments and improvements to that system through technical cooperation resources, principally from the Program to Implement the External Pillar of the Medium-term Action Plan for Development Effectiveness (PRODEV). With respect to internal and external controls, the Court of Accounts and the Legislative Assembly, together with the Internal Audit Units, are responsible for government oversight, and their powers are well defined in current law. However, there are limitations related mainly to the lack of resources and independence. 27 Given these limitations, the external control system is not used to supervise operations financed by the Bank. Accordingly, external audits of projects are performed by the country’s leading private firms.

5.2

With respect to the government procurement system, the country has studies from 2006 28 that need to be updated. 29 Based on the results of the evaluation of that system, the administration plans to revise its strengthening plans to improve management by the apex agency and executing agencies, develop regulations and tools to facilitate processes, standardize bidding documents, and improve execution mechanisms and the system for lodging protests to increase bidder participation.

5.3

The administration is making efforts to improve its transparency indicators. It has made headway in developing an electronic procurement notice system, the functionality and structure of which were evaluated in 2008 and deemed acceptable for publishing procurement notices for projects financed by the Bank. Nonetheless, there are plans to improve the rest of the system’s functions (COMPRASAL),

25

PEFA measurement.

26

See Fiduciary Technical Note, Integrated Financial Management System.

27

Democratic institutions in El Salvador (Fundación Salvadoreña para el Desarrollo Económico y Social, FUSADES), http://www.instituciones-fusades.org/portada.htm.

28

Country Procurement Assessment Review, World Bank/IDB (2004), updated and agreed with the government in 2006.

29

With the Bank's support, the government is applying the OECD/DAC indicators methodology, www.oecd.org.

- 13 -

which requires a status assessment and determination of the actions needed for their development.

5.4

The government acknowledges the importance of strengthening fiduciary systems given their current status and impact on execution of the national budget, in the context of the investment defined in this strategy. The Results Matrix of the country strategy reflects the status of the fiduciary sector and outcomes for this strategy period.

B.

Other country systems

5.5

The Bank will continue supporting monitoring and evaluation systems through a PRODEV operation already under way. This operation will contribute to institutionalization of the National Planning System (SNP); implementation of a monitoring subsystem applied in select institutions to strengthen the development of indicators; implementation of the initial phase of the evaluation subsystem, applied in at least two priority programs; and development of the necessary information system modules for the monitoring and evaluation system. In addition, the Bank will support the government in adapting the budget process so as to permit the integration of performance data obtained through the monitoring and evaluation system. Until the new monitoring and evaluation system is fully deployed, the Bank will continue allocating resources for that activity.

5.6

National statistics are up to date. The economic census was conducted in 2005; the population and housing census—with technical assistance from the IDB—and the agricultural census were conducted in 2007. In addition, the Multipurpose Household Survey (EHPM) has been carried out nationwide each year since 1992.

The Bank makes full use of statistics generated by various official institutions for both its own research and the analysis and monitoring of indicators. The Government of El Salvador plans to create a national statistics and indicators system within the Technical Secretariat of the Presidency (STP), which coordinates all statistics institutions. The Bank could offer its technical and financial support for such purpose.

5.7

In order for the country environmental systems to meet the Bank’s standards, the government needs support in the following areas: (i) solidifying the capabilities of existing entities, particularly the Ministry of the Environment and Natural Resources (MARN); (ii) defining more specific technical regulations and promoting their strict enforcement; and (iii) strengthening of the civil protection system for the management and prevention of natural disasters, with resources targeting communities and city halls. As part of future programming exercises, this strategy includes studies to identify opportunities and environmental risks in the key target areas, as well as to evaluate the country’s capacity for environmental management. It is not anticipated that country environmental systems will be fully deployed by the end of the strategy period.

- 14 -

C.

Coordination with other donors

5.8

From a sector standpoint, the main coordination activities are in the public finance area with the World Bank and the IMF; in the housing sector with the UNDP; in the water sector through cofinancing with the Spanish Cooperation Fund for Water and Sanitation in Latin America and the Caribbean; and in transportation and energy with FOMILENIO and Brazil. In the social area, important work is being done to coordinate and distribute areas of action with the World Bank and the UNDP. Coordination activities with bilateral agencies are essentially through the “donor coordination forum,” a standing body of the different bilateral and multilateral cooperation agencies in San Salvador. For more information, Annex VII presents a summary of activities and sectors in which coordination activities are conducted.

VI. RISKS

The main risks for implementation of the country strategy include: 6.1

Macroeconomic and fiscal risk. El Salvador is highly dependent on flows of exports, remittances, and direct investment, which were affected by the current financial crisis. As described in Annex V, a slow recovery, interest rate hikes, or difficulties in obtaining approval for fiscal reforms could disrupt the macroeconomic equilibrium and, therefore, adversely affect execution of the country strategy. Accordingly, one of the central elements of the Bank’s strategy is to support the country in achieving fiscal sustainability.

6.2

Political risk. Given that none of the parties has an absolute majority in the Legislative Assembly, there is a risk related to legislative authorization and ratification of the operations envisaged under this strategy, especially policy-based loans (PBLs). The continuation and expansion of dialogue already started by the government with different political forces concerning the reforms will be paramount to overcoming this risk. During deployment of this strategy, the Bank will continue supporting the government-Legislative Assembly dialogue to explain the objectives and scope of the Bank’s technical and financial support for the country. At the same time, it will support strengthening of the Legislative Assembly’s capacities so that it can exercise its constitutional powers more efficiently.

6.3

Natural disaster risk. A large-scale natural disaster would change the government’s priorities and make it necessary to redirect resources and operations.

During this strategy period, the Bank will endeavor to support the government in mitigating these risks through more robust risk evaluations and investments to build capacity to cope with natural disasters and mitigate their impact, as well as for prevention and financial management of this type of catastrophe.

6.4

Institutional risk. Weak public institutions and potential difficulties in coordinating multisector programs could jeopardize the effectiveness and impact of the Bank’s operations in nearly all areas of the strategy. Consequently, the Bank will provide the technical and financial assistance necessary to overcome those

- 15 -

risks and to support the government’s objectives of building a responsible, efficient, effective, modern, and transparent public sector.

- 16 -

ANNEX I: SELECTED MACROECONOMIC AND SOCIAL INDICATORS, 2002-2009

Real Sector Real GDP growth (%) GDP at current prices (US$ millions) GDP per capita (US$) Consumer prices (annual variation, %), end of period External Sector Trade balance (% of GDP) Remittances (% of GDP) Current account balance (% of GDP) Financial and capital account (% of GDP) Foreign direct investment (% of GDP) Gross international reserves (US$ millions) Gross international reserves (% of GDP) Public Finances Overall balance NFPS (% of GDP) Primary balance NFPS (% of GDP) NFPS debt (% of GDP) External debt of the public sector (% of GDP) Social Indicators Population (in millions) Unemployment rate (%) Households in extreme poverty (%) Households in poverty (%) Notes: p Preliminary data at year-end.

2002

2003

2004

2005

2006

2007

2008 2009 p

2.3 14,307 2,389 2.8

2.3 15,047 2,504 2.5

1.9 15,798 2,621 5.4

3.3 17,070 2,822 4.3

4.2 18,654 3,071 4.9

4.3 20,373 3,340 4.9

2.4 22,107 3,609 5.5

-3.5 21,100 3,430 -0.2

-13.0 13.5 -2.8 6.3 3.5 1,589 11.1

-15.2 14.0 -4.7 7.7 0.8 1,906 12.7

-16.8 16.1 -4.0 1.4 2.3 1,888 12.0

-17.2 17.7 -3.3 5.1 2.3 1,829 10.7

-19.0 18.6 -3.6 6.1 1.3 1,907 10.2

-20.1 18.1 -6.0 3.3 6.9 2,198 10.8

-19.9 17.1 -7.6 7.8 3.3 2,541 11.5

-13.2 16.4 -1.5 3.5 1.3 2,969 14.1

-5.1 -3.3 38.7 33.8

-4.2 -2.2 40.4 36.9

-3.1 -1.0 40.5 36.1

-3.5 -1.3 39.6 36.1

-2.9 -0.5 40.1 35.5

-1.9 0.6 38.8 31.6

-3.1 -0.7 39.7 31.2

-5.6 -3.0 49.0 38.4

5,989 6.2 15.8 36.8

6,008 6.9 14.4 36.1

6,027 6.8 12.6 34.6

6,049 7.2 12.3 35.2

6,074 6.6 9.6 30.7

6,099 6.3 10.8 34.6

6,125 5.9 12.4 40.0

6,153 … … …

- 17 -

ANNEX II: DIALOGUE AND CONSULTATION Background Since mid-2008, in understanding and coordination with the Government of El Salvador, the Bank has been engaged in ongoing dialogue with the political parties represented in the Legislative Assembly and with opinion leaders, in order to share and jointly analyze information that could be used as the basis for evaluating conditions in El Salvador, its main structural problems, the importance of solving those problems, and the opportunities and benefits that programs with multilateral lenders could bring to the country. The purpose of those actions has been to strengthen knowledge in the country concerning key development issues and the relationship with the Bank, and to create an environment conducive to strengthening the Bank’s financial support. Based on this dialogue and consultations with other stakeholders, a program was designed for studies to be carried out by the Bank teams and consultants in order to support the policy dialogue with the authorities and to provide a basis for developing the new country strategy.

The consultation process for the country strategy with El Salvador 2010-2014 was comprised of the following main phases: (1) dissemination and discussion of the baseline studies; and (2) consultations to validate the strategy. Following is a description of the main actions in each phase.

1. Dissemination and discussion of baseline studies (a) El Salvador Day, which was held in April 2009 with the participation of 45 delegates from the IDB, the World Bank, and the IMF, had the following objectives: (i) improve the quality of the studies being prepared by the Bank for dialogue with the new authorities and as the basis for the country strategy, by disseminating them among the different teams involved (within the Bank and at the other institutions), receive crossfertilization, and strengthen those studies by incorporating approaches and up-to-date information on the global crisis and its impact on the country; (ii) identify knowledge gaps and propose additional activities; (iii) improve the quality of presentations to be made to the new authorities on the findings of the studies and identify strengths and weaknesses in the different topics required for the dialogue; and (iv) make headway with the strategy and common language that the Bank, World Bank, and IMF would use for future dialogue with the authorities. (b) Policy dialogue with the government-elect of El Salvador. The economic and social policy dialogue, coordinated by the IDB, was conducted with the participation of the recently elected administration, the World Bank, and the IMF. The meeting took place on 6-7 May 2009, before the team that would make up the administration’s cabinet had been selected. However, important members from the teams working on the transition and on policies to respond to the crisis were involved in the dialogue. Some of those individuals were later appointed to the new cabinet, including the new Technical Secretary and Minister of Finance. A considerable number of FMLN representatives also participated (9). The President-elect participated the first morning and during the closing session. (c) Publication of the book “Hacia la generación de más oportunidades: Agenda de desarrollo económico y social en El Salvador” [Creating more opportunities: Basis for a development agenda for El Salvador], which compiles 20 of the studies and aims to contribute to the discussion of the country’s key issues.

- 18 -

2. Consultations to validate the country strategy 2010-2014 (a) Consultation with the government. Consultation with the government took place in several stages during the month of June, at the technical and political levels, with the involvement of all institutions relevant to the strategy, under the leadership of the Technical Secretariat of the Presidency (STP). The Bank and government reached agreements during these consultations that were incorporated into the draft results matrix and text of the strategy. A final meeting was held on 9 June 2010, attended by the Country Department Central America, Mexico, Panama and the Dominican Republic (CID), the Country Office, and the Council of Ministers and senior officials relevant to the strategy. The strategy document was validated at that meeting. (b) Consultation with main multilateral and bilateral cooperation agencies (10 June 2010). The two main objectives of this meeting were to: (i) present the draft strategy; (ii) hear those agencies’ opinions and recommendations on the strategy’s vision and areas of major focus; and (iii) identify areas of common action, and actions and resources that should be coordinated with them. The following donors attended: the United Nations system, European Union, World Bank, the Central American Bank for Economic Integration (CABEI), and the bilateral cooperation agencies of Spain, Japan, Germany, USAID, France, and Canada. At the end of the meeting, the IDB was asked to serve as focal point for the consolidation of information on support to the country in the strategy areas. (d) Dialogue with civil society representatives (10 June 2010). The main objectives of this meeting were to: (i) establish the new Civil Society Consultation Group (CONSOC); (ii) share the Bank analyses of economic and social conditions in El Salvador that had served as the basis for this country strategy; (iii) present the main target areas of the country strategy for the period 2010-2014; and (iv) hear the opinions of key stakeholders from civil society, and exchange views with them.

Representatives of the following institutions attended the meeting: FUNDE, UCA, Universidad José Matías Delgado, Fundación PROESA, Movimiento Social Para Mujeres, CEMUJER, FUSALMO, CORDES, Grupo CREO, Fundación Llort, SACDEL, and Salvanatura.

- 19 -

ANNEX III: LESSONS LEARNED The most important lessons learned by the Bank in implementing the country strategy have been the following: 1. Political polarization. Political polarization can seriously hinder attainment of the development objectives of the planned actions. This can occur mainly due to difficulties in obtaining the qualified majority required for legislative authorization and ratification of loan operations. The execution of projects requiring a consensus among stakeholders could face the same obstacles. It has been shown that the Bank’s collaboration with the authorities to explain the objectives and scope of loan operations has a good outcome. Such support in the dialogue with the Legislative Assembly will be implemented as part of this strategy, which is consistent with recommendation of the Bank’s Office of Evaluation and Oversight (OVE) in its Country Program Evaluation (CPE) 2004-2008.

2. Social vulnerability. Despite progress in poverty reduction and the ongoing support that the country strategy should give to achieving that objective, the economic crisis has demonstrated that such progress is vulnerable. This strategy will support formalization and implementation of an integrated social protection system, in general geared toward ensuring access by the population, starting with the poorest, to a minimum level of social services and, specifically, serving as a temporary expedient in critical situations. This action squares with OVE’s recommendation that the Bank’s program should rely more on knowledge transfer than on resource transfer in order to have the greatest impact.

3. Capacity of executing units. In the recent past, not enough attention has been given to the institutional capacity of the executing units during the preparation phase of new operations, in particular with respect to internal control and financial management. To address this, special units were developed outside the national institutional framework, or the Bank’s units were used to provide very close supervision.

Following OVE’s recommendation, this strategy will rely more heavily on local project execution and evaluation capacities, technical assistance will be given to strengthen the executing agencies, and technical cooperation projects will be structured that target key institutions, in order to increase the use of country systems.

4. Conditions precedent to declaration of eligibility. The conditions precedent to the first disbursement—established for the declaration of eligibility of an operation—in many cases meant that longer periods would be required to fulfill those conditions, in particular in the case of approvals of laws or reforms with a political impact. The programs should be designed with a minimum and manageable number of conditions precedent to the first disbursement and, if possible, establish effective execution conditions, both before and during the preparation and approval process.

5. Evaluation of achievement of the development objectives. The large majority of projects supported by the country strategies with El Salvador have not had indicators and a baseline to measure impact and outcomes during and at the end of the operation. An important lesson is to identify indicators that measure the direct impacts on the beneficiaries and, insofar as possible, the indirect impacts of the

- 20 -

outputs obtained. Likewise, in many cases, the project performance monitoring reports have been a useful tool for incorporating the indicators and baseline necessary to measure the effects and outcomes of the Bank’s work in the country. At the same time, and following OVE’s recommendation, support will continue to be given (especially through PRODEV) for country results-based management and monitoring systems, to make them independent from program execution and, at the same time, leverage them for the Bank’s monitoring systems.

- 21 -

ANNEX IV: ANALYSIS OF MACROECONOMIC RISKS The lending framework for the country strategy is defined according to: (i) the country’s gross financing needs; (ii) the IDB’s amortization profile; and (iii) country debt indicators.

As a starting point, the base scenario takes the economic projections that the Government of El Salvador recently agreed upon with the IMF to calculate the gross financing needs of the public sector. This scenario assumes that the economic recovery that started in late 2009 will continue into 2010 (see Table A1), based on a rapid recovery of exports, the flow of remittances, and an increase in tax revenue intake due to reforms approved in late 2009, such that tax revenue will increase in the medium term. That scenario entails a favorable medium-term debt profile, as described in greater detail in the Independent Macroeconomic Assessment (IMA) and debt sustainability analysis, both attached to this strategy.

In this regard, two types of risks are relevant to the macroeconomic assumptions. First, there is an exogenous risk that the economic recovery, rooted in a recovery of exports and growth in remittances, will not be as high as expected, which would mean lower tax revenue and, therefore, a less favorable public debt profile. Second, there is a risk that the tax reforms planned for the medium term will not be approved by the Legislative Assembly, or that they will not meet expectations in terms of tax revenue intake. In addition, if government spending is out of step with the conditions on the ground, the medium-term deficits and, consequently, the public debt profile would be less favorable. This annex explores both possibilities.

Exogenous risk – Slow recovery The risk of a slower recovery due to lower export demand from trading partners combined with a slower recovery in the flow of remittances could result in a low growth scenario.

Even if the tax reform is implemented as planned, slower economic growth would result in a higher NFPS deficit, higher interest rates associated with greater macroeconomic risk, and, therefore, a less favorable debt path (see Table A2).

In this scenario, the Bank could offer higher medium-term policy-based loans (PBLs), thus ensuring resources for priority social investments. Consequently, the size of the program for 2010-2014 would increase from a total of US$1.08 billion under the base scenario to US$1.22 billion under the low growth scenario (Figure A1), with a slightly higher slope towards PBLs (Figure A2). The allocation of resources and the flow of funds in this scenario are detailed in Table A2.

Fiscal risk – Failures in implementation of fiscal reforms The third scenario considers the risk of problems in implementing the anticipated fiscal reforms, less growth than expected in the base scenario, and relatively higher interest rates associated with greater macroeconomic risk. The reforms associated with the base scenario assume implementation of medium-term tax measures in order to increase the tax ratio from 12% of GDP in 2009 to 16% of GDP in 2014. To obtain that increase, decisions will have to be made to increase the tax base, raise tax rates, and/or introduce new taxes. Likewise, the fiscal reform assumes that the existing generalized subsidies will be targeted, ensuring fiscal headroom for other priority social spending. However, that targeting will be difficult to

- 22 -

implement and could be derailed by powerful interest groups. In this scenario, the NFPS deficit would be higher, and fiscal sustainability could be in jeopardy (see Table A3).

In this scenario, the Bank would have to restrict its PBLs, and the portfolio would be reduced to medium-term investment loans. If this situation is not corrected, the size of the program would have to be reduced. In the short term, this change would occur automatically since for 2010 the base scenario envisages a PBL in which the conditions precedent will depend on implementation of the anticipated fiscal reforms. Unless those conditions are fulfilled, the Bank’s support would be limited. In the medium term, future PBLs will depend on a favorable macroeconomic environment, which in the case of El Salvador crucially depends on the fiscal outlook. Consequently, the size of the program for 2010-2014 would be reduced from a total of US$1.08 billion under the base scenario to US$900 million under the fiscal risk scenario (Figure A1), with a slope towards investment loans (Figure A2). The allocation of resources and the flow of funds in this scenario are detailed in Table A3.

Figure A1. IDB Loan Approvals for El Salvador (in millions of U.S. dollars) 500 Base Scenario

450

Low growth Fiscal risk

400 350 300 250 200 150 100 50 0 2008

2009

2010

2011

2012

2013

2014

- 23 -

Figure A2. IDB Loan Disbursements to El Salvador (in millions of U.S. dollars) 400 Base Scenario Low growth

350

Fiscal risk

300 250 200 150 100 50 0 2008

2009

2010

2011

2012

2013

2014

- 24 -

Figure A3. IDB Net Flows to El Salvador (Disbursements – Repayment of Principal) (in millions of U.S. dollars)

250 Base Scenario Low growth

200

Fiscal risk

150

100

50

0 2006 -50

-100

2007

2008

2009

2010

2011

2012

2013

2014

- 25 -

Table A1. Selected Indicators. Base Scenario 2008

2009

2.4 2.0 5.5

-3.5 -4.0 -0.2

External Sector Exports (FOB) (volume) Imports (FOB) (volume) Remittances

5.5 -8.2 2.5

-15.5 -15.9 -8.5

NFPS Revenue and grants Net tax revenues Expenses and net lending Primary deficit NFPS Overall surplus (deficit)

16.9 13.1 20.0 -0.7 -3.1

National Income and Prices Real GDP GDP per capita Consumer Price Index (end of period)

Gross financing needs Of which: Amortization External Sector Current account deficit Trade balance Exports (FOB includes maquila) Imports (FOB includes maquila) Remittances Public Sector Debt External debt NFPS debt Outstanding multilateral debt/Outstanding NFPS externa Outstanding IDB debt/Outstanding multilateral debt IDB Support IDB approvals IDB disbursements IDB repayments IDB net flows (disbursements - repayment of principal) Memorandum Items: Nominal GDP (US$ millions) IDB disbursements Percentage of financing needs Debt stock of NFPS with IDB (% of GDP)

Base Scenario 2011 2012

2013

2014

(Percentage change) 1.0 3.0 3.0 0.5 2.5 2.5 1.5 2.8 2.8

4.0 3.4 2.8

4.0 3.5 2.8

4.6 5.8 5.0

6.4 6.6 9.5

6.7 7.0 9.5

6.7 6.7 8.0

15.9 12.3 21.5 -3.0 -5.6

(In percent of GDP) 17.9 18.6 19.7 13.5 14.2 15.4 22.7 22.2 22.2 -1.8 -0.5 0.6 -4.8 -3.6 -2.5

20.0 16.3 21.8 1.2 -1.8

20.0 16.4 21.7 1.3 -1.7

7.3 4.2

13.6 7.8

11.6 6.8

11.4 7.9

7.2 4.7

6.2 4.4

7.1 5.4

-7.6 -19.9 20.9 -40.7 17.1

-1.5 -13.2 18.3 -31.5 16.4

-2.9 -15.1 18.7 -33.8 16.7

-2.9 -15.2 19.1 -34.3 17.0

-2.8 -15.5 19.3 -34.8 17.5

-2.9 -15.8 19.4 -35.2 17.9

-2.9 -16.1 19.6 -35.7 18.1

31.2 39.7 39.2 68.6

38.4 49.0 38.6 66.5

40.7 50.6 42.4 58.5

39.4 50.2 45.4 54.9

38.0 49.5 48.3 51.5

35.8 48.2 49.4 50.7

35.1 46.3 48.3 50.7

110 188 -191 48

50 186 -175 57

600 288 168 183

300 488 -170 379

2010

6.2 4.2 7.5

(In millions of U.S. dollars) 470 280 170 237 179 208 -178 -177 -205 122 63 61

22,107

21,100

21,739

22,961

24,459

26,230

27,991

15.6 7.9

12.1 9.4

9.4 9.6

6.8 9.4

11.8 9.1

11.6 8.6

9.4 8.3

Source: Prepared with data from the Ministry of Finance and the Central Reserve Bank.

- 26 -

Table A2. Selected Indicators. Low Growth Scenario 2008

2009

2.4 2.0 5.5

-3.5 -4.0 -0.2

External Sector Exports (FOB) (volume) Imports (FOB) (volume) Remittances

5.5 -8.2 2.5

-15.5 -15.9 -8.5

NFPS Revenue and grants Net tax revenues Expenses and net lending Primary deficit NFPS Overall surplus (deficit)

16.9 13.1 20.0 -0.7 -3.1

National Income and Prices Real GDP GDP per capita Consumer Price Index (end of period)

2010

Low Growth Scenario 2011 2012 2013

(Percentage change) 0.5 2.0 2.0 0.0 1.5 1.5 0.7 2.8 2.8

2014

2.0 1.5 2.8

2.0 1.5 2.8

4.8 4.6 8.0

5.3 4.6 8.0

6.3 4.8 8.0

15.9 12.3 21.5 -3.0 -5.6

(In percent of GDP) 17.8 18.5 19.4 13.4 14.1 15.1 22.9 22.6 22.3 -2.0 -0.9 0.3 -5.1 -4.1 -2.9

19.5 15.7 22.0 0.5 -2.6

19.5 15.9 22.1 0.5 -2.5

7.3 4.2

13.6 7.8

11.9 6.8

12.3 8.2

8.0 5.1

7.4 4.8

8.5 5.9

External Sector Current account deficit Trade balance Exports (FOB includes maquila) Imports (FOB includes maquila) Remittances

-7.6 -19.9 20.9 -40.7 17.1

-1.5 -13.2 18.3 -31.5 16.4

-1.0 -13.3 19.7 -33.0 16.8

-0.4 -13.0 20.3 -33.3 17.2

0.2 -13.1 20.4 -33.5 17.6

0.7 -13.1 20.7 -33.8 18.1

1.4 -13.0 21.2 -34.3 18.7

Public Sector Debt External debt NFPS debt Outstanding multilateral debt/Outstanding NFPS external deb Outstanding IDB debt/Outstanding multilateral debt

31.2 39.7 39.2 68.6

38.4 49.0 38.6 66.5

40.9 51.5 42.4 58.5

40.0 53.4 45.4 54.9

39.2 53.7 48.5 52.0

37.8 53.7 49.9 51.6

37.9 55.3 49.0 52.2

(In millions of U.S. dollars) 470 280 220 237 179 258 -178 -177 -205 122 63 111

150 228 -191 88

100 236 -175 107

Gross financing needs Of which: Amortization

IDB Support IDB approvals IDB disbursements IDB repayments IDB net flows (disbursements - repayment of principal)

600 288 168 183

300 488 -170 379

9.6 2.6 4.6

6.4 2.9 7.5

Memorandum Items: Nominal GDP (US$ millions) IDB disbursements Percentage of financing needs Debt stock of NFPS with IDB (% of GDP)

22,107

21,100

21,622

22,616

23,854

25,098

26,274

15.6 7.9

12.1 9.4

9.2 9.7

6.4 9.5

13.6 9.5

12.4 9.4

10.6 9.4

Source: Prepared with data from the Ministry of Finance and the Central Reserve Bank.

- 27 -

Table A3. Selected Indicators. Fiscal Risk Scenario 2008

2009

2.4 2.0 5.5

-3.5 -4.0 -0.2

External Sector Exports (FOB) (volume) Imports (FOB) (volume) Remittances

5.5 -8.2 2.5

-15.5 -15.9 -8.5

NFPS Revenue and grants Net tax revenues Expenses and net lending Primary deficit NFPS Overall surplus (deficit)

16.9 13.1 20.0 -0.7 -3.1

National Income and Prices Real GDP GDP per capita Consumer Price Index (end of period)

Gross financing needs Of which: Amortization External Sector Current account deficit Trade balance Exports (FOB includes maquila) Imports (FOB includes maquila) Remittances Public Sector Debt External debt NFPS debt Outstanding multilateral debt/Outstanding NFPS external debt Outstanding IDB debt/Outstanding multilateral debt IDB Support IDB approvals IDB disbursements IDB repayments IDB net flows (disbursements - repayment of principal)

2010

Fiscal Risk Scenario 2011 2012 2013

(Percentage change) 0.5 2.0 2.0 0.0 1.5 1.5 0.7 2.8 2.8

2014

2.0 1.5 2.8

2.0 1.5 2.8

4.8 4.6 8.0

5.3 4.6 8.0

6.3 4.8 8.0

15.9 12.3 21.5 -3.0 -5.6

(In percent of GDP) 17.5 17.7 17.4 13.2 13.3 13.2 22.8 22.5 22.7 -2.1 -1.3 -1.7 -5.3 -4.8 -5.3

16.7 13.0 22.5 -2.1 -5.8

16.5 12.8 22.7 -2.3 -6.2

7.3 4.2

13.6 7.8

12.1 6.8

13.1 8.3

10.4 5.2

10.6 4.8

12.0 5.8

-7.6 -19.9 20.9 -40.7 17.1

-1.5 -13.2 18.3 -31.5 16.4

-1.0 -13.3 19.7 -33.0 16.8

-0.4 -13.0 20.3 -33.3 17.2

0.2 -13.1 20.4 -33.5 17.6

0.7 -13.1 20.7 -33.8 18.1

1.4 -13.0 21.2 -34.3 18.7

31.2 39.7 39.2 68.6

38.4 49.0 38.6 66.5

40.9 51.5 42.4 58.5

40.0 53.6 45.4 54.9

38.5 55.7 47.6 50.3

36.8 58.0 48.5 48.9

36.6 61.9 47.2 48.5

(In millions of U.S. dollars) 470 250 130 237 176 108 -178 -177 -205 122 60 -40

50 136 -191 -4

0 143 -175 14

600 288 168 183

300 488 -170 379

9.6 2.6 4.6

6.4 2.9 7.5

Memorandum Items: Nominal GDP (US$ millions) IDB disbursements Percentage of financing needs Debt stock of NFPS with IDB (% of GDP)

22,107

21,100

21,739

22,961

24,459

26,230

27,991

15.6 7.9

12.1 9.4

9.0 9.7

5.8 9.5

4.2 8.9

4.9 8.4

4.3 8.1

Source: Prepared with data from the Ministry of Finance and the Central Reserve Bank.

- 28 -

ANNEX V: INCORPORATION OF RECOMMENDATIONS OF THE COUNTRY PROGRAM EVALUATION: EL SALVADOR 2004-2008 1. Recommendation 1: The Bank should review with the government the diagnostic work prepared for the last program cycle, much of which remains relevant to the country’s development challenges.

Response: The diagnostic work done prior to 2004 was analyzed and taken into account in identifying the new program of studies prepared in 2008 and 2009 with a view to the new strategy. This latter group of studies (compiled in the book “Hacia la generación de más oportunidades: fundamentos de una agenda de desarrollo para ES” [Creating more opportunities: Basis for a development agenda for El Salvador], see http://www.iadb.org/countries/ home.cfm?lang=es&id_country=es) was presented and discussed extensively with the authorities.

A new growth diagnostic was conducted, taking into account more recent indicators of the main obstacles to growth. The analysis was supplemented by a full set of studies at the sector level that explores in detail some of the issues resulting from the growth diagnostic, and several studies also address the fiscal issue in light of the global economic crisis.

2. Recommendation 2: The financial parameters of the proposed program should be clearly established at the outset. If the program continues the past practice of anticipating significant resource transfers from the country to the Bank, then the expectations for the Bank’s development impact should be scaled accordingly. Such a program would need to rely on knowledge transfer rather than resource transfer for its impact, and should be monitored accordingly.

Response: The financial parameters of the new strategy are clearly established in it (see Annex V). The lending program is projected to be positive in terms of net flows (disbursements – repayment of principal). All areas for action envisaged by the Bank in the new strategy include significant knowledge transfer. The proposed strategy will strike a balance between investment and PBLs, the latter precisely to ensure resource transfers so as to maintain allocations in key areas at times of crisis and significant fiscal constraints. The strategy also envisages support for strengthening tax effort and expenditure efficiency to ensure fiscal stability (paragraph 3.6). Lending parameters are established in the new strategy, including projected approvals and disbursements, the breakdown between PBLs and investment loans, and projected net transfers to the country (see Annex V).

3. Recommendation 3: The Bank should consider a more inclusive approach to the programming process. Past disagreements between the executive and legislative branches on priorities completely blocked the approval of new lending operations. To avoid repeating this experience in a context of continued significant political polarization, the Bank should work to ensure that its proposed program commands a broad consensus in both the legislative and executive branch.

Response: Since 2008, as OVE acknowledges, the Bank has engaged in dialogue with various stakeholders—including the Legislative Assembly—thereby enhancing the Bank’s relevance in the country and making possible the approval of two operations for US$900 million and unanimous ratification of the PBL in the Legislative Assembly. This success has been one of the

- 29 -

positive lessons learned, taken into account in the new strategy (see paragraph 2.3 and Annex IV). Dialogue and consensus-building will continue in the cycle of this new strategy.

4. Recommendation 4: The Bank should rely much more heavily on local capacity for the management of project execution and the evaluation of project accomplishments...At the same time, national systems for results monitoring should be encouraged (via loans and technical cooperation operations) to become fully independent of the execution of programs, and the Bank should work to integrate these local evaluation efforts with its own systems for project monitoring.

Response: At present, the integrated financial management system (SAFI) is not sufficiently itemized to monitor a specific project or function, making it difficult to meet international monitoring and control standards (see paragraphs 5.1-5.4 and the results framework). As for national controls, weaknesses remain in the external control exercised by the Court of Accounts.

The Government of El Salvador recognizes the importance of strengthening its national financial management and procurement systems, including internal and external control mechanisms. The Bank is already supporting the preparation of strengthening plans in both areas, and the new strategy cycle sets as a goal utilization of the recently adopted validation mechanisms to move toward full use of the country systems.

5. Recommendation 5: The next country strategy should review the 19 specific recommendations contained in the last country program evaluation, the vast majority of which were not incorporated into the last strategy.

Response: Following is a table summarizing the response to each recommendation of the previous CPE.

- 30 -

List of Recommendations of the Previous Country Program Evaluation and How They Are Addressed in the New Strategy Recommendations of the previous CPE The core objective in 2005-2009 should be to complement the government’s efforts to make progress in terms of growth, productivity, and employment, which are essential challenges in continuing to reduce poverty and close the gap in the delivery of social services.

The cost-benefit analysis of projects and of the program should focus on verifying the impact on: - The quality and governance of public expenditure.

- Enhancing productivity, export performance, and private investment.

- Achieving institutional and budgetary sustainability for social spending.

The program should help strengthen the municipal institutions.

An effort should be made to define the scope of the expected contribution to resolving the development issues addressed by the program (i.e., attribution).

The Bank’s strategic programming should be placed in the context of the government’s fiscal planning (income, expenditures, and financing) as set out in a projected multiyear budget. This should be done at a minimum for the period spanning the program, making annual adjustments.

Intervention alternatives should be designed based on risk scenarios that cover the public sector’s direct obligations, forward planning of contingent liabilities, and volatility in the macroeconomic environment. These scenarios should be consistent with the projected budget equilibrium during the period covered by the program.

The program’s results framework should contain indicators agreed on with the country to verify evidence of its progress during execution in terms of the impact targets that were accorded priority. In particular, a baseline must be established for those indicators that can be used to measure progress.

In keeping with the foregoing, disbursements for execution of projects should be based on indicators of compliance with the planned activities in order to achieve the development objectives. Those indicators must reflect the progress being made in the process, not simply the end points, and must be tailored to the budget expenditure financing needs associated with the implementation of projects.

The net future benefits of interventions and of the program should be estimated and should not be less than the costs of borrowing from the Bank.

With regard to the Bank’s interventions: Approval of operations by the Bank’s Board of Executive Directors should be processed only when the executive branch indicates that the time is right for presenting them for ratification and authorization of their signature by the Legislative Assembly and that the effective period of the project is consistent with that ratification.

Country strategy 2010-2014 The diagnostics and feasibility analyses have identified—for the new strategy—that the Bank’s thematic action areas should be directed at fiscal strengthening, better social protection, the urban environment, water and sanitation, and transportation and energy.

These aspects emphasized by OVE are part of the analyses made during preparation of the operations, where applicable (e.g., the impact on export performance is not relevant in all cases, etc.). Additionally, the Bank (in conjunction with the World Bank) has conducted a study on the quality of public expenditure, which has provided feedback for the new country strategy.

A major effort will be made in the new strategy as part of the objective of strengthening public finance (paragraphs 3.4-3.6).

The new strategy defines indicators and a baseline for each of its interventions (see results framework).

Programming under the new strategy will be performed in the context of medium-term fiscal planning and based on the gross projected financing needs (see paragraphs 4.1-4.4 and Annex V).

The new strategy takes account of macroeconomic risk in different scenarios and defines Bank intervention in each scenario (see paragraphs 4.1-4.4 and Annex V).

The results framework for the new strategy contains indicators agreed with the authorities and defines a baseline for each indicator so that it can be monitored during execution (see results framework).

Disbursements based on compliance with the activities measured by indicators are more consistent with fast-disbursing operations. Operating modalities will be defined during the programming exercise and not at the strategy level.

This is a basic principle to be taken into account in contracting loans with the Bank. Cost-benefit analysis is used at the project level, but not implemented at the country program level.

The new operations will be discussed at length with the legislature and will depend on a clear indication by the executive branch that the time is right to ensure their ratification (see paragraph 2.3 and Annex IV).

- 31 -

The design of Bank operations should seek to simplify contractual conditions and reporting requirements, rely more on government-designed initiatives and government monitoring systems, improve the adaptability of logical frameworks to the country’s conditions and risk levels, delegate supervision functions, pre-verify that institutional capacity is adequate, and seek to ensure that the persons who help to formulate the program are involved in its execution in order to maintain their ownership.

Any contract amendments introduced once the operation has begun should be based on evidence that the proffered changes are more efficient in terms of achieving objectives, by reducing the program’s exposure to disturbances generated by exogenous risks. Foreseeable special cases should be addressed with specific instruments geared to the problem being faced bearing in mind the pertinent lessons learned.

Program designs should be made more evaluable in terms of their development effectiveness, chiefly by establishing verifiable targets on the efficiency of the government measure being supported and the efficiency of the instruments being used.

The country’s involvement and consensus should be improved in the project cycle and in the reports generated in each stage thereof, so as to strengthen results-based public management.

To that end, the collection of relevant data should be organized, in order to monitor and evaluate impact from the outset of execution.

For the purposes of efficiency, once again, in project design, activities (resources) should be organized in processes that support the outputs (means), themselves organized based on the mid-term and final purposes (goals) being supported, so that the budget resources are tied to the activities to obtain outputs in the necessary time frame.

Assessment of the contribution toward the development objectives should be based on, at a minimum, verification of: (i) whether the objectives achieved were those attributed to the operation; (ii) the change produced compared to the starting point; and (iii) whether the project’s contribution can be sustained by the country both institutionally and budgetarily.

Risk analysis should be improved, in order to increase predictability and improve mitigation when the risks materialize in project outcomes.

The country’s diagnostic assessment efforts should be supported to build knowledge based on the lessons learned from the ex post impact evaluation of operations.

Based on the weaknesses observed in actions with the private sector: the strategic efforts of the Bank’s various private sectorrelated facilities should be incorporated into a shared approach for the country; modes of participation related to streamlining and standardizing procedures, as well as reducing the transaction costs for the instruments used, should be developed; and risk management should be bolstered, in order to build confidence and attract new players to the capital market.

The best use of country systems and simplification of supervision methods utilizing local capacities is one of the lessons learned that has been explained in the new country strategy (see paragraphs 5.1-5.4 and results framework).

This is one of the basic principles taken into account in managing Bank operations. It is unnecessary to reiterate policies and practices established in the country strategy document.

Although indicators and baselines will be established in the strategy, targets will be identified in each program or project when programming is available.

Indicators, baselines, and targets will be coordinated with the government in order to evaluate the impact of each intervention.

This is a principle of project design and evaluation taken into account during effective implementation of strategies. It is inappropriate to explain it in the country strategy.

This is a recommendation for future evaluation of the country program, once the objectives attributed to operations for which the program is to be implemented have been achieved.

The strategy will identify general risks, as well as sector risks, and will propose mitigation mechanisms in each case (see paragraphs 3.7, 3.14, 3.19, 3.26, 3.31, 3.36, and Section VI).

Lessons learned have been obtained based on the project completion reports (PCRs) for completed operations in the country. Those lessons have been incorporated in the diagnostics and the main ones will be summarized in an annex to the new country strategy (see Annex IV).

The activities of the Bank’s private sector window are incorporated as part of the country strategy (see paragraphs 3.12, 3.16, 3.23, 3.30, and 3.34).

- 32 -

ANNEX VI: ACTIONS OF OTHER DONORS Due to fiscal constraints, international cooperation will play a key role in meeting the goals set by the new administration. In addition to the IDB, the country’s main multilateral partners are the World Bank, the Central American Bank for Economic Integration (CABEI), the European Union, and the United Nations agencies. The bilateral donors with the strongest presence include the United States, Spain, and Japan.

In executing the new strategy, the IDB will coordinate closely with international cooperation agencies to support the government’s objectives. It is already participating in cooperation forums led by the Government of El Salvador, the most active of which is the Universal Social Protection System (USPS). The Bank has also advanced that coordination, particularly with the World Bank, United Nations, Spain, and the European Union, which will carry out actions in some of the strategic areas identified in the new strategy. The strategy’s consultation process will include the main donors active in the country.

The following table lists the support actions of other agencies in El Salvador, organized by pillar of this strategy. In addition to those pillars, donors are also supporting productive development (European Union, USAID/MCC, Japan/JICA, and Chile) and environmental improvement (JICA and GTZ).

Country objectives Strengthening of public finance

IDB strategic objectives - Improvement in tax and customs administration - Increase in expenditure efficiency - Support for government transparency

Actions of other agencies - WB: Strengthening of tax administration (US$20 million for fiscal management and public sector development) - GTZ: Technical advisory support on fiscal policy: tax policy and expenditure efficiency (5 million euros) - WB: Modernization of the performance-based financial and budgetary management system and targeting of social spending - WB: Modernization of the government procurement system and implementation of a transparency policy - USAID: Greater transparency and financial accountability in the use of public resources - UNDP: Support for the Economic and Social Council - Chile (AGCI): Strengthening of the capacities of municipios to formulate international cooperation projects - Spain: Support for administration of the SSMA, civil service policy, and civil service training program - EU: Improvements in coordination between tax collection agencies, management of public finance, and transparency

- 33 -

Country objectives Creation of the Universal Social Protection System (USPS)

IDB strategic objectives - Support for the USPS, including the Comunidades Solidarias Urbanas and Comunidades Solidarias Rurales programs

- Violence prevention

- Comprehensive support for the health sector

Actions of other agencies - WB: Temporary income protection program; strengthening of the job placement and training system; and design of social protection policies (US$100 million). Also, the master registry of beneficiaries.

- Spain: Water projects and general support for the infrastructure component - UNDP: Urban and rural poverty maps; technical assistance for the USPS, with an emphasis on Comunidades Solidarias Urbanas; support for the temporary income program - Chile (AGCI): Technical missions on social protection systems, with an emphasis on Comunidades Solidarias Rurales and Comunidades Solidarias Urbanas - USAID: Temporary income protection program - EU: Support for Comunidades Solidarias Rurales and Comunidades Solidarias Urbanas - UNDP: Support for security plans in municipios and in Comunidades Solidarias Urbanas. Citizen security: training of National Civilian Police Force agents in community policing; technical assistance for the national security plan; and creation of a national violence monitoring center.

- Spanish cooperation: Support for citizen security at the local level - Japan/JICA: Community policing - EU: Promotion of social cohesion and citizen security: US$84.7 million - USAID: Program to prevent violence in high-risk communities - GTZ: Program to prevent youth violence - Chile (AGCI): Advisory support on security program - CABEI: Prevention of violence and crime and strengthening of the 911 system of the National Civil Police - WB: Loan operation to implement primary health care reform (areas not covered by the IDB loan), strengthening of selected hospitals and emergency medical system (components not covered by IDB) - CABEI: Loan for construction of maternity hospital - USAID: Support for strengthening of the health care system, service quality improvements, and actions to combat HIV/AIDS - AECID: Support for implementation of health care reform (components: neonatal health, shortening of waitlists for elective surgery and specialist consultations, renal health unit) - PAHO/WHO: Technical support for most components of sector reform - UNS (various agencies): Food and nutritional security, sexual and reproductive health, child health - Other bilateral donor agencies are: Japan/JICA, Taipei China, Korea/KOICA

- 34 -

Country objectives

IDB strategic objectives - Improvements in education

Improvement of the urban environment

- Better access to housing

- Improvement of informal settlements

Increase in water and sanitation coverage

- Improvement in water and sanitation services in the SSMA

Development of transportation infrastructure

- Strengthening of rural road infrastructure - Strengthening of port infrastructure - Improvements in public transportation

Access to energy

- Access to energy in rural areas - Development of alternative fuels

Actions of other agencies - WB: Support for higher education and science and technology policies - UNS/UNICEF: Nursery schools and early childhood education - Japan/JICA: Improvement of academic quality (Megatec de La Uni贸n) - USAID: Support for the Ministry of Education (MINED) to improve the use of basic education resources - FOMILENIO: Strengthening of technical and vocational institutions in the Northern Region and scholarship plan - CABEI: Friendly, welcoming, and safe school environments - UNDP: Model for low-income housing and housing best practices - Japan/JICA: Improvement in technology for building earthquake resistant low-income housing - CABEI: Housing for families in high-risk areas affected

by Tropical Storm Ida - Chile (AGCI): Support for neighborhood improvement programs with community involvement and technical support for low-income housing institutions - UNDP: Pilot programs for productive urban settlements - Spanish Cooperation Fund for Water and Sanitation in Latin America and the Caribbean: Water projects - Spain: Strengthening of ANDA - Japan/JICA: Development of ANDA capacities, particularly in San Salvador - FOMILENIO: Water and sanitation - EU: Water and hygiene - FOMILENIO: North Longitudinal Highway - CABEI: Highways, roads, and electrification - Japan/JICA: Construction of La Uni贸n port - Brazil: Loan from the National Economic and Social Development Bank of Brazil (BNDES) to renew the fleet of minibuses and buses - WB: Urban mass transit project (SSMA) - FOMILENIO: Rural electrification - Brazil: Support for biofuels

The administration of President Funes is currently developing cooperation agreements with various bilateral agencies.

- 35 -

Donor Coordination: Loans and Technical Assistance for the Public Sector in Strategy Areas

World Bank European Union CABEI United Nations: UNDP Chile (AGCI) Spain (AECI) Japan (JICA/JBIC) USA (USAID) USA (FOMILENIO) Brazil Germany (GTZ)

Mainly loans

Mainly nonreimbursable financing or technical assistance

Energy

Energy

Urban transportation

Road infrastructure

Transportation

Rural roads

Water and sanitation

Water and sanitation

Neighborhood improvement

Violence prevention

Social protection

Health

Education

Housing

Urban environment

Social protection system

Government transparency

Expenditure efficiency

Tax strengthening/revenue

Public finance

- 36 -

ANNEX VII: DEVELOPMENT EFFECTIVENESS MATRIX OF THE COUNTRY STRATEGY

In August 2008, the Board of Directors approved the Development Effectiveness Framework (GN-2489) to increase the evaluability of all Bank development products.

The Development Effectiveness Matrix for Country Strategies (DEM-CS) is a checklist of the elements that are necessary to evaluate a country strategy. It is based on the evaluation criteria developed by the Evaluation Cooperation Group of the Multilateral Development Banks in the “Good Practice Standards for Country Strategy and Program Evaluation.”

The DEM-CS is a yes/no system with a partial score for each of the four evaluation criteria.

SCORE I. RELEVANCE A. Ownership and Alignment: establishing consistency of CS objectives with government's plans & priorities B. Coherence: establishing (i) the definition of Country Strategy focus in terms of anticipated results and (ii) the integration across Bank instruments/products

10.0 10.0 10.0

II. EFFECTIVENESS

7.2

A. Strategy Results Framework

7.3

B. Financial Transfers

10.0

C. Build up and use of Country systems

4.0

III. EFFICIENCY

IV. RISKS

To be determined in Programming Document 10.0