Report and Recommendation of the President · PDF fileReport and Recommendation of the President ... local government performance measurement system ... Medium-Term Philippine Development

Report and Recommendation of the President to the Board of Directors

Project Number: 39516 November 2007

Proposed Program Loan and Technical Assistance Grant Republic of the Philippines: Local Government Financing and Budget Reform Program Cluster (Subprogram 1)

CURRENCY EQUIVALENTS (as of 30 October 2007)

Currency Unit – peso (P)

P1.00 = $0.02 $1.00 = P44.04 ¥1.00 = $0.008 $1.00 = ¥114.177

ABBREVIATIONS

ADB – Asian Development Bank ADTA – advisory technical assistance AIP – annual investment plan AusAID – Australian Agency for International Development BIR – Bureau of Internal Revenue BLGF – Bureau of Local Government Finance BSP – Bangko Sentral ng Pilipinas (Central Bank of the Philippines) CCD – Coordination Committee on Decentralization COA – Commission on Audit CSP – country strategy and program DBM – Department of Budget and Management DENR – Department of Environment and Natural Resources DILG – Department of the Interior and Local Government DOF – Department of Finance DOH – Department of Health DPSP – Development Policy Support Program EO – executive order GAA – General Appropriations Act GDP – gross domestic product GFI – government financial institution GNP – gross national product GPRA – Government Procurement Reform Act GTZ – Deutsche Gesellschaft für Technische Zusammenarbeit

(German Agency for Technical Cooperation) IRA – internal revenue allotment JBIC – Japan Bank for International Cooperation JMC – joint memorandum circular LBM – local budget memorandum LDC – Local Development Council LDIP – local development investment program LDP – local development plan LFF – LGU financing framework LGC – Local Government Code LGFBR – Local Government Financing and Budget Reform LGFPMS – local government financial performance monitoring system LGPMS – local government performance measurement system LGU – local government unit LIBOR – London interbank offered rate

LOGOFIND – Local Government Finance and Development MDFO – Municipal Development Fund Office MDG – Millennium Development Goal MTPDP – Medium-Term Philippine Development Plan NEDA – National Economic and Development Authority NGAS – New Government Accounting System NGO – nongovernment organization NTRC – National Tax Resource Center OECD – Organisation for Economic Co-operation and Development OPIF – organization performance indicator framework PDAF – Priority Development Assistance Fund PDF – Philippine Development Forum PFM – public financial management PROLEND – Program (policy) lending facility RPT – real property tax SRE – statement of receipts and expenditures TA – technical assistance UBOM – Updated Budget Operations Manual USAID – United States Agency for International Development VAT – value-added tax

NOTES

(i) The fiscal year (FY) of the Government and its agencies ends on 31 December.

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

Vice President C. Lawrence Greenwood Jr., Operations 2 Director General A. Thapan, Southeast Asia Department (SERD) Director J. Ahmed, Governance, Finance, and Trade Division, SERD Team leader T. Niazi, Public Sector Management Specialist, SERD Team members J. Balbosa, Country Specialist (Philippines), SERD C. Buentjen, Senior Capacity Development Specialist, Regional and

Sustainable Development Department R. O’Sullivan, Senior Counsel, Office of the General Counsel V. Tan, Financial Management Specialist, SERD M. van der Auwera, Social Security Specialist, SERD

CONTENTS

Page LOAN AND PROGRAM SUMMARY i

I. THE PROPOSAL 1 II. THE MACROECONOMIC CONTEXT 1 III. THE SECTOR 4

A. Review of the Sector and Performance 4 B. Issues and Opportunities 8 C. Lessons 16

IV. THE PROPOSED PROGRAM 17 A. Impact and Outcome 17 B. Policy Framework and Actions 19 C. LGFBR Medium Term Program: Subprogram 2 Indicative Policy Actions 22 D. Important Features 24 E. Financing Plan 24 F. Implementation Arrangements 25

V. TECHNICAL ASSISTANCE 27 VI. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 28

A. Expected Impact 28 B. Risks and Mitigating Measures 29

VII. ASSURANCES 30 VIII. RECOMMENDATION 30 APPENDIXES 1. Design and Monitoring Framework 31 2. Development Policy Letter 35 3. Policy Matrix 42 4. Development Partners’ Coordination Matrix 49 5. Sector Analysis: Decentralization and Governance 52 6. Summary Poverty Reduction and Social Strategy 64 7. List of Ineligible Items 67 8. Advisory Technical Assistance 68

SUPPLEMENTARY APPENDIXES (available on request) A. Detailed Sector Analysis: Administrative and Fiscal Decentralization in the Philippines B. Terms of Reference for the Advisory Technical Assistance

LOAN AND PROGRAM SUMMARY Borrower Republic of the Philippines The Proposal The proposal comprises (i) a program cluster to the Republic of

the Philippines for the Local Government Financing and Budget Reform (LGFBR) Program, consisting of two subprograms; (ii) a proposed loan of ¥34,253,100,000 ($300,000,000 equivalent) for Subprogram 1 of the LGFBR Program; and (iii) a technical assistance (TA) grant for $800,000.

Classification Targeting classification: General intervention

Sector: Law, economic management, and public policy Subsector: Public finance and expenditure management Themes: Governance, sustainable economic growth, capacity development Subthemes: Public governance, promoting economic efficiency and enabling markets, organizational development

Environment Assessment

Category C

Program Rationale The Local Government Code (LGC), 1991, transferred the main

responsibility for the delivery of basic services (health, education, infrastructure, etc.) to local government units (LGUs). Decentralization has brought choices closer to the people while opening up space for innovative responses and solutions to service delivery issues. The LGC’s “finance follow function” premise set in place an intergovernmental transfer mechanism for sharing in the revenues of the Government of the Philippines (the Government) as well as allowing local governments to raise their own revenues. However, LGUs’ capabilities in discharging their functions continue to be constrained, so the Philippines faces significant challenges in ensuring that stable mechanisms are in place to channel adequate resources to local governments. Financial accountability, transparency, and capacity also represent significant constraints for local governments. Finally, significant improvement is needed in service delivery, governance, and performance measurement. While the scope of decentralization includes fiscal, administrative, and political dimensions, the LGFBR focuses mainly on the fiscal dimension where the implementation difficulties have been most challenging and are perceived as binding. It supports the Government’s ongoing efforts to improve local financing (facilitating access of LGUs to development credit), service delivery (credit financing for devolved services) and governance (improving public financial management and implementation of the Government Procurement Reform Act of 2003 at the local level). The LGFBR program will broaden the reform program in five target areas: (i) improving the completeness, timelines, and transparency of local government shares in national revenues; (ii)

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deepening reforms in fiscal management, planning, and public expenditure management by enhancing efficiency and accountability in these areas; (iii) enhancing effectiveness and transparency in the delivery of critical public services at the local level; (iv) improving LGUs’ access to public and private sources of capital for financing policy reforms and development projects; and (v) reducing LGU dependency on the internal revenue allotment (IRA) by developing buoyant sources of revenues at the local level, thereby reducing fiscal pressure on the Government. Asian Development Bank (ADB) support to the Philippines is determined by the four pillars of the country strategy and program (CSP) 2005–2007: (i) fiscal consolidation, (ii) strengthening investments, (iii) good governance, and (iv) support for achieving the Millennium Development Goals (MDGs). The proposed LGFBR program contributes to fiscal consolidation, good governance, and achieving the MDGs by: (i) lessening LGU dependence on national government transfers through improved mobilization of own-source revenues and enhanced predictability of resource flows, thereby promoting fiscal consolidation; (ii) supporting improved delivery of essential services through improved LGU access to developmental credit, thereby promoting activities for achieving the MDGs; and (iii) supporting sector efficiency and improved governance by establishing transparent and accountable LGU financial and administrative management systems for coordinated development planning, thereby promoting good governance at the local level. The reform program was prepared by a joint team of representatives of the Government and ADB working concertedly since 2006.

Impact and Outcome The proposed LGFBR program supports the Government in its

efforts to help LGUs develop enhanced capacities to plan and budget for the general welfare of their constituent communities in a transparent and accountable way. It contributes to increased efficiency and effectiveness in the delivery of basic public services to residents by increasing fiscal resources and financing options for the LGUs. The intended impact is achieved by strengthening the policy, financing, financial, and regulatory framework for decentralization as well as developing capacities at the local government level.

Financing Plan A loan of ¥34,253,100,000 ($300,000,000 equivalent) from the

ordinary capital resources of ADB will be provided under the London interbank offered rate (LIBOR)-based lending facility for subprogram 1 of the LGFBR program. The loan will have a 15-year term including a grace period of 3 years, an interest rate to be determined in accordance with ADB’s LIBOR-based lending facility, a commitment charge of 0.75% per annum, and such other terms and conditions set forth in the draft program loan agreement. ADB’s Board of Directors has discounted the commitment charge to 0.25% for loans approved from 1 July 2007 up to and including 30 June 2008.

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Period and Tranching The program cluster period is from January 2006 to December 2010, with a single tranche loan of ¥34,253,100,000 ($300 million equivalent) to be disbursed under subprogram 1 when the Government has met the conditions for effectiveness. Subprogram 2 will be submitted for Board consideration approximately 36 months after the effectiveness of subprogram 1, subject to adequate progress of reforms and the Government’s readiness to continue with its reform agenda.

Counterpart Funds The Government will use the local currency counterpart funds

generated by the loan proceeds to meet program expenditures and associated costs of local reforms.

Executing Agency Department of Finance (DOF) Implementation Arrangements

The Department of Interior and Local Government (DILG), Department of Budget and Management (DBM), National Economic and Development Authority (NEDA), Bureau of Local Government Finance (BLGF), and Municipal Development Finance Office (MDFO) will be the Implementing Agencies responsible for implementing the Program. An LGFBR coordination committee (the Committee) has been established and is chaired by the undersecretary of DOF and comprises officials from DILG, DBM, and NEDA. It is responsible for coordinating the implementation of the LGFBR program reform actions. The Committee meets quarterly to monitor progress and oversee implementation of the Program, and provides guidance and direction to the executing and implementing agencies.

Procurement and Disbursement

The loan proceeds will be used to finance the full foreign exchange costs (excluding local duties and taxes) of items produced and procured in ADB member countries, excluding ineligible items and imports financed by other bilateral and multilateral sources. The loan proceeds will be disbursed to the Borrower in accordance with the provisions of ADB’s Simplification of Disbursement Procedures and Related Requirements for Program Loans.

Program Benefits and Beneficiaries

The LGFBR program will provide significant benefits and will have a positive impact on local service delivery, financing, and governance issues. The key expected benefits are as follows:

(i) Streamlined intergovernmental fiscal relations as a result of completeness, timeliness, and transparency in the release and reporting of LGU shares in national government revenues—thereby improving the accuracy of local budgeting and programming of local expenditures.

(ii) Improved transparency, efficiency, and accountability in planning, public expenditure management, and financial management as a result of rationalized and streamlined national government oversight functions and strengthened local capacity.

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(iii) Enhanced delivery of critical public services at the local level by providing additional financing options and linking them to performance outcomes as well as improved national government-LGU arrangements for devolved functions.

(iv) Greater LGU access to public and private sources of capital as a result of an improved policy and institutional environment, thereby contributing to increasing LGU ability to finance the delivery of local public services.

(v) Increased LGU own-source revenues to fund social and development expenditures as a result of strengthened LGU capacity to generate revenues from real property and business taxes—thereby reducing LGU reliance on national government transfers, and consequently reducing the Government’s fiscal burden.

Risks and Assumptions While some of risks are irreducibly political—outside the scope of

the Program to mitigate directly—core elements of the Program and advisory TA contribute to mitigating these risks through greater transparency and accountability mechanisms that strengthen the capacity of local authorities and provide active monitoring by civil society groups. The potential risks to subprogram 1 and underlying assumptions are the following:

(i) Political delays. Delays may be experienced in engaging the LGUs for the second phase since the election for their League officers are held in the third quarter of 2007. However, the Leagues have endorsed the phase one and two triggers and it is expected that no major changes in policy orientation will occur despite changes in the Executive Board of the Leagues.

(ii) External pressures. Deterioration in the external environment may trigger internal financial problems and may encourage the Government not to release the IRA amount fully to the LGUs. A portion of the IRA was withheld during the 1997 financial crisis since it was determined to be an “unmanageable public sector deficit”. However, the Government is strongly committed to achieving its fiscal consolidation objectives to maintain macroeconomic stability. In addition, legislative and legal measures are now in place to prevent a recurrence of the 1997 chain of events.

(iii) Coordination and capacity constraints. The willingness for coordination among oversight agencies for harmonization of local planning, investment programming, revenue administration, budgeting, and expenditure management may weaken over time. However, the Government is committed to implementing the joint memorandum circular (JMC) 2007-1. To resolve possible issues and ensure continued progress, a technical committee is being organized to oversee JMC implementation.

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(iv) Resource constraints. The Government may run out of resources for capacity development activities planned under this Program. Although these are heavily funded by current ADB projects, it is possible that some training programs may be underfunded. An advisory TA is being provided to fill any such gaps. However, many donors are also providing TA grants for reforms and capacity development at the local level.

Technical Assistance In connection with the LGFBR program, the Government has

asked ADB for an advisory TA grant. The TA is estimated to cost a total of $1,100,000, of which ADB will finance $800,000 on a grant basis from the Japan Special Fund, funded by the Government of Japan. The TA will support the development of a medium-term reform agenda in local government financing and governance and its implementation, as well as provide the Government with just-in-time policy advice. It will include the following areas: (i) support creation and functioning of a Coordination Committee on Decentralization to promote, coordinate, and oversee decentralization reforms, including the changes envisaged in the LGFBR program policy matrix; (ii) analysis of existing capacities for planning and budget management at city level, development and pilot testing of revised planning and budgeting systems, and preparation and dissemination of city planning guidelines; and (iii) development of the local government performance measurement system to be used as a tool to link access to intergovernmental transfers, grants, and capacity development support with service delivery performance. A total of 95 person-months of national consultancy will be required. All recruitment and engagement will be undertaken in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time).

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on (i) a proposed program cluster to the Republic of the Philippines for the Local Government Financing and Budget Reform (LGFBR) program comprising two subprograms, and (ii) a proposed loan for subprogram 1 of the LGFBR. The LGFBR program was prepared by a joint team of representatives of the Government of the Philippines (the Government) and the Asian Development Bank (ADB). This report also describes proposed technical assistance (TA) for developing capacity for oversight agencies. If the Board approves the proposed loan, I, acting under the authority delegated to me by ADB’s Board of Directors, will approve the TA. The program design and monitoring framework is in Appendix 1.

II. THE MACROECONOMIC CONTEXT

2. The basic premise of the Medium-Term Philippine Development Plan (MTPDP) 2004–2010 is to fight poverty by building prosperity for the greatest number of the Filipino people. The MTPDP outlines the strategy of the administration in the 10-point legacy agenda, one of which focuses on good local governance through decentralized development, and decongestion of Metro Manila and creation of new growth centers across the country. The MTPDP reinforces and supports the principles outlined in the Local Government Code (LGC). 3. Consistent with the MTPDP, the Philippines country strategy and program (CSP) 2005–20071 is based on an analysis and prioritization of binding constraints to more rapid growth, greater inclusiveness, and faster poverty reduction. The CSP breaks with ADB’s past model for engaging with the Philippines in fundamental ways by introducing a thematic, rather than sector-based, strategic focus; greater project selectivity; and a results-based partnership with high lending contingent on macroeconomic performance. The strategy outlined in the CSP supports and advances the objectives of decentralization and good local governance, and is aligned with the Government’s reform agenda. When endorsing the CSP in mid-2005, ADB’s Board noted that new public sector lending commitments could be up to $1.5 billion for the 3 years, depending on the pace and quality of fiscal consolidation and sector reforms. Because of the large budget deficit of 2.7% of gross domestic product (GDP) in 2005, new lending commitments were low ($175 million). Subsequently, fiscal consolidation gained traction as the deficit dropped to 1% of GDP in 2006 and is expected to fall to 0.9% in 2007 and a balanced budget by 2008. This created the policy space for ADB to move to a “high case” lending scenario, with lending of $650 million in 2006 and an expected $700 million in 2007. 4. The improved macroeconomic performance and stability achieved in 2006 continued into 2007. The Philippine economy ended 2006 with overall annual real GDP growth of 5.4%. This was slightly up from 5% in 2005 and above the average growth rate of 4.3% per annum from 1990 to 2005. Table 1 presents data on key indicators for 2005 and 2006 to show the sustained positive macroeconomic performance and stability since 2004. Economic growth accelerated to 7.5% in the second quarter of 2007, among the highest growth rates in Southeast Asia. Services continued to be the fastest growing sector with average annual growth of 6.7% since 2003, contributing to almost 60% of economic growth, followed by manufacturing and utilities. Second quarter 2007 growth was led by the services sector growing by 8.4% year on year, with industry following at 8%. On the demand side, consumption spending contributed to 70–80% of economic growth, followed by a strong pickup in electronics and garments exports. In the second quarter of 2007, consumer spending rose by 6% while government spending rose by

1 ADB. 2005. Country Strategy and Program (2005–2007): Philippines. Manila.

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13.5%, making them the main drivers of growth. The upturn in the economy in 2006 and the continued expansion into 2007, despite higher oil prices, indicates that the Philippine economy is now more resilient.

Table 1: Aggregate Economic Performance (%) Indicator

2005 Actual

2006 Actual

2006 MTPDP Targets

Gross National Product Growth Rate (%) 5.6 6.2a 6.5–7.5 GDP Growth Rate (%) 5.0 5.4a 6.3–7.3 Investment/Nominal GDP (%) 15.1 14.8 28.0 Inflation Rate (%) 7.6 6.2 4.0–5.0 91-Day T-Bill Rate (%) 6.4 5.4 7.5–8.5 Fiscal Balance (% of GDP) (2.7) (1.1) (2.9) Consolidated Public Sector Fiscal Position (% of GDP) (1.9) 0.2 (5.3) Exports of Goods, Growth Rate (%) 3.8 14.6 10.0 Import of Goods, Growth Rate (%) 8.0 10.6 11.0 Current Account Balance ($ million) 1,984.0 5,022.0 1,029.0 Current Account Balance (% of GDP) 2.0 4.3 1.0 Poverty Incidence (% of families) — 24.4d 22.9–23.9 Unemployment Rate (%) 7.8e 7.9 — Memo Items: Dubai Oil Prices, Average ($/barrel) 49.3 61.5 29.2 Peso-US Dollar Exchange Rate 55.1 51.3 55.0–57.0

( ) = negative, MTPDP = Medium-Term Philippine Development Plan, GDP = gross domestic product,. a As of January 2007. b Preliminary. c As computed by the Central Bank of the Philippines. d Based on the 2003 official poverty estimates. e Average of April, July, and October labor force surveys. Sources: National Economic Development Authority, National Statistical Coordination Board, Central Bank of the Philippines (BSP), Bureau of Treasury, National Statistics Office, and Department of Finance.

5. Reducing Fiscal Deficit. The Government has attempted to trim the fiscal deficit by raising the tax effort and improving expenditure management. After implementing several difficult tax and fiscal measures, the consolidated public sector deficit declined from a peak of 5.2% of GDP in 2003 to 1.9% in 2005, and almost balanced in 2006 (deficit of 0.2% of GDP), surpassing its target of a 2% deficit. The small consolidated public sector deficit was aided by a fall in the Government’s budget deficit of 1.1% of GDP in 2006, well below its programmed target deficit of 2.1%, and substantial reduction in the deficit of the National Power Corporation. The Government’s fiscal deficit for the first 5 months of 2007 reached P41.8 billion or stabilized around 1.0–1.5% of GDP, on track to meet its programmed target for 2007.2 Tax revenues performed strongly in 2006, growing by 22%, with revenues from value-added tax (VAT) growing by about 64% because of the implementation of reforms that increased the tax-GDP ratio to 14.3% in 2006 from 13% in 2005. Local government units (LGUs), social security institutions, and government financial institutions (GFIs) all recorded surpluses. Because of the improved fiscal position, the Government was able to reduce its borrowings in 2006; the borrowing cost also decreased.

6. The medium-term outlook for the Philippines remains positive. Projections for economic growth this year range between 5.4% and 6.0%, with an increase in growth expected in 2008 led by consumption and exports, and with recovery in investment. Notwithstanding the economy’s improved performance, GDP and gross national product (GNP) growth rates remain

2 Bureau of Treasury, Department of Finance. 2007. Budget Report for May 2007. Manila. Available:

http://www.treasury.gov.ph/

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below the targets set by the MTPDP of 6.3–7.3% (GDP) and 6.5–7.5% (GNP). Higher growth is required to address the goals of poverty reduction and attainment of the Millennium Development Goals (MDGs). The Philippines appears on track to achieve several MDG targets but it is behind targets in health, education, and environment because of expenditure compression adopted by the Government to reduce the fiscal deficit. For the MTPDP’s macroeconomic reform efforts to bear fruit, the Government needs to address wide-ranging policy and institutional issues at the subnational level. More fundamentally, it has to take advantage of the initial gains arising from decentralization and devolution initiatives of the past decade, which have encouraged growth in the regions and the LGUs. While the macroeconomic and fiscal consolidation reforms have provided an enabling context for economic growth, reforms need to be more widely implemented at the LGU level. In many important ways, the LGUs are now the fulcrum of the development process and are recognized as the most important agents for pursuing sustained national growth and alleviating overall poverty. 7. Since 2004, the Government-led Philippine Development Forum (PDF) has evolved as a potent platform for advancing the country’s development agenda. Through its Working Group on Decentralization and Local Government, the PDF 3 provides a forum for dialogue on core development issues, including those concerning local governments (finance, capacity development, performance benchmarking, and policy reforms on devolution). PDF serves as a vehicle through which all stakeholders—development partners, government agencies, LGUs, private sector, and civil society organizations––coordinate their efforts by sharing information and discussing reform programs. PDF has also provided policy advice and technical backstopping to LGU Leagues4 to enhance their advocacy to key government agencies. ADB plays a major role in this working group, serving as co-chair of the sub-working group for LGU capacity development, and participating actively in development partner dialogues concerning local development. Through the PDF, ADB and the Government have shared the policy measures outlined in the LGFBR program with other development partners. 8. Moreover, the CSP encourages ADB to widen its constituency of partners to enhance the quality and relevance of its activities. Since 2005, ADB’s program has included more intensive interaction with the LGUs through loans and TA projects that support capacity development, public expenditure management, investment planning, widening access to financing sources, improved service delivery, and performance monitoring. 5 The LGFBR program is the first policy-based program cluster for the Philippines that tackles major policy issues to strengthen local governance as envisioned in the MTPDP and the CSP. It complements the broader policy support provided by the Development Policy Support Program (DPSP). While the LGFBR strengthens the LGUs and government institutions that directly support local development, the DPSP supports a broader national strategy of policy reforms in four target areas: (i) fiscal consolidation and macroeconomic stability, (ii) public financial management and anticorruption, (iii) investment climate and infrastructure, and (iv) protecting 3 Available: http://pdf.ph/decentralization_1.htm 4 LGU Leagues were created under the LGC to act as a coordinating and advocacy body for each level of local

government. These associations are the League of Provinces of the Philippines, League of Cities of the Philippines, League of Municipalities of the Philippines, and Liga ng mga Barangay (village league).

5 ADB. 2006. Technical Assistance to the Republic of the Philippines for Local Governance and Fiscal Management Project. Manila (TA 4778-PHI for $1.8 million); ADB. 2005. Technical Assistance to the Republic to the Philippines for the Local Government Finance and Budget Reform Project. Manila (TA 4556-PHI for $850,000); ADB. 2005. Technical Assistance to the Republic of the Philippines for Harmonization and Managing for Results. Manila (TA 4686-PHI for $700,000); and ADB. 2004. Technical Assistance to the Republic of the Philippines for Strengthening Provincial and Local Planning and Expenditure Management. Manila (TA 4512-PHI for $350,000) are playing key roles in reviewing the implementation of the LGC, capacity development, and implementation of the LGFBR policy actions.

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CSP Pillars

the budget provisions for social sectors. The LGFBR program will deepen the reforms in fiscal consolidation, good governance, and improved service delivery down to the local government level. This dual-policy approach of ADB provides a comprehensive package to support the Government’s overarching objective of reducing poverty and enhancing equitable growth. Figure 1 captures the links between the two programs under the MTPDP and the CSP.

III. THE SECTOR

A. Review of the Sector and Performance

9. Unlike in many other countries, decentralization is well grounded in both the constitution and legal framework of the Philippines. The economic rationale for decentralization that it can improve governance by making public service delivery more efficient was an important consideration in shaping reforms. Local governments are in closer contact with citizens than the national Government, so they are better placed to respond to citizens’ preferences, which allow them to match services to local needs. In practice, however, decentralization reforms were mostly driven by political considerations. In the Philippines, the decision was sparked by strong reactions to a period of centralized authority. This was reflected in the 1987 Constitution, which

CSP Pillars

MTPDP Priority Areas

1. Economic growth and job creation. 2. Energy independence. 3. Social justice and basic needs. 4. Education and youth opportunities. 5. Anticorruption and good

governance.

1. Economic and fiscal reforms. 2. Governance and anti-corruption. 3. Growth and investment climate. 4. MDGs and social progress. 5. Decentralization and local

government. 6. Sustainable rural development 7. Mindanao

PDF Working Groups

LGFBR Core Areas

1. Fiscal consolidation. 2. Governance. 3. Investment climate. 4. Social sectors.

1. Intergovernmental fiscal relations. 2. Fiscal management, planning and

expenditure management. 3. LGU performance measurement and

service delivery. 4. Credit financing. 5. Local own-source revenues.

1. Fiscal consolidation. 2. Strengthening investments. 3. Good Governance. 4. Support for achieving

Millennium Development Goals.

DPSP Core Areas

Figure 1: Links between the Medium-Term Philippine Development Plan Philippine Development Forum, ADB’s CSP, and the LGFBR Program

CSP = country strategy and program, DPSP = Development Policy Support Program, LGFBR = Local Government Financing and Budget Reform, LGU = local government unit, MTPDP = Medium-Term Philippine Development Plan, PDF = Philippine Development Forum. Note: Bold letters show interlinks. Source: Asian Development Bank.

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assured autonomy to local governments. The 1991 LGC outlined key aspects of the intergovernmental system by defining local functional assignments, allocating a share for LGUs in the national revenues, and allowing LGUs to raise their own revenues.6 However, while the basic structure for decentralization is now in place, there is a need to improve local fiscal capacity and to fine tune the intergovernmental relations in above areas. 10. Local Autonomy and Governance. The LGC created important local bodies like the Local Development Council (LDC) and mandated participatory planning to strengthen accountability. The LGC elaborates on local autonomy by providing the following governance features: (i) accountability, with the term of office set at 3 years; (ii) transparency, with local officials mandated to submit their statements of assets and liabilities, and members of the Sanggunian (legislative assembly) required to disclose their business interests; and (iii) participation, with local governments mandated to create local special bodies for school, health, peace, and development with representation from nongovernmental organizations (NGOs). Although decentralization can strengthen accountability, a number of key governance risks emanating from the inherently political nature of decentralization could weaken the economic benefits of decentralization: (i) state/elite capture, (ii) clientelism, (iii) capacity constraints, (iv) power struggle between levels of government, and (v) weaknesses in interregional informational flows that are critical for effective competition (Appendix 5). Powers in the LGUs tend to be concentrated in the executive, with weak representation from institutions that are to check on state capture, such as the judiciary. This is mitigated partly by the countervailing forces of empowerment of, and widening participation by, communities in local affairs. Civil society groups in the Philippines have mushroomed at the local level. 11. Local Autonomy and Service Delivery. The LGC devolved responsibilities of the Government to the LGU level at three tiers (Figure 2). LGUs were made responsible for the “general welfare” of their constituencies by: (i) devolving the service delivery functions of national government agencies to LGUs, (ii) transferring the regulatory functions of certain national government agencies to LGUs (these include zoning and reclassification, watershed management and fishing vessels operating within 15 km radius of LGU shoreline); and (iii) enhancing the governmental and corporate powers of LGUs to enable them to discharge the devolved powers and functions effectively. The LGC transferred to LGUs the main responsibility for the delivery of basic services and the operation of facilities for land use planning, agricultural extension and research, community-based forestry, solid waste disposal system, environmental management, primary health care, hospital care, social welfare services, municipal services and enterprises, and local infrastructure facilities. The construction of public school buildings became a shared function between the Department of Education and LGUs. The provinces are assigned functions that involve the inter-municipal provision of services such as operation and maintenance of district and provincial hospitals. The municipalities are responsible for the delivery of basic services, such as primary health care, and construction and maintenance of public elementary schools. The sub national share of expenditure in the Philippines is around 26 percent of the total government expenditure (as compared to 46% for Vietnam and 10% for Thailand).7Appendix 5 and Supplementary Appendix A analyze the structure, functions, and issues relating to LGUs.

6 It transfers the authority for decision making, finance, and management to quasi-autonomous units of local

government; and disperses the responsibility for certain services to regional branch offices. It also transfers responsibility for decision making and the administration of public functions to local governments not wholly controlled by the central Government, but wholly accountable to it.

7 World Bank. 2005. East Asia Decentralizes. Washington, DC. There is some evidence, however, that a more accurate measure of the extent of decentralization is the share of own-source revenues: in the Philippines this ratio exceeds that of Vietnam considerably (see page 14, para 37).

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Figure 2: Structure of the Local Government System in the Philippines

Level 1

Level 2

Level 3

Total number of cities = 118; total number of barangays = 41,995. Source: National Statistics Coordination Board (as of March 2007).

12. Administrative and Political Dimension of Decentralization. Under the LGC, provinces have administrative oversight over component cities and municipalities—except highly urbanized and independent component cities. Cities and municipalities have administrative oversight over barangays(villages). Each level of government up to the barangay has its own budget. At the national government level, five agencies have varying degrees of oversight over the LGUs. The Department of Finance (DOF) through the Bureau of Local Government Finance (BLGF) provides oversight through local treasurers and assessors regarding local revenue management and taxation. The Department of Budget and Management (DBM) oversees budget and expenditure matters. The National Economic and Development Authority (NEDA) oversees local planning at the provincial level while the Department of Interior and Local Government (DILG) oversees local planning at the city and municipal level. The Commission on Audit (COA) has oversight of accounting and audit matters. Of the five agencies, only COA has regulatory powers over LGUs. 13. Fiscal Dimension of Decentralization––Resources. In the Philippines, the concept of “finance follows function” is adhered to, which means greater local autonomy is synonymous with greater fiscal and financial autonomy. In this context, it is not surprising that most of the issues that have arisen from the implementation of the LGC relate to Book II of the LGC (Fiscal Matters and Taxation). These include issues related to intergovernmental transfers and the extent of LGUs’ taxing powers. Issues in Book III (Local Government Units), such as the conversion of municipalities to cities, also have fiscal implications. The efforts of municipalities to become cities, so that they can get larger share of transfers, is a case in point. The LGC provided greater fiscal autonomy to LGUs by entitling them to (i) a 40% share in the collection of national revenue taxes referred to as Internal Revenue Allotment (IRA), (ii) a share in the incremental revenue from the collection of VAT, and (iii) a 40% share in the tax collected from utilization of natural resources in their respective geographical areas. In addition, LGUs are empowered to levy taxes, charges, and user fees not imposed by the Government; issue debt to

National Government (20 National Government Departments)

Highly -Urbanized City

(28)

Province(81)

IndependentComponent City

(4)

Component City (86)

Municipality (1,510)

Barangays (2,726)

Barangays(211)

Barangays(3,858)

Barangays (35,200)

7

the private sector; enter into nontraditional business arrangements such as build-operate-transfer and joint venture agreements; and operate income-generating or economic enterprises. 14. Fiscal Dimension of Decentralization––Development Spending. Since the objective of decentralization is for LGUs to provide for the general welfare of their communities, the efficient and effective delivery of basic services becomes the standard by which outcomes are measured. In line with the transfer of functions and more resources at their disposal, the total LGU expenditure expanded relative to GNP and total government expenditure. Total LGU spending doubled from an average of 1.6% of GNP in 1985–1991 to 3.4% of GNP in 1992–2005. Similarly, the share of LGUs in total general government expenditure, net of debt service, rose from an average of 11.0% in the pre-Code period to an average of 24.2% in the post-Code period (Appendix 5, Table A5.1). The major increase in LGU spending on social services between 1991 and 2005 went to health and education. Aggregate LGU expenditure on health rose almost threefold from 0.1% of GNP in 1991 to 0.3% of GNP in 2005, while LGU spending on education doubled from 0.1% of GNP to 0.2% of GNP. Table 2 presents the distribution of LGU social expenditure during 2001–2005 and shows that education and health comprise more than 78% of total social expenditures. However, social expenditures for housing and community development and social welfare have been declining or stagnant over the same period.

Table 2: Subsectoral Distribution of LGU Social Expenditure, 2001–2005 (percent at current prices)

Year

Education

Health, Nutrition, and

Population Control

Labor and

Employment

Housing and Community

Development

Social

Welfare

Total Social Expenditure

2001 27.1 44.0 0.6 16.8 11.6 100.0 2002 25.5 45.7 0.6 17.2 11.0 100.0 2003 30.1 47.6 0.5 10.5 11.3 100.0 2004 29.9 49.7 0.3 9.3 10.8 100.0 2005 31.9 46.8 0.3 10.0 11.0 100.0

LGU = local government unit. Source: Department of Finance: Bureau of Local Government Finance-Statement of Receipts and Expenditures. 15. Service Delivery in Health and Education. The increase in education spending largely reflects the higher priority that local officials assign to this sector, as the LGUs did not have to absorb devolved personnel. On the other hand, the increase in health spending was largely because LGUs absorbed the devolved health personnel, which constituted over half the total cost of all devolved personnel. Studies show that average annual improvement in the percentage of underweight children per 1,000 declined from 0.93% in the pre-devolution period to 0.19% in the post-devolution period, and average annual improvement in the number of deaths per 1,000 declined from 0.70% in the pre-devolution period to 0.34% in the post-devolution period.8 On the other hand, the average annual improvement in infant mortality rate increased from 0.3% in the pre-devolution period to 1.5% during the post-devolution period. The elementary level participation rate increased from 84.6% in the pre-devolution period to 88.9% in the post-devolution period, while secondary level participation rate increased from 54.7% in the pre-devolution period to 61.7% in the post-devolution period9.

16. The major bottlenecks that constrain improvements in local service delivery and governance can broadly be attributed to four factors: (i) unclear expenditure assignments, (ii) lack of resources, (iii) weak fiscal and expenditure management, and (iv) lack of performance

8 Bautista, V.A. 2002. Philippine Experience in Health Service Decentralization. Manila: University of the Philippines. 9 Department of Education.

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measurement. Unclear expenditure assignments result from an inappropriate matching of expenditure assignments or functions and resources both at the inter-governmental level (i.e., national government and LGUs) and intra-governmental levels (i.e., between provinces and cities). The lack of resources is mainly due to insufficient access of LGUs to development credit from public sources for social projects and private capital markets for income-generating projects, uncertainty in national transfers, and insufficient generation of local own-source revenues. Weak fiscal and expenditure management can be attributed to a lack of clear guidance and support from national government oversight agencies and weak local capacity. The ineffective performance measurement system is due to insufficient resources to improve existing systems and lack of incentives for LGUs to be more performance-oriented. These limiting factors have been categorized in the next section. B. Issues and Opportunities

1. Unclear Expenditure Assignments and Overlapping Service Delivery

Mandates 17. Although the main responsibility for the delivery of basic services has been devolved to LGUs, the institutional arrangements are not always clear. National government agencies continue to play a significant role in the planning and implementation of functions that have legally been devolved. Although Section 17 (b) of the LGC enumerates the basic services that LGUs are expected to deliver, Sections 17 (c)10 and (f)11 encourage a two-track delivery system where both the Government and LGUs can initiate devolved activities. This complicates what should have been a clear-cut assignment of service deliveries and blurs expenditure responsibilities. It has proven difficult to separate the oversight functions of line agencies from service delivery functions, as line agencies also tend to engage in direct service delivery for devolved functions. Many of the devolved national government agencies remain accountable for service delivery in their respective areas. For example, the Department of Health (DOH) continues to be in charge of the country’s overall state of health, just as the Department of Environment and Natural Resources (DENR) is still held responsible for national environmental management. Therefore, they feel compelled to make full use of Section 17 (f) of the Code, so the budgets of national agencies continue to grow disproportionately. The justification given by the agencies is that there is a need to ensure that national policy objectives are met. Furthermore, oversight agencies, such as DBM, have insufficient capacity and mechanisms to control spending for devolved functions by line agencies. There is a need to develop more indirect instruments for ensuring that policy objectives are met, such as specific grants. 18. The ability of LGUs to provide devolved services at their own discretion is further constrained by many unfunded mandates left to them by the Government. For example, LGUs are expected to provide budgetary support (either in the form of additional personnel benefits or outlays for maintenance and other operating expenses) to many national government agencies operating at the same level such as the police, fire protection, and local courts. LGUs also have to comply with nationally prescribed controls on their local budget allocations, especially in personnel services. They are required to comply with standardization of salaries in the public sector and continue to provide for additional benefits to devolved health workers under the Magna Carta for Health Workers. 10 “Notwithstanding [LGU mandate to deliver enumerated basic services and facilities], facilities, programs, and

services funded by the National Government … are not covered by the [devolution] except in those cases where the [LGU] concerned is duly designated as the implementing agency for such …”

11 “The National Government ... may provide or augment the basic services and facilities assigned to the ... LGU when the services or facilities are not made available or … are inadequate …”

9

19. Recent Developments. There is a need to clarify the expenditure assignments and functional roles of various levels of the Government to eliminate jurisdictional overlaps and to reduce the gaps between mandates and funding. This will make the expenditure and budget needs of LGUs more transparent and improve accountability in the management of their resources. Executive Order (EO) 366 was issued in 2004 requiring government departments to strategically review their operations and organizational structures. Staffing levels were to be rationalized to remove overlaps and duplications, redirect resources to vital services, and improve the quality and efficiency of service delivery. In July 2005, EO 444 was issued directing DILG to conduct a strategic review of the devolution of government services and functions. DILG is reviewing decentralization in five priority departments—Department of Agriculture, Department of Social Welfare and Development, DOF, DOH, and DENR. The review is being done in consultation with the Leagues, departments concerned, and oversight agencies. It is expected to be completed in 2008.12 20. To address the issues emerging from devolution—especially in the light of rationalization of the bureaucracy, recurring problems emerging from implementation of the LGC, and the need to review its provisions (an action prescribed in the LGC every 5 years)—the Government is exploring the possibility of constituting the Coordination Committee on Decentralization (CCD). Membership of the CCD will be drawn from the legislature, executive (oversight agencies), LGU Leagues, and others. The committee will discuss solutions to such issues and, if necessary, propose amendments to the Code.

2. Lack of Completeness, Timeliness, and Transparency in Intergovernmental Fiscal Transfers 21. National Transfers. Government transfers to LGUs are of three types: (i) formula-based block grants (i.e., IRA); (ii) origin-based share in national government revenues (i.e., share in national wealth and other taxes); and (iii) ad hoc categorical grants. Under the LGC, the aggregate IRA of LGUs is set at 40% of the actual internal revenue tax collections of the Government 3 years prior to the current year. The aggregate IRA is then divided among different local government levels as follows: 23% to provinces, 23% to cities, 34% to municipalities, and 20% to barangays. The IRA share of each tier of local government is then apportioned to individual LGUs based on population (50%), land area (25%), and equal sharing (25%)13. 22. The IRA is the most significant revenue source, especially for third to sixth income class LGUs14. For example, IRA accounts for 88% of the regular income of third income class provinces, 94.5% of fourth income class provinces, and 80% of third to fifth income class municipalities.15 The IRA surged from 3.9% of government revenues (3.3% of government expenditures or 0.6% of GNP) in 1985–1991 to 14.6% of government revenues (12.3% of government expenditures or 2.2% of GNP) in 1992–2005. The contribution of the IRA to total LGU income net of borrowings expanded from 36.7% in 1985–1991 to 64.6% in 1992–2005 for all LGUs combined (Table 3). This trend is more prominent in provinces and municipalities than cities. It increased from 33.2% (pre-LGC) to 46.2% (post-LGC) in cities, compared to 38.3%

12 ADB. 2006. Technical Assistance to the Republic of the Philippines for Local Governance and Fiscal Management

Project. Manila (TA 4778-PHI for $1.8 million) is assisting the Government in reviewing devolution of functions. 13 Equal sharing is 25% of IRA for a particular LGU level divided by the number of LGUs in that level. 14 Bureau of Local Government Finance classifies LGUs in 6 classes based on a four year average of their regular

income with 1 being the wealthiest. 15 Bureau of Local Government Finance. 2005. Statement of Income and Expenditures. Manila.

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(pre-LGC) and 73.8% (post-LGC) for municipalities, and 38.8% (pre-LGC) and 81.0% (post-LGC) for provinces.

Table 3: IRA and Other Grants as a Portion of Total LGU Income and LGU Expenditure (%)

Government Transfers as

% of LGU Total Income Government Transfers as

% of LGU Expenditure Year Total IRA Other Grants Total IRA Other Grants

Average 1985–1991 51.4 36.7 14.7 53.2 38.0 15.2 1992–2005 66.0 64.6 0.6 67.2 65.7 0.6

IRA = internal revenue allotment, LGU = local government unit. Source: Commission on Audit, Bureau of Local Government Finance. 23. International best practice norms have been moving towards simplifying complex intergovernmental transfer systems, improving the transparency and predictability of allocations, and increasing subnational discretion over the use of these resources.16 National transfers have been criticized for: (i) lack of reliability in releases and appropriations, which undermine the ability of LGUs to plan and manage expenditures effectively; (ii) inequalities and distortions in distribution built into the current allocation system (i.e., allocation among various levels of LGUs and between different LGUs at the same level, making some LGUs such as cities better off in terms of net transfers less cost of devolved functions); and (iii) negative incentives created for local revenue generation since LGUs are assured of income from the IRA and the increase in the IRA share is subject to improvements in national tax collections instead of good governance on the part of LGUs. 24. Lack of Reliability in the IRA Release. This constraint not only affects LGUs’ ability to budget and plan effectively, but also limits their ability to tap finances since creditors rely heavily on the IRA deposits as collateral. Despite the provisions of the LGC, the Government retained considerable discretion in appropriating and releasing IRA. The transfers evolved into a highly unpredictable revenue source between 1998 and 2004 as the Government, faced with fiscal constraints, persistently reduced the amount due to LGUs. In 4 of the 6 years between 1998 and 2004, the mandated IRA share was either not appropriated in full, or not released in full or in a timely fashion, or was effectively cut because of reenactment of the budget. The gap between appropriation and obligation ranges from P1.5 billion to P16.5 billion. The Supreme Court ruled twice in favor of LGUs: in 2000, it ruled that the IRA should be released automatically; and in 2004, it ruled that the IRA should not only be automatically released but also distributed according to the Codal formula. In July 2006, the Government closed the loop by passing the Republic Act 9358 which provided for automatic annual appropriation of the IRA without the need to pass through Congress. To complement the reforms in the predictability, transparency, and timeliness of the IRA releases, DBM has started posting IRA shares of LGUs on its website beginning January 2007. DBM is also instituting the distribution of a local budget memorandum (LBM) to LGUs, announcing their IRA shares for the next year by June of every year. The monthly releases of the Notice of Cash Allocations will also be posted along with the comprehensive allotment release within the first quarter of every year.

25. Inter and Intra LGU Inequalities in the IRA. Although the IRA transfer to LGUs has exceeded the cost of devolved functions in the aggregate, for some LGUs (notably provinces

16 Shroeder, L., and P. Smoke. 2003. Intergovernmental Fiscal Transfers: Concepts, International Practice and Policy

Issues. Manila.

11

and municipalities) the transfers do not completely cover the cost of devolved functions. Generally, cities have emerged as relative winners in accessing transfers while provinces and municipalities have not fared favorably (118 cities share 23% while 1,510 municipalities share 34% of the IRA). This has created incentives for municipalities to lobby to become a city. This points to the need for strengthening the capacity of the Government to equalize fiscal capacity and to monitor the financial performance of LGUs. DILG is currently commissioning a study to recommend amendments to the IRA allocation formula with a more equalizing factor. 26. Non-IRA Transfers: Grants. The Priority Development Assistance Fund (PDAF) is allocated to members of Congress for discretionary spending at LGU level. These funds have been channeled to local investments in a non-transparent way, undermining LGU planning for strategic use of such funds. It is estimated that non-IRA funding to LGUs is P25.4 billion, with Congressional allocations amounting to over 60% of this amount.17 To improve transparency in the allocation and use of such funds, DBM is posting the PDAF figures on its website. 27. Non-IRA Transfers: Share in National Wealth. Some LGUs are entitled to a 40% share in tax collections and royalties from the exploitation of their natural resources. These special shares include mining taxes, tax on energy resources, forestry charges, and mining royalties. The timely and complete release of LGU shares in national wealth taxes was hampered by: (i) problems in accurately estimating the tax collections from natural resources since actual tax collections for the immediately preceding year are not yet known when the General Appropriations Act (GAA) is prepared; and (ii) lack of information on the situs18 of the tax. In February 2006, DBM, DOF, DENR, and Department of Energy issued Joint Circular No. 2006-1 which streamlined estimation and determination of the situs and procedures for release of LGU shares in national wealth by reducing the documentary requirements from five to two.

3. Weak Governance and Systems in Public Financial Management, Local Development Planning, and Expenditure Management

28. Planning and Budgeting Linkage. The LGC prescribes a participatory approach to planning and mandates that each LGU should have a comprehensive, multi-sectoral development plan formulated by its LDC and approved by its legislature. However, only 30–50% of LGUs have LDCs in place. In addition, the LGC mandates that 25% of LDC members should come from NGOs, but compliance is poor. Weak coordination between the Government and LGU planning has resulted in a break in the planning chain—occurring between the regional and provincial levels. Local officials report that their investment plans are formulated independent of regional and national investment plans and vice versa. Less than 70% of provinces have up-to-date local development plans (LDPs) and annual investment plans (AIPs), which often are not linked to each other. Furthermore, AIPs do not appear to be anchored in clear goals, strategies, and programs as many LGUs do not perform systematic evaluation of projects’ costs and benefits. The integrity of local budgeting is distorted by poor revenue estimates during the budget formulation process.19 29. Recent Developments. Some recent initiatives by the Government strengthen the planning and budgeting link. In March 2007, DBM, DOF, DILG, and NEDA jointly issued joint memorandum circular (JMC) No. 1—Guidelines on the Harmonization of Local Planning, Investment Programming, Revenue Administration, Budgeting, and Expenditure Management.

17 World Bank. 2003. A Study to Revisit the LGU Financing Framework and its Implementation. Washington, DC. 18 Situs refers to the site or location of the taxable entity. 19 ADB/World Bank. 2005. Decentralization in the Philippines. Washington, DC.

12

Its purpose is to: (i) provide guidelines on the harmonization and synchronization of local planning, investment programming, revenue administration, budgeting, and expenditure management; (ii) strengthen coordination between LGUs and national government agencies on mutually supporting approaches to planning, investment programming, revenue administration, budgeting, and expenditure management; and (iii) clarify responsibilities among DILG, NEDA, DOF, and DBM relative to local planning, investment programming, revenue administration, budgeting, and expenditure management. DBM has completed and issued the Updated Budget Operations Manual (UBOM), which contains basic principles and guidelines that will form the platform for performance-based budgeting. Although it is unlikely that the organization performance indicators framework (OPIF) will be introduced to LGUs within the next 3 years, given that the priority is to internalize this effectively within the national agencies first, the directions leading towards the OPIF can be initiated through the UBOM. DBM plans to implement the UBOM in all 81 provinces and 28 highly urbanized cities by 2010. 30. Gender and Development. Guidelines for the preparation of an annual gender and development plan and budget (Joint Circular No. 2004-1 by DBM, NEDA, and the National Commission on the Role of the Filipino Women) provide guidance on the identification of gender-responsive programs, activities, and projects for inclusion in agencies’ gender and development budgets (GAA mandates all departments and agencies to set aside at least 5% of their appropriations for projects that address gender issues), and the formulation of performance indicators that will form the bases for monitoring and evaluating the agencies’ accomplishments and achievements on gender and development.20 31. Procurement. As part of expenditure management reforms, the Government Procurement Reform Act (GPRA) was passed in 2003 to: (i) address the proliferation of laws on public sector procurement, which facilitated rent-seeking and inefficiencies; (ii) reorganize and strengthen agency and local government bids and award committees and procurement units; and (iii) strengthen the system of reward and punishment in the performance of the procurement function. Implementation of the GPRA has been intensified at the LGU level. The Government Procurement Policy Board of DBM has reported that 86% of all LGUs have implemented the law as of June 2007. To address problems that LGUs are still encountering in implementation of the GPRA, DBM will develop a manual for simplified procurement procedures for LGUs and a procurement manual for barangays. 32. Financial Reporting and Audit. COA is an independent constitutional body and the Philippines’ supreme audit institution. It has introduced a National Government Accounting System (NGAS) at all levels of the Government to simplify government accounting, conform to international accounting standards, and generate periodic financial statements for better performance monitoring. The audited statements of LGUs, in accordance with NGAS, need to be made publicly available and accessible. BLGF is currently harmonizing its LGU financial reporting system for local treasurers—the statement of receipts and expenditures (SRE)— with the NGAS to achieve this. 20 Sections 446, 457, and 467 of the LGC address gender participation by explicitly providing women representation

in local councils at the three major subnational levels, although there are concerns regarding the quality of such participation. The advisory TA, Local Governance and Fiscal Management Project (footnote 5) and the TA on Strengthening Provincial and Local Planning and Expenditure Management (footnote 5) will be providing training to local development council members, including women, on participatory budget and planning process.

13

4. Lack of Effective Performance Measurement System 33. In recent years, there has been increased interest on the part of LGUs, government agencies, and international organizations in the assessment of LGU fiscal, financial, and service delivery performance. In the past, many tools were developed to evaluate the performance of local governments, but most did not prove very effective or addressed only narrow concerns. The Local Government Performance Measurement System (LGPMS) of DILG is the most promising initiative to date. It provides LGUs with a tool to assess their strengths and weaknesses in the performance of their roles and responsibilities, and uses indicators derived largely from the LGC. The LGPMS measures performance in 4 areas (governance, administration, social services, and economic development) by collecting data for 111 input and output indicators in 17 service areas. Service areas to measure performance for governance include local legislation, transparency, and participation. Service areas to measure performance in administration include revenue generation, resource allocation and utilization, financial accountability, customer service, and human resource management and development. Service areas to measure performance in social services include health and nutrition, education, housing and basic utilities, and peace, security, and disaster risk management. Service areas to measure performance in economic development include agriculture and fisheries development and entrepreneurship, business, and industry promotion. DILG has reported that the LGPMS has been introduced in all LGUs in 2007. Although under implementation, DILG (in cooperation with DOF, DBM, and NEDA) is continuously fine-tuning and improving the LGPMS, by developing a framework for its use by executive agencies. 21 The LGPMS is a self-diagnostic tool for LGUs, which may lead to quality issues that clearly limit the usefulness of the data for purposes such as performance-based grant allocation. It is envisioned that, with greater comfort of LGUs, disaggregated data for each LGU will be made available in the medium term. 34. BLGF is also setting up a database called the local government financial performance monitoring system (LGFPMS). Currently, the LGFPMS is being linked to the LGPMS to allow integration of financial data with development and service delivery data, and strengthen the linkage between measuring outputs and allocating inputs. Out of the 16 LGFPMS indicators, 11 indicators are being integrated into LGPMS. These indicators are revenue target accomplishment rate, real property tax accomplishment rate, cost of collection rate, revenue per capita, social expenditure ratio, economic expenditure ratio, personal services expenditure ratio, internal financing ration, expenditures per capita, debt servicing ratio, and public enterprises profitability rate.

5. Lack of Access of LGUs to Development Credit Financing 35. Credit financing is used by LGUs to support the development of infrastructure, capital investment, and a portion of operating expenses. Sources include domestic banks, GFIs, and loans through the Government from foreign sources. Although LGUs are empowered to borrow, the LGC puts a ceiling on debt servicing which should not exceed 20% of their regular income. The Government’s long-term vision is for the capital market, rather than national agencies, to play a dominant role in financing LGUs, although little progress has been made to end LGU reliance on GFIs, despite the initial adoption of the LGU financing framework (LFF) in 1996. Private lending is still not substantial. GFIs and the Municipal Development Fund Office (MDFO) continue to be the dominant source of LGU financing, accounting for 76% (GFIs) and 7% (MDFO) of total LGU borrowing in 2006. GFIs have an advantage in the LGU credit market

21 This will be considered under improvements to the LGPMS in the Local Governance and Fiscal Management

Project (footnote 5) and the advisory TA.

14

because of their role as LGU depository banks22 while MDFO has access to an IRA intercept mechanism in the event of a loan default. Private banks have indicated that the mandated use of GFIs as depository banks for LGUs is a significant structural impediment to their entry into the market of lending to LGUs. This is compounded by lack of reliable information on LGU creditworthiness. Nonetheless, the pool of potential LGU bond issuers has slowly grown, as specific LGUs develop a firm financial foundation. This was facilitated by the creation of the Local Government Unit Guarantee Corporation, which guarantees debt issues of LGUs from private sources. 36. Recent Developments. In February 2007, DOF issued a memorandum officially adopting the LFF and the Government’s cost-sharing arrangement, and clarifying a number of issues. The memorandum explicitly states that provision of credit to LGUs by the Government will be governed “through a policy of market segmentation, hand-in-hand with the policy to graduate creditworthy LGUs to private sources of capital”. MDFO is also commissioning a study to develop a framework for allowing LGUs to open depository accounts in private banks. The framework will improve access of LGUs to private capital markets while taking into consideration the implications this will have on GFIs and the moral hazard problems that may arise from allowing private banks open access to LGU financial accounts. Under the Local Government Finance and Development (LOGOFIND) project and the Community-Based Resource Management (CBRM) project, MDFO is lending to third to sixth income class LGUs for urban infrastructure, health, and environmental projects. In addition, the P2 billion program-policy lending facility (PROLEND), which provides provinces with a program loan for pursuing policy reforms, and the P500 million MDG fund have been launched in 2007. Both these facilities will be financed through the second-generation fund of MDFO.

6. Inadequate Local Own-Source Revenues and Inefficient Tax Administration

37. The estimated own-source revenue of sub national governments as percentage of total LGU revenue is 31.1 percent, the highest in the region (for Thailand it is 10.9% and for Vietnam it is <5%).23 In the Philippines, tax revenues accounted for 25% of total LGU income in 2006. However, studies have shown that LGUs have created revenue codes with a huge array of taxes, fees, and charges.24 Many of these are under-collected or not collected at all. In addition, many low yielding taxes impose substantial collection and administrative costs and contribute to a lack of transparency. For example, taxes on peddlers, fishing vessels, and radio fees, each bring in an average of no more than 0.02% of LGUs’ total own-source revenue. In Bacolod City, there are over 200 different rates for the mayor’s business permit fee, all of which depend on the type of establishment. There is a need to focus on taxes, fees, and charges that have high yield potential, and to improve their administration and collection. 38. Although LGUs have greater taxation powers under the LGC, local governments face disincentives to improve collections because of lack of critical tax information and inconsistent financial policy guidelines. LGUs are authorized to levy business taxes as a percentage of the gross sales of businesses. To remedy this, the LGU Leagues have actively lobbied BIR for implementation of Section 171, which requires BIR’s revenue district offices to share their tax information with the local treasurer. However, this has met with resistance from BIR which 22 GFIs do not have an IRA intercept mechanism to protect against default. They protect themselves through a “back-

to-back” agreement by requiring LGUs to sign an agreement that authorizes the GFI lender, in the event of a default for payment of interest and amortization of principal, to debit the LGUs’ IRA depository account in the GFI.

23 World Bank. 2005. East Asia Decentralizes. Washington, DC. 24 This can be attributed to the Code itself. Section 143, Tax on Business, has a very detailed schedule of fees that

can be simplified.

15

considers this to be in conflict with tax information secrecy provisions. The policy environment relating to LGU tax administration also needs to be improved. Some implementing regulations on local taxation are not favorable to all LGUs. Key among this is the guideline for taxation of bank branches in favor of the head office, and hence the LGU hosting the head office.25 The current interpretation of the relevant LGC provision has caused the bulk of the bank’s revenues to be posted to the head office—causing the bank branches, usually in less wealthy LGUs, to face a lower basis for imposition of their business tax. 39. DOF is currently reviewing sets of instructions, which will have a significant impact on the taxation powers and capacity of LGUs. The first is a draft EO that will implement Section 171 of the Code on the sharing of tax information between BIR and LGUs. The second is an amendment to Local Finance Circular 1-93 that will require banks to reflect sharing of their gross sales, in terms of amount of loans approved, at the bank branch where the loan application originated. This will increase the gross sales of these branches and give LGUs higher revenue on which to base their business tax. The third is the local finance circular, which will guide LGUs in the imposition of business taxes on mining projects. Local tax administration is severely inadequate in many LGUs. This is highlighted by the declining trend in the collection efficiency of real property tax (RPT) of both provinces and cities in the post-Code period (Appendix 5, Table A5.5). Consequently, the contribution of LGUs to total government revenues (central Government and LGUs combined) remains low—an average of 7.1% in 1992–2005 compared to 4.9% in 1985–1991 (Table 4).

Table 4: Share of National and Subnational Governments to General Government Revenue (%)

Total Revenues Tax Non-Tax Year GG NG LG GG NG LG GG NG LG

Average 1985–1991 100.0 95.1 4.9 100.0 96.1 3.9 100.0 90.9 9.1 1992–2005 100.0 92.9 7.1 100.0 93.8 6.2 100.0 87.4 12.6 1985–2003 100.0 93.4 6.6 100.0 94.2 5.8 100.0 88.1 11.9

GG = general government, NG = national government, LG = local government. Source: Commission on Audit, Bureau of Local Government Finance. 40. LGU tax administration is weighed down by three overarching deficiencies: (i) low professional qualifications of staff, (ii) inadequate automation of core tasks, and (iii) weaknesses in supporting policies at the national government level.26 The low capacity of LGU tax staff is manifested by inadequate cash controls, weak internal audit, absence of effective management, and lack of independent oversight. Some LGUs are investing in information technology (IT) to improve assessment and collection of RPT and business fees, but for a majority it remains an expensive proposition. National government bodies or local government associations, such as the League of Municipalities, have not explored adoption of a common IT platform for tax or licensing. In addition, the LGC is not completely consistent with local autonomy criteria. While boosting local tax authority, it also constrains local revenue collection through rules on rates, assessments, appeals and administrative responsibilities—leaving LGUs little control over one

25 Department of Finance. 1993. Local Finance Circular 1-93. Manila. 26 ADB/World Bank. 2005. Decentralization in the Philippines, Washington, DC.

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of the main levers for mobilizing revenues.27 RPT amounting to 37% of local revenues is one such tax.28

41. Capacity Development in Resource Mobilization. BLGF has a critical role to play in providing technical support to LGUs in local finance and local tax administration. Its ongoing efforts include important areas such as: (i) establishing an LGU financial, fiscal, and debt monitoring system to make information available to the public; (ii) developing and disseminating a manual on various modalities for LGU finance; (iii) developing and disseminating a manual on good LGU debt management and a manual of operations for computing and establishing LGU debt service and borrowing capacity; (iv) reviewing the consistency of various local tax rulings; (v) harmonizing the SRE manual with the NGAS; and (vi) updating the Local Treasurer’s Manual. MDFO is also providing substantial capacity development support and training in standardized project financing and other areas of resource mobilization. As of June 2007, MDFO had conducted 2,551 training programs for 513 LGUs in resource mobilization and updating of local revenue code. To encourage LGUs to improve RPT collection, MDFO has provided a credit window for such improvements as part of their project. In an effort to improve RPT collection, BLGF has developed valuation standards as part of their Assessor’s Manual for code of ethics, mass appraisal, and market values as valuation basis. It is also providing training in RPT valuation standards and collection. 42. Recent Issues Advocated by the LGU Leagues. Since 1999, the LGU Leagues have been actively advocating to the Government their concerns on the IRA—including its automatic release, deductions which were outside the Codal formula, and its automatic appropriation. As a result, the Supreme Court ruled in their favor on the first two issues. In 2006, the legislature and the executive closed the remaining IRA issue by passing a law on the automatic appropriation of the IRA. Currently, the LGU Leagues are advocating more transparent and timely release of their shares in national wealth. Through the PDF, the LGU Leagues have also raised a number of issues related to the improvement of own-source revenues. They presented position papers on sharing of tax information by BIR with LGUs, the situs of tax on bank branches, and situs of tax on mining firms. C. Lessons

43. International development work on decentralization and local governance in the last two decades has generated an extensive database of knowledge and practical experience from which a number of lessons were considered while designing the LGFBR program. These include the following. 29

(i) Sustainability. A major decentralization challenge is long-term sustainability. Program design should therefore embody sustained support over a period, with exit strategies and plans for up-scaling or institutionalizing program activities. The adopted phased approach imparts flexibility to the LGFBR program to exit or upscale as the reform situation warrants.

(ii) Central Government commitment. Implementation of decentralization is not always supported by top-level central government commitment. Programs of support should be holistic, taking into consideration the interrelationships

27 United States Agency for International Development (USAID). 1999. The Governance and Local Democracy

Project (GOLD): Summary Assessment. Manila. 28 World Bank. 2005. East Asia Decentralizes. Washington, DC. 29 Organisation for Economic Co-operation and Development (OECD). 2004. Lessons Learned on Donor Support to

Decentralization and Local Governance. France.

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between the central and local governments. The LGFBR program involves the national oversight agencies and strives to institutionalize a coordination mechanism to deal with decentralization issues on a regular basis.

(iii) Donor coordination. To ensure more effective coordination between donors and partner governments, joint government-donor forums may be established for implementing reforms and information sharing. PDF provides a joint forum for government and development partners, from which the LGFBR program has benefited.

(iv) Fiscal decentralization support. Programs designed to improve financial management (e.g., planning, budgeting, accounting) have been more successful than other fundamental improvements. Program design should take into account reforms of local tax systems, assignments, types of taxes, and tax sharing arrangements. The LGFBR program includes measures to strengthen these areas.

44. The reforms proposed under the LGFBR have also drawn substantially from the two major joint reports of the Government, ADB, and the World Bank.30 These include: (i) enhancing LGU ability and capacity to access resources; (ii) strengthening key resource management processes relating to planning, budgeting, procurement, and financial management; (iii) raising LGU access to credit by private financial institutions; (iv) policy actions to improve business taxes and RPT; and (v) review of the institutional arrangements for generating consensus among stakeholders on managing the decentralization process. The LGFBR program has made deliberate attempts to analyze political economy factors in LGU capacity development and change management, and to keep the reform expectations realistic.

IV. THE PROPOSED PROGRAM A. Impact and Outcome 45. Given the many issues facing the Philippine LGU sector, a focused and consolidated program is required to respond to them. The Program must first help ensure the availability of resources. The LGFBR Program (i) facilitates an augmented, dependable, and timely flow of resources that the LGUs are legally entitled to as well as facilitating other means of financing through public and private channels; (ii) facilitates local revenue generation; (iii) addresses the capacity development needs of LGUs in planning, expenditure management, and efficient procurement for better service delivery; and (iv) improves monitoring systems by making the financial and service delivery performance of LGUs more transparent. Figure 3 provides an overview of the program cluster.

30 ADB/World Bank. 2005. Decentralization in the Philippines. Manila; and ADB/World Bank. 2003. Public

Expenditure, Procurement, and Financial Management Review. Manila.

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Figure 3: Overview of LGFBR 1

EO = executive order, LGFBR = Local government Financing and Budget Reform, LGFPMS = local government financial performance monitoring system, LGPMS = local government performance measurement system, LGU = local government unit, NG = national government, PROLEND = Program (policy) lending facility. Source: Asian Development Bank.

46. The objective of the proposed LGFBR Program is to support the Government in its efforts to help LGUs develop enhanced capacities to plan and budget for the general welfare of their constituent communities in a transparent and accountable way. The LGFBR Program contributes to improved efficiency and effectiveness in the delivery of basic public services to residents by increasing fiscal resources and financing options for LGUs. The intended impact is achieved by strengthening the policy, financing, financial, and regulatory framework for

Improved Local Growth and Welfare

Enhanced Governance and Effective Delivery of

Public Services

Clear Expenditure Assignments

Effective Performance Measurement

Increased Incentives for

LGUs to Adopt Performance

Measures

Predictable National Transfers

Enhanced Guidance and Support from

Oversight Agencies

Improved Generation

of Local Own-Source Revenues

Strengthened Local Capacity in Fiscal and Expenditure Management

Rationalized Matching of Expenditure Assignments

and Resources

Increased Resources for Performance Measurement

Systems

Enhanced Fiscal and

Expenditure Management

Increased Resources

1. P2Bn for Policy Lending-PROLEND. 2. Creation of P500 M MDG Fund. 3. LGU Access to Private Banks. 4. LGU Financing Framework as National Policy. 5. NG-LGU Cost Sharing. 6. Credit Financing for Devolved services.

1. Passage of RA 9358 which Automatically Appropriates IRA. 2. Timely Estimation of IRA shares of LGUs. 3. Issuance of Joint Circular 2006-1 on Release of LGUs’ Shares in National Wealth. 4. Uploading of Priority Development Assistance Fund.

1. Training on real property taxation and Business Taxation. 2. Loans for Business Tax Enhancement 3. Valuation training for LGUs. 4. E.O. for Tax Information sharing. 5. Revision of Interpretation of Situs of Tax Rule for Banks.

1. Issuance of Joint Memorandum Circular 2007-1 for a Coordinated Framework for Streamlining Oversight Functions. 2. Training on Updated Budget Operations Manual. 3. Training in Government Procurement Reform Act.

1. Issuance of Updated Budget Operations Manual. 2. Harmonization, Computerization, and Implementation of Statement of Expenditures and Receipts. 3. Training in Project Management, Operations and Maintenance, Planning and Investment Programming.

1. Agreement on Establishing Coordination Committee on Decentralization to Improve Devolution of Functions. 2. Issuance of Updated Budget Operations Manual. 3. Credit Financing for Devolved Services.

1. Local Government Performance Measurement System (LGPMS) Implemented in all Provinces, Cities, and Municipalities. 2. Local Government Financial Performance Monitoring System (LGFPMS) Integrated intoLGPMS.

1. Creating a Loan Facility Providing Performance Grants of Up to 20% of the Total Project Cost.

Improved Access to

Development and Private

Credit Markets

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decentralization as well as developing capacities at the local government level. This is supported by a series of action-oriented policy reform measures undertaken by the Government and TA targeting the national oversight agencies. 47. ADB’s Contribution to Subprogram 1 Core Policy Actions. ADB has contributed significantly to the achievement of the subprogram 1 core policy actions by working with the Government in a concerted manner since 2006. The automatic appropriation of the LGU’s IRA, posting of the PDAF, and improvements in the release of the LGU special shares supports the policy of increased transparency in budget releases that started with the DPSP. TA 455631 assisted in computerization and implementation of the SRE, revision of the Assessor’s Manual with new valuation standards, integration of the LGPMS with LGFPMS, and training of LGUs in standardized project financing. TA 451232 supported development and training on the provincial guidelines, which is NEDA’s contribution to the JMC. TA 468633 provided the LGUs with a generic procurement manual and training in its use. TA 477834 is helping in the implementation of the LGU special shares, reviewing the LGC, improving the UBOM, developing a simplified barangay procurement manual and providing training in participatory budgeting. B. Policy Framework and Actions

48. Program Cluster Modality. The Program is structured in sequential subprograms under the program cluster modality with: (i) two single tranche operations (subprogram 1: January 2006–December 2007; subprogram 2: January 2008–December 2010), with a well-defined, medium-term framework specified at the outset, including completed reforms prior to Board consideration under subprogram 1; and (ii) expected prior actions for subprogram 2 to ensure a continuous dialogue with the Government. Subprogram 2 will be further formulated during the subprogram review to allow flexibility to adjust the Program based on progress made and changes in the external environment. This does not obligate ADB to additional lending for subprogram 2, which will be subject to Board approval. Specifically, the LGFBR Program will support government reforms in the following five policy areas:

(i) Intergovernmental fiscal relations. Improving completeness, timeliness, and transparency in the release of LGU shares in national government revenues and grants. The policy area will enable LGUs to increase the ratio of shared taxes in local revenues.

(ii) Fiscal management, planning, and public expenditure management. The policy area will contribute to improved transparency and accountability at the LGU level.

(iii) Performance measurement and service delivery. The policy area will enable LGUs to ensure effectiveness and transparency in the delivery of critical public services.

(iv) Credit financing. The policy area will contribute to improved LGU access to public and private sources of capital for financing of policy reforms and development projects.

(v) Local own source revenues. The policy area will help develop local sources of revenues and reduce LGU dependency on the IRA.

31 Local Government Finance and Budget Reform Project (footnote 5). 32 Strengthening Provincial and Local Planning and Expenditure Management (footnote 5). 33 Harmonization and Managing for Results (footnote 5). 34 Local Governance and Fiscal Management Project (footnote 5).

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1. Intergovernmental Fiscal Relations

49. The LGFBR supports the Government’s reforms in intergovernmental fiscal relations. The policy area contributes to improved completeness, timeliness, and transparency in the release of LGU shares in national government revenues. This is achieved by: (i) improving the completeness and transparency in the release of the IRA; and (ii) improving the release of special shares in national wealth such as mining taxes, tax on energy resources, forestry charges, and mining royalties. First, Republic Act 9358 passed in 2006 provides for automatic appropriation of the IRA from 2007. The predictability and transparency in the release of the IRA is ensured by timely estimation and certification of the IRA share for 2008 in 2007 by BIR, and distribution of the LBM to LGUs by June of every year announcing their IRA share for the coming year. The IRA share of each of the 43,704 local governments will be in line with the formula prescribed in the LGC and posted on the DBM website on an annual basis. In addition, the releases of the PDAF are also being posted on the website. As a result of these measures, the LGUs have received P161 billion as IRA for 2006 and are expected to receive P183 billion in 2007. The posting of fund release information on the website has two objectives: (i) to reduce uncertainty in fiscal planning at the local level, and (ii) to inform citizens the amount each LGU is receiving from the Government.

50. Second, the release of LGU special shares in national wealth and other taxes will be improved by instituting a more effective and efficient process for estimation of tax collection and schedule of release of income shares. Under this policy area, the LGFBR Program supports issuance and implementation of Joint Circular 2006-1 which will streamline the release of LGU’s special shares in the proceeds from the development and utilization of national wealth in mining, forestry, energy and mining royalties. Initially this issuance has reduced the documentary requirements for the release of these shares from 5 to 2.

2. Fiscal Management, Planning, and Public Expenditure Management 51. The LGFBR Program supports enhanced efficiency and accountability in fiscal management, planning, and budget management at the local level; and coordination of oversight functions and capacity development measures among national government agencies. This addresses the need to increase the overall efficiency of public expenditure, given the limits of tax effort. Actions to achieve this include: (i) streamlining the oversight and capacity development functions of key government agencies in LGU fiscal management, planning, and public expenditure management; (ii) improving the fiscal management capacity of LGUs by ensuring that the SRE financial reporting system is fully implemented; and (iii) improving the implementation of the GPRA at the local level.

52. The LGFBR Program supports reforms under this policy area by facilitating implementation of JMC 1 on harmonization of local planning, investment programming, revenue administration, budgeting, and expenditure management; introduction of the UBOM to LGUs and training for at least 90% of all provinces, cities and municipalities; completion of the local Assessor’s manual; dissemination of the provincial planning guidelines to all provinces; introduction of the NGAS-harmonized SRE; providing 2,551 training programs for 513 LGUs in standardized project financing; completion and distribution of the debt management manual; training of 86% of provinces, cities and municipalities in the GPRA; implementation of a simplified procurement manual for LGUs and preparation of a barangay procurement manual.

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3. Performance Measurement and Service Delivery

53. The LGFBR Program supports the Government’s agenda to enhance effectiveness and transparency in the delivery of critical public services. Action taken to achieve this includes: (i) enhancing financing options for improved service delivery in urban infrastructure, health, environment, and rural and agricultural services; and by adopting a mechanism that rewards better fiscal performance; (ii) improving implementation of devolved functions by institutionalizing a coordination body at the national level to address recurrent and future issues on decentralization; and (iii) enhancing the effectiveness of existing LGU performance monitoring systems by improving quality and transparency. 54. The LGFBR Program will support improved access of at least 217 third to sixth income class LGUs, to development credit aimed at improving local service delivery through investment in urban infrastructure and public services—with loans amounting to P2.25 billion; provision of credit for health and agricultural services projects; establishment of the CCD;35 development of a framework for performance-based grants; coverage of all provinces, cities, and municipalities by the LGPMS; integration of the LGFPMS with the LGPMS; and public disclosure of performance data.

4. Credit Financing 55. The LGFBR Program supports the Government’s agenda to improve LGU access to public sources of credit for financing policy reforms and development projects and access to private sources of capital for higher income LGUs and selected income-generating projects. Actions taken to achieve this include: (i) improving access to private sources of financing by relaxing policy and legal constraints that prevent LGUs from becoming borrowers of private funds; (ii) increasing the availability of development financing and rationalizing the market for LGU financing by channeling limited resources of national government direct lending to areas which the private sector may not finance, such as social services; and (iii) improving the financial information system on LGUs to facilitate the private sector’s ability to gauge the creditworthiness of potential borrowers.

56. Under this policy area, the LGFBR Program will support policy guidelines that increase LGU access to private sources of capital, such as allowing institutional investors to hold bonds to comply with their reserve requirements, allowing private banks to act as trustee banks for a municipal bond float, and approval of the LFF as a national policy. Additionally, the LGBFR Program will support refinement of the LGU grant-loan mix in support of lower income LGUs and social projects; increased funding for credit facilities for policy reform such as the PROLEND to P2 billion; emphasis on meeting MDGs by providing a financing window amounting to P500 million; credit windows for local service delivery in key sectors such as health, education, and environment; a credit program amounting to $83.75 million for LGU urban infrastructure, with a grant amounting to 20% of the total project cost subject to the attainment of tax collection targets; and investment in improving the creditworthiness of LGUs by implementing the SRE.

35 There is continuous interest and advocacy for amending some LGC provisions. Initiatives emanating from LGU

Leagues, NGOs, and civil society groups have resulted in omnibus bills such as Candazo in 1999 (Congress) and Pimentel (Senate) in 2000 seeking to amend specific provisions such as the IRA share of LGUs, or local taxation. The CCD will be well positioned when the political environment becomes more conducive to amending the Code.

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5. Local Own-Source Revenues 57. The objective of this policy area is to help the Government reduce LGU dependency on the IRA by developing buoyant sources of local revenues. Actions needed to achieve this include: (i) enhancing LGU ability to generate revenues from local business taxes, and (ii) improving collection of RPT. Under this policy area, the LGFBR Program will support issuance of the EO requiring BIR to share its tax information with LGUs; prompt revisions in interpretation of Situs of Tax Rule for Banks under Local Government Circular 1-93; provide credit financing for improvements in business tax enhancement for 11 LGUs; provide credit facility to 60 LGUs for increased collection of RPT; training of at least 1,002 LGUs in resource mobilization, improvements in valuation standards for mass appraisal, market values, and equipment and machinery; and training in the new valuation standards for 1,406 LGUs. C. LGFBR Medium Term Program: Subprogram 2 Indicative Policy Actions

58. The LGFBR Program sets out the Government’s LGU reform agenda for the next 3 years, building on the reform momentum of subprogram 1. Indicative policy actions or the triggers for subprogram 2 are described in Appendix 3. The milestones to be monitored for subprogram 2 are listed in the design and monitoring framework (Appendix 1).

1. Intergovernmental Fiscal Relations

59. Improve Completeness, Timeliness, and Transparency in the Release of the IRA and PDAF. There are two policy triggers for the second subprogram. For the first trigger, the Government, through DBM, will complete the timely release of the IRA share of LGUs as certified by BIR for the 2007 IRA. The amount of P183 billion will be verified in the first quarter of 2008. For the second trigger, the Government, through DBM, will distribute to LGUs the LBM for indicative IRA for the ensuing budget year by June of the current year beginning 2008. The provision of this information to LGUs will improve local budgeting and lend greater transparency to the entire process of intergovernmental fiscal relations. 60. Improve Release of LGUs’ Special Shares in National Wealth. The Government will streamline the process for releasing LGUs’ shares in mining taxes by BIR (as collecting agent) and DBM (as disbursing agent). In the medium term, the Government is committed to streamlining the release of LGUs’ other special shares in national wealth—energy resources and forestry charges.

2. Fiscal Management, Planning, and Public Expenditure Management

61. Streamline the Oversight and Capacity Development Functions of National Government Agencies. There are two policy triggers for the second subprogram. For the first trigger, the Government through BLGF, will complete and distribute the Local Treasurer’s Manual to all provinces, cities and municipalities. For the second trigger, the Government, through NEDA, will ensure that provinces prepare the Provincial Development and Physical Framework Plan and Provincial Development Investment Program using the guidelines on provincial/local planning and expenditure management. These policy triggers will not only ensure compliance with the coordinated framework of the JMC over the medium term but will improve the fiscal capacity of provinces, cities and municipalities and enhance the planning capacity of provinces.

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62. Improve Fiscal Management Capacity of LGUs. There are two policy triggers for the second subprogram. For the first trigger, the Government, through BLGF, will fully implement the SRE financial reporting system by all provinces, cities, and municipalities. This is expected to improve local financial reporting and make available the financial information about LGUs to potential private creditors and the private sector as a whole. For the second trigger, the Government, through BLGF, will complete and implement the Competency Certification System for local treasurers. This will standardize a benchmark for evaluating the performance of local treasurers and make their skills marketable.

3. Performance Measurement and Service Delivery 63. Enhance Financing Options to Improve Service Delivery in Key Sectors. There are three policy triggers for the second subprogram. For the first policy trigger, the Government, through MDFO, will facilitate at least 250 LGUs to avail of loan financing for improved service delivery through investment in environment and health related projects. This trigger focuses on health and environmental management. For the second policy trigger, the Government through MDFO, will complete a study on performance-based grants that will be used to develop a framework for a performance-based system for LGUs. For the third policy trigger, the Government through MDFO, will adopt the framework for a performance-based grant system for LGUs in a future financing window. This framework will provide a performance component to the credit financing operations of MDFO and institute greater appreciation among LGUs for improving performance in local service delivery.

4. Credit Financing 64. Increase LGU Access to Private Financing. The Government, through DOF, will issue guidelines for allowing LGUs to open depository accounts in private banks. The LFF supports the graduation of LGUs to private sources of capital, and allowing LGUs to open depository accounts in private banks is consistent with this policy position. In the medium term, LGUs will be able to establish a genuine borrower-creditor relationship with private banks, which will result in direct access to their loanable funds. 65. Increased Availability of Development Financing for LGUs. There are three policy triggers for the second subprogram. In the first trigger, the Government will, through MDFO, enable at least 10 LGUs to avail of PROLEND loans. This trigger builds on the first subprogram by increasing the funding for this policy-based window to P2 billion. In the second policy trigger, MDFO will make available loans through its MDG window to 50 LGUs. This trigger builds on the first subprogram by creating a financing window for projects to help achieve MDGs at the local level. In the medium term, improved achievement of policy reforms is expected in the provinces and their component cities and municipalities, by improved delivery of services for the attainment of MDGs. In the third policy trigger, MDFO will develop a Disaster Calamity Fund to provide an immediate source of financing to LGUs hit by calamities. 66. Improved Availability of Financial Information on LGUs. There is one policy trigger for the second subprogram. The Government, through BLGF, will complete and issue the Revised Income Classification System for LGUs. This policy trigger will improve provision of financial information available to private investors and increase private sector confidence in LGUs as borrowers leading to increased local investment.

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5. Local Own-Source Revenues 67. Enhance LGUs’ Ability to Generate Revenues from Local Business Taxes. There are two triggers for the second subprogram. Firstly, the Government will, through DOF and BIR, issue guidelines and instructions for the BIR regional offices for sharing tax information with LGUs. In the medium term, this trigger will improve LGU information about the sales of firms in their jurisdictions—providing an accurate basis for imposition of business tax, resulting in increased collections. Secondly, the Government will, through DOF, issue guidelines on the situs of the tax rule for mining firms in levying local business tax. This trigger will allow LGUs to levy business taxes on mining operations in their localities which, in the medium term, will result in increased business tax collections. 68. Improve Collection of RPT. There are two triggers for the second subprogram. Firstly, the Government will, through BLGF, issue valuation standards for equipment and machinery as part of an addendum to the Local Assessor’s Manual. Secondly, BLGF will train at least 70 LGUs in valuation standards. This will improve LGU capacity to levy RPT and improve collections in the medium term. D. Important Features

69. The LGFBR program has a number of distinct features. First, it is an appropriate instrument for strengthening ADB’s partnership with the Government. By basing financial assistance on completed actions derived from the Government’s own reform program; LGFBR offers a way to strengthen Government’s ownership of the strategies of its development partners. By including policy triggers and milestone actions for subprogram 2, it creates a vehicle for broad-based dialogue for the Government’s agenda. Second, the LGFBR program helps establish an institutional mechanism to achieve better interagency coordination and implementation of reforms. Third, the program cluster approach used is a useful tool for the local financing and governance program as pursued by LGFBR, laying out a comprehensive and rather complex set of reforms that need to be properly sequenced in line with political expectations and taking into account the prevalent fiscal reality. A single-tranche program cluster approach gives more flexibility to adjust to changing circumstances within the longer term cluster concept, while focusing on achievable, upfront outcomes. E. Financing Plan

70. The Government has requested a loan of ¥34,253,100,000 ($300,000,000 equivalent) from ADB’s ordinary capital resources to help finance subprogram 1 of the LGFBR program. The loan will have a 15-year term, including a grace period of 3 years, an interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility, and a commitment charge of 0.75% per annum.36 The Government has made its own independent decision to borrow under ADB’s LIBOR-based lending facility, and it has given an undertaking that this choice was not made on the basis of any advice from ADB. The Government envisages that a loan of $300,000,000 will be needed to finance subprogram 2, the loan amount to be confirmed at the time of loan processing in 2010. The loan for subprogram 1 will be released in one tranche upon meeting the conditions of the policy matrix. Prior to the processing of subprogram 2, the Government will have demonstrated satisfactory progress with implementation of subprogram 1.

36 ADB’s Board of Directors has discounted the commitment charge to 0.25%, and waived the front-end fee of 1.00%

for loans approved from 1 July 2007 up to and including 30 June 2008.

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71. The program loan reflects the development financing needs of the Government (Table 5). According to DOF budget reports, the gross financing (external and domestic) requirements for 2007 are P390 billion. Based on the Government’s debt strategy for 2007 (the expected disbursement period for subprogram 1) the DOF projects gross external borrowings at P131 billion ($2.59 billion). The Government’s debt management strategy is to diversify its liability portfolio by increasing the weight given to domestic debt financing, lengthening the debt maturity profile, and maximizing overseas development assistance financing. ADB staff assessment of debt sustainability indicates that the Government’s debt stock and strategy are sustainable over the medium term, provided fiscal consolidation remains on track. The LGFBR proposed loan amount of $300 million equivalent will help to close the financing gap for 2007.

Table 5: Government of the Philippines Projected Financing Requirements for 2007

Financing Mix in 2007 Proposed Amounts in 2007 ($) Gross Financing Requirements 7,760.00 million Less Amortization 6,030.00 million Net Financing Requirement 1,730.00 million Programmed Gross External Borrowings 2,590.00 million of which:

ADB’s proposed loan pipeline 586.00 million DPSP 250.00 million Integrated Coastal Development 36.00 million LGFBR 300.00 million

Other donor and commercial borrowings 1,670.00 million ADB = Asian Development Bank, DPSP = Development Policy Support Program, LGFBR = Local Government Financing and Budget Reform. Note: Exchange rate: $1 = P46. Sources: Department of Finance and ADB. F. Implementation Arrangements

1. Program Management

72. DOF will be the Executing Agency and responsible for the overall implementation of subprogram 1—including complying with all policy actions, program administration, disbursements, and maintenance of all program records. An LGFBR program coordination committee (the Committee) has been established, chaired by the undersecretary of DOF and comprising officials from BLGF, MDFO, DILG, DBM, and NEDA. The Committee is responsible for coordinating the implementation of LGFBR program policy actions with agencies supporting the Program. The Committee meets quarterly to monitor the progress and oversee the implementation of the Program. ADB may be invited to participate in the meetings as an observer. DOF will be responsible for program implementation activities and will report progress to ADB.

2. Implementation Period 73. The subprogram 1 period is from January 2006 to 31 December 2007. All actions included in the policy matrix have been implemented within this period. The Government and ADB will prepare a completion report for subprogram 1 by June 2008, which, subject to subprogram 2 being approved, will be used as part of the overall program completion report.

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3. Procurement and Disbursement Arrangements 74. The loan of ¥34,253,100,000 ($300 million equivalent) will be released in a single tranche upon effectiveness (i.e., all conditions in the subprogram 1 policy matrix in Appendix 3 must be satisfactorily complied with prior to release of the tranche). The loan proceeds will be used to finance the full foreign exchange cost (excluding local duties and taxes) of items produced and procured in ADB member countries, excluding ineligible items, and imports financed by other bilateral and multilateral sources. In accordance with the provisions of ADB’s Simplification of Disbursement Procedures and Related Requirements for Program Loans,37 the proceeds of the program loan will be disbursed to the Republic of the Philippines as the Borrower. Under this Program, the Government will certify that the value of total imports minus (i) imports from nonmember countries, (ii) ineligible imports, and (iii) disbursements made under other official development assistance, is greater than the amount expected to be disbursed during the year. ADB reserves the right to audit the use of the loan proceeds and verify the accuracy of the Government’s certification. Disbursements will be made under the simplified procedures for program loans. In accordance with the simplified disbursement procedures and related requirements for program loans, all goods and services produced and originating in ADB member countries will be procured, with due consideration to economy and efficiency, in accordance with the Government’s standard public procedures and normal private sector commercial practices acceptable to ADB. Goods commonly traded on the international commodity market will be procured in accordance with procedures appropriate to the trade and acceptable to ADB. LGFBR 1 will provide for retroactive financing for expenditures incurred by the Government 180 days prior to loan effectiveness. The borrower has been informed that the approval in principle of the retroactive financing does not commit ADB to finance this Program. 4. Anticorruption and Fiduciary Issues 75. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the Program. To support these efforts, relevant provisions of ADB’s Anticorruption Policy are included in the loan regulations and the bidding documents for the Program. In particular, all contracts financed by ADB in connection with the Program shall include provisions specifying the right of ADB to audit and examine the records and accounts of the Executing Agency and all contractors, suppliers, consultants, and other service provides as they relate to the Program.

76. For the purposes of this program, an assessment of the country's financial management systems has been carried out to determine appropriate fiduciary arrangements. The diagnostic assessments were based on the Philippines Public Expenditures, Procurement, and Financial Management Review 200338 led by the World Bank with the participation of ADB. The World Bank, with the participation of ADB and the Australian Agency for International Development (AusAid), also produced the latest series of the Public Expenditure Review and Public Financial Management (PFM) Performance Report, which applied the Public Expenditure and Financial Accountability framework in assessing the country’s PFM systems, processes, and institutions. Discussions with the Government during formulation of the LGFBRP have taken into

37 ADB. 1998. Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila. 38 ADB and World Bank. 2003. A Public Expenditure, Procurement and Financial Management Review. Washington,

DC.

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consideration the ongoing reforms identified by these diagnostics. Based on this assessment, the fiduciary arrangements for the Program are deemed satisfactory. 77. The Government’s commitment to a balanced budget by 2008 and an improved Medium-Term Expenditure Framework for the 2007 budget preparation represents meaningful progress on PFM reforms. The first paper on budget strategy, linking policy priorities and budget allocations, was prepared for the 2007 budget call. This resulted in earmarking allocable funds to high priority health, infrastructure, and education sectors. The Government has piloted agency performance measures through the OPIF in 20 departments for the 2007 budget call; the OPIF links financial inputs with performance outputs. This is hand in hand with rationalization of the Government’s compensation system and eventual introduction of performance-based salaries. DBM is also managing a program requiring rationalization plans from departments to eliminate redundant activities. An empowered Government Procurement Policy Board is overseeing implementation of the GPRA to ensure transparency, efficiency, and accountability at the national and local level. Bids and awards committees are functioning in each agency, complaint mechanisms have been defined, and posting of invitation and awards on the website is mandated. DBM has trained 86% LGUs on the GPRA; and completed the simplified procurement manual for provinces, cities, municipalities, and barangays. The Government has also launched a National Anti-Corruption Program of Action and addressed some key areas, such as strengthening the Office of the Ombudsman, establishing anti-graft units in many government agencies, and lifestyle checks on civil servants. Many LGFBR policy actions are cascading the PFM reforms to the LGUs by linking LGU planning and budgeting to higher levels of the Government.

5. Accounting, Auditing, and Reporting

78. ADB retains the right to audit the use of the loan proceeds and to verify the accuracy of the Government’s certification for the withdrawal application. Prior to withdrawal, the Government will open a deposit account with the Central Bank of the Philippines (BSP) to receive the loan proceeds. The account will be managed, operated, and liquidated in accordance with terms satisfactory to ADB.

6. Performance Monitoring, Evaluation, and Program Review

79. In coordination with the Committee, ADB will carry out periodic reviews of the progress of implementation and assess the impact of the LGFBR Program. The Government will keep ADB informed of the outcome of policy discussions with other multilateral and bilateral agencies that have implications for LGFBR implementation, and will provide ADB with the opportunity to comment on any resulting policy proposals. ADB will, in collaboration with the Committee, undertake a review of program performance 12 months after loan effectiveness to review the outcome of subprogram 1 and prepare for subprogram 2.

V. TECHNICAL ASSISTANCE

80. In connection with the LGFBR Program, the Government has asked ADB for an advisory TA (ADTA) grant. The TA is estimated to cost a total of $1,100,000, of which ADB will finance $800,000 on a grant basis from the Japan Special Fund, funded by the Government of Japan. The TA will support the development of a medium-term reform agenda in local government financing and governance and its implementation, as well as provide the Government with just-in-time policy advice. It will include the following areas: (i) support creation and functioning of a CCD to promote, coordinate, and oversee decentralization reforms, including the changes

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envisaged in the LGFBR program policy matrix; (ii) analysis of existing capacities for planning and budget management at city level, development and pilot testing of revised planning and budgeting systems, and preparation and dissemination of city planning guidelines; and (iii) development of the LGPMS to be used as a tool to link access to intergovernmental transfers, grants, and capacity development support with service delivery performance. The TA components and cost estimates are described in Appendix 8.

VI. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

A. Expected Impact

81. The LGFBR will provide significant benefits and will have a positive impact on local service delivery, financing, and governance issues. The key expected benefits are:

(i) streamlined intergovernmental fiscal relations as a result of completeness, timeliness, and transparency in the release and reporting of LGU shares in national government revenues, thereby improving the accuracy of local budgeting and programming of local expenditures;

(ii) improved transparency, efficiency, and accountability in planning, public expenditure management, and financial management as a result of rationalized and streamlined national government oversight functions and strengthened local capacity;

(iii) enhanced delivery of critical public services at the local level by providing additional financing options and linking them to performance outcomes as well as improved national government-LGU arrangements for devolved functions;

(iv) greater LGU access to public and private sources of capital as a result of improved policy and institutional environment, thereby contributing to increasing LGU ability to finance the delivery of local public services; and

(v) increased LGU own-source revenues to fund social and development expenditures, as a result of strengthened LGU capacity to generate revenues from real property and business taxes, thereby reducing LGU reliance on national government transfers, and consequently reducing the Government’s fiscal burden.

82. Institutional. The LGFBR will contribute to significant institutional development. The passage of RA 9358; issuance of Joint Circular No. 2006-1; issuance of JMC No. 1; and development and distribution of new and/or updated local planning, budgeting, procurement, treasurers’ and assessors’ guidelines/manuals are major steps towards improving predictability and transparency in the release of the IRA and LGUs’ share in national wealth as well as the policy and institutional environment for planning, public expenditure management, financial management, and local revenue generation. In this manner, enhancement of the governance structure in the LFF—through approval of the LGU financing framework and the eligibility of municipal bonds as reserve investments of insurance companies, and issuance of the Central Bank of the Philippines (BSP) guidelines allowing private banks to act as trustee banks for LGU bond issues—promotes institutionalization of market discipline in LGU operations. Altogether, these enhancements in the policy and regulatory environment will promote greater efficiency in local administration functioning and also improve service delivery. 83. Social and Economic. By increasing the resource inflows of LGUs from both intergovernmental transfers and local sources, and by improving LGU performance measurement in the delivery of devolved services, the LGFBR Program enhances not only the

29

capacity of LGUs to fund social sector expenditures but also their effectiveness. It is expected that, in the medium term, both the volume and quality of social spending will increase. By improving LGU access to the private capital market and increasing the availability of financing for urban infrastructure, the LGFBR increases the ability of LGUs to fund critical local infrastructure, which is key to promoting local economic development and growth.

B. Risks and Mitigating Measures

84. While some of risks are irreducibly political, therefore outside the scope of the Program to affect directly, core elements of the Program and ADTA contribute to mitigating these risks through greater transparency and accountability mechanisms that strengthen the capacity of local authorities and provide active monitoring by civil society groups. Potential risks to subprogram 1 and underlying assumptions are as follows:

(i) Political delays. Delays may be experienced in engaging the LGUs for the second phase since the elections for their respective League officers are in the third quarter of 2007. However, the Leagues have endorsed the phase one and two triggers and it is expected that no major changes in policy orientation will occur despite changes in the Executive Board of the Leagues.

(ii) External pressures. Deterioration in the external environment may trigger internal financial problems and may encourage the Government not to fully release the IRA amount to the LGUs. A portion of the IRA was withheld during the 1997 financial crisis since it was determined to be an “unmanageable public sector deficit”. The Government has a strong commitment in achieving its fiscal consolidation objectives to maintain macroeconomic stability. The development partners have contributed substantial resources to support the fiscal consolidation agenda. In addition, legislative and legal measures are now in place to prevent recurrence of the 1997 chain of events.

(iii) Clientelism. There is a risk that when LGUs are provided additional resources, the benefits of their investments go only to a select few. However, the LGFBR Program contains two mitigating actions. One, direct government credit related core actions support investments in basic service delivery in areas such as health and MDG projects that target the poor. Furthermore, credit programs for policy reforms are directed at improving areas of governance that do not favor a particular group. Two, the program-supported core actions and TA aims to improve local performance and measure improvement in the general community’s welfare.

(iv) Coordination and capacity constraints. Willingness for coordination among oversight agencies for harmonization of local planning, investment programming, revenue administration, budgeting, and expenditure management may weaken over time. However, the Government is committed to implementing the JMC. To resolve possible issues and to ensure continued progress, a technical committee is being organized to oversee JMC implementation.

(v) Resource constraints. The Government may run out of resources for capacity development activities planned under this Program. Although these are heavily funded by current ADB projects, it is possible that some training programs may be underfunded. However, many donors are also providing TA grants for local reforms and capacity development.

(vi) Moral hazard. Increased private sector financing to LGUs may result in a moral hazard problem. Some private financial institutions may not perform due diligence when financing LGUs because of the attractiveness of IRA deposits.

30

Furthermore, allowing private banks unrestrained access to IRA deposits may not result in additional financing for LGU projects and might merely increase the profitability of private banks from the spreads they would earn on the use of these funds. As mitigation, DOF will issue guidelines to regulate the access of private banks to LGU IRA deposits consistent with good financial governance.

85. Conditions for Loan Effectiveness. The loan will become effective on meeting all tranche conditions, as specified in the policy matrix (Appendix 3).

VII. ASSURANCES

86. In addition to the standard assurances, the Government has given the following assurances, which are incorporated in the legal documents.

(i) Counterpart funds will be used to finance the structural adjustment costs and local currency costs relating to the implementation of the Program and other activities consistent with the objectives of the Program, as more fully described in the development policy letter (Appendix 2);

(ii) The policies and actions taken prior to the date of the LGFBR Loan Agreement, as described in the development policy letter (including the policy matrix), will continue to be in effect for the duration of the LGFBR and subsequently.

VIII. RECOMMENDATION

87. I am satisfied that the proposed cluster and loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve

(i) the program cluster to the Republic of the Philippines for the Local Government Financing and Budget Reform Program Cluster; and

(ii) the loan of ¥34,253,100,000 to the Republic of the Philippines for Subprogram 1

of the Local Government Financing and Budget Reform Program Cluster, from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Program Loan Agreement presented to the Board.

Haruhiko Kuroda

President 13 November 2007

Appendix 1 31

DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks

Impact • The efficiency and

effectiveness of basic public services delivered by LGUs to their constituent communities has increased

• More than half of the

aggregate LGU level indicators (below) improve by one-fifth to one-tenth of 2005 results by 2010: (i) ratio of health facilities to population, (ii) access to basic services such as water and electricity, (iii) sanitation condition, (iv) extent of solid waste collection and disposal, (v) presence of sewerage facility

• Relevant indicators of

LGPMS dataset (comparison 2005 to 2008)

Assumption • LGU use enhanced

resources for investments other than in basic public services, i.e., government administration buildings, rent-seeking

Outcome • LGU avail of

enhanced resources and capacities to plan and budget for the general welfare of their constituent communities in a transparent and accountable way

• Real local government

revenues, including access to public and private sources of credit, increase by at least 4% annually at all levels of government from 2007 in two thirds of all provinces and highly urbanized cities and in the majority of fourth to sixth income class other LGUs

• Real expenditures for service delivery increase by at least 2% annually from 2008 in two thirds of provinces and highly urbanized cities and in the majority of fourth to sixth income class other LGUs

• Number of fraudulent cases reported by COA decreases by at least 20% at all levels of government

• BLGF SRE data • BLGF SRE data • COA information

Assumption • Mechanisms are in place

in LGUs at all levels to provide incentives to make use of enhanced resources and capacities to plan and budget for the general welfare of constituent communities

Risk • Delays may be

experienced in engaging LGUs since the election for their respective League officers is in the third quarter of 2007

Outputs 1. Completeness,

timeliness, and transparency of release of LGU shares in national government revenues is improved

• Passage of Republic

Act 9358 • IRA release to LGUs

amounts to P183 billion in 2007 and P210 billion in 2008

• Predictability of annual IRA release ensured by DBM in time for preparation of LGU budgets from 2007

• Copy of the Republic Act • Official certification from

BIR • Local budget

memorandum for the indicative IRA to the LGUs for the ensuing budget year by June of the current

Assumption • There is no political

pressure on DBM to ignore the provisions of Republic Act 9358 or to suppress transparency on IRA releases

Risk • Financial crisis leading to

unmanageable public sector deficit

32 Appendix 1

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks

2. Efficiency and

accountability in financial management, planning, and expenditure management at the local level is enhanced

3. Effectiveness and

transparency in the delivery of critical public services at the local level is enhanced

• Documentary

requirements on the release of the LGUs’ share in the proceeds from the development and utilization of national wealth in mining, forestry, and energy reduced from five to two by December 2007

• Requirements for the release of the special share of LGUs in mining taxes further reduced by BIR by December 2008

• Coordinated framework

developed for harmonization of local planning and budgeting

• Updated Budget Operations Manual issued with 90% of LGUs trained on it

• Provincial plans prepared using the Guidelines on Provincial/Local Planning and Expenditure Management for 2008 and 2009

• SRE financial reporting system is harmonized with NGAS, computerized, and available at BLGF for all provinces, cities, and municipalities from 2007

• Competency reports completed by BLGF for 50% of local treasurers by 2009

• 86% of LGUs trained in the GPRA (2003)

• 217 fourth to sixth

income class LGUs avail of financing for improved service delivery through investment in urban infrastructure and

year in 2007–2010 • Certification of posting

from DBM/DBM website • Copy of joint circular • Copy of BIR memorandum

order • Copy of joint

memorandum circular • Certification provided by

DBM • Copies of Provincial

Development and Physical Framework Plans; NEDA field reports

• Certification of SRE data

provided by BLGF/BLGF website

• Copies of competency

reports provided by BLGF • Certification from DBM • Certification from MDFO

Assumptions • Capacity development

measures for LGU financial management, planning, and expenditure management provided by oversight agencies are fully funded, efficient, and effective

• Incentives for coordination between oversight agencies will continue

• Allocation mechanisms for development funds channeled to LGUs are based on service delivery and poverty reduction criteria

Risks • Coordination among

oversight agencies may become weak

• Benefits to improved service delivery go to a select few

Appendix 1 33

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks

4. LGU access to

public and private sources of capital for financing of policy reforms and development projects is improved

5. Additional sources

of revenues developed at the local level, thereby reducing dependency on the IRA

public services with total loans amounting to P2.7 billion

• 250 LGUs avail of financing for improved service delivery through investment in environmental and health projects by June 2010

• 100% of LGUs covered by Local Government Performance Measurement System

• LGU financing

framework approved • Guidelines for allowing

LGUs to open depository accounts in private banks available by December 2008

• At least 10 additional LGUs have access to a PROLEND loan by June 2010

• At least 100 additional LGUs have access to a Millennium Development Goal loan by June 2010

• Executive Order issued

requiring BIR to provide tax information to the LGUs

• Revised interpretation of situsa of Tax Rule for Banks in levying local business tax

• BIR regional offices required to provide tax information to LGUs by December 2008

• Guidelines on the Situs of Tax Rule for Mining Firms in levying local business tax available by December 2008

• Valuation standards for equipment and machinery available as an addendum to the Assessor’s Manual in 2008

• LGU officers from 70 LGUs have access

• Certification from MDFO • Certification provided by

DILG • Copy of the financing

framework • Copy of guidelines

submitted by DOF • MDFO Policy Governing

Board resolution provided by MDFO

• MDFO Policy Governing

Board resolution provided by MDFO

• Copy of the Executive

Order endorsed by the Office of the President to be provided by DOF

• Copy of the guidelines to

be provided by DOF • Copy of Assessor’s

Manual provided by BLGF • Training reports,

certification issued by

Assumptions • Willingness of LGUs to

provide quality performance data increases over time

• Availability of private sector financing augments with increased availability of financial information on LGUs

Risk • Allowing private banks

unrestrained access to IRA deposits may increase the profitability of private banks rather than increasing financing for LGU projects

Assumptions • Business tax revenue base

of LGUs is sufficient to justify collection cost

• LGUs are increasingly willing to make use of property evaluation methods

Risk • The Government may run

out of resources for capacity development activities planned for this Program

34 Appendix 1

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks

to valuation training on equipment and machinery offered by NTRC and BLGF by 2009

NTRC and BLGF

Activities with Milestones 1.1 Improve the completeness, timeliness, and transparency in the release of IRA. 1.2. Improve the release of LGU special shares in national wealth and other taxes. 2.1. Streamline the oversight and capacity development functions of national government agencies for fiscal management, planning, and public expenditure management. 2.2. Improve the fiscal management capacity of LGUs. 2.3. Improve the implementation of the Government Procurement Reform Act of 2003. 3.1. Enhance financing options to improve service delivery in key sectors. 3.2. Improve implementation of devolved functions. 3.3. Improve effectiveness of existing LGU performance monitoring systems. 4.1. Increase LGU access to private sources of financing. 4.2. Increase availability of development financing for LGUs. 4.3. Improve availability of financial information on LGUs. 5.1. Enhance LGU ability to generate revenues from local business taxes. 5.2. Increase collection of real property taxes.

Inputs • $300 million equivalent

program loan for subprogram 1

• $300 million equivalent program loan for subprogram 2

• $0.8 million capacity development TA to support implementation of the reform measures envisaged for subprogram 2

BIR = Bureau of Internal Revenue, BLGF = Bureau of Local Government Financing (DOF), COA = Commission on Audit, DBM = Department of Budget and Management, DILG = Department of the Interior and Local Government, DOF = Department of Finance, IRA = internal revenue allotment, LGPMS = local government performance measurement system, LGU = local government unit, MDFO = Municipal Development Fund Office, NEDA = National Economic and Development Agency, NGAS = New Government Accounting System, NTRC = National Tax Research Center, SRE = statement of receipts and expenditures, TA = technical assistance. a Situs refers to the site or location of the taxable entity.

Appendix 2 35

Development Policy Letter

36 Appendix 2

Appendix 2 37

38 Appendix 2

Appendix 2 39

40 Appendix 2

Appendix 2 41

42 Appendix 3

POLICY MATRIX

Objectives Actions Taken/Results Achieved

(Core Prior Policy Actions in Bold) LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 A. Intergovernmental Fiscal Relations: Improving Completeness, Timeliness, and Transparency in the Release of LGU Shares in National Government Revenues and Grants Improve completeness and transparency in the release of IRA and PDAF

(1-1) Internal Revenue Allotment (IRA) released in a predictable and clear manner as provided in the Local Government Code (Republic Act 7160).

(1-2) Republic Act 9358 passed providing for automatic appropriation of IRA.

(1-3) IRA share of local government units (LGUs) estimated timely by Bureau of Internal Revenue (BIR) for 2007 at P183 billion.

(1-4) BIR certified an IRA of P210 billion for release in 2008.

(1-5) Issuance of the Local Budget Memorandum (LBM) on the CY 2008 indicative IRA shares of LGUs by June 2007.

(1-6) Information on IRA shares of LGUs posted on Department of Budget and Management (DBM) website by January 2007.

(1-7) Uploading of the Priority Development Assistance Fund (PDAF) releases on the DBM website.

(2-1) IRA released to LGUs amounting to P183 billion in 2007. (DBM)

(2-2) Comprehensive allotment release of the final IRA within the first quarter of the year.

(2-3) Monthly releases of Notice to Cash Allocations (NCA) and funding checks.

(2-4) Issuance of the LBM for the IRA shares of the LGUs for the ensuing budget year by June of the current year. (DBM)

(2-5) Posting of information on DBM website on IRA shares of LGUs by the first quarter of every year.

(2-6) Make transparent the deductions from gross BIR collections to arrive at the 40% IRA share of LGUs.

IRA released annually in a predictable, timely, and transparent manner.

Improved ability of LGUs to plan and budget their resources.

Improve release of LGU special shares in national wealth and other taxes

(1-8) Framework adopted on the release of LGUs’ share in the proceeds from the development and utilization of national wealth in mining, forestry, energy and mining royalties reducing the documentary requirements from 5 to 2 (Joint Circular 2006-1).

(2-7) Further streamlining of the process for releasing the special shares of LGUs on mining taxes by BIR and DBM. (DBM)

(2-8) Further streamlining of the process for releasing the special shares of LGUs on energy resources and royalty from mineral reservation by Department of Energy, Mines and Geosciences Bureau, and DBM.

(2-9) Further streamlining of the process

Increased amount of resources flowing to LGUs from national wealth. Reduced uncertainty in the release of LGUs’ share in national wealth.

Improved ability of LGUs to plan and budget their resources.

Appendix 3 43

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 for releasing the special shares of LGUs on forestry charges by Department of Environment and Natural Resources and DBM.

(2-10) Consolidation of harmonized procedures for release of special shares from mining, forestry, energy, and mining royalties.

(2-11) Posting of information on the DBM website of all releases of the LGU share in national wealth in mining, forestry, energy, and mining royalties indicating the amount released for each LGU.

B. Fiscal Management, Planning, and Public Expenditure Management: Enhancing Efficiency and Accountability in Financial Management, Planning, and Expenditure Management at the Local Level Streamline the oversight and capacity development functions of national government agencies

(1-9) Coordinated framework developed among Department of Finance (DOF), DBM, Department of Interior and Local Government (DILG), and National Economic Development Authority (NEDA) on the harmonization of local planning, investment programming, revenue administration, budgeting, and expenditure management (Joint Memorandum Circular 2007-1).

(1-10) Issuance of Updated Budget Operations Manual (UBOM), with 90 percent of LGUs trained in its use.

(1-11) New local assessors’ manual completed and distributed to all LGUs.

(1-12) Provincial planning guidelines completed and printed for distribution to provinces.

(1-13) At least 90% of provinces trained in the use of the Provincial Planning

(2-12) Local treasurers manual completed and distributed to all LGUs. (BLGF)

(2-13) Provinces prepared Provincial Development and Physical Framework Plan (PDPFP), and Provincial Development Investment Program (PDIP) using the Guidelines on Provincial/ Local Planning and Expenditure Management. (NEDA)

(2-14) UBOM implemented at the level of provinces (81) and highly urbanized cities (28).

(2-15) Debt Monitoring System completed and implemented at the provincial, city, and municipal levels.

(2-16) Barangay (village) Operations Manual issued with ongoing training.

Standardized planning, financial, budgetary, and expenditure documentary submissions to oversight national government agencies by the provinces, cities, and municipalities. Improved monitoring and assessment of LGU fiscal, financial, expenditure, budgetary, and planning performance.

Improved transparency and accountability at the local level. Improved information base for LGU performance measurement and credit rating.

44 Appendix 3

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 and Expenditure Management Guidelines by NEDA.

Improve fiscal management capacity of LGUs

(1-14) Statement of Receipts and Expenditures (SRE, formerly Statement of Income and Expenditures) financial reporting system harmonized with New Government Accounting System (NGAS) completed and computerization achieved.

(1-15) Comprehensive trainer’s training program on SRE launched by BLGF

(1-16) 2,551 mandatory and demand-driven trainings conducted for 513 LGUs in the areas of project management, operation and maintenance, planning and investment programming.

(2-17) SRE financial reporting system fully implemented at the provincial, city and municipal levels. (BLGF)

(2-18) Trainer’s training on SRE completed.

(2-19) Competency Certification System for Local Treasurers completed and implemented by BLGF. (BLGF)

(2-20) Debt Management Manual completed and distributed.

(2-21) Agreement for assistance to the Mayors Development Center for Long Distance Learning signed.

(2-22) Business Plan for Mayors Development Center for Long Distance Training completed.

(2-23) Pilot testing of modules for Long Distance Training completed.

(2-24) 228 LGUs provided training in standardized project financing and other demand-driven training.

Availability of timely and accurate financial information for LGU financial managers. Improved fiscal and financial management systems.

Improved competency of local financial managers. Improved information base for LGU performance measurement and credit rating. Improved debt management.

Improve implementation of the GPRA

(1-17) 86 percent of all LGUs trained in the new Government Procurement Reform Act (GPRA).

(1-18) Manual for simplified procurement procedures for LGUs prepared and pilot tested.

(2-25) Barangay Procurement Manual completed, distributed, and implemented.

(2-26) Manual for simplified procurement procedures and bidding documents completed; all LGUs implement the GPRA with the help of the simplified guide to the Generic Procurement Manual.

Improved local procurement down to the barangay level.

Reduced leakages from procurement at the local level.

C. LGU Performance Measurement and Service Delivery: Enhancing Effectiveness and Transparency in the Delivery of Critical Public Services at the Local Level Enhance financing options to improve service

(1-19) 217 3rd to 6th income class LGUs availed of financing for improved service delivery through investment in urban

(2-27) 250 LGUs avail financing for improved service delivery through investment in environmental and health

Majority of 3rd to 6th class provinces, cities, and municipalities benefit from loan programs.

Improved infrastructure and social service provision at the local

Appendix 3 45

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 delivery in key sectors

infrastructure and public services with total loans amounting to P2.25 billion.

(1-20) 131 LGUs availed of financing for improved service delivery through investment in environmental and health projects with total loans amounting to P2 billion.

(1-21) 32 LGUs in Mindanao availed of financing for improved delivery of rural and agricultural services with total loans amounting to S20.6 million.

(1-22) 66 LGUs availed of financing for improved delivery of rural and agricultural services with total loans amounting to P1 billion.

(1-23) Study on performance-based grants for LGUs started.

projects. (MDFO) (2-28) 225 LGUs in Mindanao availing of

financing for improved delivery of rural and agricultural services.

(2-29) 120 LGUs avail financing for improved delivery of rural and agricultural services.

(2-30) Study on performance-based grants for LGUs completed. (MDFO)

(2-31) Framework for performance-based grants adopted by MDFO (MDFO).

level.

Improve implementation of devolved functions

(1-24) Broad agreement reached among oversight agencies on establishing a Coordination Committee on Decentralization (CCD).

(2-32) Issuance of an enabling instrument for the establishment of CCD for operational matters.

(2-33) Regular meetings of the CCD called by DILG to resolve coordination issues related to decentralization.

Improved service delivery of devolved functions.

More efficient devolution of key functions and services to LGUs.

Enhance effectiveness of existing LGU performance monitoring systems

(1-25) 100 percent of provinces, cities, and municipalities (excluding ARMM) covered by Local Government Performance Management System (LGPMS).

(1-26) Local Government Financial Performance Monitoring System (LGFPMS) integrated into LGPMS.

(1-27) LGPMS aggregate data posted on DILG website annually.

(2-34) System for the use of the LGPMS by the executive agencies completed.

More accurate assessment of LGU fiscal and financial performance.

Greater private sector confidence in lending and investing in LGUs

D. Credit Financing: Improving LGU Access to Public and Private Sources of Capital for Financing of Policy Reforms and Development Projects Increase LGU access to private sources

(1-28) LGU financing framework as a national policy approved.

(1-29) Municipal bonds as eligible reserve

(2-35) Study to allow LGUs to open depository accounts in private banks becomes functional.

Increased access of LGUs to private capital markets

Better ability of LGUs to finance investments.

46 Appendix 3

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 of financing investment of insurance companies

allowed under certain conditions. (1-30) Guidelines by the Central Bank of

the Philippines (BSP) to allow private banks to act as trustee banks for LGU bond floatations.

(1-31) Guiding principles and National Government (NG)-LGU cost sharing policy in the evaluation and processing of projects involving devolved activities for LGUs financed by MDFO, reconfirmed in 2007.

(2-36) Guidelines issued for allowing LGUs to open depository accounts in private banks issued. (DOF)

(2-37) Guidelines for simplifying debt service capacity certification of LGUs for borrowing issued.

(2-38) Revisit of Investment Coordinating Committee Guidelines on the NG-LGU cost sharing arrangements completed and new guidelines adopted.

(2-39) Financial Modalities Manual completed and distributed to all LGUs.

Increased availability of development financing for LGUs

(1-32) At least P2 billion allocated for the PROLEND facility.

(1-33) PROLEND Policy and Operations Guidelines and Manual approved.

(1-34) At least two LGUs approved by MDFO Policy Governing Board (PGB) for a PROLEND loan.

(1-35) A financing window for projects supporting the Millennium Development Goals created and P500 million allocated for the facility

(1-36) A loan facility amounting to $83.75 million created providing a performance grant of up to 20 percent of the total project cost.

(1-37) Provided funding for Mindanao-Urban Basic Services loan program facility amounting to P400 million.

(1-38) Expanded LGU lending under the Local Finance and Development Project through additional funding of P500 million.

(1-39) Provided P500 million as stand-by credit for Philippine Water

(2-40) At least 10 LGUs approved by MDFO’s Policy Governance Board (PGB) for a PROLEND loan (MDFO).

(2-41) At least 50 LGUs approved by MDFO PGB for a MDG loan. (MDFO)

(2-42) At least 10 LGUs approved for Mindanao-Urban Basic Services and other loans.

(2-43) A new financing modality on Disaster Calamity Fund developed by MDFO. (MDFO)

(2-44) A loan facility for LGU health-related projects created amounting to P475 million (P400 million for sub-loans and P75 million for technical assistance).

Public funds to LGUs increasingly focused on improving service delivery. LGUs’ achievement of MDGs improved. Increased incentives for improved fiscal performance by LGU.

Improved ability of LGUs to achieve service delivery objectives

Appendix 3 47

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 Revolving Fund for water and sanitation projects at the local level.

Improved availability of financial information on LGUs

(1-40) SRE financial reporting system harmonized with NGAS completed, and computerization achieved.

(2-45) Debt Certification System completed.

(2-46) Revised Income Classification System for LGUs completed and issued by BLGF. (BLGF)

LGU creditors provided with more accurate information for assessing the creditworthiness of LGUs.

Improved LGU access to private capital markets.

E. Local Own-Source Revenues: Reducing LGU Dependency on the Internal Revenue Allotment by Developing Buoyant Sources of Revenues at the Local Level Enhance LGUs’ ability to generate revenues from local business taxes

(1-41) Executive Order issued requiring BIR to provide tax information to the LGUs.

(1-42) Revised interpretation of Situs of Tax Rule for Banks under Local Finance Circular 1-93 in levying the local business tax in 2007.

(1-43) 11 LGUs availed of loans under the Business Tax Enhancement Program of MDFO’s LOGOFIND Project as of 2007.

(1-44) 72 LGUs trained under MDFO’s LOGOFIND on demand driven modules for examination of books of accounts.

(2-47) Instructions for BIR regional offices for the provision of tax information to LGUs issued (DOF-BIR).

(2-48) Guidelines on the Situs of Tax Rule for Mining Firms in levying the local business tax issued. (DOF)

(2-49) Procedural Manual on creating a Business Tax Payer Database and Billing and Collection System for LGUs completed and distributed.

Development of business tax as a significant source of local revenue.

Development of a comprehensive database and availability of new information on LGU taxpayers. Improved LGU business tax collections. LGU dependency on IRA reduced.

Improve collection of real property taxes

(1-45) 60 LGUs availed of loans for real property tax improvement under MDFO’s LOGOFIND Project as of 2007.

(1-46) 1,002 LGUs trained under MDFO’s LOGOFIND on Revenue Mobilization and Updating the Local Revenue Code and other demand-driven modules. (BLGF)

(1-47) Valuation standards for code of ethics, mass appraisal, and market values as a basis of valuation included in Assessor’s Manual.

(1-48) Valuation training for code of ethics mass appraisal, and market values as a basis of

(2-50) Valuation standards for equipment and machinery issued as an addendum to Assessor’s Manual. (BLGF)

(2-51) Valuation training on equipment and machinery completed for 70 LGUs. (BLGF)

Development of property tax as a significant source of local revenue.

Increased use of property valuation methods.

48 Appendix 3

Objectives

Actions Taken/Results Achieved (Core Prior Policy Actions in Bold)

LGFBR 1

Milestones and Triggers (Indicative Core Policy Actions in Bold)

LGFBR 2

Medium-Term Reform Actions

Broad Directions

Expected Results

2006–2007 2008–2010 valuation completed for 1,406 LGUs.

ARMM = Autonomous Region of Muslim Mindanao, BIR = Bureau of Internal Revenue, BLGF = Bureau of Local Government Finance, BSP = Central bank of the Philippines, CCD = Coordination Committee on Decentralization, CY = calendar year, DBM = Department of Budget and Management, DILG = Department of Interior and Local Government, GPRA = Government Procurement Reform Act, IRA = internal revenue allotment, LGFBR = Local Government Financing and Budget Reform, LGPMS = local government performance measurement system, LGU = local government unit, MDFO = Municipal Development Fund Office, NEDA = National Economic and Development Authority, NGAS = New Government Accounting System, PDAF = Priority Development Assistance Fund, PGB = Policy Governing Board, PROLEND = program-policy lending facility, SRE = statement of receipts and expenditures, UBOM = Updated Budget Operations Manual. Source: Asian Development Bank.

Appendix 4 49

DEVELOPMENT PARTNERS’ COORDINATION MATRIX

Core Policy Areas in the Local Government Finance and Budget Reform Program

Components

ADB Support for Policy Reforms

Major Support from Other Development

Partners Fiscal management capacity of LGUs

• TA 4556-PHI: Local Government Finance and Budget Reform

• TA 4778-PHI: Local Governance and Fiscal Management

AusAID • Human Resource Development Facility • Community Assistance Program • Area-Focused Provinces • Local Sustainability Program II CIDA • Local Government Support Program Phase II • Local Governance Support Program in the

Autonomous Region in Muslim Mindanao GTZ • Strengthening Decentralized Development

Planning Structures in the Visayas Region JICA • Cebu Social-Economic Empowerment and

Development Project TAF • Barangay/Municipal Development Planning UNDP • Governance Review and Strengthening of

Capacity of Independent Accountability Institutions

USAID • Transparent and Accountable Governance • Integrated Multisectoral Capacity Building World Bank • LGU Financial Management and Audit Project • Second Social Expenditure Management

Project

Fiscal management, planning, and public expenditure management

Procurement • TA 4686-PHI: Harmonization and Managing for Results

European Commission (EC) • EC-Ombudsman Corruption Prevention

Program (procurement training) TAF • Establishing Local Networks of Civil Society

Bids and Awards Committee Observers • Organizational Development and Corruption

Prevention for the Northern Luzon Coalition for Good Governance

50 Appendix 4

Core Policy Areas in the Local Government Finance and Budget Reform Program

Components

ADB Support for Policy Reforms

Major Support from Other Development

Partners World Bank • Strengthening the Implementation and

Enforcement Capacity of Procurement Institutions (procurement training)

• Professionalization of Public Procurement Practitioners (procurement training)

Improved implementation of devolved functions

• Loan 1562/1563-PHI: Fisheries Resource Management (approved in 1997)

• Loan 1472-PHI: Small Towns Water Supply Sector (1996)

• Loan 1440/1441-PHI: Rural Water Supply and Sanitation Project (1996)

• Loan 1421/1422-PHI: Cordillera Highland Agricultural Resource Management (1996)

• Loan 1396-PHI: Integrated Community Health Services (1995)

• Loan 1367-PHI: Regional Municipal Development Project (1995)

• Loan 1365/1366-PHI: Second Irrigation System Development (1995)

JBIC • Rural Water Supply and Sanitation Project

(Phase V and VI) JICA • Rural Water Supply and Sanitation

Development for Special Zone for Peace and Development

• Sustainable Improvement of Renewable Energy Development in Village Electricification

USAID • Local Government Health Services • Reducing Unintended Pregnancy and Improving

Healthy Reproductive Behavior • Improving Sustainability Management of Natural

Resources and Biodiversity Conservation World Bank • Upscaling Poverty-Focused City Development

Strategy in the Philippines • Water Districts Development Project • Agrarian Reform Communities Development

Project • Land Administration Project

LGU performance measurement and service delivery

LGU Performance monitoring systems

• TA 3959-PHI: Local Governance Performance Measurement System

Credit financing Development financing for LGUs

• Loan 2063-PHI: Development of Poor Urban Communities (approved in 2003)

• Loan 1843-PHI: Mindanao Basic Urban Service Sector (2001)

• Loan 1772-PHI: Infrastructure for Rural Productivity Enhancement Sector (2000)

• Loan 1668-PHI: Southern Philippines Irrigation Sector (1998)

• Loan 1667-PHI: Agrarian Reform Communities

USAID/JBIC/DBP • Municipal Water Loan Financing Initiative World Bank • City Development Strategy • KALAHI-Comprehensive Integrated Delivery of

Social Services • Local Government Finance and Development

Project (LOGOFIND) • Early Childhood Development (together with

ADB)

Appendix 4 51

Core Policy Areas in the Local Government Finance and Budget Reform Program

Components

ADB Support for Policy Reforms

Major Support from Other Development

Partners • Loan 1658-PHI: Clark Area Municipal

Development (1998) • Loan 1654-PHI: Secondary Education

Development and Improvement (1998) • Loan 1606/1607-PHI: Early Childhood

Development (1998)

• Rural Power Project • LGU Water and Sanitation Project • Community-Based Resource Management • Rural Finance Project • Special Zone for Peace and Development

Special Fund Project ADB = Asian Development Bank, AusAID = Australian Agency for International Development, CIDA = Canadian International Development Agency, DBP = Development Bank of the Philippines, EC = European Commission, GTZ = Deutsche Gesellschaft für Technische Zusammenarbeit (German Agency for Technical Cooperation), JBIC = Japan Bank for International Cooperation, JICA = Japan International Cooperation Agency, LGU = local government unit, TA = technical assistance, TAF = The Asian Foundation, UNDP = United Nations Development Programme, USAID = United States Agency for International Development. Source: Asian Development Bank.

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SECTOR ANALYSIS: DECENTRALIZATION AND GOVERNANCE A. The Decentralization Context

1. Governance and Accountability 1. The economic rationale for decentralization is that it can improve governance by making public service delivery more efficient. Local governments are in closer contact with citizens than the national Government, so they are better placed to respond to citizens’ preferences. This allows them to match services to local needs. The economic literature argues that political accountability can translate local information into better services. If people are dissatisfied with decisions of local politicians, they can vote them out of power (voice), or they can move (exit) to a region that better matches their preferences. Figure A5 illustrates the shortened accountability chain within a local government compared with centralized systems. 2. Better services require accountability among the actors. There are two routes, short and long, through which citizens can hold organizations accountable for service delivery. In the long route of accountability, citizens can give mandates to politicians to design services to respond to their needs. If politicians cannot fulfill their mandates, citizens can vote them out of office. In turn, politicians exercise control over civil service management authorities to motivate organizations to provide proper services to the citizens. The short route connects citizens with the organizations through a direct accountability relationship.1

Figure A5: Accountability Chains in Decentralized Context

Source: Economics and Research Department, Asian Development Bank. 2007. Critical Issues of Fiscal Decentralization. Manila.

3. In practice, however, decentralization reforms are mostly driven by political considerations—with the economic rationale being secondary if not marginal to the decision. In the case of the Philippines, the decision was sparked by strong reactions to a prolonged period of highly authoritarian rule. The 1987 Constitution includes provisions assuring local autonomy

1 World Bank. 2004. World Development Report 2004. Washington, DC.

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to local governments. The Local Government Code (LGC), 1991, spells out the detailed aspects of local autonomy. The Code has the following governance features:

(i) Accountability. Term of office is set at 3 years with a maximum of three consecutive terms; local fiscal administrative duties and responsibilities are explicitly laid out.

(ii) Transparency. Local officials are mandated to submit their statements of assets and liabilities, and members of the Sanggunian (legislative assembly) are mandated to fully disclose their business interests; government procurement is arranged through local prequalification, bids, and awards committees.

(iii) Participation. Local governments are mandated to create local special bodies: Local School Board, Local Health Board, Local Development Council, and Local Peace and Order Council, with representation from nongovernment organizations (NGOs) and other civil society groups. The role ascribed to NGOs and people’s organizations under the Code includes cooperative arrangements with local government units (LGUs) in the delivery of basic services and capacity building.

4. Although decentralization can strengthen accountability to improve services, a number of key governance risks could hamper the advantages of decentralization: (i) state capture, (ii) clientelism, (iii) capacity constraints, (iv) power struggle between levels of government, and (v) weaknesses in interregional informational flows that are critical for effective competition. These risks are more prevalent at the local level than at the national level. In case decentralization is poorly designed, these governance distortions could undermine any positive gains in accountability.2 5. State capture3 thrives when the market for political influence is dominated by highly concentrated interest groups, in particular powerful firms or families, in a context of weak political competition. It distorts the chain of accountability between politicians, organizations, and citizens. In the Philippines, as in most decentralized countries, powers in local government tend to be concentrated in the executive, with weak representation from institutions that are supposed to check on the state capture, such as the police and judiciary. These institutions often lack technical and support staff, resources, experience, and training. Other countervailing powers, such as the media and NGOs, representing a broader range of public interests, are generally less developed in local jurisdictions. Decentralization in the Philippines did not dramatically alter the local political landscape, as the political dominance of wealthy families and clans continued. However, a dynamic and vibrant civil society is emerging in many local areas. 6. Clientelism is the practice by which politicians distribute publicly funded goods to selected members of the electorate in return for votes and political support as opposed to making such goods generally accessible to all members of their jurisdiction. In poor areas in the Philippines, patronage, the so-called kasal-binyag-libing (wedding-baptism-burial) support, which a mayor is expected to provide to constituents, is the acceptable norm. 7. Capacity Constraints. Decentralization requires local governments not only to implement, but also to formulate policies. They are also required to interact effectively with a complex set of stakeholders. This requires a wide range of skills among local politicians and government officials, which they are still developing. In addition, appropriate systems for public 2 World Bank. 2005. East Asia Decentralizes: Making Local Government Work. Washington, DC. 3 Actions of individuals, groups, or firms either in the public and/or private sectors to influence the formation of laws,

regulations, decrees and other government policies to their advantage through the illicit and non-transparent provision of private benefits to politicians and/or civil servants.

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financial management need to be established. In the Philippines, capacity problems are not limited to the executive branch of the Government, but also include actors in the countervailing institutions, the legislature and judiciary, and civil society groups. 8. Intergovernmental Tension. Decentralization reconfigures the relationships between public sector institutions, and between national level and local government. It often generates conflicting incentives at different levels of government and within different branches of government. The result is that the shape of decentralization is constantly evolving, reflecting changing political and economic realities, competing interests, and shifting priorities. Discussions over the extent and contours of decentralization between levels of government tend to place constraints on the autonomy of local governments. Although the LGC provides for elaborate service delivery responsibilities for local governments, Section 17 of the Code encourages a two-track delivery system where both national and local governments can initiate devolved services—confusing what was meant to be a clear-cut assignment on the expenditure side. The most significant source of revenue for smaller municipalities, besides the internal revenue allotment (IRA), is “pork barrel”, the share of government spending allocated through congressmen to their constituents on a discretionary basis. The resulting lack of transparency and predictability undermines planning for the use of these funds. In addition, local governments often face strong constraints on raising local revenues that limit the autonomy they may have been given over local services. Notable among these are: (i) limited powers in setting tax rates, (ii) weak administrative capacity, and (iii) poor taxpayer information database. All these factors generate substantial uncertainty as to the distribution of functions and responsibilities, the extent of autonomy, and the balance of power between levels of government. Such uncertainty can weaken accountability for any of the involved actors, and can stifle investment and interregional competition. 9. Stifling Interregional Competition. One of the main justifications in favor of decentralization is that it can enhance competition among jurisdictions. With mobility of capital among regions, businesses can look for jurisdictions where regulations are not needlessly complex, where infrastructure is good, and where relationships of trust can be developed with local officials. This kind of competition can act as a disciplining device for local governments, strengthening incentives for delivering transparent and accountable services. The risk, however, is that this kind of competition could become too intense, pushing governments to overshoot incentives or resulting in negative spillover effects, such as exporting taxes or pollution to neighboring regions. Rise in economic investment is not necessarily inconsistent with “bad” governance. The economic resurgence of Cavite, for instance, coincided with repressive methods to ban workers’ strikes in factories within the special economic zones, reportedly with the local government’s tacit approval.

2. Service Delivery 10. In line with the transfer of functions to LGUs mandated under the Code, and more resources at their disposal, total LGU expenditure expanded relative to gross national product (GNP) and relative to total general government expenditure. Total LGU spending doubled from an average of 1.6% of GNP in 1985–1991 to 3.4% of GNP in 1992–2005. Similarly, the share of LGUs in total general government expenditure net of debt service rose from an average of 11.0% in the pre-Code period to an average of 24.2% in the post-Code period (Table A5.1).

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Table A5.1: LGU Expenditure Relative to GNP and to General Government Expenditure (%)

Year

Ratio of LGU Expenditure to GNP (%)

Expenditure to General Government Debt Expenditure Net of Debt Service (%)

1985 1.54 12.17 1987 1.44 10.67 1989 1.53 11.20 1991 1.89 12.74 1993 2.72 20.20 1995 3.53 22.38 1997 3.75 22.04 1999 3.67 23.55 2001 3.75 26.33 2003 3.55 26.87 2005 2.88 25.76 Average 1985–1991 1.61 11.40 1992–2005 3.36 24.15

GNP = gross national product, LGU = local government unit. Source: Commission on Audit, Bureau of Local Government Finance.

11. The major increase in LGU spending on social services between 1991 and 2005 went to health and education. Aggregate LGU expenditure on health rose almost threefold from 0.1% of GNP in 1991 to 0.3% of GNP in 2005, while LGU spending on education doubled from 0.1% to 0.2% of GNP. The increase in health spending was largely because LGUs absorbed the cost of devolved health personnel, which constituted over half the total cost of all devolved personnel. The increase in education spending largely reflects the higher priority that local officials assign to this sector, as LGUs did not have to absorb devolved personnel. In contrast, social expenditures for housing and community development and social welfare have been declining or stagnant over the same period. 12. In addition to the unclear expenditure assignments, the major bottlenecks that constrain improvements in local service delivery and governance can broadly be attributed to lack of resources, weak fiscal and expenditure management, and lack of performance measurement. The lack of resources is mainly due to insufficient access of LGUs to development credit from public sources for social projects and private capital markets for income-generating projects, uncertainty in national transfers, and insufficient generation of local own-source revenues. Weak fiscal and expenditure management can be attributed to a lack of clear guidance and support from national government oversight agencies and weak local capacity. The ineffective performance measurement system is due to insufficient resources to improve existing systems and lack of incentives for LGUs to be more performance-oriented. The following sections provide an analysis of the above-mentioned key factors that need to be addressed to ensure more effective implementation of the LGC. Some of the issues can be addressed within the existing legal provisions, while others would require changes in the LGC which may become politically feasible in the medium term. B. Intergovernmental Fiscal Relations 13. National government transfers to LGUs are of three types: (i) formula-based block grants (i.e., IRA); (ii) origin-based share in central government revenues (i.e., share in national wealth and other taxes); and (iii) ad hoc categorical grants.

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1. Internal Revenue Allotment

14. Under the LGC, the aggregate IRA of LGUs is set at 40% of the actual internal revenue tax collections of the central Government 3 years prior to the current year. The aggregate IRA is then divided among the different levels of local government as follows: 23% to provinces, 23% to cities, 34% to municipalities, and 20% to barangays (villages). The IRA share of each tier of local government is then apportioned to individual LGUs on the basis of population (50%), land area (25%), and equal sharing (25%). The IRA is transferred as a block grant, so LGUs enjoy considerable discretion in its utilization. The IRA surged from 3.3% of national government expenditures (0.6% of GNP in 1985–1991) to 12.3% of national government expenditures (2.2% of GNP) in 1992–2005, causing increased pressure on national government expenditures in recent years. 15. On average, the contribution of the IRA to total LGU income net of borrowings expanded from 36.7% in 1985–1991 to 64.6% in 1992–2005 for all LGUs combined (Table A5.2). This trend is more prominent in provinces and municipalities than in cities. The share of IRA in total income net of borrowings of cities increased from 33.2% in the pre-LGC period to 46.2% in the post-LGC period. The corresponding figures for municipalities rose from 38.3% to 73.8% while those for provinces increased from 38.8% to 81.0%. There is some evidence that the IRA tended to substitute for local tax revenues of provinces and cities in the post-Code period (1992–2000). The analysis suggests that LGUs which received higher IRA (whether in absolute terms or relative to their expenditure responsibilities) tended to be lax in their tax effort.

Table A5.2: IRA and Other Grants as a Portion of Total LGU Income and LGU Expenditure (%)

National Government Transfers as % of

LGU Total Income National Government Transfers as % of

LGU Expenditure Year Total IRA Other Grants Total IRA Other Grants

Average 1985–1991 51.4 36.7 14.7 53.2 38.0 15.2 1992–2005 66.0 64.6 0.6 67.2 65.7 0.6

IRA = internal revenue allotment, LGU = local government unit. Source: Bureau of Local Government Finance.

16. National transfers have been criticized for: (i) the lack of reliability in transfer releases and appropriations that undermine the ability of LGUs to plan and manage expenditures effectively; (ii) inequalities and distortions in distribution built into the current allocation system (i.e., allocation among the various levels of LGUs and between different LGUs at the same level of government, which result in some LGUs such as cities being better off in terms of net transfers less cost of devolved functions); and (iii) negative incentives created for local revenue generation since the LGU is always assured of income from the IRA, and increases in the LGU’s IRA are subject to improvements in national tax collections instead of good governance on the part of LGUs. 17. Notwithstanding the formula-based determination of the aggregate IRA share of LGUs and its distribution to individual LGUs, as well as the LGC provision for automatic release of the IRA, the IRA evolved to be a highly unpredictable revenue source for LGUs between 1998 and 2004 as the central Government, faced with severe fiscal constraints, persistently reduced the amount of intergovernmental transfers to LGUs. In those years, the mandated IRA share was either not appropriated in full, the amount appropriated for IRA was not released in full, the IRA appropriation was not released on time, or the IRA share was effectively cut because the budget

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was reenacted. A 2004 ruling of the Supreme Court on the IRA marked a dramatic and significant shift in the treatment of the IRA. Republic Act 9358, July 2006, stated in very clear terms that future LGU share in national internal revenue taxes or the IRA shall henceforth be automatically appropriated. This meant that the IRA is now not only automatically released but also automatically appropriated (Table A5.3)

Table A5.3: Comparison of IRA Appropriations and IRA Obligations

(P billion) Item 1998 1999 2000 2001 2002 2003 2004 (1) Mandated IRA share: 40% of net BIR revenues 3 years back a 81.0 96.8 121.8 131.9 134.4 141.0 143.4 (2) Appropriations 81.0 96.8 111.8 b 111.8 134.4 141.0 141.0 (3) Obligations 76.9 95.3 114.3 c 115.8 134.4 141.0 141.0 (1) less (3) 4.1 1.5 7.5 16.1 0.0 0.0 2.4 BIR = Bureau of Internal Revenue, IRA = internal revenue allotment. a As indicated by IRA level proposed in President’s budget. b P10 billion of the P121.8 billion mandated share was put under “unprogrammed funds” in the General

Appropriations Act. c in the course of the budget year, P2.5 billion was transferred from the “unprogrammed funds” to the

“programmed” portion of budget. Source: Department of Budget and Management.

18. Finance did not follow function overall4. Variations in net resource transfer5 across levels of local government are substantial. In the aggregate, the net resource transfer for cities is consistently larger than those for provinces and municipalities. While the net resource transfer has consistently been positive for cities in 1995–2003, it was estimated to be negative for provinces and municipalities in 1995–1999. This analysis suggests that provinces and municipalities in the aggregate are relative net losers while cities were relative net winners from fiscal decentralization. In relation to the IRA, the Congressional Development Fund and Priority Development Assistance Fund (PDAF) are allocated to members of congress for discretionary spending at LGU level. These funds have been channeled to local investments in a non-transparent way, undermining LGU planning for strategic use of such funds. It is estimated that the non-IRA funding to LGUs is P25.4 billion, with congressional allocations amounting to over 60% of this amount.6 To improve transparency in the allocation and use of such funds, the Department of Budget and Management (DBM) is posting the PDAF figures on its website.

2. Share in National Wealth

19. In addition to the IRA, LGUs are entitled to a 40% share in the forestry charges and mining taxes and royalties collected by the central Government from entities operating in their territorial jurisdiction. They also have a 40% share in the proceeds that the central Government receives in any joint venture, coproduction, or production agreements in the utilization and development of national wealth in their jurisdiction. The timely and complete release of the LGUs’ share in national wealth taxes in the past has been hampered by (i) problems in accurately estimating the tax collections from natural resource taxes since actual tax collections for the immediately preceding year are not yet known when the General Appropriations Act 4 A basic principle of fiscal decentralization is that devolved functions need to be adequately financed. 5 The net resource transfer for a given year is computed as the difference between the IRA for the said year, and the

sum of the adjusted cost of devolved functions, cost of other mandates including the provision for the 20% Development Fund and sectoral representation and 1992 IRA.; adjustments on the cost side were made to take into account population growth and inflation.

6 Pellegrini, Soriano. 2003. A Study to Revisit the LGU Financing Framework and its Implementation. Washington, DC: World Bank.

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(GAA) is prepared; and (ii) lack of information on situs7 of tax. In particular, the collection agencies (BIR for mining taxes, Department of Environment and Natural Resources for forestry charges, Department of Energy for energy taxes, and Mines and Geosciences Bureau for mining royalties) are required to submit a certification showing the corresponding share of each province, city, municipality, and barangay; a certificate of actual remittance of tax collections for the preceding year from the Bureau of Treasury; and a request for the release of the shares to DBM. 3. Specific Grants and Subsidized Credit Programs 20. Many sector agencies provide specific grants to LGUs funded out of their own budgets. These programs are aimed at encouraging LGUs to fund and undertake activities that are supportive of national programs and objectives. The matching grants program of the Department of Health for the promotion of family planning is an example. The official development assistance funds intended for LGUs are first appropriated and allocated to the Municipal Development Fund Office (MDFO) that serves as a conduit. The MDFO then releases the funds in the form of either loans and/or grants to LGUs. The MDFO prescribes a loan/equity/grant mix in the financing of varying types of LGU projects, depending on the income type of the LGU concerned. For instance, other things being equal, the grant share of lower-income LGUs is larger than that of higher-income LGUs (correspondingly, the equity share and loan share of less well-off LGUs is smaller than those of better-off LGUs). On the other hand, the grant share is highest for social projects and blue/green (marine and forest related) environmental projects, followed by brown (waste management) environmental projects and revenue-generating projects. C. Financial Management, Planning, and Public Expenditure Management

1. Local Development Planning and Public Expenditure Management 21. There is a need to strengthen capacities for local development planning and strengthen the linkage between development planning and budget management in order for LGUs to meet their mandate for local economic development more effectively and efficiently. Local planning capacities tend to be weak. According to a recent study, less than 70% of provinces surveyed had up-to-date local development plans (LDPs) and local development investment programs (LDIPs). LGUs are also under pressure to prepare a multitude of sector specific planning documents and are besieged by numerous planning guidelines, some of which are outdated. The only plan available in many of the smaller municipalities is the annual investment plan (AIP). In many LGUs, the AIPs are prepared to comply with the budgetary requirement that no appropriation chargeable to the Local Development Fund can be made if the project is not listed in the LGU’s AIP. The AIPs in many LGUs do not appear to be anchored on clear goals, strategies, and programs. They typically do not set program targets and, seldom if ever, is there an explicit assessment of benefits. At best, some cursory reference is made to “beneficiaries” or “clients served”. In many LGUs, investment programming is also not based on a systematic evaluation of projects’ costs and benefits. Instead, prioritization appears to be done largely on an ad hoc basis, and the process is driven by local chief executives. 22. Only 30–50% of LGUs have Local Development Councils (LDCs) in place. Moreover, one survey found that less than a third of LGUs have development plans that benefited from

7 Situs refers to the site or location of the taxable entity.

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meaningful NGO/people’s organization participation.8 Given this situation, it is not surprising that LGU officials do not have a good understanding of their constituents’ expenditure preferences. In a survey, it was found that municipal officials correctly anticipate households’ first priority in 5 out of 10 cases while provincial officials cite the top preference of households in only 3 cases. This finding raises questions on the extent of the improvement in allocation efficiency that is expected to result from fiscal decentralization.

23. Poor coordination between national Government and LGU planning has resulted in a break in the planning chain—occurring between the regional and provincial levels. The regional development plan, formulated by the Regional Development Council, is seldom if ever taken into consideration by LGUs.9 Thus, the LDPs of many LGUs are formulated quite independently of regional and national development plans. Conversely, regional development plans tend to ignore LDPs ostensibly because they are meant to focus solely on interprovincial projects. Many LGU officials complain that national government agencies do not consult adequately with LGUs in the planning and implementation of programs and projects located within their jurisdictions. Many of these projects are reported to be inconsistent with the perceived needs of the LGUs themselves (i.e., local demand) since national line agencies are not obliged to follow the Regional Development Investment Plan-based regional budget. Consequently, the regional development plans are usually more reflective of the national government line agencies that have the budget to fund the projects contained therein. Even for LGUs that have current LDPs, the programs and projects in the AIP bear little resemblance to those in the LDP and LDIP. Closer scrutiny of the LDPs, LDIPs, and AIPs in five sample provinces shows that there is an imperfect match between the projects listed in the LDPs/LDIPs and those listed in the AIPs. Consequently, there is often very little correlation between the LGU’s LDP and its budget of expenditures. 24. The local budget process tends to be inefficient and non-transparent. 10 First, income/revenue estimates, on which the annual budget is based, tend to be poor. Many local treasurers do not appear to follow a systematic approach in calculating their income estimates. Aggregate LGU data for 1997–2001 show that, in general, the revenue estimates for own-source revenue are seldom met, with 5–15% shortfall in own-source revenues. Poor revenue estimates lead to the sequestration of allotments (especially in the early part of the year), delays in obligations, and subsequently, project implementation. Thus, for the most part, the appropriation does not necessarily reflect actual fund utilization. In addition, budgeting at the local level is done largely in an incremental fashion for existing programs. It not clear, however, that the allocable balance is allocated in a strategic manner in line with their local development plans. There appears to be no consideration given in a systematic fashion to program performance and expected outcomes in allocating the budget across sectors and programs. 25. Gender and Development. The GAA has a gender and development policy requiring that at least 5% of the total budget be allocated to gender concerns. At the local level, this policy is implemented under the Joint Memorandum of Agreement 2001-01 between the National Commission on the Role of Filipino Women, Department of Interior and Local Government (DILG), and DBM, which postulates “all province, cities, municipalities, and barangays shall prepare a gender and development plan addressing the gender issues of the locality” in line with the provisions of the LGC”. The Local Government Code (Sections 446, 457, and 467) address

8 United States Agency for International Development (USAID). Governance and Local Democracy Project. 9 World Bank/Asian Development Bank (ADB). 2003. Philippines: A Public Expenditure Management, Procurement

and Financial Management Review. Washington, DC. 10 World Bank/ADB. 2005. Decentralization in the Philippines. Washington, DC.

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gender participation by explicitly providing women representation in the local councils at the three major sub national levels. 2. Procurement 26. As part of expenditure management reforms, the Government Procurement Reform Act (GPRA) was passed in 2003 to address the reported persistent corruption in government procurement at all levels and to: (i) address the proliferation of laws on public sector procurement, which facilitated rent-seeking and inefficiencies; (ii) reorganize and strengthen agency and local government bids and award committees and procurement units; and (iii) strengthen the system of reward and punishment in the performance of the procurement function. The implementation of the GPRA has now been intensified at the LGU level. The Government Procurement Policy Board of DBM has reported that, as of June 2007, 86% of all LGUs have implemented the law. 3. Financial Reporting and Audit 27. The Commission on Audit (COA) is an independent constitutional body and the Philippines’ supreme audit institution. It has introduced and rolled out a New Government Accounting System (NGAS) for all levels of government, aiming to (i) simplify government accounting, (ii) conform to international accounting standards, and (iii) generate periodic and relevant financial statements for better performance monitoring. It has several features that make it a significantly better system—including a modified accrual accounting basis, improved accounting for assets, the adoption of a single fund concept, and a simplified three-digit chart of accounts. In accordance with the NGAS, the audited statements of LGUs need to be made publicly available and accessible. The Bureau of Local Government Finance (BLGF) is currently harmonizing its LGU financial reporting system for local treasurers, the statement of receipts and expenditures (SRE), with the NGAS to achieve this.

D. Performance Measurement 28. In recent years, there has been a significant increase in interest on the part of LGUs, national government agencies, and international organizations in the assessment of LGU fiscal, financial, and service delivery performance. In the past, many tools were developed to evaluate the performance of local governments, but most did not prove very effective or addressed only narrow concerns. The Local Government Performance Measurement System (LGPMS) of DILG is a major initiative. It provides LGUs with one tool to assess their strengths and weaknesses in the performance of their new roles and responsibilities brought about by devolution, and uses indicators mostly derived from the LGC. BLGF is also compiling an online database of 126 financial characteristics of LGUs. This database is integrated in a parallel performance monitoring system called the Local Government Financial Performance Monitoring System (LGFPMS). Currently, the BLGF database or LGFPMS is being linked to the LGPMS to allow the integration of financial data with development and service delivery data, and strengthen the linkage between measuring outputs and allocating inputs. E. LGU Credit Financing 29. Credit financing is used by LGUs to support development of infrastructure, capital investment, and a portion of operating expenses. Sources include domestic banks, government financial institution (GFIs), and loans through the Government from foreign sources. LGU borrowings rose steadily from P448 million in 1991 to a peak of P6.9 billion in 2004 and an

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average of P5.8 billion in 2001–2005. Thus, LGU borrowing became a more important source of LGU financing, accounting for 3.5% of total LGU receipts net of borrowing in 2005 from less than 2% in 1991 (Table A5.4). Cities had greater access to the LGU credit market than provinces and municipalities. Borrowings contributed to 5.4% of the total receipts net of borrowings of cities compared to 3.7% in the case of provinces and 2.1% in the case of municipalities in the post-Code period.

Table A5.4: LGU Borrowings, 1985–2005 (P million)

Average Item 1985–1991 1992–2005 1991 1995 1999 2001 2002 2003 2004 2005 All LGUs 110 4,111 448 2,493 5,949 5,574 4,219 5,635 6,879 6,651 Provinces 57 961 325 593 771 1,639 1,482 1,794 1,735 1,360 Municipalities 12 840 37 579 561 892 915 1,853 1,103 1,610 Cities 41 2,310 87 1,321 4,618 3,043 1,822 1,988 4,041 3,680 Ratio to LGU Average Income (%) 1985–1991 1992–2005 1991 1995 1999 2001 2002 2003 2004 2005

All LGUs 0.79 3.76 1.91 3.81 5.20 4.21 2.65 3.26 3.95 3.46 Provinces 1.50 3.69 5.51 3.59 2.78 5.21 3.87 4.48 4.36 3.09 Municipalities 0.23 2.08 0.37 2.30 1.32 1.87 1.58 2.95 1.78 2.33 Cities 0.88 5.37 1.13 5.59 10.48 5.70 2.88 2.83 5.60 4.65 LGU = local government unit. Source: Bureau of Local Government Finance.

30. The Government’s long-term vision is for the capital market, rather than national agencies, to play a dominant role in financing LGUs. However, several key issues need to be addressed to facilitate LGU access to private capital markets. There is a need for transparent LGU financial information, credible LGU loan repayment capacity, availability of a collateral and other loan security, and a framework for LGUs to make deposits and set up special accounts for bond repayments. Addressing these issues may mitigate creditors’ more general fears over the short terms of local chief executives, lack of LGU familiarity with financing instruments, their weak project identification and preparation capacities, low credit worthiness, and the danger of default.

31. Not many LGUs are able to borrow from banks because not all are creditworthy. Overall, cities are better positioned to access credit financing. Thus, cities account for the bulk (54%) of total outstanding LGU loans (as of 30 June 2004) while provinces account for 18.8% and municipalities 25.8%. Part of the problem is the lack of reliable information on LGU creditworthiness. On the other hand, cities are likely to have better financial information than provinces and municipalities. However, important constraints continue to hamper the development of the LGU bond market: higher costs associated with bond flotation compared with direct bank borrowing, lack of reliable information about LGUs, uncertainty about management capacity at the LGU level, lack of a market for secondary trading, and lack of access to IRA as security for LGU obligations.

32. Some recent developments augur well for increasing LGU access to the capital market. In October 2006, the Insurance Commission approved the request of the Financial Executives Institute of the Philippines for the approval of municipal bonds as an eligible reserve investment of insurance companies. In February 2007, the Department of Finance issued a memorandum order officially adopting the LGU Financing Framework and the Government’s cost-sharing arrangement. The memorandum explicitly states that the provision of credit to LGUs by the Government will be governed “through a policy of market segmentation, hand-in-hand with the

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policy to graduate creditworthy LGUs to private sources of capital”. The issuance further states that “LGUs with higher creditworthiness ratings will avail of private commercial financing, except for environmental and social projects, LGUs that have medium creditworthiness rating will access financing from GFIs, and those LGUs in the lower income tiers will avail of financing from the Government through the Municipal Development Fund”. The issuance also provides a maximum grant of 50% for LGUs in matters of LGU-national Government cost sharing. MDFO is also looking into performance-based grants and is commissioning a study to develop a framework for policy-based grants which can be implemented next year. E. Local Own-Source Revenues

33. In 2006, tax revenue only accounted for 25% of total regular income.11 Studies have shown that LGUs have created revenue codes with a huge array of taxes, fees, and charges.12 Many of these are under-collected and some not collected. In addition, there are many low yielding taxes that impose substantial collection and administrative costs on LGUs and contribute to a lack of transparency on the side of the taxpayer. For example, taxes on peddlers, fishing vessels, and radio fees, each bring in no more than 0.02% of the LGUs total own-source revenue on average. In Bacolod City, there are over 200 different rates for the mayor’s business permit fee, all of which depend on the type of establishment. There is a need to focus on taxes, fees, and charges that have high yield potentials; and to improve their administration and collection. 34. The LGC seriously limits the power of LGUs to set local tax rates. First, the Code fixes the tax rate of some of the taxes that are assigned to LGUs (like the Special Education Fund, real property tax and the community tax). Second, while LGUs have some discretion in setting tax rates in the case of other local taxes, the Code sets ceilings (or floors) on the tax rates that LGUs may impose, which in some cases appears to be low (or high) given current realities. For instance, the LGC set ceilings for the real property tax assessment levels for different classes of property whereas the assessment levels themselves were fixed in the pre-LGC period. Moreover, the maximum assessment levels set under the LGC are no higher and often significantly lower than the fixed assessment rates in the pre-LGC period,13 resulting in a reduction in the effective assessment levels of residential land, all types of buildings, and all types of machinery—potentially leading to an erosion of real property tax (RPT) revenues. Third, the Code mandates that tax rates can only be adjusted once in 5 years and by no more than 10%. This provision is particularly restrictive in the case of taxes (e.g., the professional tax and the tax on delivery vans and trucks) whose rates are specified in nominal peso terms. Clearly, the resulting adjustments will not allow LGUs to maintain the real value of their revenues. That local tax administration is severely inadequate in many LGUs is highlighted by the declining trend in the RPT collection efficiency of both provinces and cities in the post-Code period (Table A5.5).

11 Bureau of Local Government Finance. 12 This can be partly attributed to the Code itself. Section 143 – Tax on Business has a very detailed schedule of fees

that can be simplified. 13 The LGC also provided for the exemption of residential buildings with market value below P175,000 from real

property taxation.

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Table A5.5: Collection Rate of Current Year for Basic RPT, 1989–2000 (%) Year All LGUs Provinces Cities 1989 58.0 55.6 61.0 1991 58.9 54.1 65.1 1994 60.7 54.0 66.3 1997 57.4 50.0 62.0 1999 54.1 52.4 54.9 2000 54.6 44.7 57.1 Average 1989–1991 58.2 54.4 63.1 1992–2000 55.4 49.0 59.7

LGU = local government unit, RPT = real property tax. Source: Commission on Audit, Bureau of Local Government Finance. 35. LGU tax administration capacity is constrained because of low staff professional qualifications and inadequate automation of core tasks. These problems affect all aspects of tax administration—poor taxpayer registration systems and low-quality record keeping results in widespread tax delinquencies; tax audits and enforcement are inadequate, which erode the credibility of the system and results in low compliance; and limited availability of taxpayer services increases taxpayer compliance costs. The collection of local taxes is further weakened by either the lack of or the inadequacies of certain implementing guidelines governing local taxation. For instance, the Local Treasurers’ Manual has not been updated since 1954. BLGF is currently in the process of addressing this constraint. The revised local treasurers’ manual is currently being prepared. 36. In an effort to improve real property tax collection, BLGF has improved the valuation standards in the updated local assessors’ manual, which was completed in 2006. The manual includes revised valuation standards for a code of ethics, mass appraisal, and market values as a basis of valuation. In 2008, it will be further updated to incorporate an addendum for valuation standards for equipment and machinery. BLGF also provides an RPT enhancement program (as well as a local business enhancement program) that supports LGU efforts to improve their collections through tax mapping, valuation techniques, and assessment support. MDFO is also providing substantial capacity development support and training in standardized project financing and other areas of resource mobilization. From 2008 onwards, MDFO is targeting to train an additional 228 LGUs in the aforementioned areas. To encourage LGUs to improve RPT collection, MDFO through BLGF has provided a credit window for such improvements under its Local Government Finance and Development (LOGOFIND) project.

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SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

A. Linkages to the Country Poverty Analysis

Is the sector identified as a national priority in country poverty analysis?

Yes

No

Is the sector identified as a national priority in country poverty partnership agreement?

Yes

No

Contribution of the sector or subsector to reduce poverty in the Philippines: Decentralization brings government closer to the people, making it more responsive and more likely to develop policies and programs that meet local needs. It is thus argued that, in an economy with significant local variations in preferences, and when there are no significant economies of scale and scope, decentralized provision of public services can enhance efficiency in the provision of these services and result in welfare gains.a Intergovernmental competition can also result in innovations in the provision of public services. Decentralization makes it is easier to identify the beneficiaries of public services and to impose user charges on them when appropriate. Thus, decentralized provision of such services can help to link revenue-expenditure decisions at the margin. This can improve both efficiency and accountability in the provision of public services, improving overall social welfare. However, to provide better services in response to local needs, local government units (LGUs) need the requisite technical capacity and appropriate institutional arrangements. In almost all countries, the poor are mostly concentrated in poorer localities and regions. In places where poverty is concentrated, the levels of social services and physical infrastructure provided are low, resulting in low productivity of both capital and labor. Therefore, it is necessary to ensure that certain key services falling into the class of merit goods are provided in these regions at a minimum level of standard without adversely affecting the incentive structure of local governments. Although redistribution is traditionally considered a central government responsibility, it is erroneous to conclude that local governments do not have any role in implementing direct poverty alleviation policies. Proximity to the people reduces information and transaction costs in significantly designing and implementing anti-poverty strategy. Local governments have a distinct advantage in identifying the poor because of their proximity to the people. However, experience in other countries shows that local participation in financing a part of the schemes, and in implementing the programs, also improves accountability to local citizens on the one hand and to higher-level governments on the other. The passage of the Local Government Code (LGC) in 1991 represented a major step in decentralization in the Philippines. The LGC paved the way for increased local autonomy, expenditure responsibility, and revenue authority. In particular, the main responsibility for the delivery of basic public services in health, education, and infrastructure was devolved to the LGUs. In addition, the LGUs were given taxing authority to be able to generate resources to complement the internal revenue allotment (IRA), which they receive from the national Government. Best practices have emerged in many LGUs on resource mobilization, revenue generation, and service delivery, as well as in improved overall management and reinvention of LGUs, improved local human resource management, increased cooperation among LGUs, and improved social services. These best practice examples highlight the potential of local autonomy and devolution in contributing to the improvement of service delivery and overall welfare at the local level. However, preliminary evidence also suggests that, despite these achievements, the expected benefits of decentralization have yet to be realized fully.

B. Poverty Analysis Targeting Classification: General intervention What type of poverty analysis is needed? The Medium-Term Philippine Development Plan (MTPDP) contains ambitious poverty reduction targets. It proposes to reduce the poverty incidence of families from 28.4% in 2000 to 17.9% in 2010. Similarly, the subsistence incidence of families is programmed to fall from 13.10% in 2000 to 8.98% in 2010. This would effectively allow the Philippines to meet the United Nations Millennium Development Goal (MDG) of halving poverty incidence in 2010 rather than 2015. In reality, poverty incidence (defined as the proportion of families deemed poor) declined from 39.9% in 1991 to 27.5% in 2000 and 24.7% in 2003. Subsistence poverty incidence fell from 20.4% in 1991 to 10.4% in 2003. The Philippine performance to date in reducing poverty suggests that the country is likely to achieve the MDG on poverty reduction although it might have some difficulty in meeting the MTPDP 2010 target. At the same time, geographical inequalities across the country’s three island groups present a daunting challenge to development efforts. Social indicators reveal large regional disparities, with poverty incidence lowest in Metro Manila

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(National Capital Region) and highest in the Autonomous Region in Muslim Mindanao. Provision of infrastructure (e.g., transport and communications) is uneven, isolating many communities from goods and basic services within the country, and lowering regional ability to connect to the global economy. Mindanao lags significantly in terms of economic and social development indicators. It is home to nearly 24% of the country’s population and accounts for about 40% of people living in poverty. Conflict-affected areas, ravaged by years of unrest and intermittent warfare, are home to the poorest of the poor. The poorest provinces and areas in Luzon and Visayas (particularly Bicol, Region V) also need special attention in addressing interregional and intraregional disparities. A poverty mapping exercise identified the poorest 40 provinces.b Access to opportunities is far from equal in the Philippines as shown in Table A6 below. The poor belonging to the bottom of the income distribution have less job opportunities than the non-poor. Health services are largely utilized by the top end of the income distribution. The majority of people prefer private clinics or rural health unit health centers. However, access to private clinics is mainly for the top end of the income distribution and access to the rural health unit and barangay (village) health stations are utilized more by people at the lower end of the income distribution. Children at the bottom end of the income distribution have lower access to primary and secondary education. Basic infrastructure services are not equally shared across the population, particularly for electricity and clean drinking water.c

Table A6: Poverty Impact Analysis Matrix

Effects on the Poor Possible Channels of Effect Direct

Short Run Indirect

Short Run Indirect

Medium Run

Effects on Other Stakeholders

Mitigation or Enhancement

Measures

Access to Labor Markets, Wages

Access to Markets and Prices

Access to Assets

Service Access X X X X

Direct Transfers X X Net impact: Slightly positive Source: Asian Development Bank. While it has been suggested that growth processes in recent years have allowed lagging regions to catch up with leading regionsd (i.e., there is a tendency for household incomes at the provincial level to converge over the long term), the response of poverty reduction to provincial income growth is quite modest by international standards. Evidence shows that improvements in access to roads, health, schooling, and electricity have positive effects not only on income growth rates but also on poverty reduction. The sustained empowerment of LGUs remains critical. The Local Government Financing and Budget Reform (LGFBR) will address poverty reduction indirectly by contributing to increased efficiency and effectiveness of basic public services delivered by LGUs to their constituents through improved LGU access to development credit, thereby promoting activities towards achieving the MDGs. The LGFBR will further contribute indirectly to more efficient and effective public service delivery by addressing constraints in the predictable release of revenues and by improving access to private sources of capital, as well as through support to improved governance, by establishing more transparent and accountable LGU financial and administrative systems. The LGFBR will contribute to enhancing LGU ability to generate own revenues from local business taxes and real property taxes. C. Participation Process

Is there a stakeholder analysis? Yes No Is there a participation strategy? Yes No However, as part of the LGFBR process, extensive consultations were held with a wide range of stakeholders, including the private sector, civil society groups, and development partners. In addition, the Philippines Development Forum Working Group on Decentralization and Local Government provides for a continuous dialogue between the main stakeholders from the Government and the development partners.

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D. Gender Development Strategy to maximize impacts on women: The LGFBR has gender impacts through the promotion of participatory policy-making processes in local development councils that enable women to have a much greater say in decisions that affect their lives. The guidelines for the preparation of an annual gender and development plan and budget (Joint Circular No. 2004-1 by the Department of Budget and Management, National Economic and Development Authority, and the National Commission on the Role of the Filipino Women) provides guidance on the identification of gender-responsive programs, activities, and projects for inclusion in agencies’ gender and development budgets; and the formulation of performance indicators that will form the bases for monitoring and evaluating agencies’ accomplishments and achievements on gender and development. The advisory technical assistance (ADTA) and technical assistance (TA) on Local Governance and Fiscal Management Projecte and on Strengthening Provincial and Local Planning and Expenditure Managementf are helping in providing training and capacity building that target women. Has an output been prepared? Yes No

E. Social Safeguards and Other Social Risks Item

Significant/

Not Significant/ None

Strategy to Address Issues

Plan Required

Resettlement

Significant

Not significant

None

Implementation of the LGFBR will not require involuntary resettlement.

Full

Short

None Affordability

Significant

Not significant

None

The poor and vulnerable are expected to benefit disproportionately from the enhanced capacities of the LGUs to plan and budget for the general welfare of their constituent communities.

Yes

No

Labor

Significant

Not significant

None

It is expected that sustained economic growth will result in more jobs. The LGFBR does not envisage any changes to labor market policies.

Yes

No

Indigenous Peoples

Significant

Not significant

None

The LGFBR does not specifically target indigenous people and is not expected to have significant negative effects on indigenous people.

Yes

No

Other Risks and/or Vulnerabilities

Significant

Not significant

None

The livelihood of the poor and vulnerable is expected to be positively affected.

Yes

No

LGC = Local Government Code, LGFBR = Local Government Financing and Budget reform, LGU = local government unit, MDG = Millennium Development Goals, MTPDP = Medium-Term Philippine Development Plan, TA = technical assistance. a Oates, Wallace. 1999. An Essay on Fiscal Federalism. Journal of Economic Literature. Nashville. b NSCB/World Bank. 2005. Estimation of Local Poverty in the Philippines. Manila. c Ali, I and H. Son. 2007. Defining and Measuring Inclusive Growth: Application to the Philippines. ERD Working

Paper No. 98. Manila: ADB. d Balisacan. Arsenio. 2007. Local Growth and Poverty Reduction. In The Dynamics of Regional Development: The

Philippines in East Asia. Chelten. e ADB. 2006. Technical Assistance to the Republic of the Philippines for Local Governance and Fiscal Management

Project. Manila (TA 4778-PHI for $1.8 million) f ADB. 2004. Technical Assistance to the Republic of the Philippines for Strengthening Provincial and Local

Planning and Expenditure Management. Manila (TA 4512-PHI for $350,000)

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LIST OF INELIGIBLE ITEMS

No withdrawals will be made for the following:

(i) expenditures for goods included in the following groups or subgroups of the United Nations Standard International Trade Classification, Revision 3 (SITC, Rev. 3), or any successor groups or subgroups under future revision to the SITC, as designated by notice to the Borrower:

Table A7: Ineligible Items

Chapter Heading Description of Items

112 Alcoholic beverages 121 Tobacco, unmanufactured; tobacco refuse 122 Tobacco, manufactures (whether or not containing tobacco

substitute 525 Radioactive and associated material 667 Pearls, precious and semiprecious stones, unworked or worked 718 718.7 Nuclear reactors, and parts thereof, fuel elements (cartridges), non-

irradiated for nuclear reactors 728 728.43 Tobacco processing machinery 897 897.3 Jewelry of gold, silver or platinum-group metals (except watches and

watch cases) and goldsmiths’ or silversmiths’ wares (including set gems)

971 Gold, nonmonetary (excluding gold ore and concentrates) Source: United Nations.

(ii) expenditures in the currency of the Borrower or of goods supplied from the

territory of the Borrower; (iii) expenditures for goods supplied under a contract that any national or

international financing institution or agency will have financed or has agreed to finance, including any contract financed under any loan or grant from the Asian Development Bank (ADB);

(iv) expenditures for goods intended for a military or paramilitary purpose or for

luxury consumption; (v) expenditures for narcotics; (vi) expenditures for environmentally hazardous goods, the manufacture, use or

import of which is prohibited under the laws of the Borrower or international agreements to which the Borrower is a party; and

(vii) expenditures on account of any payment prohibited by the Borrower in

compliance with a decision of the United Nations Security Council taken under Chapter VII of the Charter of the United Nations.

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ADVISORY TECHNICAL ASSISTANCE

A. Purpose and Background 1. The purpose of the technical assistance (TA) is to support the Government in building institutional capacity in development and implementation of a medium-term reform agenda in local government financing and governance, and to facilitate the achievement of delivery targets/commitments in the Local Government Financing and Budget Reform (LGFBR) policy matrix. The Asian Development Bank (ADB) is also actively supporting, through many ongoing TA projects, the implementation of related local government reforms. These include establishing frameworks for provincial and other local government unit (LGU) planning processes, improving quality and availability of financial data on LGUs, improving creditworthiness of LGUs, exploring impediments in resource mobilization, improving public service delivery, and developing capacity in key oversight agencies. The TA will fill in any gaps in the ongoing assistance and specifically target the medium-term reform areas. B. Impact and Outcome 2. The TA strives to increase the efficiency and effectiveness of basic public services delivered by LGUs to their constituent communities. The expected outcome is the enhanced capacities of the LGUs to plan and budget for the general welfare of their constituent communities in a transparent and accountable way. C. Outputs 3. Coordination Committee on Decentralization (CCD). This will strengthen the coordination mechanism by establishing a CCD to promote, coordinate, and oversee decentralization reforms, including the changes envisaged in the LGFBR policy matrix through the following activities:

(i) Support the Department of Interior and Local Government (DILG) in the review of previous experiences with decentralization coordination bodies in the Philippines and other countries (e.g., Thailand) as well as in the analysis of relevant political economy issues in the Philippines.

(ii) Support DILG in discussions with other oversight agencies (National Economic and Development Authority [NEDA], Department of Finance [DOF], Department of Budget and Management [DBM]); the LGU Leagues; and other potential members to agree on the specific mandate, participants, and working arrangements of the committee. Relevant topics include issues covered in the LGFBR program matrix such as the rollout of the joint memorandum circular no. 1 (JMC), and implementation of decentralization at the local level. Other areas that can be addressed include horizontal and vertical equity issues of transfers, and other concerns raised by the LGU leagues.

(iii) Facilitate the work of the Committee in matters such as agenda setting, facilitation, documentation of meetings, dissemination of minutes, and drafting of recommendations on the direction of necessary changes in legislation based on guidance provided by the Committee and relevant implementation agencies.

(iv) Support evaluation of the work of the Committee at regular intervals.

4. Planning Guidelines and Capacity Needs Assessment. This will strengthen planning and budget management capacities at the city level by supporting the analysis of existing

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capacities for planning and budget management at city level, the development and pilot testing of revised planning and budgeting systems, and the preparation and dissemination of city planning guidelines. Attention will be paid to (i) the synchronization between city and provincial planning systems, (ii) development of mechanisms to ensure citizen voice and accountability, and (iii) a comprehensive assessment of existing capacities and capacity development needs in selected pilot cities. The following activities will be undertaken:

(i) Review the planning and budget management systems for provinces and cities and identify capacity development support needs drawing on existing studies, if necessary.

(ii) Conduct a capacity development needs assessment on city planning and budget management systems for up to three cities, utilizing tools that have been applied in other countries (such as Indonesia) and techniques that address institutional, organizational, and individual capacities.

(iii) Drawing on the findings of the needs assessments and existing performance measurement and accountability systems (such as the local government performance measurement system [LGPMS] and citizen report card surveys), recommend improvements to the city planning guidelines to address identified needs, and ensure citizen voice and accountability and gender mainstreaming by operationalizing pilot Local Development Councils (LDCs) with women and nongovernment organization (NGO) representation.

(iv) Provide on-the-job training to selected city government officials in the first round of implementation of the revised guidelines.

5. Refined LGPMS. This will strengthen the performance management system by supporting development of the LGPMS to be used as a tool to link access to intergovernmental transfers, grants, and capacity development support with service delivery performance. The following activities will be undertaken:

(i) Incorporate new local government financial performance monitoring system

(LGPFMS) indicators developed under the Local Government Finance and Budget Reform Project1 into the LGPMS manual covering both data capture and benchmarks.

(ii) Utilize LGPMS results in physical planning and investment programming (NEDA Provincial Guidelines developed under the TA on Strengthening Provincial and Local Planning and Expenditure Management, 2 in budgeting (DBM Updated Budget Manual), and financial resource mobilization (DOF).

(iii) Promote transparency on data gathering and utilization of LGPMS data through an annual LGU Performance Report similar to the annual financial performance report published by the Bureau of Local Government Finance (BLGF). This TA will design an LGU Performance Report template in coordination with the Local Governance and Fiscal Management Project.3

(iv) Utilize the LGPMS to develop LGU service standards useful for establishing investment priorities.

1 ADB. 2005. Technical Assistance to the Republic to the Philippines for the Local Government Finance and Budget

Reform Project. Manila (TA 4556-PHI for $850,000). 2 ADB. 2004. Technical Assistance to the Republic of the Philippines for Strengthening Provincial and Local

Planning and Expenditure Management. Manila (TA 4512-PHI for $350,000). 3 ADB. 2006. Technical Assistance to the Republic of the Philippines for Local Governance and Fiscal Management

Project. Manila (TA 4778-PHI for $1.8 million).

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(v) Utilizing the LGPMS, develop a framework for analyzing overall LGU performance by linking governance with revenue performance and service delivery performance in coordination with the Local Governance and Fiscal Management Project (footnote 3).

(vi) Review performance-based grants systems implemented in other countries and being discussed in the Philippines, and assess how well the LGPMS meets the needs of performance measurement systems to be used in performance-based grant systems.

(vii) Inventory and review of delivery systems for the capacity development and training of LGUs, with focus on LGFBR policy matrix needs and development of alternative modes.

6. The following training sessions, workshops, and meetings will be organized and conducted by the consultant team with administrative and secretariat support from DILG: (i) project inception; (ii) setting up of CCD; (iii) workshop on framework mechanism for use by CCD; (iv) discussions with CCD; (v) workshop on draft revised city planning guidelines; (vi) training on revised city planning guidelines; (vii) training on pilot testing of revised city planning guidelines; (viii) workshop on draft revised LGPMS manual; (ix) training on revised LGPMS manual; (x) workshop on assessment of capacity development needs in pilot cities; (xi) workshop on integrating LGPMS with NEDA, DBM, and DOF guidelines; (xii) training on use of LGPMS in planning, programming, budgeting, and financial resource mobilization; (xiii) workshop on draft LGU performance report template; (xiv) training on LGU performance report template; (xv) training on LGU service level standards; (xvi) training on linking LGU performance with governance, revenue performance, and service delivery; (xvii) workshop on LGU capability building and training delivery modes; and (xviii) project completion. D. Cost and Financing 7. The TA is estimated to cost a total of $1,100,000, of which ADB will finance $800,000 on a grant basis from the Japan Special Fund, funded by the Government of Japan. The cost breakdown is presented in Table A8. The Government will provide administrative and support costs, including salaries of counterpart staff, secretarial support, supplies, office accommodation, local transportation, miscellaneous costs for training courses, and per diems associated with attendance at such events not covered under this TA.

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Table A8: Cost Estimates and Financing Plan (’000)

Item

Total Cost

A. Asian Development Bank Financinga 1. National Consultants a. Remuneration and Per Diem 540.0 b. Local Travel 20.0 2. Equipment 22.0 3. Trainings, Seminars, and Conferences 90.0 4. Miscellaneous Administration and 38.0 Support Cost 5. Contingencies 90.0 Subtotal (A) 800.0 B. Government Financing 1. Office Accommodation and Transport 80.0 2. Remuneration and Per Diem 180.0 of Counterpart Staff 3. Others 40.0 Subtotal (B) 300.0 Total 1,100.0

a Financed by the Japan Special Fund, funded by the Government of Japan. Source: Asian Development Bank estimates.

E. Implementation Arrangements 8. The Executing Agency for the TA will be DILG. A project steering committee will consist of DILG, DOF, DBM, NEDA, and representatives of the League of Provinces, League of Municipalities, and League of Cities. DILG will coordinate with DBM, DOF, NEDA, the LGU Leagues, and participating LGUs. The project steering committee will meet quarterly to review written assessment of implementation progress and recommendations prepared by a technical review committee and discuss those with the ADB project officer. The technical review committee will also conduct the staff review of the TA’s outputs prior to the workshop with the project steering committee. 9. The Government will commit to the required counterpart funding in terms of the provision of suitably furnished office space, travel and meeting cost requirements not covered by the TA, staff resources, and workshop secretariat support. The TA will be implemented over 18 months commencing January 2008, with completion expected in June 2009. To implement the TA, the following consulting services will be required: 95 person-months of national consultants in the areas of local governance and decentralization; LGU financial resource mobilization; public administration and management; LGU performance assessment; LGU cost accounting; organizational restructuring; human resource management, including training design and execution; development financing, policy reform and advocacy, liaising with different tiers of government (including LGU Leagues), monitoring and evaluation, and participation; and information and communication technology. All recruitment and engagement will be undertaken in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time).

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10. Thirteen consultants (for 70 person-months), including the team leader, will be hired through a firm. Other consultants will be needed in the following areas: LGU financial resource mobilization; public administration and management, LGU performance assessment, LGU cost accounting, human resource management (including training design and execution), development financing, policy reform and advocacy. Three consultants (for remaining 25 person-months) will be hired on an individual basis, as the distinct areas of expertise involved may not be available through a single firm. The individual consultants will be the senior LGU advisor (18.00 person-months), the decentralization policy and change management specialist (5.75 person-months), and the gender specialist (1.25 person-months). The outputs of the TA will be monitored on the basis of program indicators and TA-specific output milestones. All the consultants will be national, as expertise needed in the output areas is available and sufficient. The outline terms of reference are in Supplementary Appendix B. 11. The following information and communication technology and related equipment will be procured by the consultants in accordance with ADB’s Procurement Guidelines (2007, as amended from time to time). All equipment purchased under the TA will be used by the consultant for the entire duration of the TA and will be transferred to DILG at the end of the project: (i) four desktop computers, (ii) four laptop computers, (iii) four printers, (iv) one server, (v) one heavy-duty copier, and (vi) one multimedia projector.