World Bank Document€¦ · enterprises; (iv) reducing the losses of the Agricultural Marketing Agency (CNP); (v) reducing public investment expenditures; (vi) increasing tariffs

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The World Bank

FOR OFFICAL USE ONLY

Report No. 12952

PROGRAM COMPLETION REPORT

REPUBLIC OF COSTA RICA

STRUCTURAL ADJUSTMENT LOANS I AND II(LOANS 2518-CR and 3005-CR)

April 12, 1994

Country Operations Division 2Country Department IILatin America and the Caribbean Region

This document has a restricted distribution and may be used bv recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EOUIVALENTS

Currency Unit = Col6n (c)US$1.0 = c 136 (December 1992)c 1.0 = US$0.0074

GLOSSARY OF ACRONYMS AND ABBREVIATIONS

CACM Central American Common MarketCAT Tax Rebate Certificate (Certficado de Ahorro Tributario)CET Central American Common External TariffCNP Agriculture Marketing Agency (Consejo Nacional de Produccion)CODESA State Holding Corporation (Corporaci6n Costarricense de Desarrollo)EDL Export Development LoanESL Export Sector LoanGATT General Agreement on Tariffs and TradeIS Industrialization through import substitutionIM Initiating MemorandumIMF International Monetary FundOECF Overseas Economic Cooperation FundPCR Program Completion ReportSOE Statement of ExpendituresTAL Technical Assistance Loan

FISCAL YEAR

January 1 to December 31

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.S.A

Offloo of Director-GeneralOperation. Evaiua±on

April 12, 1994

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Progran Completion Report on Republic of Costa Rica -Structural Adjustment Loans I and n (Loans 2518-CR and 300S-CR)

Attached is the Program Completion Report on Republic of Costa Rica - Structural AdjustmentLoans I and II (Loans 2518-CR and 3005-CR). Parts I and mI were prepared by the Latin America andthe Caribbean Regional Office. Part II was prepared by the Borrower.

The PCR provides a good and detailed account of the preparation and implementation of thesetwo SALs, and places it in the context of the highly gradual process of consensus-building in Costa Rica.Seven years elapsed from Board approval of SAL I to completion of SAL II. Coordination with the IMFwas close throughout.

The main objective of the adjustment program, supported by the Bank SALs, was a fundamentalchange in economic strategy by opening the economy to foreign competition, with emphasis on export-ledgrowth, and by reducing and redefining the role of the public sector. The action programs were wide-ranging. SAL I covered tariff reforn, export promotion, government finances, including privatizationof state firms and reducing the losses of the state Agrizultural Marketing Agency, and debt management.SAL II pursued further action in all of ihese areas while adding reforms iii agricultural pricing policiesand in banking.

Two themes stand out. First, the reform process encountered numerous delays and was muchslower than anticipated by the Bank. In the case of SAL I some of the conditionality was eventuallyrevised, while in the case of SAL II, two conditions on public finances had to be waived. The mainshortcoming for both SALs was in the public finance area, where the focus had been on aggregate targets,such as public savings, rather than on the underlying causes of public sector inefficiency and fiscalpressures. The latter are expected to be addressed in SAL III which has already been approved by theBoard. Second, the policy achievements in many areas, though delayed, have been substantial and therehave been no reversals in these cases. In terms of outcome, a striking development was the growth innon-traditional exports. In the above perspective the SALs may be rated as marginally satisfactory. Thesustainability of the reform process, however, is uncertain pending fundamental solutions to the fiscalproblem. The institutional impact has been modest.

The SALs will be audited by OED with special attention to the sustainability issue and to thereasons for Costa Rica's impressive export performance.

Attachment

|his doemmat ha a rted dsbutio ad may be usd by recipib only in the perfonue o dr offiaol dodo. Itscont| t my wot odtwiu be diclosed witbout World Bank authorization. l

FOR OFFICIAL USE ONLY

PROGRAM COM-LETION REPORT


SUCItURAL ADJlUSTMENT LOANS I AND II(LOANS 2518CR and 3005-CR)

TABLE OF CONTENTS

PREFACE ................................................. iEVALUATION SUNNMM RY ..................................... iii

Part I: PROGRAM REVIEW FROM THE BANK'S PERSPECTIVE .... ...... 1

Program Identity . .............................................. 1

I. INTRODUCTION ........................................... 1

II. MACROECONOMIC BACKGROUND ............................. 2

]II. STRUCTURAL ADJUSTMENT LOAN I ........................... 4A. Loan Preparation ....................................... 4B. The Structural Adjustment Program ........................... 7

a) Export Development and Trade Policy Reform .................. 7b) Public Sector Reform ................................. 9c) External Debt Management .............................. 11d) Conditions for Second Tranche Release ...................... 11e) Bank Technical Support for the Structural Adjustment Program ... ..... 12

C. Implementation and Results ................................ 12a) Review of Second Tranche Conditionality-November 1985 .... ....... 12b) Progress to June 1986 and Second Tranche Release ............... 13c) Overall Performance ................................... 15

IV. STRUCTURAL ADJUSTMENT LOAN II .......................... 18A. The Period between SAL I and SAL II ......................... 18B. Second Phase of the Structural Adjustment Program ................. 19

a) Trade Policy ........................................ 20b) Public Finances . .................................... 20c) Financial Intermediation .......... ...................... 21d) Agricultural Policy . .................................. 22e) Second and Third Tranche Release Conditions .................. 22

This document has a restricted distribution and may be used by recipients only in the performance of theirI official duties. Its contents may not otherwise be disclosed without World Bank authorization. l

TABLE OF CONTENTS (cont'd.)

C. Implementation and Results ................................ 23a) Effectiveness ....................................... 23b) Compliance with Second Tranche Conditionality ................. 23c) Compliance with Third Tranche Conditionality .................. 25d) Overall Performance .................................. 27

V. RELATIONSHIP WITH GOVERNMENT STABILIZATION POLICIESAND IMF . .............................................. 28

VI. EVALUATION OF THE GOVERNMENT'S STRUCTURAL ADJUSTMENTPROGRAM AND BANK SUPPORT .............................. 29

A. Overall Approach ...................................... 29B. Major Program Components ................................ 30C. Economic Performance ................................... 33D. Government Ownership ................................... 33E. The Bank's Performance .................................. 35F. Sustainability ......................................... 35G. Main Findings and Lessons Learned ........................... 35

Part II: SUtMMARY PROGRAM REVIEW FROM BORROWER'SPERSPECTIVE.....................37

A. Introduction . ......................................... 37B. The Bank's Performance .................................. 38C. The Borrower's Performance ............................... 39D. The Relations between the Bank and the Borrower .................. 40E. Performance and Relationship of OECF and the Borrower (SAL I1) .... .... 40

Part III: STATISTICAL INFORMATION ............................ 41

Basic Data Sheet-SAL I .................................... 41Basic Data Sheet-SAL II ................................... 42Related Bank Loans ....................................... 43

ANNEXES:

1: Costa Rica: Key Macroeconomic Indicators ........................ 452: SAL I: Matrix of Tranche Release Conditions and Actions Taken .... ....... 473: SAL II: Matrix of Tranche Release Conditions and Actions Taken .... ...... 55

ATTACHMEN

Program Review of SAL I and II Prepared by the Government of Costa Rica ... 59

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L~~~-I E

PROGuRAM CQNr1LETOEPOWRT

REUBLIC OF COSI RICA

(LOANS 2518-CR and 3005-CR)

PREFACE

This is the Program Completion Report (PCR) for the Structural Adjustment Loans (SAL) Iand II (Loans 2518-CR and 3005-CR). SAL I in the amount equivalent to US$80.0 million wasapproved by the Board on April 16, 1985 and SAL II in the amount equivalent to US$100.0 millionon December 13, 1988. The loan account for SAL I was closed on June 30, 1986, as scheduled inthe Loan Agreement and that for SAL II was closed on July 31, 1992 eighteen months behindschedule. Both loans were fully disbursed.

The PCR (Parts I and III) was prepared by the Country Operations Division 2, CountryDepartment H, of the Latin America and the Caribbean Regional Office. Part II is a summary basedon the Borrower's comprehensive PCR and approved by the Borrower. The PCR was discussed withthe Borrower and there were no significant differences in views on the information and analysispresented in the PCR.

Preparation of this PCR was based, inter alla, on the President's Reports, Loan Agreements,relevant economic and sector documents, information in program files, and discussions with Bankstaff and Costa Rican officials.

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EVALUATION SUMMARY

Background

i. In 1980-82, Costa Rica faced an economic and financial crisis without precedent since the1930s resulting from structural weaknesses of an inward oriented strategy and extensive Governmentinterventions in the economy, as well as inappropriate macroeconomic management in response toadverse external developments (see para. 3-5). Progress in social indicators decelerated and povertylevels worsened, and public finance inflexibilities resulted in cuts in public spending in social sectorsfrom 23 to 14 percent of GDP. Fiscal deficits to GDP reached unprecedented levels resulting indeteriorating balance of payments conditions, aggravated by sharp declines in terms of trade andcontraction of exports, especially to regional markets. External debt increased substantially tofimance fiscal and balance of payments deficits. Eventually Costa Rica accumulated arrears onexternal debt and, in August 1981, suspended most of its principal and interest payments to creditorsother than multinational institutions (see para. 5).

ii. In December 1981 the Government failed for a third time, since March 1980, to reach alasting agreement with the IMF due to lack of corrective measures on public finances-which in turndelayed Bank support. The new Administration, which took office in May 1982, undertookcorrective measures aimed at reducing fiscal deficits and resuming foreign public debt servicepayments. Partial payments of interest on Costa Rica's commercial debt were resumed in July 1982.In support of these initiatives the IMF approved a one-year Stand-by Arrangement on December 20,1982 while the Government reached an agreement with commercial and bilateral creditors on aninitial round of debt rescheduling (see paras. 6-7).

iii. Bank assistance was resumed with the Export Development Loan (EDL) approved by theBoard in May 1983 and aimed at supporting the Government's initial stabilization and debtnegotiation efforts (see paras. 14-15). The Bank assistance strategy had a long-run view of thestructural adjustment process and envisioned that a series of SALs would follow those initial efforts(see para. 13). The Technical Assistance Loan (TAL) supported the first SAL and prepared basicanalytical work needed for subsequent stages of the adjustment. The first SAL was approved, jointlywith the TAL, by the Board in April 1985 and closed in June 1986; and SAL II in December 1988and closed in July 1992. Both loans were fuilly disbursed (see paras. 1-2 and Part III).

Objectives

iv. The structural adjustment program supported by the two SALs aimed at achieving sustainedgrowth through a reorientation of the country's development strategy. This was to be achieved by

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opening the economy to foreign competition and encouraging exports, and by redefining the role ofthe public sector, moving it away from direct involvement in productive activities and limitingintervention in key markets (see paras. 16 and 19). In a first stage, the reform process aimed toreduce the anti-export bias of the trade regime, increase public sector efficiency, and reestablishcreditworthiness. A second stage supported economic recovery by continuing trade policy reformand public sector reform, and improving efficiency of financial intermediation and agriculturalpolicies (see para. 20).

v. The Government's program under SAL I focused on external trade liberalization and publicsector reform. The main actions in trade reform were: (i) maintaining an exchange rate policyconsistent with the IMF Stand-by Arrangement; (ii) replacing specific rates for ad valorem tariff ratesand reducing of tariff levels and ranges; (iii) reducing export taxes; and (iv) increasing incentivesto exporters. The main actions in public sector reform were: (i) limiting public employment andwages; (ii) reducing earmarking; (iii) privatizing Costa Rican Development Corporation (CODESA)enterprises; (iv) reducing the losses of the Agricultural Marketing Agency (CNP); (v) reducing publicinvestment expenditures; (vi) increasing tariffs and prices of public enterprises (see paras. 21-38).

vi. The Government's program under SAL II aimed at deepening the reforms started in SAL Iand extending the scope of reforms in the areas of the financial sector and agricultural policies. Themain actions were: in trade reform: further reduction of average tariff rates and tariff ranges; andmeasures to rationalize the export incentive system; in public finances: to divest 41 CODESAenterprises and not to add new legislation establishing earmarked tax revenues; and in financialintermediation: to gradually expand private bank activities, reduce the share of loans overdue, avoidgeneralized domestic debt rescheduling, reduce the spread on outstanding subsidized credit, andstrengthen the regulatory powers of the Superintendency of Banks (see paras. 59-70).

Design, Implementation and Results

vii. The design of the SALs aimed at addressing the structural weaknesses underlined by theseriousness of the financial problems faced by Costa Rica in the early 1980s. The design problemsof the SALs can be largely ascribed to insufficient Bank and Borrower experience with the designand implementation of early structural adjustment programs (see paras. 17 and 53). SAL I focusedon policy changes in some critical areas, notably trade policy reform, but lacked a comprehensiveapproach to structural reform and some specific conditionality was deficient. Design issues weremore pronounced concerning the reduction of CNP losses as neither the Bank nor the Governmenthad defined clear means to achieve the targets, and on public sector employment as there was noemployment base to be monitored nor evaluation mechanisms the Government would use toimplement the employment freeze which in the event could not be enforced fully (see paras. 29, 32,42, and 43). The design of SAL II clearly benefitted from the experience of SAL I (see para. 61).Design, and consequently implementation, was satisfactory in agriculture and foreign trade, but therewere problems in targeting the level of public savings as there were no specific measures requiredto achieve the savings target (see paras. 8649). In the event the Bank decided to grant a waiverand fall back on the IMF's assessment that the Government was addressing fiscal imbalances.

viii. The design of the SALs, however, did focus on the main structural problems faced by theCosta Rican economy and progressively expanded the scope of reforms (see paras. 54 and 89). An

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open trade regime is the primary means to improve resource allocation, provide access to newtechnology, and create a dynamic economic environment needed to finance social development.SAL I initiated foreign trade liberalization in Costa Rica and provided momentum for a similarprocess in other Central American countries (see para. 52). The expansion of public employmenthas been the main source of public finance imbalances and without the efforts made in SAL I it islikely the fiscal imbalances would have been much more severe (see para. 53). Divestiture ofCODESA enterprises and subsidiaries would significantly reduce public finance imbalances, as theseoperations accounted for up to 20 percent of public deficits, and reduce inefficiencies (see paras.44, 48 and 99). And limiting CNP losses attempted to reduce fiscal imbalances as well as reducingdistortions in agriculture (see para. 32). The design of SAL II appropriately included continuationof trade policy reform, and more importantly initiated reforms in the banking sector and agriculturalpolicy (see para. 61).

ix. Implementation of the SALs took longer than initially anticipated by the Bank (see paras. 71and 85). The process posed difficult trade-offs and decisions for both the Bank and the Government(see paras. 46-47, and 78). Both maintained intensive consultations to identify critical policyreforms and to reach the consensus needed for Legislative approval, required by the Constitution,of the programs and their implementation. The experience of the two SALs, also, indicates thatreaching consensus may lengthen the period to initiate and implement policy reforms but tends toprevent reversals when conditionality is well defined, appropriate and shared by both parties (seeparas. 88-89, 112-114).

x. The main accomplishment of the two SALs was to help begin and strengthen the process ofreorienting Costa Rica's development model. The process was by no means completed with SAL II,but substantial progress was achieved and structural reform has continued and deepened during thepast two years. Specific achievements are discussed in detail in the sections on overall performance(see paras. 49-54, 8549) and can be summarized as follows: (i) as a result of trade reform, theeconomy is now relatively open, with a more diversified export base and less protected domesticsector; (ii) Costa Rica took the early lead in promoting trade reform in the region; (iii) the relativesize and scope of the public sector have been reduced, and Government engendered distortions inkey markets have been significantly curtailed; and (iv) the private sector has expanded its role in thefinancial sector and prudential regulations have been strengthened. Progress in social indicators andimproving of poverty alleviation, having weakened with the crisis of the early 1980s, was resumedduring the period of the programs following closely the pace of economic growth.

xi. The main limitations of the SALs were in not addressing in a more comprehensive way twocritical areas in Costa Rica's economy: public sector reform and the role of the state-owned bankingsector (see paras. 53, 65, 100, 103). The former is being addressed under SAL III approved by theExecutive Directors in April 1993 and there are indications of an emerging domestic consensus onthe need for privatization of state banks.

Sustainability

xii. Sustainability needs to be addressed on two levels: first, the sustainability of specificmeasures or conditions required by the adjustment operations; and second, the sustainability andcontinuity of the overall adjustment process over the longer term. Although SAL I faced difficult

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implementation problems and a number of second tranche measures had to be redesigned, specificreforms, once agreed, were sustained (see paras. 46 and 54). In SAL II some delays wereencountered in implementation of second tranche conditions and a waiver was required for the publicsavings target, but once implemented reform measures were sustained (see para. 85). For bothSALs there has been no backtracking on reform actions.

xiii. Experience with the sustainability of the overall adjustment process has been positive to date.SAL I begun the process of structural adjustment, which was continued and deepened in SAL II.The process has continued beyond SAL II, with the recent Board approval of SAL III which would:(i) complete the trade reform effort envisaged at the start of the SAL process; (ii) carry out acomprehensive restructuring of the role and functions of the state; (iii) further deepen financial sectorreforms; and (iv) complete the process of domestic trade deregulation.

Findings and Lessons Learned

xiv. Overall the Bank support for Costa Rica's structural adjustment process through the twoSALs has been justified and effective, despite some important shortcomings such as those in the areaof public sector reform. Throughout the process, the Bank has approached the structural reformprocess in Costa Rica with a great deal of flexibility and has been effective in tailoring the SALinstrument to the country's special circumstances. In particular, the Bank accepted the need toimplement reforms in a gradual manner and its judgement on overall Government commitment andability to implement reforms has been generally correct. The marked improvement in economicperformance, especially in 1992, has been a strong indicator of the success of the reforms.

xv. The main a mplishments of the SALs, discussed in detail in the subsections on overallperformance, were: under SAL I, trade reform, changing the activities of CNP, addressing publicemployment, and safeguarding the privatization of CODESA (see paras. 4748, 52-53); and underSAL II, initiating reforms in financial intermediation and agricultural pricing policy reforms whilecontinuing trade reform (see paras. 86 and 88). Structural reforms progressed gradually and theadjustment process was maintained.

xvi. The main limitations of the SALs were addressing in a more comprehensive way twocritical areas in Costa Rica's economy: public sector reform and financial sector reform. Regardingpublic sector reform the SALs were in line with the trend on institutional matter then prevailing inthe Bank -focusing on a few institutions or processes identified as priority problem areas. Theselimited the costs of the public sector inefficiencies and some of its financial imbalances but onlytemporarily since the programs lacked a comprehensive framework to address the structuralweaknesses of the public sector (see para. 87). Regarding the financial sector reform these werelimited by the political economy of the sector reflecting the Bank's cautious approach to reform ofthe banking system (see paras. 103-105). These measures, however, contributed significantly tobroadening the scope of reforms of the financial sector needed to support structural adjustment ofproductive sectors.

xvii. TUe experience of the SALs once again confirms that there is no substitute for a strongpolitical commitment to the process of economic reforms. How to ensure this commitment in asociety such as Costa Rica's, however, is a difficult question. Clearly, program implementation was

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affected by the political cycle, but it is difficult to see what additional steps, if any, the Bank couldhave taken to ensure that a bi-partisan commitment was in place before proceeding with the SALs(see paras. 46, 71, 85). In the final analysis, since the Bank can only deal with Governments, itmust rely on its own judgment that the objectives and design of the reform program effectivelyaddress country constraints and priorides. This is the only guarantee the Bank can have that a newAdministration will be equally committed to the reform program. In addition to an appropriatedesign, the Bank must demonstrate flexibility and realism in evaluating progress toward agreedobjectives (see paras. 54, 8849). The experience in Costa Rica suggests that the politicalcommitment, albeit wavering at times, has been sustained and that the Bank demonstrated sufficientflexibility in assessing performance in overall program implementation. The two SALs straddledthree Administrations and the Bank managed to correct the more important flaws in program designin order to ensure continuity of the adjustment process.

xviii. The most important lessons, for future operations, are:

a) The Bank needs to emphasize that the objectives and design of the reform programeffectively address the country's fundamental constraints particularly when programimnplementadon can be affected by the political cycle.

b) Program objectives need clearly specified actions idendfied as conditionalities forsuccessful implementation.

c) In addition to an appropriate design, the Bank needs to demonstrate flexibility andrealism in evaluadng progress towards agreed objectives while maintaining credibilityin the actions that would follow non-compliance.

d) The experience of the SALs reviewed here once again confirms that there is nosubstitute for a strong political commitment to the process of economic reforms toensure proper design and successful implementation of a program.




Part I: PROGRAM REVIEW FROM THE BANK'S PERSPECTIVE

Program Identity:

Names Structural Adjustment Loans I and IILoan Numbers : 2518-CR and 3005-CRRVP Unit Latin America and the CaribbeanCountry : Costa RicaSector : Non-Project Lending

I. INTRODUCIION

l. To assist the Government of Costa Rica in addressing the serious economic problemsemerging from the 1982 crisis, as well as the structural deficiencies accumulated in prior years, theBank supported the country's structural adjustment program through:

a) An Export Development Loan (EDL; Loan 2274-CR), which was approved on May 3,1983, for $25.2 million, to provide, through a revolving fund mechanism, the foreignexchange needed by exporters to pay for their imported inputs;

b) The First Structural Adjustment Loan (SAL I; Loan 2518-CR), approved on April 16,1985, for $80 million aimed mainly at supporting improvements in the fiscal situation;privatizing industrial state enterprises; strengthening the public sector investment program;and reforming trade and industrial policies;

c) A Technical Assistance Loan (TAL; Loan 2519-CR), for $3.5 million, approved jointlywith SAL I and designed to help implement the reforms supported by the Loan and to carryout preparatory work to support follow-up adjustment lending; and

d) The Second Structural Adjustment Loan (SAL II; Loan 3005-CR), which was approvedon December 13, 1988, for $100 million, to support policy reforms aimed mainly at reducingeffective protection, promoting exports, eliminating price and interest rate subsidies, andstrengthening the financial system and the Government's fiscal position.

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2. This Program Completion Report (PCR) covers SAL I and II. Since PCRs for the EDL andTAL operations have already been prepared,' only some references are made to them here to takeinto account the fact that these four loans were closely related, as important vehicles of Bank supportfor Costa Rica's adjustment efforts in the 1980s. Part I of the report is organized in the followingway: Section II includes a summary macroeconomic analysis of the economy during the periodleading up the first structural adjustment operation; this macroeconomic section provides aframework for the analysis of SAL I and SAL II performance in Sections III and IV, respectively;Section V discusses the role of stabilization policies and the IMF during the adjustment period; andSection VI summarizes the main conclusions reached and lessons learned in the analysis of the SALprograms, as well as of some relevant aspects of the Bank's EDL and TAL operation. Part IIincludes the views of the borrower on both SALs.

II. MACROECONOMIC BACKGROUND

3. In 1980-82, Costa Rica faced an economic and financial crisis without precedent since the1930s. After growing by less than 1 percent in 1980, real GDP declined by 2.3 percent in 1981 andby more than 7 percent in 1982. Inflation accelerated from 18 percent in 1980 to more than 90percent in 1982. Real wages fell during 1980-82 to about 30 percent of the 1976 level and openunemployment increased from 5.9 percent in 1980 to 9.4 percent in 1982.

4. The crisis resulted from structural weaknesses in the economy, as well as inappropriatemacroeconomic management in response to adverse external developments. The terms of tradedeteriorated sharply with the fall in coffee prices in 1978 and continued with the second oil shockin 1979. Demand for Costa Rica's exports, especially to the Central America Common Market(CACM), also declined rapidly. However, the main cause of the crisis was the adoption ofexpansionary demand policies, as the Government's initial response to the fall in real incomes wasto increase public spending, financed by domestic and external borrowing. The overall deficit ofthe non-financial public sector (excluding Central Bank losses), already close to 9 percent of GDPin 1979, increased to 13.3 percent in 1980 and averaged 13.5 percent in 1981-82.

5. The exchange rate, fixed for many years, became significantly misaligned contributing tosubstantial capital outflows and a deteriorating balance of payments. External debt doubled rapidlyfrom about $1.4 billion in 1978 to $2.8 billion in 1982 to finance fiscal and balance of paymentsdeficits. Debt service increased sharply as external borrowing expanded and international interestrates rose. The external public and publicly guaranteed debt service ratio, which had averaged about10 percent of exports during 1970-77, increased to about 27 percent in 1979. The cost of servicingthis debt became unsustainable and Costa Rica began to accumulate arrears in 1980 and early 1981.In August 1981 the Government suspended most of its principal and interest paymnents to creditorsother than multilateral institutions. Despite the seriousness of the situation, the Government failedthree times (between March 1980 and December 1981) to reach a lasting agreement with the IMF,mainly because of its inability to control public spending.

1 PCR of EDL, April 18, 1988; PAR of EDL, Report No. 7779, May 10, 1989; PCR of the TAL mubmiited toOED on June 24, 1992.

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6. The new Administration, which took office in May 1982, took a number of measures aimedat containing inflationary pressures and resuming foreign public debt service payments. TheGovernment introduced new taxes, adopted a flexible exchange rate policy, raised tariffs of publicutilities and increased the price of petroleum derivatives. Partial payments of interest on CostaRica's commercial debt were resumed in July 1982. In support of these initiatives the IMF approveda one-year Stand-by Arrangement on December 20, 1982 while the Government reached anagreement with commercial and bilateral creditors on an initial round of debt rescheduling.

7. Public finances and overall economic performance improved in 1983. The overall deficit ofthe non-financial public sector fell from about 14 percent of GDP in 1981 to 3.6 percent in 1983.By the end of 1983 the exchange rate was unified at the higher free market rate and there was somerepatriation of private capital, somewhat improving the net international reserve position of theCentral Bank. Inflation declined from 90 percent in 1982 to about 33 percent in 1983 (consumerprice index) and real GDP grew by 2.4 percent. By the end of 1983 Costa Rica had eliminatedalmost all external debt arrears.

8. Despite progress in 1983, serious problems persisted. Exports fell and the current accountdeficit remained high at about 11 percent of GDP in 1983. Although economic growth resumed,open unemployment remained at about 9 percent. Domestic credit to the public sector was higherthan targeted, power tariff increases were partially rescinded in mid-1983, and public sector agenciesfailed to service their debt obligations with the Central Bank. Central Bank losses, arising mainlyfrom interest and exchange rate losses, reached 5.6 percent of GDP in 1982 and 4.9 percent in 1983.Central Bank losses, which represented additional credit to the public sector, largely offset thecontractionary effects of lower public sector deficits.

9. Fiscal, monetary and balance of payments performance deteriorated in the first half of 1984and Costa Rica faced a foreign exchange liquidity crisis which was temporarily resolved through astandstill arrangement with foreign commercial banks and additional U.S. bilateral assistance. TheGovermnent implemented a package of tax and balance of payment measures in mid-1984, includingincreases in selective consumption taxes, a 10 percent tax on imports previously exempted, changesin the corporate income tax, and a 0.5 percent administration charge on tax revenues collected bythe Government on behalf of other public entities. The monetary measures included increases in thebasic deposit rate, establishing a marginal reserve requirement of 50 percent, and increasing localcurrency deposit requirements for all requests for foreign exchange from 50 to 100 percent.

10. These measures led to a marked improvement in 1984. GDP growth shot up to 8 percent,the non-financial public sector deficit decreased to 1.6 percent of GDP (5.9 percent including CentralBank losses), and inflation dropped to 12 percent. The weak point remained the balance ofpayments. Although the current account deficit decreased in 1984, at 7.6 percent of GDP itremained high and exports showed little dynamism.

11. Costa Rica's 1980-82 economic crisis, the Government's attempts to restore macroeconomicequilibrium through ad hoc stabilization measures and the still fragile extemal position set the stagefor a redefinition, albeit gradual and tentative, of the country's development strategy. A politicalconsensus began to emerge on the need to reorient the economy, away from its inward orientationand dependence on preferential access to regional markets, toward an export-led economy that could

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compete in markets outside Central America. Coupled with this was the perceived need to containthe overexpansion of the State, reduce distortions caused by Government intervention, and deal withthe pressures which had led to expansionary fiscal policies. Although Costa Rica's then prevailingdevelopment model of industrialization through import substitution and accompanying extensiveGovernment interventions in the economy was being seriously questioned, there was also a strongdomestic consensus on the need to implement change in a gradual manner that would not underminethe country's impressive economic and social development achievements.

III. STRUCTURAL ADJUSTMENT LOAN I

A. LOAN PREPARATION

12. In 1980, shortly after the Bank started its structural adjustment lending, the Government andBank staff started to discuss the possibility of Bank support for a structural adjustment program inCosta Rica. Bank assistance for this purpose was formally requested by the Govermnent during the1980 Board of Governors meeting. Since at that time, the likelihood of adopting the requiredpolicies was highly doubtful (for instance, the Government was not complying then with a Stand-byagreement reached with the IMF in March 1980), the initial Bank response was justifiably cautious,and the Bank suggested to intensify its policy dialogue to ascertain whether SAL-type lending wasa viable option.

13. By mid-1981, serious concerns were raised by Bank managers regarding Costa Rica'screditworthiness. It was then decided to intensify the policy dialogue, starting iimmediately (througha July 1981 mission) with Bank assistance for the preparation of a structural adjustment program andof a quick-disbursing export development operation, which would support some of the required initialpolicy reforms. It was expected then that Bank assistance would be closely coordinated with theIMF, which had agreed on a new Stand-by Arrangement with the Government in June 1981. InAugust 1981, Costa Rica suspended the servicing of its commercial and bilateral debt. In November1981, the LAC Region submitted an Initiating Memorandum (IM) to Bank Management, whichproposed several stages of Bank assistance to the structural adjustment process, starting with anExport Sector Loan (ESL) to be followed by a series of SALs. The IM envisaged an ESL withsubstantial policy conditionality, covering: (i) appropriate exchange rate management; (ii) reductionor elimination of export taxes; (iii) simplification of export procedures; (iv) elimination of traditionalexport quotas; (v) interest rate adjustment to reduce subsidies and and-saving biases; (vi) anacceptable stabilization program; (vii) auditing and restructuring of the public commercial banks; and(viii) establishment of a discount facility to channel foreign currency resources to exporters. TheIM proposed that conditionality for the first SAL would include: (i) further interest rate increases;(ii) continuation of the stabilization program; (iii) reform of pricing and marketing policies; and (iv)improvements in public sector management. The conditionality of the ESL would concentrate ontrade policy and selected financial policy issues, while the SAL would focus on other key policyareas and in the continuation of reforms initiated with ESL support. It should be noted that the mostimportant of the required trade policy reforms-the reduction in the level and dispersion of tariffprotecdon-was not included in the proposed conditionality of either loan, since it was notconsidered feasible to obtain quickly the regional Central American consensus that would be

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required. The IM suggested, however, that the processing of the first SAL would include a reviewof effective protection.

14. The economy continued to deteriorate in 1981 but the Carazo Administration made noprogress in either stabilization or some of the preliminary reform measures that would have beenrequired to process the ESL and SAL operations. During this period there was no effective policydialogue with the Administration and the Government lacked the political will to confront the seriouschallenges facing the economy. The new Administration, which had taken office in May 1982,however, gave high priority to starting the reform process. The Government's economic team andthe Bank recognized the need to move quickly on stabilization and debt negotiations. By the end of1982, the new Administration had put in place a new stabilization program supported by the IMFand discussions also intensified on the possible SAL from the Bank. Since the formulation andadoption of the structural reform program to be supported by the SAL would take quite sometime,as well as the urgent need to increase foreign exchange inflows and assist Costa Rica deal with itsexternal debt problem, the Government and the Bank decided to give priority to processing quicklythe ESL that had been originally proposed in late 1981, with an important difference-no policyconditionality was attached to the operation, which was then renamed 'Export Development Loan'(EDL). The EDL was essentially a vehicle to transfer resources quickly to the country and todemonstrate Bank support for the Government's initial stabilization and debt negotiation efforts.Although the EDL was the first step in the adjustment process, it was treated more as an investmentproject with conditionality limited to project-related matters and not an adjustment operation. TheBank and the IMF were also active in assisting Costa Rica to work with the commercial banks andin presenting its case to the Paris Club in January 1983.

15. The EDL was approved by the Bank Board in May 1983, and was expected to disbursequickly, through a revolving foreign exchange fund which would finance imported inputs requiredby exporters. However, performance under this loan left much to be desired. The expected quickdisbursing of loan funds did not materialize owing to: (i) design deficiencies associated mainly withan overestimation of the demand for foreign exchange funds by exporters; and (ii) delays in therequired approval by the Legislative Assembly, which made it necessary to postpone loaneffectiveness until March 1984. The loan was not fully disbursed until December 1985. Theproblems affecting implementation of the EDL-which were analyzed in the PCR dated April 18,1988, and in the OED Program Performance Audit Report dated May 10, 1989-also contributedto the substantial delays affecting preparation of the SAL in 1983 and 1984.

16. Given Costa Rica's overall economic situation, before a SAL could be appraised it wasnecessary for the Government to adopt a number of important economic policy decisions aimed atstabilization and reestablishing Costa Rica's creditworthiness. The formal preparation of SAL Istarted during a Bankl mission which visited Costa Rica in June-July, 1983. In January 1984, aftersubsequent consultations with the Government and within the Bank, it was decided to appraise thisloan once: (i) the then ongoing negotiations between Costa Rica and the IMF had been satisfactorilycompleted; and (ii) there were reasonable prospects for Costa Rica obtaining the requiredconcessional assistance from other donors and furtier commercial debt relief. It was decided thatthe minimum SAL program should include: (i) reallocation of resources between the public andprivate sectors, including agreement on the composition and size of the public investment programand ceilings on total public sector employment; (ii) strengthening of public sector management,

especially improving the efficiency of major state enterprises of the Costa Rican DevelopmentCorporation (CODESA) and eliminating CODESA's access to Central Bank credit; (iii) exportpromotion and rationalization of the trade regime; and (iv) resource mobilization. In addition to thestandard fiscal and tariff policy conditionality, the IMF was expected to have primary responsibilityfor reaching agreement with the Government on the following issues: interest rate policy; subsidies;credit ceilings and controls for the banking system; and exchange rate policy. It was also decidedto explore further the scope for improving Costa Rica's trade regime vis-d-vis third countries, eitherunder the CACM regime or otherwise. The Bank decided, moreover, that key SAL conditionsrequiring a Legislative Assembly decision would have to be approved by the Assembly before BoardPresentation. The Bank's Technical Assistance Loan (TAL) would include support for SAL Iimplementation, as well as preparatory work to support future adjustment lending.

17. The processing of SAL I, after the authorization to appraise had been given to the Regionwas long and difficult, taking one full year from appraisal to negotiations, which were completed inFebruary 1985. This was due largely to the following reasons:

a) The initial design proposal for SAL I does not seem to have been based on a clearanalysis, both by the Bank and the Government, of the impediments to sustained growth,the measures to overcome them, and their sequencing. These shortcomings, which werepointed out in an internal note by the Regional Vice President dated November 26, 1984,were addressed through the country economic work undertaken subsequently by Bankstaff and reflected in the SAL I President's Report.

b) An important factor contributing to the lengthy preparation of SAL I was a lack ofeconomic leadership caused in large measure by a change in the Government's economicteam. Although the Government took some important steps to stabilize the economy, themomentum for structural reform slowed with the departure of the Central Bank President.

c) The adoption of policy reforms which, by their nature, often are unpopular or affectpowerful political and/or economic interests, generally takes a long time in Costa Rica,because of the need to achieve national consensus and the protracted approval process ofthe Legislative Assembly.

d) Some of the key reforms supported by SAL I also faced obstacles posed by priorcommitments made by Costa Rica at the regional level, in the framework of the CACM.

18. The combination of the above factors made it necessary for the Bank to modify its positionin several important aspects during SAL I processing. For instance, at the time of the InitiatingMemorandum, it was envisaged that the maximum nominal tariff level would be reduced from 220percent (a level determined by the Central American Common External Tariff [CETI) to 50 percent,and that effective protection would be also reduced by eliminating exemptions and increasingminimum tariffs on imported inputs and capital goods. The Bank reconsidered its position in theserespects, resulting in a program which included smaller tariff reductions and which was aimed at"reducing effective protection to a maximum level of 120 percent by 1990."

- - - - - --_- -- - - - - - - - - -

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19. The above difficulties notwithstanding, the overall policy reforms adopted by Costa Ricaduring 1982-85 constituted a significant change in the direction of economic policy, and an importantfirst stage of the structural reform process. These measures-many of which were associated withBank conditionality for appraisal, negotiations and Board presentation-are listed in the secondcolumn of the SAL I policy matrix (Annex 1) and included: (i) Export promotion and trade: amore realistic and flexible exchange rate policy; the establishment of a revolving Export FinancingFund; the elimination of export taxes on non-traditional exports to third markets; the introductionof an improved drawback mechanism; and agreement on a new regional tariff treaty; (ii) Publicsector resource mobilization: measures aimed at increasing current revenues by 7.5 percentagepoints of GDP during 1982-85; and increases in public utilities and petroleum prices; and (iii) Publicsector management and efficiency: reduction of public sector investment expenditures from 10percent of GDP in 1981 to 6.4 percent in 1983, and to no more than 6.5 percent in 1984-86; a 1984-86 freeze on public sector employment levels; reorganization of CODESA and privatization of itsenterprises; and measures aimed at reducing the Agricultural Marketing Agency (CNP) losses byone-half in 1985.

B. THE STRUCTURAL ADJUSTMENT PROGRAM

20. SAL I was approved by the Bank Board in April 1985. The adjustment program it supportedaimed at overcoming what both the Government and the Bank considered to be the criticalimpediments to the resumption of sustained growth: (i) the anti-export bias of the trade regime,which had resulted in the development of an inefficient, import-intensive industrial sector, orientedmainly to national and regional import substitution activities, at the expense of fostering exports toextra-regional markets; (ii) a too large public sector, and an inefficient control of its expenditures,which restricted the resources available for private sector development; and (iii) the country'sextremely high external debt service requirements, and the related need for large external financialassistance and for effective control of new indebtedness. The first phase of the structural adjustmentprogram--the phase supported by SAL I-focused on these areas. It was anticipated at the time thatadditional adjustment phases-to be supported by subsequent SALs-would deal with three otherareas: the banking system, the policy framework in agriculture, and the cost-effectiveness of thesocial security, health and education sectors. TAL included basic analytical work that would beneeded to support subsequent reforms in these areas.

a) Export Development and Trade Policy Reform

21. The first phase of the Government's Structural Adjustment Program, concerning trade policy,aimed at promoting rapid and sustainable growth of extra-regional exports, with emphasis on non-traditional products. The SAL I President's Report identified the main obstacles to the rapiddevelopment of new extra-regional exports as: "(i) a policy framework which biases the incentivesystem (exchange rate, tariff regime, export taxes, etc.), toward regional import substitution, wheremarkets are better known and quality controls are less stringent; (ii) the small size of locally ownedindustries, which are mainly operated by family oriented entrepreneurs who tend to avoid riskingtheir own funds and have limited marketing skills for a successful export drive; (iii) the fact thatmany large firms have significant transnational participation, which may cause difficulties inexporting outside the region, depending on the policies of the parent corporation and the existenceof sister plants in the importing countries; (iv) the weak financial position of firms affected by the

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traumatic events of 1980-82; and (v) the higher freight costs and delivery delays associated with thelack of direct sea freight services to markets outside the region. ' To address these problems, theadjustment program focused on: (i) an exchange rate policy consistent with the IMF Stand-byArrangement; (ii) the tariff regime; (iii) export taxation; and (iv) other export incentives andpromotion measures. The action programs adopted in those four areas are summarized below.

22. Exchange Rate. The Government would maintain its flexible exchange rate policy, with theCol6n being adjusted as needed to improve export competitiveness. In addition to the adjustmentsthat had already been made in 1984 and 1985, further devaluation would take place during theremainder of 1985, within the framework of the IMF Stand-by Arrangement. The Bank wouldmonitor the competitiveness of exports.

23. Reform of the Trade Regime. This was considered as the most important long-term policyreform supported by SAL I, although its agreed goals were less ambitious than those initially soughtby the Bank. This component was being implemented through modification of the CET and relatedfiscal incentives, which already had been initiated at the regional level, and for which theGovernment was playing a leading role. In December 1984, the five countries of the regionapproved a new tariff and customs treaty which, at the time of Board approval of SAL I, had alreadybeen ratified by four countries, including Costa Rica and was expected to be put in effect not laterthan October 1, 1985. The modifications to the CET system agreed at the regional level included:

a) adoption of the Brussels nomenclature, and the transformation of the system to an advalorem basis, eliminating existing specific duties;

b) elimination of all exemptions on raw materials, and intermediate and capital goods;

c) elimination of regional investment incentives;

d) creation of a Central American Council for Tariffs and Customs, with authority toestablish and modify region-wide import tariffs;

e) new tariffs for raw materials, intermediates and capital goods, which would be raised toa range of 5-10 percent for non-competing items (i.e., those items not produced inCentral America), and to 20 percent for competing ones (i.e., those produced in CentralAmerica); and

f) new tariffs for all finished consumer goods not produced in Central America (non-competing), which would be reduced to a 5-10 percent range.

24. The Government agreed to implement these reforms before the release of SAL I secondtranche. In addition, the Government committed itself to seek regional agreement on further tariffreform measures, and to enact these measures at the national level if no regional agreement wasobtained. These additional reforms, which would also be enacted before second tranche release,included: (i) tariffs for non-competing capital goods would be raised to 20 percent, while the tariffsfor non-competing raw materials and intermediates would be 10 percent in all cases; and (ii) tariffsfor competing final goods would be reduced from a range of 40-220 percent to 35-70 percent. The

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Government also agreed to seek further tariff reforms at the regional level to reduce the maximumeffective protection level to no more than 120 percent by 1990, and to undertake-with support tobe provided by the TAL-a detailed analysis of the impact of the new trade regime, in order toidentify further changes that might be necessary.

25. Export Taxes. The Government had reduced export taxes substantially in 1983-84, byeliminating all taxes on non-traditional exports to third markets (which had been 4 percentpreviously); and by reducing the specific banana tax from $1.00 to $0.75 per box, and the tax onbeef from 4 to 1 percent. While some export taxes (mainly on coffee and bananas) remained at highlevels, these reforms were an important step in the process of reducing the prevailing anti-exportbias. In the context of SAL I, the Government also indicated that it did not plan to introduce newexport taxes on non-traditional exports to third markets.

26. Other Export Measures. The Government had already adopted a series of measures toincrease incentives for non-traditional exporters to extra-regional markets, including: (i) exemptionof taxes for imported inputs required by those exporters; (ii) an income tax exemption equivalent toa subsidy of 10 percent of the value of non-traditional exports; (iii) the streamlining of pre-existingtax rebates (the CAT system) to make them more automatic and to expedite payment of the rebatesby the Government; and (iv) a new package of additional subsidies and other benefits for exportersagreeing to specified increases in their export levels. The Government also agreed as a conditionfor second tranche release, to complete preparation of a comprehensive assistance program for theexport-oriented modernization of industrial enterprises.

27. The Structural Adjustment Program originally included a component for Industrialmodernization to be developed under the TAL. The TAL was to develop a program to assistindustries to modernize, including a detailed analysis by industrial sub-sector of specific needs forupgrading plant and equipment, financial assistance, technical support and training programs formanagement and labor. The actual analysis, however, addressed the issues of industrialmodernization through the effects of trade policy reform and the focus of the program was adjustedaccordingly.

b) Public Sector Reform

28. The Government and the Bank shared the view that the public sector's size, its inefficiency,and the share of resources that it consumed, constituted major impediments to growth. TheGovernment was not able to properly monitor and control budgets and prograrns, and to ensureefficient use of resources. As pointed out in the President's Report these problems had been broughtabout by: "(i) a comprehensive system of revenue earmarking and compulsory expenditures whichlimits the discretionary power of the Government; (ii) the rapid growth of the public sector and thelarge number of constitutionally mandated programs, some operating on a virtually autonomousbasis; (iii) the lack of adequate administrative systems to prepare and control public sector budgetsin a comprehensive and coordinated fashion; and (iv) the ease with which Government agencies havebeen able to borrow unilaterally for investment as well as current expenditures, including externalborrowing, without taking into account overall Government priorities and resource constraints." Toaddress the pressing need for public sector reform, the Structural Adjustment Program focused on:"(i) limiting public employment and wages; (ii) budgetary administration and control; (iii)

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restructuring CODESA; (iv) reducing CNP's losses; (v) public sector investment planning; (vi)public resource mobilization; and (vii) external public debt management and improvedcreditworthiness."

29. Public Employment and Wages. In February 1984, the Government had "(i) imposed afreeze on public sector employment levels for three years (1984-86) effective March 2, 1984; (ii)retired all Central Government officials 65 years or older; (iii) authorized public institutions to payaccrued benefits to employees as a bonus to encourage relocation to the private sector; and (iv)restricted further wage increases to absolute changes in the cost of a basic basket of goods andservices", which would hold wage increases below the rate of inflation. The Government wascommitted to continuing this policy and agreed that maintaining the employment freeze would be acondition for second tranche release. Although there was agreement as the need to maintain anemployment freeze, there is no indication this target was based on analysis that would define theemployment base or the mechanisms that would be used to implement and monitor the freeze.

30. Budgetary Administration and Control. To address the need for maintaining control overCentral Government finances, the Government planned to: (i) submit tax reform proposals to theLegislative Assembly in mid-1986; (ii) further reduce earmarking in the 1987 budget; (iii) strengthenthe control of budget execution; and (iv) analyze budget performance with a view to identifyingissues requiring further attention in subsequent years. The Government, moreover, agreed with theBank that it would not propose or approve any legislation incorporating new earmarking of taxrevenues.

31. Restructuring and Privatization of the Costa Rican Development Corporation(CODESA). In view of the major drain in public finances caused by the operations of this stateholding company and its subsidiaries-accounting for up to 20 percent of the total public sectordeficit in some years-the Government had decided to sell CODESA enterprises or to liquidate theirassets if no buyers were found. CODESA would remain the majority owner (60 percent) of onlytwo enterprises (fertilizers and cement), for which it would enter into 10-year management contractswith private investors, who would also purchase the other 40 percent of their shares. TheGovernment agreed that completion of an action plan to carry out the divesture of CODESAenterprises during 1985 would be a second tranche condition.

32. Reduction of Losses of the Agriculture Marketing Agency (CNP). This autonomousGovernment agency was responsible for setting producer prices for rice, beans, corn and sorghum,and was also involved in importing, exporting and selling domestically a variety of agricultural andagroindustrial products and inputs. CNP's operational losses amounted to 40 percent of the 1984non-financial public sector deficit. The Government agreed to reduce CNP's deficit by 50 percenteach year, starting in 1985. Compliance with this goal in 1985 would be a condition for secondtranche release. Although there was agreement as the importance of reducing CNP losses, there isno indication that the Bank or the Government had undertaken a careful analysis of how this targetwas to be achieved.

33. Public Sector Investment Planning. To address the need to reduce the size and increasethe efficiency of the public sector, the Government and the Bank also agreed on a revised 198486Public Sector Investment Program, including the Central Government and all key public sector

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entities. This agreement reduced substantially the previously planned public investment levels.Satisfactory compliance with the 1985 targets would be a condition for second tranche release. Inaddition, the Government also decided to undertake, with Bank technical assistance, a reorganizationof the Planning Ministry and a strengthening of its planning functions, particularly those related topublic investment.

34. Public Resource Mobilization. To help achieve the Government stabilization targets, andto improve the long-term performance of public finances, the Structural Adjustment Programincluded the following actions related to public sector revenues: (i) undertaking a comprehensivereview of the tax system, which would lead to a tax reform proposal, and a substantial strengtheningof tax administration; and (ii) maintaining tariffs and prices of public enterprises at levels sufficientto cover operational expenditures, debt service requirements and a reasonable share of investmentexpenditures. The Government also indicated that domestic prices for oil products, already aboveinternational levels, would be further adjusted if needed to reflect any increase in the cost of oilimports.

c) External Debt Management

35. External debt had increased rapidly until 1981 owing to over-expansionary macroeconomicpolicies, and to the lack of appropriate controls on external borrowing by public sector entities. Thehigh debt service levels had made it necessary for the Government to restructure the public sectorcommercial and bilateral debt, and to obtain new commercial and official financing in the frameworkof the stabilization and structural adjustment programs. To better control external debt, theGovernment decided to require prior approval of new borrowings based on an evaluation of debtservice implications by the Budget Authority, the Planning Ministry and the Controller General. TheGovernment was also strengthening the debt statistical and projection system of the Central Bank.

d) Conditions for Second Tranche Release

36. It was agreed that before release of the second tranche-which was expected to take placein November, 1985-the Government would have taken the policy actions listed in the third columnof the SAL I policy matrix (Annex 1), including: (i) all necessary measures to implement a freezeon public sector employment; (ii) measures required to reduce CNP's operating losses; (iii) designof a program to modernize the industrial sector; (iv) preparation of a plan of action for the divestiturein 1985 of CODESA's enterprises; (v) compliance with the 1985 public sector investment targets,and review of the 1984-86 public investment program; (vi) measures to put into effect the agreedcharges on imports of raw materials, intermediates and capital goods; and (vii) measures to put intoeffect the Nomenclature Arancelaria Uniforme Centroamericana, convert tariffs schedules onimported goods to an ad valorem base, and implement the new regional trade regime. It was alsoagreed that before releasing the second tranche, the Bank should have found satisfactory the overallprogress in the execution of the Government's Structural Adjustment Program, and in carrying outthe SAL-related studies and programs financed by the TAL.

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e) Bank Technical Support for the Structural Adjustment Program

37. Bank staff provided technical support for the preparation and implementation by theGovernment of the Structural Adjustment Program through frequent missions to Costa Rica, otherdiscussions and consultations held as part of the overall policy dialogue. In addition, the TAL'sobjective was to help implement the reforms supported by SAL I, and to assist in the preparation ofsubsequent policy actions, which could become the basis of further Bank support for the structuraladjustment process.

38. The TAL provided financing for a variety of studies related to the strengthening of selectedfunctions of the Budgetary Authority, CODESA, the Planning Ministry, the social security system,the state-owned commercial banks, the Tax and Customs Administrations, and the nationaleducational system. It also included support for the preparation of studies and programs onagricultural policy, public sector salary and incentive policies, and the impact of trade policy reformon the industrial sector. The TAL PCR findings on the implementation of the TAL indicate that itshasty preparation, lack of clear focus in its formulation, and poor linkage with an overall frameworkto ensure the consistency of the various institutional development activities supported by the Loan,reduced substantially its beneficial impact, and its relevance for the structural adjustment process2.

C. IMPLEMENTATION AND RESULTS

39. SAL I (and TAL) effectiveness occurred on August 23, only four months after Boardapproval. The unusually short time, by Costa Rican standards, taken by the Legislative Assemblyto approve these loans suggests that after the lengthy delays in preparing SAL I, there was a growingpolitical realization of the urgency to begin the process of structural reform. By the time of loaneffectiveness, however, Costa Rica was discussing remedial actions with the IMF to keep theprogram in track and in accordance with the Loan Agreement, the Bank proceeded to declare theloan effective and to disburse fully the first tranche in early September.

a) Review of Second Tranche Conditionality-November 1985

40. A review of compliance with second tranche conditionality was carried out in November,1985, which concluded that performance up to then had been mixed. The political cycle in CostaRica had a considerable impact on program implementation. In fact, by the time of loaneffectiveness the political campaign leading up to the February 1986 elections was in full swing.Both the Government and the Legislative Assembly were preoccupied with the electoral campaignand more vulnerable to political pressures.

41. At the time of the review of compliance with second tranche conditionality, a number ofimportant issues on tariff reform were unresolved, including the lack of approval by the LegislativeAssembly of the new individual tariffs on a product-by-product basis; the approval by the Assemblyof two amendments exempting agricultural inputs from tariff increase, and authorizing the Ministryof Economy to spread tariff reductions on final goods over a three-year period in cases where an

2 Tm PCR for the TAL provides more dotailed information on its original design, the subsequent changes madein its contents, and the main results obtined through its implementation.

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immediate reduction could cause 'serious injury'; the reluctance of the Government to enact theimport surcharge on inputs; and the existing differences between the new tariff levels approved atthe regional level and those agreed between Costa Rica and the Bank (for instance, the new tarifflevels for competing, regionally-produced raw materials and intermediate goods spread over a 10-100percent range, while the range agreed with the Bank was 20-30 percent).

42. The CNP deficit, which the Government had agreed to cut by 50 percent in 1985, hadactually increased by about 40 percent, as a result of poor management and of higher-than-expectedsorghum production.

43. PubLic employment had increased by an estimated 2.5 percent in 1985, instead of beingfrozen at the 1984 level, as agreed with the Bank. Such increase was first estimated to be equivalentto about 3,500 employees. This estimate was later reduced to 2,800. This higher employment levelhad been caused mainly by the inability of the Central Government to enforce the employment freezein autonomous agencies. For instance, the Social Security Administration had added 1,500 newemployees for the expansion of rural health services and other programs. Employment in the CentralGovernment had also increased, although by a smaller proportion (0.7 percent).

44. Compliance was much better in the case of CODESA. Although divestiture had notprogressed as fast as originally programmed, valuation of the larger enterprises had been completed,and the bidding process was under way. Likewise, substantial progress had been made concerningimplementation of the public sector investment program, and the Government was in compliancewith the quantitative target (no more than 6.5 percent of GDP) agreed with the Bank.

45. The lack of compliance with most second tranche conditions in November 1985 made itimpossible for the Bank to release the second tranche on schedule. The previous month Costa Ricahad also failed to meet the IMF performance criteria, but could draw the remaining resources underthe Stand-by Arrangement on the basis of a waiver approved by the IMF Board on October 23.

b) Progress to June 1986 and Second Tranche Release

46. During the following six months, progress in implementation of SAL I continued at a slowpace and performance in meeting second tranche conditions was unsatisfactory. A new Governmenttook office in May 1986 and, while restating its commitment to the adjustment program, indicatedit would be unable to fulfill all second tranche conditions before the Loan's closing date (June 30,1986). The Government proposed a series of measures on trade, CNP and public employment,which it felt were politically feasible but which the Bank found not fully satisfactory. In April 1986,the Bank considered three options: (i) insist on full compliance with second tranche conditionality,which would have implied the cancellation of SAL I; (ii) accept the Government's initial proposal,which was unsatisfactory; or (iii) accept that the original second tranche conditions could not be fullymet but seek further actions in line with the overall objectives of the reform program. The Bankchose option (iii) and proposed to the Government revised actions which would get the program backon track (par. 47). In reaching its decision, the Bank judged that the revised actions representedsubstantive policy changes, implying greater discipline in approaching commitments to the adjustmentprogramn and because of it there were good prospects for the continuation of the adjustment effortwhich could be supported by a second SAL.

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47. Agreement on the revised set of conditions for second tranche release was reached on April28, 1986.3 These focused on three areas: (i) Tariff reform: significant reductions of surchargeson final consumer goods4 and their elimination by end of 1986, and reducing the tariff ceiling ofcommodities in Part II to 70 percent; (ii) CNP: suspension of CNP activities in the marketing of riceand elimination of the subsidy, price adjustments on basic grains, suspension of CNP purchases ofsorghum;' and (iii) Public Sector Employment: a freeze on new hiring for the remainder of 1986and 1987 unless offset by reductions elsewhere and an agreement on an action plan, includingquantification, to reduce public sector employment to March 1984 level.

48. By June 5, 1986 Bank Management decided that sufficient progress had been made in meetingrevised tranche release conditionality to justify release of the second tranche, which took place onJune 23, after the Government made public the last required policy decisions. Performance at thetime of second tranche release can be summarized as follows:

a) The Government was in compliance, albeit at later dates than agreed upon, withconditions on CODESA's divesture program; implementation of the public sectorinvestment program; and the initial design stage of a program to modernize the industrialsector.

b) The Government did not comply with the original condition to reduce CNP's losses by50 percent starting in 1985. On the contrary, during that year, CNP losses increasedfurther, owing to higher sorghum production and larger rice purchases than planned. TheGovernment took the revised measures agreed for second tranche release of which themost important was excluding the public sector from the marketing of sorghum and rice.These measures were designed to cut CNP's deficit in 1986 to no more than 800 millioncolones during the subsequent 12 months.

c) Public employment had not been frozen at the 1984 level, as agreed under SAL I. Theregistered increase (between 2.0 and 2.5 percent, depending upon the sources of figuresand estimates) was, however, much smaller than in previous years, when it had averagedabout 6 percent annually. The Bank relied on a Government commitment to maintain,for the remainder of 1986 and 1987, the employment freeze and an action plan to reducepublic employment thereafter.

d) Compliance with trade reform conditions was mixed since conditions under SAL I hadnot been fully met due mainly to limited progress in regional negotiations within the

3 The LAC Regional Vice President submitted these changes in conditions for second tranche release for approvalto the Senior Vice President Operations in a memorandum dated April 24, 1986, who approved them on April 28,1986.

4From 12.5 to 7 percent on regionally produced final consumer goods; and from a range of 40- 100 to 30 percenton non-regionally produced final consumer goods.

5 Estimated CNP savings from these measures, over the following 12 months, was 1.3 billion colones - representinga reduction on CNP overall deficit of 62 percent.

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CACM but measures were taken and the revised actions agreed for second tranche releasehad been complied with. The main aspects of issues at that time were:

i) The Government maintained its commitment to seek a regional agreement within theCACM on the basis of the 20-30 percent level by Board presentation. The newregional tariff had, however, a range of 10-100 percent for competing raw materialsand intermediate goods, instead of the 20-30 percent range agreed with the Bank.There were also some other, less important, differences with the new regional tariff.

ii) Import surcharges on final consumer goods were reduced in June 1986 from 12.5 to7.5 percent for non-regionally produced items, and from 40-100 percent to amaximum of 30 percent for regionally produced ones. These surcharge levels werefurther reduced (to 3.5 and 15 percent, respectively) by September 1986, and fullyeliminated by December 1986. The Government had also, as agreed in the revisedconditions for second tranche release (para. 47), submitted by June 13, 1986 forLegislative approval a law exempting final consumer goods from the general 3percent import tax.6

iii) In December 1985, the Central Bank had approved a surcharge of 2 percent on'most' non-regionally produced raw materials and intermediate goods which,combined with regional tariff rates, resulted in an average rate of 7 percent. TheCentral Bank also approved a surcharge of 10 percent on 'most' non-regionallyproduced capital goods which, combined with regional tariffs, reached an unweightedaverage of 15 percent tariff level. These new overall tariffs represented a substantialincrease, although they remained below the floor levels of 10 percent for non-regionally produced raw materials and intermediate goods and of 20 percent for non-regionally produced capital goods agreed under SAL I.

iv) No regional agreement within the CACM had been reached on tariff levels for someimportant items, including textiles, garments, plastics and paper products. As aresult, each country (including Costa Rica) set up tariffs for these items at very highlevels, typically in the 70-100 percent range. The Government indicated to the Bankthat it would seek regional approval-and subsequent ratification by the LegislativeAssembly-for lower tariffs on these items, which would not be higher than the 70percent previously agreed as revised actions for second tranche release.

c) Overai Performance

49. The decision to release the second tranche was based on a positive judgment by the Bank onthe overall performance in implementing the Structural Adjustment Program (stated in the LoanAgreement) and compliance with the revised set of conditions agreed on April 28, 1986 (para. 47).At the end of 1985, when the second tranche was scheduled to be released, overall performance hadfallen well short of expectations. In addition to the specific issues identified in the November 1985

6 As agreed, this tax continued to be applied to imports of raw materials, intermediate and capital goods therebyfiuther reducing effective protection.

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review, the stabilization and structural adjustment programs were both clearly off-track. Instead ofdeclining, the overall public sector deficit had risen to 7 percent of GDP. Partly owing toexpansionary domestic policies, the inflation rate had reached 15 percent. The current accountdeficit had risen to 8 percent of GDP, partly due to a sharp deterioration in the terms of trade, andby year-end, Costa Rica was not servicing its external debt. GDP growth slowed to less than 1percent.

50. By mid-1986, however, the situation had changed. The new Government had taken importantremedial actions which reduced the public sector deficit, improved interest and exchange ratemanagement, and slowed inflation. The Bank based its decision to release second tranche on theGovernment's improved stabilization effort combined with the agreed corrective measures to dealwith the non-compliance problems faced by the second tranche. It could be argued that once thesecond tranche was released, the Bank had no way of supporting the sustainability of the correctivemeasures agreed with the Government. However, from the beginning the structural reform programwas conceived as a process that would require more than one SAL, so that in deciding to release thesecond tranche the Bank was, in effect, making a judgement that the Government would maintainprogress and deepen the adjustment effort under a follow-up operation. The Bank also expected thatthe Government's stabilization measures would improve macroeconomic performance. The publicsector deficit to GDP was projected to fall to about 5.5 percent in 1986 from 7 percent in 1985, thecurrent account deficit was to decline to 3.6 percent of GDP from 8 percent in 1985, and GDP wasexpected to grow by about 4.5 percent in 1986. These expectations were by and large confirmedby 1986 actual results.

51. An assessment of the results obtained under SAL I depends necessarily on the yardstick usedto measure performance and the particular circumstances of the country. Compared with laterreform efforts in Latin America, and with the conditionality of policy-based loans which supportedsuch efforts, it could be argued that the overall objectives of SAL I were too timid an attempt toremedy a situation which required much stronger and quicker action, particularly concerning theneeded changes in the trade regime-where protection levels were still far too high-and the reformof the public sector, which failed to address the need for overall institutional reform. Two factors,however, argue against such a negative assessment. First, the development of Costa Rica's societyand political structures since the 1940s suggests that change can only occur gradually and througha complex consensus-building process. A more ambitious or faster-paced reform program wouldhave been unacceptable or unsustainable, especially since SAL I was the first stage of what was tobe a longer-term reform effort. Second, even at this gradual pace, program preparation andimplementation were adversely affected by the electoral cycle.

52. Concerning trade policy reform, there is no doubt that nominal protection rates of, forinstance 70 percent, were far too high, and that the spread of tariff protection for final consumergoods was too wide. But it is also true that the changes in the trade regime achieved during 1985-86initiated foreign trade liberalization in Costa Rica providing momentum for foreign tradeliberalization in other Central American countries and an outward-oriented reform of the CACM

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accord observed in the late 1980s and early 1990s.7 With Costa Rica playing a leading role, thecountries of the region started to adopt outward-oriented trading policies, taking decisions that werepolitically difficult to adopt in a multi-national framework, and that were equally difficult within ademocratic system such as that prevailing in Costa Rica. Trade reform was a major achievementof SAL I.

53. Concerning reform of the public sector, SAL I conditionality followed the trend oninstitutional matters then prevailing in the Bank-to focus only on the few institutions or processeswhich had been identified as priority problem areas. The Bank (and the Government), however,failed to take into account that for increasing the efficiency and reducing the size of the public sector,it is not enough to reform selected Government entities, privatize some enterprises, freeze publicemployment and reduce the real wages of public employees. In fact, some of these measures mayfurther reduce efficiency levels when they lead to salary compression and erosion in the incentivesnecessary to attract qualified staff. By focusing on the symptoms the reform limited, to some extent,the costs of the public sector inefficiencies and some of its financial imbalances but only temporarily.Nevertheless, it is clear that a more comprehensive approach to public sector reform would haverequired considerably more preparation and analysis of its role, size and structure, even if there hadbeen the political will to undertake a more ambitious reform effort. Moreover, placing the need forpublic employment freeze in the policy agenda was an important achievement, despite the setbacksin implementation. It is likely that public employment would have been much higher otherwise.

54. Despite its shortcomings, SAL I can be considered as a critical first stage in the process ofreforming the structure of the economy. Some reforms (e.g., trade policy, reduction of costlypractices by CNP) were deepened during the implementation of SAL II and beyond. Other importantpolicy changes were initiated with SAL II support, including reform of the banking system and ofagricultural policy. The stage of the structural adjustment process supported by SAL I can,therefore, be considered as breaking point with a past development strategy characterized by over-protection of import-substitution activities, by excessive Government intervention, and by theresulting distortions in the overall structure of economic incentives. Looked at in this light, andtaking into account national and regional political constraints, the limited conditionality of SAL I,as well as the Bank decisions to release its second tranche and to process SAL II, seem on balancejustified. This was based on a judgment, certainly risky at the time, that there were good prospectsfor the continuation and deepening of the reform process.

7 See The World Bak, April 1992, Economic Polcies and Peifomance wnder Alternative Trade Regimns: LatinAmerica during the 1980s, by Noguis J. nd S. Gulati, IAtin America and the Caibbean Technical Deprtment,Regional Studies Program, Report No. 27; and Noguds J. and R. Quintanilla, 1992, Latin America's Integrationand the Multilateral Trading Systan, in De Mlo J. and A. Panagariya, eds. New Dimensions in Regionalntaotion, The World Bank and Center for Economic Policy Research.

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IV. STRUCTURAL ADJUSTMENT LOAN II

A. THE PERIOD BETWEEN SAL I AND SAL II

55. After SAL I second tranche was released in June 1986, both the Government and the Bankexpected to process quickly a second adjustment operation, expecting that full compliance would bereached in the process. During the following six months, the Bank continued to monitorimplementation of the Government's Structural Adjustment Program, particularly aspects related toreforms supported by SAL I. Progress was slower than expected in some areas, such as theexemption of final consumer goods from the 3 percent general import surcharge, which by the endof 1986 had not been approved by the Legislative Assembly. Similarly, the 1987 budget envisagedan increase in public employment-instead of the reduction required to gradually return to the 1984level, The planned improvement in CNP's financial position was being achieved at a slower pacethan previously expected. And there was a moratorium on arrears of some agricultural producersto public banks.

56. The Government, however, indicated repeatedly to the Bank-in visits of its officials toWashington, during Bank missions, and through correspondence and telephone contacts-that itcontinued committed to the objectives of the program, and also requested repeatedly a second SALfrom the Bank. Simultaneously, the Government was holding negotiations with the IMF for a newStand-by Arrangement-which was finally approved by the IMF Board in April 1987-withcommercial banks (on debt rescheduling) and with bilateral donors (Japan and the Netherlands) ontheir possible participation in a co-financing facility linked to the proposed SAL II.

57. After an April 1987 Mission concluded that "there was general agreement (with Government)on the overall policy approach for a second phase of economic adjustment", the Bank sent a SAL IIpreparation mission to Costa Rica on May 25. On August 27 the Region submitted the IM for SAL-- to the Operations Committee, which on September 4 authorized its appraisal, on the basis that SALII would support a deepening of the reforms initiated under SAL I, and would also aim at reformingagricultural policy and the banking system. By that time, the IMF Managing Director had cleared(subject to completion of the required financing package) submission to the Board of a new Stand-byArrangement.

58. It should be noted that the economy was improving substantially at the time of SAL IIappraisal, although balance of payments and inflationary pressures were increasing. As a result oflarge real exchange rate devaluations (40 percent between mid-1985 and December 1986), and non-traditional exports were increasing rapidly, especially to third markets, albeit relying on very highfiscal incentives. By end-1987, the non-financial public sector deficit had virtually disappeared, andthe consolidated deficit (including Central Bank losses) had been reduced to 3.5 percent of GDP.GDP had grown for two consecutive years, 5.5 percent in 1986 and 4.8 percent in 1987, after aweak performance of 0.7 growth in 1985. On the other hand, imports increased very rapidly in 1987(24 percent in real terms) with the result that the current account deficit reached over 9 percent ofGDP, which was clearly unsustainable. Inflation had accelerated to 20 percent by mid-1987 a ratethat was reduced by year-end to about 16 percent, on a December-to-December basis.

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59. The main actions taken by the Government during implementation of SAL I and thepreparation of SAL II, which were considered sufficient to justify presenting SAL II to the Board,are listed in the second column of the SAL II policy matrix (see Annex 3), and can be summarizedas follows: (i) Trade policy: implementation of the first phase rationalization of the regionalCACM tariff regime, including reduction of nominal tariffs below 70 percent, with some exceptions;implementation of a crawling peg exchange rate regime; implementation of the new export incentivesystem; establishment of privately administered trade zones in 1985; application for membership inGATT; and opening of air cargo transportation to foreign carriers. (ii) Agriculture policy: freezingof nominal support prices to producers of beans and corn during 1987; liberalization of rice pricesin 1987; and transfer of rice import rights to the private sector. (iii) Public sector management:1987-88 revenue increases equivalent to 1.3 percent of GDP per year; stricter control of budgetallocation by the Finance Ministry; and approval in 1984 of CODESA's divestiture program; and(iv) Financial sector: liberalization of interest rates and credit allocation controls; reduction ofsubsidized credit to 16 percent of total lending; submission to the Assembly of draft laws to relaxadministrative controls on public banks, strengthen supervision of financial institutions, andencourage the operation of securities markets; and authorization to private banks to intermediatefinancial assets of 180-90 days maturity.

60. The Executive Directors approved SAL II on December 13, 1988, and the corresponding loanagreement was signed on December 16. The Loan, however, did not become effective until elevenmonths later (November 16, 1989), mainly because of delayed approval by the Legislative Assembly.During this period, the Government and the Bank also completed negotiations with Japan's OECF,which provided the equivalent of $100 million in co-financing for SAL II.

B. SECOND PHASE OF THE STRUCrURAL ADJUSTMENT PROGRAM

61. Taking into consideration the lessons of experience from SAL I design and implementation,the second phase of the Structural Adjustment Program, supported by SAL II, continued to attachpriority to trade policy reform and added financial intermediation and agricultural policies, with aview to advancing further the reform of the incentives system initiated under SAL I. Likewise, theimprovement of public finances-required for both stabilization and developmentpurposes-continued to be a main objective in SAL II, although as in SAL I, the reforms envisagedunder the program did not include the institutional changes that would have been required to achieveand sustain the targeted financial improvement. In agriculture, there was a clear realization that aredefinition of CNP's role was required both to improve agricultural incentives and to reduce fiscalpressures. Since the inefficiency of the largely state-owned banking sector was clearly a majorimpediment to the sustainable, market-oriented development of Costa Rica's economy, its reform wasadded under SAL II as another main objective of the structural adjustment process. The main policyreforms included in this second stage of the program were summarized as follows in the President'sReport: "(i) continuing with the reform of the trade regime and export incentives to promoteincreased exports to third markets; (ii) additional steps to increase public savings, reduce the overallpublic sector deficit (including Central Bank losses) and increase the effectiveness and efficiency ofthe public sector investment program; (iii) improve the ability of the financial system to mobilizefinancial resources; and (iv) rationalize pricing, marketing and subsidy policies in the agriculturalsector.' As indicated later on, in the same Report, the program would also include measures aimedat improving external debt management. The key reforms envisaged under SAL II are listed below.

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a) Trade Pocy

62. The trade policy measures in the program aimed at deepening the reforms supported bySAL I, including:

a) Actions designed to further reduce the average rate and dispersion of the tariff system.Thus, over a three-year period (textiles, apparel and shoes would take five years), alltariffs were to be adjusted to a range of 540 percent, with the exception of non-competing essential goods such as medicines, which would have a tariff of 1 percent, andsome non-competing final goods (primarily luxury goods), which would be subject totariffs in excess of 40 percent. Within this framework, the tariffs on rawmaterials/intermediates and capital goods would have a ceiling of 20 percent and a floorof 5 percent.

b) Reform of the export incentive system, through:

i) An export contract scheme, under which individual exporters could obtain income taxexemption on profits generated by non-traditional exports, exemption from all importtaxes on goods used in the production of non-traditional exports to third markets, andtemporary Tax Rebate Certificates (CATs);

ii) Elimination of CATs as a general export incentive, limiting compensatory subsidiesto cases where domestic charges exceeded international ones for certain expensesincurred in the export process, such as port charges and costs of electricity and fuel.(The exact nature of these subsidies was still to be specified as part of the thenongoing GATT negotiations.);

iii) Extension of export incentives to producers of inputs for export production,and-through drawback certificates-to producers for both export and domesticmarkets of final export goods, and to producers of inputs used by producers sellingto both markets;

iv) Establishment of new free trade zones, to be administered by the private sector alongthe lines already used in the Cartago Free Trade Zone, which had been establishedin 1985;

v) Establishment of a 'one-stop window' for all export requirements; and

vi) Opening of international air transportation to competition by authorizing severalforeign airlines to carry commercial cargo to and from Costa Rica.

b) Public Finances

63. The Government had approved in November 1987 a tax package designed to increase fiscalrevenues by 1.3 percent of GDP. It had also cut expenditures by 0.5 percent of GDP in 1987 and1 percent in 1988, including the reduction of CNP's deficit to 0.1 percent of GDP in 1988. The

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Government had likewise prepared a 1988-90 public sector investment program which, after someagreed modifications, was judged by the Bank to be fully consistent with the Structural AdjustmentProgram. These actions were expected to result in a surplus of the non-financial public sector of 0.4percent of GDP in 1988 and 1.0 percent in 1989, and in public sector savings of no less than 5.7percent of GDP in 1988, and no less than an average of 6.0 percent for 1988 and 1989.

64. The Government program agreed with the Bank also included two actions: (i) Faced withsubstantial problems in the management of public finances caused by extensive earmarking of taxrevenues, the Government restated its commitment to avoid proposing new legislation establishingearmarked tax revenues; and (ii) By November 1988, 36 out of the original CODESA 41 enterpriseshad been divested. The Government committed itself to sell two more firms, and 40 percent of theshares of a third one.

c) Financial Intermediation

65. The efficiency of the country's financial system in resource mobilization had remained formany years at a low level owing mainly-in the view of Bank staff as stated in the SAL IIPresident's Report-to three problems: (i) the large non-performing portfolio of public banks; (ii)the lack of competition in the banking sector; and (iii) weak supervision and control of financialintermediaries. To address these problems, the second phase of the Government's StructuralAdjustment Program included measures to:

a) gradually allow private banks to accept 180-90 days deposits;

b) reduce the share of loans overdue by more than 180 days in the public banks' portfolioto no more than 5 percent and 3 percent by the end of 1988 and 1989, respectively;

c) avoid any future generalized domestic debt rescheduling of the type imposed by law inMay 1987;

d) maintain outstanding subsidized credit at the nominal December 31, 1986 level, withseasonal variations of no more than 5 percent; and

e) require the Superintendency of Banks to issue regulations aimed at:

i) allowing banks to charge penalty interest rates on debts not paid on their maturities;

ii) prohibiting banks from registering as income interest accrued on loans that had beenpast due for more than 180 days; and

iii) instructing banks to have their annual financial statements audited by externalauditors, and to publish such audited statements in newspapers with nation-widecirculation.

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d) Agricultural Policy

66. The agricultural policy conditionality of SAL II aimed at further reducing the role of CNP,and at rationalizing gradually the price of basic grains. During 1986-88, the Government had alreadyeliminated CNP's role in the rice subsector, entrusting the marketing of rice to an association ofprivate producers and distributors, which could import any amount of rice needed to satisfy domesticdemand. The agreed measures had the following specific objectives: (i) eliminate CNP's monopolyto import and market beans and corn; (ii) decrease CNP's subsidies by unifying domestic consumerand producer prices; and (iii) reduce the divergence between domestic producer support prices andinternational prices for basic grains.

67. The program envisaged a gradual reduction during 1988-90 of the spread between domesticsupport prices and the five-year average of the international prices for rice, beans and corn. Afterthe planned reductions in the minimum guaranteed prices during that period, it was expected thatsuch spread would not exceed 40 percent by 1990. It was likewise agreed that by 1990, quantitativerestrictions on imports of rice, corn and beans would be eliminated, with CNP's role limited topurchasing corn and beans from small farmers.

e) Second and Third Tranche Release Conditions

68. Given the gradual approach followed in several of the reforms supported by SAL II, it wasdecided to disburse the loan in three tranches. The first tranche was to be released upon loaneffectiveness. Release of the second and third tranches was expected to take place in July 1989 andJanuary 1990, respectively. A general requisite included in the loan agreement for releasing thesecond and third tranches was that the Bank would have to be satisfied with the overall progressachieved by the Government in carrying out the program supported by the Loan.

69. Specific conditions for release of the second tranche are listed in more detail in the thirdcolumn of the SAL II policy matrix (Annex 2) and included: (i) three equal semi-annual tariffreductions; (ii) reduction of import prior deposits; (iii) satisfactory operation of the new exportincentive system; (iv) reform of the system of producer and consumer prices for beans, corn, andrice; (v) elimination of CNP's monopoly on imports of basic grains; (vi) reductions in the publiccommercial banks' overdue portfolio; (vii) freezing, in nominal terms, of the total subsidized creditgranted by public commercial banks; (viii) measures aimed at increasing the efficiency of the bankingsector and at strengthening the supervision of its operations by the Superintendency of Banks; (vix)agreed public sector savings targets for 1988 and 1989; (x) implementation in the 1988 budget of theagreed public investment program; and (xi) avoiding proposing new legislation establishingearmarked revenues.

70. Specific conditions for release of the third tranche, also listed in the third column of the SALII policy matrix, included: further actions related to tariff reductions; prior import deposits;producer support prices for basic grains; the public banks' overdue portfolio; public sector savings;and the public investment program.

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C. IMPLEMENTATION AND RESULTS

a) Effectiveness

71. SAL II became effective on November 15, 1989, eight months after the originally planneddate and eleven months after Board approval, owing mainly to delays in the approval of the Loanby the Legislative Assembly, which was published in the Official Gazette on October 17, 1989.Several factors seem to have contributed to this delay:

a) Lack of prior agreement between the Government and the main opposition party onthe need for fast approval of the Loan by the Assembly, which was particularlydifficult given that 1989 was a pre-election year;

b) The economic deterioration, particularly concerning public finances, whichaccelerated in mid-1989 and which seems to have distracted both the Administrationand the Legislative Assembly from taking urgent action on SAL II; and

c) The added complication of Japanese cofinancing of SAL II. In this respect, anamendment to the Loan Agreement, to add an optional cross-default clause withJapan's OECF, was signed on December 4, 1989.

b) Compliance with Second Tranche Conditionality

72. During 1989, even before effectiveness, several Bankl missions reviewed the progress beingmade on second tranche conditions. Progress was considerably slower than expected at the time ofBoard approval, when it was planned to release the second tranche by July 1989. A Bank missionin October 1989 concluded that the following conditions had not been met: (i) establishing a newexport incentive system; (ii) allowing private traders to import basic grains, and establishing anauction system for import licenses of those products; (iii) reducing commercial bank loans in arrearsfor more than 180 days to less than 5 percent of their portfolio; and (iv) prohibiting commercialbanks from registering as income the interest accrued on loans that were past due for more than 180days. The mission also concluded that all other conditions in the trade, agricultural and financialintermediation policy areas, as well as all conditions on public finances (including the agreed increasein public savings) had been met satisfactorily.

73. The Back-to-Office Report of a February-March, 1990 supervision mission offers a morecomplete and worrisome picture of the situation. Although some of the conditions identified aslacking compliance in October 1989 had been met, the overall economic situation had deterioratedsharply. The report pointed out that 'the major problem of the Costa Rican economy today is thedeterioration of the fiscal accounts". The December 31, 1989 IMF fiscal targets had not been met;Central Government expenditures on wages, pensions and export incentives had been higher thanexpected; tariffs of public services lagged behind increasing costs; and the consolidated non-financialpublic sector had registered a deficit of about 2.7 percent of GDP in 1989, instead of the planned0.5 percent surplus. Although, somewhat surprisingly, the March 1990 report does not evaluatecompliance with the second tranche public savings condition, the data presented in that report wasclearly inconsistent with the October 1989 conclusion that "the 1988 level of public savings, when

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taking the broad definition of the public sector, was kept above the minimum level agreed upon inthe loan agreement". The 1988 agreed level was 5.7 percent of GDP, while according to subsequentinformation, the level actually achieved was 4.95 percent.

74. The deteriorating fiscal situation also contributed to a 20 percent increase in imports, and toa 1989 trade deficit of $380 million, in spite of continuing growth in non-traditional exports. In viewof the fiscal and balance of payments situation, the Region concluded that progress in implementationof the overall adjustment program was not satisfactory. Based on this, and the lack of compliancewith two specific second tranche conditions (the reform of export incentives and the import of basicgrains by the private sector), the Regional Vice President informed Senior Bank Management onApril 10, 1990 that he did not recommend releasing the second tranche. The Bank decided to releasethe second tranche only after actions were taken, by a new administration (May 1990), to correct thefiscal and balance of payments situation (see paras. 75-76), there was a new IMF Stand-byAgreement (see paras. 77-78), there was agreement on solving the audit problems of SAL I andSAL II (see paras. 78-79) and the Board approved the request to waive the condition on publicsavings and revise the calendar dates due to delays in implementing the Loan (see par. 79).

75. SAL II and the IMF Stand-by Arrangement were linked to a package of bilateral assistanceand to a debt reduction agreement with commercial banks, which included a buy-back of most ofCosta Rica's commercial debt. For this purchase to take place, Costa Rica needed $210 million ofexternal funds by May 7. The lack of compliance with the Stand-by Arrangement and with theSAL II second tranche conditions, and the corresponding postponement in the release of IMF andBank resources, made it impossible for Costa Rica to obtain on schedule all the envisaged bilateralfunds and to comply with the May 7 buy-back deadline. The Bank and the IMF, however, activelysupported the process. The buy-back deadline was then extended to May 21, when Costa Rica'sbuy-back agreement with the commercial banks was finalized, covering 98 percent of the outstandingdebt with those institutions. By that time, although Bank and IMF resources had not been released,Costa Rica had obtained 75 percent of the funds required for the buy-back scheme from otherbilateral and multilateral sources, financing the remaining 25 percent from its own foreign exchangereserves.

76. The fiscal deterioration and the lack of compliance with second tranche conditionality and theStand-by Arrangement, took place in the midst of an electoral process, which ended in a victory forthe main opposition party, and the subsequent inauguration of the Calder6n Administration in May1990. In retrospect, it seems clear that the Government and the Bank underestimated the difficultiesassociated with maintaining fiscal restraint in a pre-election year.

77. The Calderdn Administration acted quickly to correct the situation by increasing taxes,adjusting prices of public services, accelerating the pace of devaluation, and tightening monetarypolicy. Economic performance in 1990, however, remained worrisome. The deficit of theconsolidated public sector (including Central Bank losses) was 5 percent of GDP, only slightly lowerthan in 1989. Meanwhile, the trade deficit increased from 7.3 percent in 1989 to 11.2 percent in1990, and the annual (December-to-December) inflation rate increased from 10 to 27 percent. Theexpansionary fiscal policy had contributed to a high (5.7 percent) GDP growth rate in 1989 atconstant prices, which decined to 3.6 percent in 1990. Given the magnitude of the adjustments that

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would be needed to correct the existing macroeconomic and financial disequilibria, and theunderlying structural causes of such disequilibria, it was clear that growth would be lower in 1991.

78. In January 1991, a memorandum of the Country Operations Division Chief indicated thatpublic sector savings was one of the policy areas in which second tranche conditionality had not beencomplied with and would recommend waiving the SAL II condition in that respect, provided that thenew IMF program made it reasonable to expect good public savings performance. The samememorandum also noted that a new conditionality issue had emerged: prior import deposits had beenraised to 70 percent, far in excess of the 30 percent maximum level stipulated in SAL II and madereference to the Costa Rican request for a third SAL, which would focus on reform of the publicsector and the pension system, in addition to having a social sector component and continuingsupport for trade and financial sector reforms.

79. A March 1991 supervision mission concluded that: (i) the agreed (but not yet in effect) newIMF Stand-by Arrangement was aimed at achieving acceptable public savings levels, thus justifyingwaiving the SAL II condition in this respect (the IMF Board approved the Stand-by on April 8); (ii)all the other compliance problems referred to above had been solved; and (iii) a new problem, thathad been detected several months before, was still unresolved: the lack of compliance with SAL Iand SAL II audit covenants, particularly with respect to the audit of the participation of the publicbanks by external auditors. The supervision mission proposed releasing the second tranche as soonas a satisfactory solution had been reached on the audit issue.

80. After agreement had been reached on the audit issue (although the required audit reports hadnot yet been received by the Bank - see para. 82), Bank Management recommended to the Board towaive the condition on public savings and revise the calendar dates due to the delays in processingthe Loan. Since agreement had been reached on a reasonable solution, which the Government wasexpected to comply with by third tranche, the request did not mention the problems related to theaudit covenants. The Executive Directors approved both waivers, and the second tranche wasreleased on July 1, 1991, two years later than originally planned. The third SAL II tranche wasexpected to be released 4-6 months later.

c) Compliance with Third Tranche Conditionality

81. Compliance with third tranche conditionality was much better than with second tranche,although most measures were adopted substantially later than envisaged, when SAL II was approved.The Bank sent three supervision missions after release of the second tranche, in November andDecember 1991, and January/February 1992. After dealing with temporary deviations from theagreed conditions-such as those related to CATs and to a 1991 import surcharge-theJanuary/February mission reported that all third tranche conditions had been met, with the exceptionof the public savings condition, which had already been waived together with the respective secondtranche condition. In fact, the third tranche could have been released earlier except for the lack ofcompliance with SAL I and SAL II audit covenants.

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82. The audit covenants issues can be summarized as follows:

a) According to the SAL H Loan Agreement, the Government should have sent to the Bankan external auditors' report within four months after the end of each fiscal year in whichlan disbursements had been made. The first report under SAL II was due by April 30,1990. On January 10, 1990 the Bank sent a cable reminding the Government of the needto comply with this covenant, and in April 1990 sent the LAC Regional audit specialistto Costa Rica for the same purpose. After more Bank requests, the audit reports werereceived in October 1991.

b) Likewise, a similar SAL I audit covenant had not been complied with, but this was onlyrealized in June 1989, when the LAC Regional audit specialist indicated in amemorandum that there was no indication in LAC files that the SAL I audit reports for1985 and 1986 had been received by the Bank. The audit specialist agreed with theCentral Bank in April 1990 on the procedures to be followed for the audits of both SALs,and reported to the Bank on April 30, 1990, that he had inspected 'the SOEs [Statementof Expenditures] and supporting documentation, and found it is well filed and that properdocumentation is in order in the different departments of the Central Bank' for bothLoans. He added that he did not expect "any serious problem at the time of locating thesupporting evidences on the part of the private audit firm."

c) In January 1992 the Bank reviewed the audit reports received in October 1991, and tofollow up on the information included therein, the LAC Regional audit specialist visitedCosta Rica, who found that: (i) the supporting documentation and accounting records forthe SOEs submitted to the Bank for disbursements under the SAL I second tranche couldnot be found; (ii) the lack of that documentation had made it impossible for the auditorsto audit the SAL I second tranche; and (iii) about $6 million of disbursements of the SALIT first tranche were not eligible for financing, because they corresponded to importsmade before the period specified in the Loan Agreement.

d) By failing to take timely action, the only legal remedy left to the Bank in connection withthe SAL I Loan agreement would have been the acceleration of loan maturities.

83. The audit issue was solved by amending in February 1992 the SAL II Loan Agreement,adding the receipt of the following information as conditions for third tranche release:

a) a supplemental audit report for the disbursements of SAL I second tranche, based upon$43 million equivalent in new SOEs submitted by the Central Bank;

b) a supplemental audit report for SAL II first tranche based on $6,033,193 equivalent innew SOEs submitted by the Central Bank;

c) the audit report for SAL II second tranche (which according to the Loan Agreement wasnot due until April 30, 1992); and

d) a pre-audit of the SOEs required to disburse SAL II third tranche.

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84. The processing of the loan amendment referred to above, and the subsequent compliance withthe additional audit requirements, further delayed release of the third tranche, which took place onApril 1, 1992, more than two years after the date envisaged at the time of Board approval.

d) Overal Performance

85. Owing partly to the political environment, the second phase of the Structural AdjustmentProgram supported by SAL II faced initially serious difficulties, which delayed its implementationfor about two years. However, planned reforms were eventually carried out (see Annex 3 fordetails), in some cases beyond the agreed targets, and macroeconomic performance improvedsubstantially in 1991. The consolidated public sector deficit was reduced from 5 percent of GDPin 1990 to 2 percent in 1991; monetary expansion was kept within strict limits; exports increased by10 percent; imports declined by 5 percent; foreign exchange reserves increased by over $300 million;and inflation had started to decline by end-1991. Overall economic growth, meanwhile, declinedfrom 3.6 percent in 1990 to 2.1 percent in 1991, as an unavoidable short-term effect of thestabilization effort.

86. By the time the third tranche was released, the Government had met or exceeded all tradepolicy conditions, including: a) the establishment of a new export incentive system; b) the reductionof the level of tariff protection to a maximum of 40 percent, with a few specified exceptions (actualtariff reductions went beyond the requirements of third tranche conditionality); and c) the eliminationof prior import deposits (a decision that also went beyond the reduction to 10 percent of the importvalues which had been agreed as a third tranche release condition). In early 1992, moreover, theGovernment adopted several important decisions beyond what was required under SAL II, includinga major deregulation of the foreign exchange market and the announcement of a further lowering oftariff protection to a maximum of 20 percent by April 1993. The Government met all conditionsrelated to rmancial intermediation and agricultural pricing policies, and to the agreed limits onpublic investment. A further liberalization of imports and domestic prices of basic grains was alsoannounced in January 1992.

87. As with SAL I, the most important shortcoming of SAL II referred to the required reformof the public sector. Although the Government complied with the condition of not proposing newearmarking of taxes, it failed to achieve the agreed increases in public savings-a condition that theBank decided to waive. In agreeing to this condition, the Government and the Bank had dealt witha macro target-the overall size of public savings-without identifying all the specific policymeasures required to achieve it, and the structural reforms needed to sustain the desired improvementover the longer term. As happened under SAL I with the public employment conditions, the macrotarget was not met, and the required policy reforms were not carried out.

88. Despite its shortcomings SAL II provided continuation in the process of economic reformsstarted in SAL I and initiated reforms in critical areas such as the banking system and agriculturalpolicy. The continuation of foreign trade liberalization under SAL II facilitated the consolidation offoreign trade reform. The modest reforms in the banking system initiated policy changes in financialintermediation and contributed significantly to broadening the scope of reforms of the financialsystem essential to support the structural transformation of productive sectors. Agricultural policychanges reduced price distortions allowing for more efficient patterns of production and extended

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private sector participation in activities till then dominated by CNP. Reforms envisioned in SAL IIwere carried out, in some areas beyond agreed targets, macroeconomic performance imnproved,foreign trade and private sector activity expanded.

89. In summary, SAL II had substantial positive effects in supporting the consolidation of acomprehensive trade policy reforrn program, and imnportant reforms in financial intermediation andagricultural pricing policies. On the other hand, as in SAL I, the Government and the Bank failedto deal adequately with the pressing need for public sector reform. Despite this shortcoming-andof the regrettable lack of proper supervision of the audit requirements referred to above-the overallresults of SAL II were, on balance, positive. The decisions to approve SAL II and to release itssecond and third tranches were, in the context of the overall adjustment process, justified.

V. RELATIONSHIP WITH GOVERNMENT STABILIZATION POLICIES AND IMF

90. The Bank's overall support for Costa Rica's structural adjustment process was closely linkedthroughout the 1980s and early 1990s with the Government's stabilization programs supported bythe IMF. Given the seriousness of the financial problems faced by Costa Rica during this period,the Bank, while avoiding explicit cross-conditionality with the IMF, repeatedly took into accountstabilization performance, the prospects to maintain and deepen the extent of reforms with a long runview of the process of structural reforms. This approach allowed the Bank and Costa Rica, workingin close consultation with the IMF, to correct some important flaws in program design andimplementation and maintain the adjustment program. At the same time, the Bank and the IMFplayed a critical role in supporting Costa Rica's efforts to deal with the external debt crisis.

91. In 1980, when Costa Rica first requested a SAL, the Bank postponed its decision until anacceptable stabilization program was in place. In late 1982, a Stand-by Arrangement was agreedwith the IMF and shortly after the Bank decided to start processing the EDL which had no policyconditionality and initiate the preparation of SAL I. These efforts supported the measures taken bythe Government to deal with the external debt problem.

92. The processing of SAL I was substantially delayed owing mainly to unsatisfactoryperformance under the stabilization program. It was not until March 15, 1985 that a new IMFStand-by was approved, followed one month later by the Board approval of SAL I. These markedthe initiation of structural adjustment and a post-crisis stabilization program. A gradual process ofstructural reforms was launched, however, the complexities of the public sector's underlyingweaknesses contributed to the difficulties maintaining the Government's stabilization and adjustmentefforts.

93. The preparation and processing of SAL II was carried out as planned since the conceptionof SAL I. The approach in solving the difficulties of second tranche release of SAL I (June 1988)to some extent assumed full compliance with the adjustment program would be reached in theprocess. SAL II was approved by the Board in November 1988. Implementation of SAL IIimproved though public finance problems reported by the IMF in October 1988 remained. Theseproblems caused important delays in the implementation of public sector policies of SAL II. The

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second tranche was released in July 1991, more than two and a half years after Board approval, witha waiver on public savings target.

94. It should be noted, however, that SAL II initiated modest but critical reforms in the bankingsystem. SAL II addressed the practices in the banking system contributing to Central Bank losses,a significant component of the combined public sector deficit, and financial intermediation limitingadjustment in the productive sectors. The political economy of the banking system limited the extentof SAL II reforms of this sector but it is now recognized that these contributed significantly tobroadening the scope of reforms of the financial system.'

95. The period to implement the SALs took longer than initially anticipated by the Bank. Theprocess posed difficult trade-offs and decisions by the Bank and intensive consultations with theGovernment to identify critical policy reforms and to reach the consensus needed for Legislativeapproval, required by the Constitution, of the programs and their implementation. The experienceof the two SALs, however, indicates that reaching consensus lengthen the period to initiate andimplement policy reforms but prevented reversals when conditionality was well defined andappropriate.

VI. EVALUATION OF THE GOVERNMENT'S STRUCTURAL ADJUSTMENTPROGRAM AND BANK SUPPORT

A. OVERALL APPROACH

96. Although the 1980-82 crisis prompted a reassessment of the overall economic model and arealization that placing Costa Rica back on a course of sustained growth would require a fundamentalreorientation of the development strategy, the Government's thinking had not progressed beyond thearticulation of general reform principles. At that time it was also highly doubtful that the CACMtrade reforms would prove to be politically feasible. Moreover, during the early part of the 1980sthe Government remained preoccupied with stabilization issues and its external debt problem.During 1980-83, the Bank was just beginning to develop its approach to structural adjustmentlending, both analytically and operationally, and there was little practical experience to draw fromfor the design of successful structural adjustment programs. Thus, it is not surprising that the Bank'sinitial advice seemed to be somewhat tentative and lacking an overall, longer-term framework toguide the adjustment process. The 1981 Initiating Memorandum (IM) for an Export Sector Loanproposed several stages of Bank assistance to the structural adjustment process starting with an ESLto be followed by a series of SALs. While the IM recognized the need for trade policy reform andfor substantial institutional changes in the public sector the proposed adjustment strategy was limitedto a review (and not a reform) of the trade regime, tariff protection in particular, in the first SALand improvements (and not substantial institutional changes) in public sector management.

I Gonzalez-Vega, C. Mach 1990, "Polfticas de Intermediaci6n Financiera, Seminario sobre Polfticas Econ6micauen Costs Ri&, San Jod, Costa Rica.

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97. In the immediate aftermath of the 1982 external debt crisis, the Bank focused on determiningthe external debt situation of Costa Rica and sought mechanisms to support Costa Rica's efforts inreestablishing a more manageable balance of payments. The EDL approved in 1983, without anypolicy conditionality, provided financing for imported inputs required by exporters, and its mainobjective was to provide bridging balance of payments support while the Bank and the Governmentworked to define a more comprehensive structural adjustment program. It was not until 1985, whenSAL I was approved, that the structural adjustment program started to come into focus.

B. MAJOR PROGRAM COMPONENTS

98. Export promotion and trade policy reform constituted the first critical element of thestructural reform process and also the area in which Costa Rica's achievements have been morepositive and sustained. Although the initial reform measures, especially in terms of reducingprotection, were far from ambitious and, because of the need to ensure consistency with the regionaltariff reform process, lacking in specificity, the approach adopted in the SALs had two importantconsequences: (i) it began the process of transforming the economy from an inward to an outwardorientation; and (ii) it served as a catalyst for the rest of Central America. Under SAL III, theGovernment expects to have brought most tariffs within a range of 20-10 percent by December 1994and to have eliminated all import and export licensing requirements. The anti-export bias whichcharacterized the economy in the early 1980s will have, if not disappeared fully, at least ceased tobe a serious obstacle to efficient economic development. Moreover, it appears likely that withinCACM Costa Rica will continue to advocate further reform with the ultimate objective of reachinga flat CET.

99. Public sector reform constituted the second critical element of the structural reform process.In this area, however, performance was mixed, both by the Government and the Bank. Althoughthe Governrment and the Bank recognized that the inefficiency and overextension of the public sectorwere at the root of Costa Rica's basic economic problems, the Structural Adjustment Program failedto develop and carry through a comprehensive public sector reform program. The reform programwas relatively successful in dealing with the parastatal sector and the public sector investmentprogram, but failed to tackle the Central Government itself. Performance in terms of privatizingCODESA enterprises was impressive,' especially given the size of CODESA's holdings and thekinds of problems privatization efforts have encountered in other adjusting countries. In Costa Rica,the privatization process appears to have been relatively noncontroversial and fast. Followingadoption in 1984 of the law to divest most of CODESA's 41 enterprises, by January 1988 only 5companies remained in its portfolio.10 The program was also successful in streamlining the publicinvestment progran, improving investment planning capabilities, and keeping the overall size ofpublic investment below agreed levels.

9 The privatiztion of CODESA enterprises was initiated and carried out to a large extent with USAID technicaland financial assistnc.

10 It is surprising to find that Costa Rica's successful experience is rarely acknowledged or analyzed in the Bank'sextensive literature on divestfitur.

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100. One of the major shortcomings was the lack of a comprehensive framework for public sectorreform that would include the Central Government. Instead of dealing with the underlying causesof public sector inefficiency and fiscal pressures, the Bank largely focused on aggregate targets(employment freeze, CNP losses and public savings levels). This would have been understandableduring SAL I, when it could be argued that the Region was essentially following what were thengeneral Bank practices, but seems less justifiable in SAL II. Instead of learning from the failure ofthe employment targets in SAL I, in SAL II the Bank maintained its approach of setting macrotargets but chose instead to target the level of public savings, which in the event were not met.

101. It is interesting to note that the Bank adopted a sounder approach in dealing with CNP losses.While SAL I was initially concerned only with reducing CNP losses, lack of compliance with the50 percent reduction in CNP losses forced the Bank to focus on CNP's activities. Thus, for secondtranche the Bank accepted the Government's decision to remove CNP from the marketing of sorghumand rice. Prior actions for SAL II included the freezing of support prices for beans and corn andthe liberalization of rice prices. SAL II then logically focused on the wider issue of sector efficiencyand the role of the public sector in agricultural marketing. SAL II supported measures to reducepublic subsidies and increase the role of the private sector in agricultural marketing, rather thanrepeating the targeting of CNP losses, which had the effect of reducing CNP losses but alsoimproved incentives and efficiency in the sector.

102. No such change in focus for the Central Government was in evidence in SAL II. Moreover,although the reform of the state component in the TAL supported the functioning of a bi-partisanCommission to provide overall guidance in institutional reform matters, the key causes of the publicsector's inefficiency and overextension were largely not addressed. In this respect, the Bank can befaulted for not insisting on a more fundamental structural reform in the Central Government, or atleast for making a start in the process. Instead the Bank was content with specifying public savingstargets which were eventually not met and required a waiver by the Board. Although this wasclearly a design flaw in SAL II, it is also likely that at that time the Government had not reached thepoint of beginning to question the need for a more fundamental redefinition of the role and functionsof the State-partly due to its own political orientation but also because very few countries were theninvolved in such reform efforts.

103. Financial sector reforms were largely supported by SAL II, although SAL I included asprior actions the elimination of the sectoral credit allocation system, access by private banks to theCentral Bank rediscount facility fianced with foreign funds, and a Government commitment tomaintain positive real lending rates. The IM for SAL II identified the inefficiency of the large publicbanks and weak supervision as major constraints in the fnancial sector. Public banks, whichaccounted for about 85 percent of all financial transactions, provided credit to specific sectors atsubsidized rates, had a monopoly on demand deposits and unlimited access to the Central Bankdiscount and liquidity facilities. The rationing of financial resources implied significant distortionson interest rates, financial transactions, and loan portfolio of public banks (30 percent of which wasin arrears of over 90 days). The IM argued that removing the monopoly on demand deposits (whichdo not pay interest) would create large losses in the public banks which would need to be coveredby the Government and would lead to serious macroeconomic imbalances.

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104. The IM recommended that deregulation should proceed at the same pace as the strengtheningof the public banks' portfolio. As a first step in this gradual process, SAL II supported theGovernment's decision to allow private banks to intermediate all types of financial instruments withmaturities of 180 to 90 days maturity. It is interesting to note that neither the IM nor the supportingESW" challenges the rationale for maintaining a public banking sector. Instead, the argument ispresented in terms of strengthening public banks to compete in a more deregulated sector. In fact,the Financial Sector Report echoes the warning of dire macroeconomic consequences from too rapidderegulation and mentions that 'close attention should be given... .to improving the competitive spirit'of public banks. The Report also emphasized the need to strengthen prudential supervision in a moreliberal environment.

105. Although the concern over losses in the banking sector may have been real, it is likely thattwo other more important factors influenced the Bank's cautious approach to banking reform. First,the need to focus on restructuring public banks, and the implicit assumption that state enterprisescould be made efficient and more like private firms, at the time seemed to be in line with theapproach followed by the Bank elsewhere. In many countries, the Bank often took as a given thatprivatization of state enterprises, especially commercial banks, was not politically feasible andtherefore focused its advice on deregulation and ways to improve the efficiency of state-ownedenterprises. Second, raising the possibility of eventual privatization of Costa Rica's public banks,even as a longer-term objective, was not politically acceptable. The nationalization of bankinginstitutions, which had taken place in 1948, was considered a major national achievement, especiallyby the party then in power.

106. Judged in terms of outcomes and subsequent developments, the Bank's cautious approach toreform of the banking system proved justified. The decision to allow private banks to beginintermediating financial instruments of less than 180 days maturity represented the first critical stepin the process of breaking the public sector's monopoly on demand deposits without directlychallenging the existence of the public banking sector. As it turned out, the Government wentbeyond the actions required by SAL II and continued to gradually reduce the terms for local currencydeposits (investment certificates), from 90 to 31 days in January 1992. The process was completedin November 1993, when as part of SAL III conditionality private banks were allowed to acceptshort-term deposits of any maturity. This last step, however, was highly controversial and it openedup, for the first time, a vigorous political debate on the role of the public banking sector. Althoughthe dust has yet to settle, there are indications that a consensus is emerging on the need to legallyremove the state monopoly on demand deposits and to move toward privatization of the public banks.The current debate in Costa Rica is on how to privatize and on whether part of the public bankingsector should be retained to perform an as yet undefined development banking role. The Bank'sfocus on strengthening prudential supervision was also well placed and the process is continuing aspart of the program supported under SAL III.

1 World Bank. 1988. Costa Rica: Sclected Finanial Sector Issues. Washington, D.C.

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C. ECONOMIC PERFORMANCE

107. Non-traditional exports have consistently grown at a fast pace since 1986, causing totalexports to also rise substantially during this period. Owing to the sharp reduction of the anti-exportbias emerging from the structural adjustment process, exports have been a key source of economicgrowth during these years. The performance of public finances has been erratic, reflecting structuralconstraints in the public sector and the stop-go approach to dealing with fiscal pressures. Thisuneven pattern in fiscal behavior has had a corresponding effect on inflation, and despite sustainedexport growth, on the current account deficit. Although due to high import demand and adverseterms of trade, the current account deficit remains large, there was considerable progress in reducingthe fiscal deficit during 1991-92. Thanks mainly to the strong export performance, however, GDPgrowth rates were quite acceptable, averaging 4.6 percent annually during 1985-92.

D. GOVERNMENT OWNERSHIP

108. Borrower ownership of the structural reforms, which is a pre-requisite for successfuladjustment lending, is particularly important in the case of Costa Rica. The country has a highlydeveloped democratic system, and a strong national desire to seek consensus and avoid conflict. Thissystem coupled with the Constitutional requirement that external loans contracted by the Govermnentneed to be approved by a two-thirds majority in the Legislative Assembly, means that the approvaland implementation of complex reforms will be a difficult and drawn out process. Even when thereis a strong commitment on the part of the Government, the need to reach a consensus with theParliamentary opposition and other major social forces before proceeding with reforms, almostensures that the implementation of SALs will take longer than initially anticipated by the Bank.Although, as happened with the two SALs, the system ends up lengthening the period required toimplement structural reform programs and can cause some impatience among Bank staff, the effortinvested in seeking consensus is an important strength. Once consensus is reached backtracking israre. This was indeed the experience of the two SALs. When the conditionality has been welldefined and appropriate there have been no reversals, and in some instances the Government clearlyhas gone beyond what was required for tranche releases. The major failures were in meeting publicsector macro targets, which this PCR has argued were inappropriately set.

109. A related question refers to the Bank's role in supporting this consensus-building process.There are two ways in which the Bank can assist in the process. First, by insisting up-front on theapproval of key reforms, especially those requiring legislative approval; and, second, by broadeningthe policy dialogue beyond the Government and its economic team. On the first point, it wouldappear that the Bank went as far as it could in terms of setting Board presentation conditions. Onthe second point the Bank has had to tread a careful path between helping to explain the analyticalrationale for the adjustment program and becoming a participant in the ensuing political debate.Although no information is available in the files on this aspect of the Bank's involvement, it appearsthat Bank management and staff have always been prepared, at the request of the Administration,to broaden the dialogue beyond the Government, including with the opposition.

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COSTA RICASELECTED ECONOMIC INDICATORS, 1980-92

Avg.1960- Est.1963 1964 1985 1986 1987 1988 1989 1990 1991 1992

IN % OF GDP

PUBLICSECTOR

NFPS Current 20.3 25.2 24.5 25.0 26.0 26.7 26.7 26.1 27.6 29.1Revenues

NFPS Current 21.7 21.0 20.8 20.6 21.3 21.8 23.6 23.9 23.7 23.0Expenditures

NFPS -1.4 4.2 3.7 4.4 4.7 4.9 3.2 2.2 3.8 6.1Savings

NFPS Overall -9.8 -1.6 -1.7 -1.7 -0.3 -0.3 -2.7 -2.9 -0.1 0.7Satlnce

Consolidated -10.4 -5.9 -7.0 -5.5 -3.8 -3.6 -5.4 -5.0 -2.0 -1.1-IPubtic

Balance /

ALANCE OFPAYMENTS

Trade -6.4 -3.6 -4.4 -1.7 -6.2 -5.1 -7.3 -11.2 -7.0 -11.5Bal ance

Resource -3.4 -0.3 -1.7 0.9 -4.3 -1.9 -3.9 -6.8 -0.7 -5.2Bal nce

Current -13.5 -7.6 -7.8 -4.5 -10.0 -8.3 -10.9 -10.2 -4.0 -7.6AccountBalance J

ANNUAL GROWTH RATES

Domestic 44.5 12.0 15.1 11.8 16.8 20.8 16.5 19.0 28.7 21.8Prices

GDP J 2.3 8.0 0.7 5.5 4.8 3.4 5.7 3.6 2.3 7.3

Total -3.0 12.0 -2.2 13.9 4.0 11.6 13.6 7.3 11.5 16.0Exports ofgod *ndservices J/

Non- -6.3 18.0 -6.7 13.7 20.7 24.1 22.7 4.8 3.8 27.8TraditionalExports 4/

(1/) Includes Central Bank losses; (/) - Does not include official transfers; (QJ) - In constant prices;(4/) - In U.S. dollars.

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E. THE BANK'S PERFORMANCE

110. The Bank had an active role during the complete cycle of the Loans focusing first onsupporting the Government in stabilization and initiation of economic reforms and then on deepeningand expanding the scope of the adjustment process. In identification of SAL I the Bank focused ondifficult but critical policy changes to initiate economic reforms and work intensively with theGovernment through the process obtaining Legislative ratification within a short period of time, byCosta Rican standards, from Board presentation. The process of implementation was difficult andthe Bank agreed to narrow but deepen the measures supported within SAL I. Given the difficultdecisions posed by a protracted process required to initiate and implement the programs the Bankappropriately gave a strong emphasis to maintaining the process of reforms. SAL II benefitted fromthe experience of SAL I and identification focused on deepening the reforms initiated in SAL I,notably trade policy reform, initiated reforms in critical areas for the structural adjustment such asthe banking system and strengthening of supervision improved implementation.

111. The Bank showed flexibility in implementing both SALs and has to a large extent beeneffective in tailoring the SAL instrument to Costa Rica's gradual approach to structural reform. Along run view of the process of structural reforms and the prospects to maintain and deepen theextent of reforms have been an overriding factor in the Bank's decisions while implementing bothSALs. This approach allowed the Bank to correct some important flaws in program design andimplementation and maintain the adjustment process.

F. SUSTAINABILITY

112. Sustainability needs to be addressed on two levels: first, the sustainability of specificmeasures or conditions required by the adjustment operations; and second, the sustainability andcontinuity of the overall adjustment process over the longer term. Although SAL I faced difficultimplementation problems and a number of second tranche measures had to be redesigned, specificreforms, once agreed, were sustained. In SAL II some delays were encountered in implementationof second tranche conditions and a waiver was required for the public savings target, but onceimplemented reform measures were sustained. For both SALs there has been no backtracking onreform actions.

113. Experience with the sustainability of the overall adjustment process has been positive to date.SAL I begun the process of structural adjustment, which was continued and deepened in SAL II.The process has continued beyond SAL II, with the recent Board approval of SAL III which, ifimplemented, would: (i) complete the trade reform effort envisaged at the start of the SAL process;(ii) carry out a comprehensive restructuring of the role and functions of the state; (iii) further deepenfinancial sector reforms; and (iv) complete the process of domestic trade deregulation.

G. MAIN FINDINGS AND LESSONS LEARNED

114. Overall the Bank support for Costa Rica's structural adjustment process tirough the twoSALs has been justified and effective, despite some important shortcomings such as those in the areaof public sector reform. Throughout the process, the Bank has approached the structural reformprocess in Costa Rica with a great deal of flexibility and has been effective in tailoring the SAL

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instrument to the country's special circumstances. In particular, the Bank accepted the need toimplement reforms in a gradual manner and its judgement on overall Government commitment hasbeen generally correct. By 1990 public spending in social sectors as a percentage of GDP wasincreased to 22 percent close to the 1980 ratio, and families under the poverty line (ECLAmethodology) was reduced by at least 4 percentage points. Overall progress in social indicators andevolution of poverty alleviation followed closely the pace of economic growth. The markedimprovement in economic performance, especially in 1992, has been a welcome indicator of thesuccess of the reforms.

115. The main accomplishments of the SALs, discussed in detail in the subsections on overallperformance, were: under SAL I, trade reform, changing the activities of CNP, addressing publicemployment, and safeguarding the privatization of CODESA; and under SAL II, initiating reformsin financial intermediation and agricultural pricing policy reforms while continuing trade reform.Structural reforms progressed gradually and the adjustment process was maintained.

116. The main limitations of the SALs were addressing in a more comprehensive way twocritical areas in Costa Rica's economy: public sector reform and financial sector reform. Regardingpublic sector reform the SALs followed the trend on institutional matter then prevailing in the Bank -focusing on a few institutions or processes identified as priority problem areas. These limited thecosts of the public sector inefficiencies and some of its financial imbalances but only temporarilysince the programs lacked a comprehensive framework to address the structural weaknesses of thepublic sector. Regarding the financial sector reform these were limited by the political economy ofthe sector and reflecting the Bank's cautious approach to reform of the banking system. Thesemeasures, however, contributed significantly to broadening the scope of reforms of the financialsector needed to support structural adjustment of productive sectors.

117. The main lessons learned can be grouped into two main areas - design and commitment.Although, at the time of SAL I, there was agreement on the need to reduce the levels of protection,reduce CNP losses and cap employment expansion in the public sector, the specific conditionalitywas not well designed. On reducing CNP losses, targets were clear but neither the Bank nor thegovernment had a clear understanding as to how those targets would be reached. On public sectoremployment there was no employment base to be monitored or an evaluation of the specificmechanisms the Government would use to implement the employment freeze. The Bank relied onthe imposition of a freeze by the Government, which in the event could not be enforced fully.

118. The design of SAL II clearly benefitted from the experience of SAL I, except for publicsector reform. SAL II was better able to deal with reforms in agriculture and external trade but inthe public sector reverted to the setting of macro targets. SAL II did not attempt to deal with thelevels of public sector employment and wages but focussed on targeting the level of public savings.Although this was a more flexible way of confronting the fiscal problem but there were no specificmeasures to achieve the savings target. In the event the Bank decided to grant a waiver and fall backon the Fund's judgment that the Government was addressing fiscal imbalances.

119. The experience of the SALs confirms that there is no substitute for a strong politicalcommitment to the process of economic reforms to ensure a satisfactory adjustment program, a factby now well established. How to ensure this commitment in a society such as Costa Rica's,

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however, is a difficult question. Clearly, programn implementation was affected by the politicalcycle, but it is difficult to see what additional steps, if any, the Bank could have taken to ensure thata bi-partisan commitment was in place before proceeding with the SALs. Since the Bank can onlydeal with Governments, it must rely on its own judgement that the objectives and design of thereform programn effectively address country constraints and priorities. This is the only guarantee theBank can have that a new Administration will be equally committed to the reform programn. Theexperience in Costa Rica suggests that political commitment, albeit wavering at times, has beensustained and that the Bank demonstrated sufficient flexibility in assessing performance in overallprogram implementation. The two SALs straddled three Administrations and the Bank managed tocorrect important flaws in program design in order to ensure continuity of the adjustment process.

120. The most important lessons, for future operations, are:

a) The Bank needs to emphasize that the objectives and design of the reform programeffectively address the country's fundamental constraints particularly when programimplementation can be affected by the political cycle.

b) Program objectives need clearly specified actions identified as conditionalities forsuccessful implementation.

c) In addition to an appropriate design, the Bank needs to demonstrate flexibility and realismin evaluating progress towards agreed objectives while maintaining credibility in theactions that would follow non-compliance.

d) The experience of the SALs reviewed here once again confirms that there is no substitutefor a strong political commitment to the process of economic reforms to ensure properdesign and successful implementation of a program.

121. Postscript. The Government and the Bank have agreed on a Third Structural AdjustmentLoan. SAL III was approved by the Board on April 15, 1993 and signed on April 19. The core ofSAL III is comprehensive reform of the public sector which benefitted from the lessons learned inthe design and implementation of the previous two SALs.

Part II: SUMMARY PROGRAM REVIEW FROM TlE BORROWER'S PERSPECTIVE'2

A. INTRODUCTION

122. This summarizes the reports that evaluate the two loans (2158-CR and 3005-CR) approvedby the World Bank to the Government of Costa Rica to support its Structural Adjustment Programduring the period for 1985-91.

12 Thi8summay was prepared by Bank ftff based on the PCR prepared by the Government of Costa Rica. TheGovernmment approved this summary.

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123. In this summary, the Government of Costa Rica presents its own independent analysis of theexperience in implementing both loans. In particular, it studies the role of the Bank and theBorrower during the design and implementation of the loans, examining the relationship between thetwo and that between the Government and the cofinancier (in the case of SAL II).

B. THE BANK'S PERFORMANCE

124. The Bank adopted an active role during the development and implementation of both loans,facilitating their successful execution. The Bank emphasized the need to focus first on adjustmentand then on the deepening of the of adjustment process.

125. The above is particularly relevant for an economy such as Costa Rica's which, for more thanthree decades, faced a relatively favorable external environment, using heterodox policies withsignificant restrictions in order to support sustainable growth in the long run. The influx of foreigninvestment in the seventies, the high coffee and banana prices in the mid-seventies and the nearlyunlimited access to foreign loans stopped Costa Rica from having to face the inherent problems inits developinent policies, which it began in the forties, and the model of industrialization throughimport substitution, adopted during the sixties.

126. Conditions, however, changed by the end of the seventies. The international environmentnot only ceased to be favorable but developed a new source of problems; we began to have to facethe obligations of an external debt that was among the highest in per capita levels in the world.

127. Thus, Costa Rica finally found itself facing the structural dilemma of its recent economicdevelopment pattern: progress in the productive structure had not acquired enough depth to financedevelopment in the social structure.

128. The Government of Costa Rica developed a recovery and stabilization program which wasimplemented at the end of 1982 with IMF support. Its main objectives included the regulation ofinflationary pressures, the reestablishment of equilibrium in the balance of payments and theimprovement of relations with external creditors. Economic recovery, however, was slow and thecountry's external position continued to be fragile because of weak export performance and highdebt-service payments.

129. The Bank's involvement during the preparation of the first structural adjustment loan wascrucial throughout the process up until the approval by the Legislative Assembly in August of 1985of the Loan Agreement, known as SAL I which aimed at initiating a series of economic adjustmentsat the macro and sectoral levels. Through this first Structural Adjustment program linked to Sal I,the Government renewed its efforts in strengthening the afling fiscal and financial sectors, productiveefficiency and the promotion of non-traditional exports.

130. After May 1986, a monetary program designed to strengthen the stabilization program wasintroduced. It was aimed at reducing the consolidated deficit of the public sector and at curbinginflation and included an exchange rate policy to reach an external balance of payments.

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131. In 1987, a second Structural Adjustment Program was introduced to strengthen the adjustmentprocess. This program's goals included: the reestablishment of sustained growth, the strengtheningof the external position through private sector export ventures and the creation of an efficientproductive sector capable of financing the social and political processes of development laid out inCosta Rica's development strategy. However, apart from the tariff reduction policies, the adjustmentprograms focused on correcting various short-term issues without addressing the deep-seatedstructural rigidities that prevailed in the national economy. Also, foreign aid from other sourcesallowed for a less profound adjustment due to the continued dominant presence of the public sectorin the economy and the inherent weaknesses of the productive system and its foreign ties.

132. The World Bank's support with respect to the second structural adjustment loan cofinancedby OECF of Japan made the implementation of policy reforms in foreign trade, public sectormanagement, financial intermediation and agricultural price-setting highly successful.

133. The Bank's contribution to the second phase of the structural adjustment plan was invaluablethroughout the process up until it was formally ratified by the Legislative Assembly in October 1989.

134. During the implementation of this second loan, the Bank played an important role in helpingthe Costa Rican Government work efficiently at correcting deviations and finding solutions toproblems within the strict measures outlined in the loan agreement.

C. THE BORROWER'S PERFORMANCE

135. Any assessment of the Borrower's performance in the context of structural adjustment musttake into consideration the political factors that weigh heavily in the design and the execution of theconcrete policies to be implemented in the corresponding program.

136. Within these political constraints which limited the Government's action in initiating theStructural Adjustment Program, we can conclude that during the first phase (SAL I), the Borrower'sperformance did not provoke major setbacks, neither in the design of the measures supported by theBank nor in its legislative approval. It was the first experiment of its kind and the Bank itself waslearning about the contents and the limits of this type of program for assisting countries that requireda comprehensive structural adjustment program.

137. The Borrower's performance was, perhaps, not altogether efficient during the second phase(SAL II) because the range of policies to be implemented was expanded and the interests of theaffected groups were more evident. This may explain the delays noted during the implementationstage. The groups involved insisted upon a very gradual execution of the adjustment measures, soit was not until December 1, 1992, that the last stage of tariff reductions in textiles, shoes andgarments was implemented.

138. The Government of Costa Rica acknowledges that it is not an easy task to attain stable andsustainable growth, in which the modernization and diversification of the productive structure haveboth the ability to maintain Costa Rica's living standards and social structure. The prolonged debateof approximately ten months for the second structural adjustment loan reflects the restrictions thatstructural adjustment programs must face regardless of the soundness of the program. Political

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debate and the arrival at a consensus are two key ingredients which cannot be overlooked whendesigning and implementing measures for structural adjustment in Costa Rica.

139. The Borrower recognizes these restrictions, and the lessons learned from these previousstages have been drawn upon in the current negotiations of a third structural adjustment loan.

140. Perhaps the main lesson in the seven years of implementing the Structural AdjustmentProgram is the need to undertake the difficult process of political re-education of pressure groupsto expedite measures that deepen the structural adjustment achieved so far.

D. THE RELATIONS BETWEEN THE BANK AND THE BORROWER

141. From the Government of Costa Rica's standpoint, the relationship between the Bank and theBorrower has been fully satisfactory with respect to the support given to them for structuraladjustment.

142. The preparatory and supervision missions have been productive and timely; the former onesfor consolidating support and the latter ones for rectifying flaws or helping the program advance inthe direction agreed upon with the Bank and satisfactory to national interests.

E. PERFORMANCE AND RELATIONSHIP OF OECF AND THE BORROWER (SAL II)

143. The Borrower's assessment is that the relations with OECF (Japan), which cofinanced theSecond Loan for Structural Adjustment, have been satisfactorily carried out with the Central Bank,within the norms agreed upon.

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Part m: STATISTICAL INFORMATION

STRUCTURAL ADJUSTMENT LOAN I(Loan 2518-CR)

BASIC DATA SHEETAmounts (US$ million)

LOAN POSIONOutstanding

Orizinal Disbursed Cancelled R id As of 2/28/

Loan 2518-CR 80 80 0 21.53 58.47

KEY PROGRAM DATA

Origrinal Loan Dates Actual or Re-estimatedInitiating MemorandumLetter of Development PolicyNegotiations 10/03/83 01/28/85Board Approval 11/22/83 04/16/85Loan/Credit Agroommnt - 04/17/85Effectiveness - 08/23/85Loan/Credit Closing - 06/30/86Actual Completion - 12/30/85

CUMULAnVE LOAN DISBURSEMENT

FY85 EXY FY87Planned $40 $80 $80Actual $0 $40 $80Actul as % of Planned 0% 50% 100%Date of Final Disbursement: August 1, 1986.

STAEPINPUT(Staff Weeks)

EXI8 EYM EY-85 E Y E7 PY90 E1Y92 EY9 TOTAL

Preappraisal 62.4 174.5 8.2 245.1Appraisal 58.9 58.9Negotiations 12.3 12.3Supervision 1.8 35.5 .5 .1 37.9Completion 7.2 7.2

Sub-Total 62.4 174.5 81.2 35.5 .5 .1 0 7.2 361.4

- 42 -

STRUCrURAL ADJUSTMENT LOAN II(Loan 3005-CR)

BASIC DATA SHEETAmounts (US$ million)

LOAN POSMIIONOutstanding

Ori¢inal Dibro Cancellod Rssaid As of 2/28/93

Loan 3005-CR 100 100 0 0 100

KEY PROGRAM DATA

Original Loan Dates Actual or Ro-estmstodInitiating MemorandumLetter of Developmet PolicyNegotiations 11/00/87 08/03/88Board Approval 05/00/87 12/13/88Loan/Credit Agreement - 12/16/88Effectivenes S.t. Condition 1/ 11/15/89Loan/Credit Closing 01/31/91 07/31/92Actual Completion 06/30/91 07/31/92

I/ Subject to conditions (offectivenss expected for 3-16-89)

C V L DI

EXY8 EX9 EPY1 E7Y9

Planned $40 $100 $100 $100Actual $0 $ 40 $ 40 $100Actuala % of Planned 0% 40% 40% 100%Date of Final Disbursment: June 4, 1992.

STF INPUT(Staff Weeks)

EPY E EPY8 EP8 EPY8 Ep8 P9 Y1 PY2E EPY9 TOTAL

Pre-appraisal 42.8 33.1 75.9Appraisal 17.8 17.8Negotiations 12.2 1.8 14.0Supervision 5.8 0.8 0.6 15.0 18.3 19.0 59.5Completion 1.8 7.1 8.9

Sub-Total 5.8 - 42.8 63.9 2.4 15.0 18.3 20.8 7.1 176.1

- 43 -

STRUCTURAL ADJUSTMENT LOANS I AND II:

RELATED BANK LOANS

Date ofBoard

Ii~Purpose royal Statiu Comments

Export Development Loan To provide, through a revolving 05/03/83 Fully disbursed Completed in(Loan 2274-CR) fund mechanism, short-term December 1985

finance of imports by non-traditional exporters.

Technical Assistance Loan To support implementation of SAL 04/16/85 Fully disbursed Completed in(Loan 2519-CR) I and carry out preparatory work to June 1990

support follow-up adjustmentlending.

Structural Adjustment Loan mI To support the Government's 04/15/93 Loan Effectiveness Congressional(Loan 3594-CR) adjustment progamn to reform the pending approval pending

public sector, continue trade policyreform, improve competitiveness ofthe financial system, increasecoverage and efficiency of socialprograms, and reform the pensionsystem.

45 -

COSTwA RICA: KEY MACROECONOMIC INDICATORS

1980 1981 1982 1983 1984 1985 1986

GDP per capita (USS) 1,961.5 1,145.7 1,011.5 1,246.6 1,429.2 1,484.6 1,619.9GDP (Current USS) 4,481 2,696 2,452 3,112 3,671 3,922 4,399CPI (Growth rate) 18.10 37.10 90.10 32.62 11.95 15.05 11.34Unenployment rate 5 5.92% 8.75% 9.37% 9.03% 7.91% 6.85% 6.23%

-NATIONAL ACCOUNTS (% of GDP)

Consumption 83.8 75.9 72.4 76.6 76.9 75.9 73.9Private 65.S 60.1 57.8 61.5 61.2 60.1 58.6Public 18.2 15.7 14.6 15.1 15.6 15.8 15.4

Total Fixed Investment 23.9 24.1 20.3 18.0 20.0 19.3 18.7Private 14.7 15.2 13.1 11.6 13.7 12.3 12.8Public 9.2 8.9 7.2 6.4 6.4 7.0 5.8

Resource Balance -10.3 -4.9 2.9 -0.7 0.4 -1.8 0.8Export of G & S 26.5 43.3 45.1 36.0 34.4 30.7 31.3Inport of G & S 36.8 48.2 42.2 36.8 34.0 32.5 30.5

Financing of Investment 26.6 29.0 24.7 24.2 22.7 25.9 25.2Gross National Savin 11.8 13.9 12.4 13.6 15.5 18.1 20.8GrossDomesticSavm 16.2 24.1 27.6 23.4 23.1 24.1 26.1Current Trauers 0.3 1.0 1.3 0.7 0.9 1.1 0.9Net Factor ncme FromAbroad -4.8 -11.3 -16.5 -10.6 -8.5 -7.1 -6.1

Foreign Saving 14.8 15.2 12.3 10.6 7.2 7.8 4.4

-BOP (million of USS)

Exports (G&NFS) 1224.9 1202.3 1124.6 1118.3 1252.6 1225.5 1396.3Inports (G&NFS -1688.1 -1332.9 -1053.4 -1155.5 -1263.3 -1291.9 -1357.9Trade Balance -527.6 -207.2 -24.9 -159.1 -133.2 -171.9 -75.5Resource Balace -463.2 -130.6 71.1- -37.3 -10.7 -66.4 38.4NetDirectForelp Invest. 48.1 66.2 26.3 55.1 51.9 65.2 57.3Net M&LT Capital flows 8S.2 198.3 -115.0 194.4 -82.0 -57.3 -234.6Total Refinandng 0.0 0.0 0.0 1153.0 203.6 374.3 145.9Total Arrea 283.0 208.2 562.8 -1070.0 121.5 -143.5 201.1Principal . 60.6 287.4 .. 99.1 -51.0 107.7Interest -. 147.6 275.4 .. 22.4 -92.5 93.4

Net Other Cap. Inflows 1/ 190.6 -94.6 -63.9 41.7 -127.3 5.4 6.8Capital Account Bablce 659.5 422.7 303.1 347.9 280.6 306.0 198.0Overall Balance -38.0 -44.8 113.4 72.4 -3.9 114.3 92.9Changes in Reseres 2/ 38.0 44.8 -113.4 -72.4 3.9 -114.3 -92.9

-NON FIN. PUB. SECTOR (% of GDP)

Current Revenues 21.0 17.9 18.1 24.2 25.2 24.5 25.0Current Expeditures 23.3 21.7 20.6 21.1 21.0 20.8 20.6Current Surplus (Deficit -) -2.3 -3.8 -2.5 3.1 4.2 3.7 4.4Capital Revenues 0.2 0.4 0.2 0.2 0.2 0.0 0.1Capital Expend.&Net Lend. 11.2 10.2 6.4 6.9 6.0 5.4 6.2Overall Bal. (- Def.) -13.3 -13.7 -8.7 -3.6 -1.6 -1.7 -1.7Fuiancing: 13.3 13.7 8.7 3.6 1.6 1.7 1.7,Net External 3/ 4.7 11.2 6.2 1.0 1.6 3.2 2.1Net Internl 6.S 3.0 2.7 2.8 -0.1 -1.4 -0.9

Adjustnent 2.1 -0.S -0.2 -0.1 0.0 -0.1 0.5

Memo:C. B. Losses 0.0 -5.0 -5.6 -4.9 -4.3 -5.3 -3.8Overall Deficit + C.D. Loss 0.0 -18.7 -14.3 -8.5 -5.9 -7.0 -5.53/ lichdm aoand omaie, pdvs md daca r debt2/ Ince valueio. adjAimA3/ Zlachd. ch in xwnml amn an zehdusiag

- 46 -

rwftCOSTA RICA: KEY MACROECONOMIC INDICATORS (cont.)

1987 1988 1989 1990 1991 MP92p

1,618.4 1,609.8 1,777.0 1,892.3 1,821.2 2,061.0 GDP per capita (US$)4,509 4,613 5,226 5,710 5,634 6,530 GDP (Current USS)16.85 20.83 16.51 19.04 28.71 21.79 CPI (Growth rate)5.58% 5.46% 3.77% 4.64% 5.54% 4.10% Unanployment rate

-NATIONAL ACCOUNTS (% of GDP)

77.1 77.3 77.3 79.6 76.7 76.0 Consiuption62.1 61.7 60.3 61.4 60.5 60.2 Private15.0 15.6 17.0 18.2 16.2 15.8 Public19.8 18.9 20.5 22.4 19.7 20.9 Total Fixed Inveshnent15.4 14.8 16.0 17.7 15.5 14.8 Private4.4 4.1 4.5 4.7 4.2 6.2 Public-4.1 -1.8 -3.8 -6.8 -0.7 -3.8 Resource Balance31.7 34.0 34.8 34.3 38.4 36.9 Export of G & S35.8 35.8 38.6 41.1 39.1 40.6 Import of G & S27.0 24.5 26.5 27.2 24.0 28.2 Fmancing of Investment17.2 16.2 16.2 17.2 21.3 23.0 Gross National Saving22.9 22.6 22.7 20.4 23.3 24.4 Gross Domestic Saving0.9 0.9 0.8 1.0 0.9 0.9 Current Transfeas-6.6 -7.3 -7.2 -4.2 -2.9 -2.3 Net Factor Income From Abroad9.8 8.3 10.3 10.0 2.7 5.2 Foreign Saving

-BOP (million of USS)

1451.6 1620.1 1841.3 1975.3 2158.1 2556.7 Exports (G&NFS)-1646.7 -1707.2 -2045.7 -2361.8 -2240.1 -2893.6 Imports (G&NFS)-282.1 -234.8 -380.3 -642.2 -396.9 -751.0 Trade Balance-195.1 -87.1 -204.4 -386.5 -82.0 -336.9 Resource Balance89.5 122.0 101.2 162.4 177.5 114.7 Net Direct Foreign Invest.

-545.9 -263.5 -334.6 -173.2 112.4 -69.3 Net M&LT Capital Flows42.9 0.0 0.0 0.0 0.0 0.0 Total Refinancing

597.8 348.3 475.0 139.0 82.9 47.2 Total Arars415.8 97.7 204.5 54.8 34.9 22.2 Principal182.0 250.6 270.5 84.2 48.0 25.0 Interest124.7 66.7 188.3 13.4 116.8 492.5 Net Other Cap. Inflowi 1/453.4 . 383.9 567.0 583.6 269.0 499.2 Capital Account Balance42.8 104.9 15.1 -305.5 303.7 160.3 Overall Balance-42.8 -104.9 -15.1 305.5 -303.7 -160.3 Changes in Reserves 2/

-NON FIN. PUB. SECTOR (l of GDP)

26.0 26.7 26.7 26.1 27.6 29.1 Current Revenues21.4 21.8 23.6 23.9 23.7 23.0 Current Expenditures4.7 4.9 3.2 2.2 3.8 6.1 Curnt Surplus (Deficit-)0.1 0.1 0.1 0.0 0.1 0.1 CapitalRevenues5.0 5.3 5.9 5.2 4.1 5.5 Capital Expend.&Net Lend.-0.3 -0.3 -2.7 -2.9 -0.1 0.7 Oveall Bal. (- Def.)0.3 0.3 2.7 2.9 0.1 -0.7 Financing:0.7 -0.2 0.4 0.3 1.7 0.6 Net Exteral 31-1.0 0.4 2.1 2.3 -1.6 -1.1 Net Internal0.6 0.1 0.2 0.3 0.0 -0.3 Adjustment

Memo:-3.5 -3.3 -2.7 -2.0 -1.8 -1.8 C. B. Losses-3.8 -3.6 -5.4 -5.0 -2.0 -1.1 Overall Deficit + C.B. Losses

ANNEC 2STRUCTUL ADAMISLfOAMNI

MARI F IRANC= RElESCONDffTONS ANDf ACTUAL ACTONS TAKEN

1. Msdendl_sPeliq ~~~Mm M

A. Ehp RAPO MO - M_wd dowlnoim 1981-Ubmd_ by pwodk drvwliooo _da Iexble exehasge rat poliqy.__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

3. Rafon of Impret Trff - Aueeaaa on roul aifW tratY. FM t b et cdu a ipos of Complin of trade refom conditionsraw mutailak amada - capitatl Ws aot vay positive, althog itPods is a deaan wit thelekte se pat beyond the Govenmet'sfor in the Pp m. contol. Tfe main aspcts wre:

(i) Th new regiona trff had a rangeI) lmplae fthe Nomclatura of 10-100% for competing raw

Arcebria Ufrms materials and intermediate goods.Centroamerlcana, (NAUCA 11); G0) inead of the agreed 20-30% asn..envft tsiff scbeduks m imported There were also soe octhr, lessgoods to - ad-vabrei base; and 0) importan, differences wkh the newimpbnt a new trade regie in regional tariff.

rdace with the provisions of the (ii) Rcfnrm of the Import surchargesCaal Americn d _ad Taff on final conasm goods also fell shortAgreement, of the envisioned goals.

(iii) In Decembe 195. the Central(TAL) Underte a analysis of the Bank approved vral surcbaSrge andutriff rform on Ca Ricn indusrry regioal tariffs that were, in gcneral,nd need for furber adjustmaet subsniy higher thn prior ones,

although they remaid below the levelsagred under SALI

- (iv) No greement on tariff levels hadbeen reced regionalY for SoMeimportant ie. includg textiles,goarents, plastics and paper products.As a result, ech country (iodudingCoam Ric) set up tariffs for thoseites at veuy high levels, typically inthe 70-100% range.

-Sao PCR of TAL foc detals on thestudy which us not earried ot.

/IPragraphs in bold conspod to te Loa Agernar, otherwis to dw Psuldet's Rcport. Prgph prooeded by (TAL) oonwpond to (mostly) sudies suppoted by the TechnialAssi1t*oce Lon thcat wo am conditions fr the seod tacho of SAL L.

,sta at,,. n..Jnaad, * 1 .. j @. . ,. ... |

C. Export Taxer All expo ptae on non-traditioaalexpors to third market were

_ diimi4.

D. Export lacenives to Markets - Establis revolving Export

Outside the CACi. Fiacing Fund in the Cintra Bank and

iroduced an iaproved dr=_bck. ~~~~~~~Wiism.

E. Modeomizo do do lndutrial - Govenmet with support of private c Del a prepam of modendtio of - It complied with the initia stae of the

Sector sectr orpalates and extei thb Nonvwes indural seor, desip of a program to moderizo the

tehic assistance, pre d props.. iNdg a p*opm for the pilt nd indutia sector, although laer tha

to asist industries to moderize, equip.nt uppaln ued1 polcy originally eavisiooed.

indcdiog rnging thdir ability to and tring of management and

obtan the maketig and tchbnologca labor.

Infonration needed to brek into nev

markets.

Goymiwmet also deviloped strategysad progms to arae foreigInestors, also wit external tcdnla

11. Impreve the Edcy of PubicSector Maaagememt, RsesoeAocaties, and C_erol of PbilcSpending

A. Public Employment and Wags. - Pblic sector employment levels fro - Take al the aesty measres to Public Employment bad Incased in

for three yea. beginig Ma 2, inpleme a on pubk sector 1985 by an cimte 2.5% (or 2,800

1. Reduce the public 1914. Ncw spoitmea limited to enplsymet in 198S in accordnce cmpoyees), insead of beig frozen at

sector's sha, in the epecial cs-e by Contrkwia, ad not to wih tle provioses of the Law No. the 1914 evel, as it had been agreed

Oconmy ex eanployment ceiing. Other . with the Boak. This was caed,

st_p take to eliminae vacat poss, maiy, by the inabiity of the Ceal

2. redce the dse of accelerte retremns and ecouep (TAL) Cry oat a study of public Governmet to enforce the employ t

maps in transfers to p nw sector. sector salay a incentive policiers. freze i autonomous agencies (e.g.,

aqditue CCSS hired IS00 nw employe).In 19U6, Public employment was

still aboe the agreed 1914 levd. The

.___ _ __ __ _ __ __ _ __ _ _ __ _ __ __ _ __ _ __ __ _ __ _ _ __ _ __ __ _ __ ___ registrd increase (b et 2.0 and

It. Pargaphs in bold corrpon to the Loan Agreaeme, otewie to the Preidecc Rept. P= pba pteded by (TAL) correspond to (mostly) uies a oztd by the Twchncl

Asidance Loan thas were also condition for the eoond awche of SAL 1.

SECTOR AND POLICY ISSUE j~Y-EOARD . -S STEPS TO DR TAKEN II'ACTIONS TAK-EN

A Public Employment and Wages. 2.5%, depending upon the sources of

(Continued) figures and estimntes) was, however,

much smaller than in previous years.when it had averaged about 6%annually.

Study completed. Sec PCR for TALfor details.

B. Budget Administration and Control.and Reorganization of PublicFinances

I Rcorgniztion of - High-lo Commission eblished byPublic Finances the Asembly to make rcomnmdatn

nd prepare draft legislation to reorderpublic finances and tax syrtm.

Law for the Financial Equilibrium ofthe Public Sector limbn: (i) CetaGovernment acces to credit from theNatil Banking System (SBN) to Spent of total budgeted expendituresfor the ptevious year. and () forbidsdeenalized tittions from obtainingexteal crodit to cover crrntoperational cost

2. Budge Authority and Etbidshmeat of a Budget Authority - (AL) Ilpfove overall budget pincers - Done. For dctails, see the PCR for the

Budpt Process d preparation of anwl piddi for through the doevelopment of procedures TAL

budget preparation. for improved budBet exctiobn an

conuls, including monkoring ofLaw for the Finncial Equilibrium of physcl an finanil progre ofthe Publi Ser esablihed _ projects, nd aalyds of post budgteriaeeL for budget pteparation, pedonmne to aid preparation of futureincuding that, all eatited budgts.editures must be tid to aequimlet level of rev_u as eufied - (TAL) Iaiae a review an revision ofby the Controller General; an currnt the legal fram_atk an admniistrativeexpenditu must be financed with ta of the Technical Secrdrat tocurrent revenuosr ad, noe-priority Improve oodinatio In prepring,budget items of decentralized imeplnmatinSg and controUing publicistitutions can be dimInat on soctor budS. P

11. Pb eha in bold or on to the Lan Agreemt, otherwine bo the iddt's Rspout Nagpbp dd by TAL) co spond to (mostly) udie suppotd by the ThnicalI -a

Asswane Loan tat w, asondition for the second trench. of SAL 1.

2. BuiptAmorky ami _ _mmaiaof te BodreBudgetPro Avt d qwib CaUtL

3. Cotrdol Of temked . anekin of er*ti mm fit sperM.taxes Nd com_uwey pupma reduced in 1964 sW 19

Nudlag Assembly aqppim of rs,Of Ssq"kipg syt, Oov_msU wlso p e no appove my islatlon__________p sa ae .earma-Ing.

C. Raobrpazmoa of CODEZA adResuctring of ki Prtfolio

I. Divetie of Pontfolio - AMa y qprp of lbgisltlos C_mplg a _ of scum ohed_ag a - TeGovernment wa basically Isasdeizin_g he Executive Drelw l toenstd_hi for am dEvude la 18S o. compliac wi the condiions rdated

WI of CODESs shn in ka t _wApiu ewmd by CODISA, I to te CODESA divetro progam.e_epris wit the ecpion ofW aewdmce wih tD pevisios of the albeit at lter dat than aSreed upon.

perent owsewuhip of FURTICA ad Law 055.CMesto" del Paco - Ie prog for FER1CA ma nota

. (TAL) Ptaae an action progm to done. See PCR for TAL for details.Within this framework CODESA baa Improv the maageme and matketingcoked DAIA mod C _moe del Valb, of FEKCA and stregtbenWho equip_maz vas "Id; sold maagmen of CATSA.Malercltara. Acuacul sad itsbusein Smib-poductos del CafE; hacesad

privas particiption in STAEAPAIU.

OGyermmt as abilIsng a Trust

Fund wih forei financing to expdite_______ _______ _______ _______ _______ divestiture.

2. h nsitton an Plicy Agremnt reacbed on ew policy - (TAL) Complte a program of This was not compltoed. See the PCR

Imptovamnts objectives and titution ideines reorganization and policy imprvements for the TAL for details.for CODESA, to rcoriet iu activitis under new guilines.to promote agro-industry projetu andexport proj6ect outside the CACM.CODESA'r participation Is liited to30 pect of total capit noeeds. Noloan, guarante or endorsmenAswould be made, except for all agro-indudry projects. All projes bjet tosict economi d fincil feasb

_ _ _ _ _ _ _ _ _ _ _ guidelne. .__ _ _ _ _ _ _ _ _ __ & f

1/. Pngaphs in bold corpond to tie Loan AgreeenYt, othwise to the Pesidd t's Report. Pargrphs preceded by (TAL) cormpond to (mosly) studies suppored by the Technical A tnce Loan tht we lo conditions for the secow unche of SAL 1.

w::8:~~~~~. .. .S .... ; -. .. .. .. .______B _____R__ .SEST ETAE 'AONS TA MEN

D. National Production Council Agreement to reduce CNP's loues by - Take *D the necessary easusres to - The Government did not comply with

(CNP) 50 percent each year beginning in 1985 reduce the 1984 operating losxs of the the condition of achieving an annualthrough appropriate price and poliqc CNP by SO% in 198S. reduction of CNP losse of 50%

adjumnents. Actions to reduce losses starting in 1985. On the contray,from corn, beans and rice already - (TAL) Carry out a study of price an during that year, CNP losses increasedtkw=. nuwketing policies, induding further, owing to higher sorghum

organizational structure of CNP, to production and larger rice purchascsdefinc policy options for reducing costs than planned. In view of this situation,of existing framewerk and provide more tbh Government took additionalcffective incentives, measures during the first half of 1986,

of which the most important wasexcluding the public sector from themarkceting of sorghum and rice. Thesemeasurcs were designed to cut CNPdeficit in 1986 to no more than 800million coloncs during the subsequent12 months, and were accepted by theBank as the basis, concerning thiscondition, for releasing the secondtranche.

- Done. See the PCR for the TAL fordetails.

E. Public Sector lnvestment Program - Agreemet on public investment cediing - (TAL) Compite n review of the - The implementation of the public sector

of 6.5 percent of GDP for Caetrl progress in caTrying out the public investment program was generally met,

Gonment and main public entitics sector invesment prognam set forth In although at later dates than originallyduring 1984-46. the Program, including the planed. See the PCR for the TAL for

compliance with the 1985 public details.Agreement reached on a revised thtee- sector investment targets set in theyear investment program (1984-86) Program.compatible with the expectedavaibabiity of domestic resources,financial position of public ceterprisesconcerned, and service conatra;ntr.

IIl. Publc Resource Mobilztioa

A. Tax Reform Since taking office the Governmentraised Central Government revenues byabout 7.5 percentage points of GDP,through pplication of new taxes andrevision of existing tax rates.

11. Pfrgraphs in bold correspond to the Lean Agreement, tewise to the President's Repott Pargaphs preceded by (TAL) correspond to (mostly) sudies supponed by the Technical *

Assiance Loan that wterie ao condikions for h scond uanche of SAL 1.

B Financing of Autonomous Public - Sipificant price and tariff increases fog

Sector Entities ead Hon-Finncsial pr. watcr* tdAecommunkationS.

Enterprises petreum prodts and urban uanspodweM pt ito effta sice 1912.

IV. Extenl Deb Management and - Directives wes sued rquiring

Centrol contracting of new external debt to beapproved by Planning. the BudgetAuthorty and the Controfler cena.

Central Bank inslled Debt reportingn4d monitoring syseem.

Decentralized agencies cannot obtainexternal credit to finace currentexpenditures.

V. Increasing Agricuturl Production - Revision of overall incentive systen

and Exports undcrvey, induding actions to adjugexchange rate and refortm Importtarifls; liminate export txes on non.traditionala to third market; ad reduce

tax on beer expons.

V. Banking Syutem

A. Credit and Ilterest Ra Polic - EstablihrnDt of positive real interest

rats and Govemrneat commitent tomaintain deposit rates above expectedinfltion.

B. Inslitutional Framweuek - Study of National Banking Systn by

high-level commission completedNovember 1984.

- Amendmeat of Money Law to permitlending in foreign exchange andtransfer of foreign exchange risk to theultimate borrower; and approval ofamendments to Central Bank L1 topernit direct prite beak acces toBCCR rediscount facilities financedwith foreign funds.

- Eliminadion of credit allocation systa

by s-sectors. %

Passr in bo oesW to Ems AL e t, o w to PrdlaKs RepotL Pagraphs preceded by (TAL) cospoad to (mostly) tdis supotd by the Technical W

hcnec lt&n IhCI was a_ ooam for zxdw tnomcwhb of SAL L

ACIN ALREADY rAT(SECTORA-ND.POLC ISE 5 BOARD PRESENTATION 61EPS T BK ACTIONS TAKE.

VIl Improving Cost-Effectivness ofKey Institutions and Programs

A. Strengthen the Financing and - Social Security (CCSS) Impleamented anManagement of Social Security and action plan to increase revenues andHealth Programs reduce costs, including pcronane

reductions. CCSS budgt for 19S4dowed a surplus.

B. Improve Cot-Eflfeivenc of - Teachber employment levd frozen forEducation Programs, Including 19S4-86 (as part of overall freeze onImproving Quality and Focus of public sector employment).Education Consistent with CurrentNeeds

1/ pangraphs in bold corrpond to the Loan Agrennent. othewse to the Priden's Report. Paagraphs precedd by (TAL) correpond to (mostly) studies suppoztd by the TechnicalAssistance Loan that wer also conditions fur the second tranche of SAL 1.

ANNEX 3STRUCMURAL ADJUSTMENT LOAN n

MATRIX OF TRANCHE RELEASECONDITIONS AND ACTIUAL ACTIONS TAKEN

R AC .TONS ALADY AIT ;SECOR: AND POLCY IS=: YBOAAD PRESETTO?B-j tfON AE

L Export and Trade Swtor

A. Anti-export bias of the trade - Implementation of first phuse a Implement three equal tariff reductions r Impklmnted the tariff reductions.regime. rationalization of CACM tariff regime, between June 30, 1938 and June 30.

including reduction of highegt nominal 1989. Reduced prior importer's deposits.tariffs below 70%, with *ome exccptions.

s Reduce prior importer's deposits from t Implkmentod the tariff adjustments50% to 30% by June 30, 1989. generaUy on trck.

tImpkment a fourth semi-annual tariff t Prior imnportcr's deposits were reoduced.reduction-equal to the prior ones-byDecember 31, 1989, to achieve by thatdate the folowing tariff structure:- AU tariffs should be within a S to40%, except: texies, apparel andshoes which would take five years;non-competing essential goods such asmedicines would pay 1 percent; somenon-competing final goods (primarilyluxury goods such as automobiks,caviar, ancbovies) would have tariffs inexcess of 40 percent Within thisframework, raw materials-Intermediate goods and capital goodswould have a ceiling of 20 percent anda floor of 5 pereent

t Reduce prior importer's deposits to10% by December 31, 1919.

I/ Panpbs in bold eorrerpond to the Loan Agreeunt otherwis to the Pesdents Report. Test folowed by 's correponds to conditions for the second tranche and text following 't cornsponds to third trnoah conditionality.

B. Need for * stble incenive - implncntation Of crawing peg cxchsng s Mudt hve Ihe new export inentive

s The incentive system is estabtished in

regime to encourge privite rate regime, with pedodic mini-

systm satisfatorily operating by June 1991

sector inveStMent in non- adjusanme.

1989.

traditional expors intended fornon CACM markets - inecntive rcegiim system and exponcontat sytem to coordinate benefit toexporer.

- Eablisbment of privaly adminsteredtrade on in 195.

- Application for memberhip in GATF.- o0eing of air cag anspottion totofeign air carriers.II. Agriculturat Pdwng Pondl

A. Pricing policies for basic grin Freezing of nominal suport price to t SL ptoducer wspport prioes for carn, Complied in 1991.

crops that doot reflc4t woaM producen of bean and comn during 1987. bewn and doe not to exced 1.4 times

market psicae offering inadequat

the;t isnalon fivo-year avenage

incentives - lAeMnlization of rice primes in 1987. during 1990.

- -

B. Publik sector monopoly on Tranfer impont rights on rime to tbe Eb_ine CN ts mnopoly an Imports s Private traders were *owed to Import

impods of some basic giimni private sector. and rnit len to permit traders to but not until 1991

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ m p ort basic grkai s.

_ _ _ _ _ _ _ _ _ _ _ _

11. Public Sortwr M get -__

_A. Need to increas overU public - 1987f198 tax actions to inc_eas

s Rabe PbIk Seco Savg to 5.7% * The Public Savings condition was

sector savings revmenes ata rate of 1.3% of GDP per GDP in 19M sad introduce provision waived by the Board for second tranche

bi the 1989 budgetto icras the disbu rt in July 1991.muwelted 198 average of publcsavgs to at kast perent of GDP. t The rbow waiver %as carried over tothe thir tranclie.

t Inrodce a proion in the 1990 budgesetins PubliC Saving to aa envigedaverage of at luet 6 peret of GDP forthe 1988-90 Period.

1t Paragphs in bold coroespond to the Loan Ageinnut otherwise to thu Ptealdenta Repost. Tex fbDlwed by s' orresponds to conditions for th second trache and tcxt folowing t

corresponds to third tran coaedtiaaiy.

ACTtONS ALREADY TA. - ... . ;SECTOR AND) POLICY ISSUE - BY BOARD PESENTATION STE-i TO BE TAKEN l: ACTIONS TAEN

B. Limited discretionary authority to - Stricter control of actual budget Not propose new legislation s Complied, with delays.

manage public expenditures allocation on pait of Finance Ministry, establishing earmarked revenues

given high percentagc of during 1988 and 189. s Investment program was implemented

earmarked expendituresa Implement in the 1988 budget the t Complied

projected three year public investmentprogram that was presented to theBank.

I Should have implemented the 198849components of the above investmentprogram.

C. Need to reduce public sector - 1984 Emergency Law with divestituresize and provide incentives for program of Government's ownedprivate sector activities CODESA's enterprises.

- Tax Reform Project to rewardreinvestment of corporate projectspresented for Congress approval.

IV. Fnancial Sector

A. Nced to increase financial - Libermzation of interest rate and credit s Maintain subsidized credit by public s Initially the caps on subsidized credit

savings and to improve their allocation controh. commercial banks at the December 31, were not met. Hawever, they were

allocation 1986 levd of C 5.3 bdLion in nominal complied by 1991.

- Total subsidized credit reduced to about terms and seasonal variation not

16% of total lending. exceed an average of 5 percent in real

tenm.

B. Need to improve efficiency of - Draft Law submitted to Congress to relax s Reduce public commercial Bask's 180 a The conditions wemr eventually met, but

and competition in the banking administrative controls on publc banks. days overdue portfolio to 5 percent of not by the target dates.

system total outstanding loans made by such

- Prognum to allow private banks to banks as of December 31, 1988 and to t Complied by late 199 1/beginning of

intermediate financial assets of less than 4 perent by June 30, 1989. 1992.

180-days of maturity.tReduce abovc portfolio to 3 percent of

total outsanding asu by December 31.

1989.

1/ Pagraphs in bold correspond to the Loan Agreemen otherwise to the President s Report Text folowed by 's' corresponds to conditions for the second tranche and text following t b

crmsponds to third unnche condstioahty.

~iCTIQNS ALREADY TI, TS,CTOR-AND POL CY ISSE BY BOARD PRESEWNATION .K , O BEEN. 11 . .... AONSTAEN

C. Need to strengthen supervision of - Draft law submitted to Congress to s The Superintendency of Banks should s The conditions were eventually met, but

the financial sector strengthen supervision of financial inplement regulations aimed at: (i) not by thc target datesinstitutions by Auditorla General de allowing banks to chare penalyBancos (AGB). Interest rates for debts not paid at their

maturity; (ii) prohibiting banks toregister as incore the interest accruedon bans that had betn past due formore than 180 days; (iii) instructingbanks to publish annual financialstatements in newspapers with nation-wide circulation; and (iy) requiringbanks to have their financial statementsaudited by external auditors.

D. Need to pmmote equity financing - Draft law submitted to Congress to s Approval of the draft Law s Complied

on new investments strengthen the operation of securities

markets.

00

11 Paragmphs in bold cormspond to the Lan Agreeeat otherwise to the Preside"W Report. Text foDowed by "s' coresponds to conditions for the second trnche and text following t b

corresponds to third trancho conditionality.

- 59 - ~~~~~~~~~Atuchikit

PROJECT COMPLETION REPORT

PARTE II

(PAE-I y PAE-II)

INTRODLUCCION'

Estas notas forman parte de los informes de finalizacio'n de

los dos-prstamos (2158-CR y 3005-CR) que el Banco Mundial concedio

Al Gabierno de Costa Rica para apoyar su Programa de Ajuste

Estructural durante el perlodo 1985-1991.

Se expresa aqui el juicio independiente del Gobierno de Costa

Rica sobre la experiencia de implementacion de los dos 'prestamos.

Especificamente as enjuicia el desempeno del Banco y del

Prestatario durante la evolucion e implementacion de los prestamos,

se establece la efectividad de la relacion entre ambos y del

Gobierno con el cofinanciador (solamente para el PAE-1I).

DESMWEO DEL BINCO

El papel activo asumido por el Banco durante la evoluci6n e

implementaci6n de los dos prestamos, permiti6 una ejecuci6n exitosa

de ellos. En efecto, el papel del Banco ha sido clave para

reforzar la toma de conciencia sobre la necesidad del ajuste

primero, y de profundizarlo despues.

Lo anterior es especialmente cierto para una economia como la

costarxicense que durante mas de tres decadas enfrento un ambiente

exterior relativamente favorable, que permiti6 una aplicaci6n de

politicas heterodoxas con serias limitaciones para sustentar un

crecimiento sostenido en el largo plazo. El flujo de inversi6nextranjero de los setentas,-los altos precios del cafe y del banano

a medLados de los setenta y, finalmente el acceso casi irrestrictoal endeudamiento externo, Rosibilitaran que estilo del desarrollocostarricense que se gesto en la decada-de los cuarentas y el

mAodelo de industrializaci6n sustitutiva de importaciones que se

puso en marcha durante los sesentas, no tuvieran que enfrentar

seriamente sus propias limitaciones.

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Page 2 of 4

Pero a finales de los setentas todo esto cambi6. La situaci6ninternacional no s6lo dej6 de ser favorable, sino que se convirti6en una nueva fuente de problemas, en especial cuando tuvimos queempezar a enfrentar los compromisos- que representaba una deudaexterna que habia alcanzado uno de los niveles per cipita mas altosdel mundo.

Asf, Costa Rica se vio finalmente confrontada con el dilemaestructural de su desarrollo reciente: los avances en su estructuraproductiva no habian logrado la profundidad necesaria parafinanciar los logros en la estructura social.

No obstante los esfuerzos del Gobierno de Costa Ricaadelantados mediante un programa de estabilizaci6n y recuperacionpuesto en prictica de fines de 1982 con el apoyo del PondoMonetaLrio Internacional, cuyos objetivos principales fueron elcontrol de las presiones inflacionarias, la restauraci6n delequilibrio en la balanza de pagos, y el mejoramiento de lasrelaciones con acreedores externos, el restablecimiento del ritmodel crec.iiento econ6mico fue fragil y la posici6n externa del palscontinuo siendo dibil, debido al pobre desempeiio de lasexportaciones y a los pagos tan elevados enel servicio de la deuda externa.

%El desempeiio del Banco resulto crucial en esta etapa depreparacion para la puesta en marcha del primer prestamo de ajusteeutructural, hasta culminar en el mes de agosto de 1985 con laaprobaci6n por parte de la AsambleaL egialativa del Convenio dePrestamo conocido como SAL I, orientado a inicar una aerie deajustes economicos a nivel global y sectorial. Mediante el primerPrograma de Ajuste Estructural asociado con el'SAL I, se reforzaronlos *sfuerzos del Cobierno en las ireas de saneamiento fiscal yfinanciero, eficiencia productiva y promocion de las exportacionesno tradicionales.

Hacia mayo de 1986, con la nueva Administracion, el programade estabil.izacion fue fortalecido con med$das diseiiadas parareducir aun mas el deficit consolidado del Sector Pfiblico, unprograma uonetario orientado iacia la contenci6n de las presionesinflacionarias, y unaL politica de tipo de cambio destinada a lograrel balance en los pagos externos.

Duranto el anio 1987, se tomo la decisi6n.de profundizar eiproceso de ajuste con e1. apoyo de un segundo Programa de AjusteEstructural por medio del ceal sQ pretendia lograr una recuperaci6n.sostenida de la economia, una posici6n externa mis fuertoencabezada por actividades. exportadoras del sector privado y uneficiente sector productivo que sea capaz de financiar los procesosde desarrollo social y politico quo definen y distinguen el estilocosta=ricense de desarrollo. Sin embargo, aparte del proceso dedesgravaci6n arancelaria, los ajustes se centraron en la correcci 6 nde algunos aspectos relativamente puntuales, y no se atacaron enprofundidad las rigideces estructurales presentes en la economianacional. Ademas, la ayuda internacional percibida de otras

-61-Pas 3 of 4

fuentes permiti6 continuar con ese estilo de ajuste moderado de losdesequilibrios estructurales propios de la exacerbada presencia delSector Piblico en la economia, y de las debilLdades inherentes alsistema productivo y sus vinculaciones externas.

En esta segunda fase, el apoyo del Banco Mundial en lost&rminos del tercer prestamo de ajuste estructuxal cofinanciado porThe Overseas Economic Cooperation Fund de Jap6n, fue altamentesatisfactorio para la implementacion de reformas en las politicasde comercio, manejo del sector pyiblico, intermadiacion financieray fijacion'de precios agricolas.

La concepci6n misma de la !uegunda fa se del ajuste estructuralfue tarea en la que el aporte del Banco resulto invaluable hastallegar a concretar el segundo pre"stamo, el cual quedo fonmal.menteratificado por la Asamblea Legislativa en octubre de 1989.

En la etapa de implementacion de este segundo prestamo fu. misvisible la presencia orientadora del Banco para corregir deavios oparp ayudar en la buisqueda de salidas a impasses en la puesta enprictica de medidas concretas que se contabilizaban en lascondicionalidades del p$estamo.

DESEIPENO DEL PRESTATRIO

Todo enjuiciamiento del desompsno del prestatario en elcontexto de1 ajuste estructural, debe considerar los elementoa deorden politico que pesan fuertemente en el disoiio y la ejecuci6n delas nedidas de politica concretas para implementar el programacorrespondiente.

Dentro de esas restricciones politicas en que se acota laaccion del Gobierno en la puesta en zarcha del Programa de AjusteEstructural, podemos afirmar quo pare la primera fase (PAE-I), eldesempeno del Prestatario no tuvo grandes contratiempos ni an laetapa de concepeion de las medidas con el apoyo del Banco nl en lade aprobacion legislativa. Era el primer experimento de eate tipoy el propio Banco estaba aprendiendo de los contenidos y alcancesde este tipo de instrumentos para apoyar a los paises que requeriande un programa comprensivo-de ajuste estructural.

Quizis el desewpeno del Prestatareo no fus del todo eficientedurante la sogunda fase (PAR-II), por cuanto el menu de pollticaspor poner en escena fue aumentado y los intereses de grupoa porafectar fueron mis evidentes. De ahi quizia la prolongacion on e1tiempo quo exhibe la etapa de implemontacian. So exigla tantagradualidad al Prestatario por parte de los grupos de poder en laaplicacion do las medidas de ajuste, que no es sino hasta el lo. dodiciembre de 1992 en que entra a regir el 'ultimo tracto dedesgravaciones arancelarias para los rubros de textiles, -calzado yconfeccionn.

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Pago 4 of 4

El Gobierno de Costa Rica reconoce gue no es taresa facillograr un crecimiento estable y sostenido, en el cual lamodernizaci6n y diversificaci6n de la estructura productiva tenganadem&s la capacidad de mantener sanamente los niveles de vida y laestructura social que caracterizan al estilo de vida delcostarricense. El proloncado debate de aproximadamente diez mesasa que fue sometido el segundb prestamo de ajuste estructural,refleja esas limitaciones a que debe hacer frente un pro7rama deajusto estructural, par mejor estructurado que este. Lanegociaci6n politica y la bCusqueda de consenso, son dosingredientes clave que no pueden soslayarse en el proceso deconcepcion e implementaci6n de las medidas del ajuste estructuralen Costa Rica.

El Prestatario es consciente de esas restricciones, y laslecciones aprendidas de las etapas previas le han servido paraaplicarlas en las actuales circunstancias en qua se negocia untercer prcstamo de ajuste estructural.

L4 necesidad de enfrentar un tortuoso proceso de reeducacionpolitica de grupos de poder para viabilizar medidas que profundicenel ajuste estructural hasta ahora alcanzado, es quizas la principalleccion aprendida en estos siete aios de la experiencia deimplementaci6n del Programa de Ajuste Estructural.

mEr&CION ENMRE EL BWCO Y EL PRESTA5ARIO

Las relaciones mant3nidas entre el Banco y el Prestatario hansido plenamente satisfaczorias desde la perspectiva del Gobierno de

*Costa Rica, en torno al apoyo del primero en el campo del ajusteestructural.

Las misiones preparatorias de los pristamos y las deseguimiento, han sido muy fructiferas y oportunas. Las prlperaspara concretar el apoyo y las segundas Vara enmendar yerros o parahacer avanzar el programa.en la direccion convenida con el Banco ysatisfactoria para los intereses nacionales.

DESEXPEkO Y REIACION DEL COFINkCIADOR PEL PAZ-Il

Sobre esto punto, la apreciacion que tiene el Prestatario eoquo las relaciones con The Overseas Economic Cooperation Fund(Japon), cofinanciador del Segundo Prestamo de Ajuste Estructuralse han manejado satisfactoriamente con el Banco Central dentro delas normativas acordadas con el primero.

World Bank Document€¦ · enterprises; (iv) reducing the losses of the Agricultural Marketing Agency (CNP); (v) reducing public investment expenditures; (vi) increasing tariffs

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