Document of The World Bank Report No: ICR00004444 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-86620) ON A LOAN IN THE AMOUNT OF US$ 200 MILLION TO THE PEOPLE’S REPUBLIC OF CHINA FOR THE CHONGQING‐DADUKOU DISTRICT FISCAL SUSTAINABILITY DEVELOPMENT POLICY FINANCING January 3, 2019 Macroeconomics, Trade and Investment Global Practice Governance Global Practice East Asia and Pacific Region i CURRENCY EQUIVALENTS (Exchange Rate Effective November 30, 2018) Currency Unit = RMB RMB 0.16= US$1 US$ = SDR 1 FISCAL YEAR January 1 - December 31 Regional Vice President Victoria Kwakwa, EAPVP EFI Practice Group Vice President: Ceyla Pazarbasioglu-Dutz, GGEVP Country Director: Bert Hofman, EACCF Senior Global Practice Director: John Panzer (Acting), GMFDR; Debbie Wetzel, GGODR Practice Director John Panzer, GMFD2; James Brumby, GGODR Sector Manager: Deepak Mishra, GMF02; Alma Kanani, GGOEA Project Team Leaders: John Litwack, GMF02; Min Zhao, GGOEA ICR Team Leader: Lorena Viñuela, GGOEW ii ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy CCP Chinese Communist Party CFAA Country Financial Accountability Assessment CNAO DOF China National Audit Office Department of Finance DPF Development Policy Financing DRC Development and Reform Commission DSA Debt Sustainability Analysis FAI Fixed Asset Investment FYP Five Year Plan GDP Gross Domestic Product GRS Grievance Redress Service IBRD International Bank for Reconstruction and Development IFC International Finance Corporation IMF International Monetary Fund IPO Initial Public Offering JSAN Joint Staff Advisory Note LDP Letter of Development Policy LGFVs Local Government Financing Vehicles MDGs Millennium Development Goals MOF Ministry of Finance MTEF Medium-Term Expenditure Framework MTFS Medium-Term Fiscal Strategy NDRC National Development and Reform Commission NPC National People’s Congress NPL Non-performing Loan OECD Organization for Economic Cooperation and Development PBOC People’s Bank of China PBSOE Public Benefit State Owned Enterprise PEFA Public Expenditure and Financial Accountability PER Public Expenditure Review PFM Public Financial Management PPP Public Private Partnership SDR Special Drawing Rights SPV Special Purpose Vehicle TSA Treasury Single Account UDICs Urban Development Investment Corporations UNDP United Nations Development Program WBG World Bank Group iii CHINA Chongqing‐Dadukou District Sustainability DPF TABLE OF CONTENTS DATA SHEET ................................................................................................................................ 3 A. BASIC INFORMATION ....................................................................................................... 3 B. KEY DATES .......................................................................................................................... 3 C. RATINGS SUMMARY ......................................................................................................... 3 D. SECTOR AND THEME CODES .......................................................................................... 4 E. BANK STAFF ........................................................................................................................ 5 F. RESULTS FRAMEWORK ANALYSIS ................................................................................ 5 G. RATINGS OF PROJECT PERFORMANCE IN ISRs .......................................................... 7 H. RESTRUCTURING (IF ANY) .............................................................................................. 7 1. PROJECT CONTEXT, DEVELOPMENT OBJECTIVES AND DESIGN............................... 8 1.1 Context at Appraisal .............................................................................................................. 8 1.2 Original Project Development Objectives (PDO) and Key Indicators ................................ 11 1.3 Revised PDO and Key Indicators, and reasons/justification ............................................... 12 1.4 Original Policy Areas Supported by the Program ............................................................... 12 1.5 Revised Policy Areas........................................................................................................... 15 1.6 Other significant changes .................................................................................................... 15 2. KEY FACTORS AFFECTING IMPLEMENTATION AND OUTCOMES ........................... 16 2.1 Program Performance .......................................................................................................... 16 2.2 Major Factors Affecting Implementation ............................................................................ 19 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization .................... 20 2.4 Expected Next Phase/Follow-up Operation ........................................................................ 21 3. ASSESSMENT OF OUTCOMES ............................................................................................ 21 3.1 Relevance of Objectives, Design and Implementation ....................................................... 21 3.2 Achievement of Program Development Objectives ............................................................ 22 3.3 Efficiency ............................................................................................................................ 27 3.4 Justification of Overall Outcome Rating ............................................................................. 27 3.5 Overarching Themes, Other Outcomes and Impacts ........................................................... 27 1 (a) Poverty Impacts, Gender Aspects, and Social Development ........................................... 27 (b) Institutional Change/Strengthening ................................................................................. 28 (c) Other Unintended Outcomes and Impacts ....................................................................... 28 3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops ................... 29 4. ASSESSMENT OF RISK TO DEVELOPMENT OUTCOME ............................................... 29 5. ASSESSMENT OF BANK AND BORROWER PERFORMANCE....................................... 30 5.1 Bank Performance ............................................................................................................... 30 (a) Bank Performance in Ensuring Quality at Entry.............................................................. 30 (b) Quality of Supervision ..................................................................................................... 30 (c) Justification of Rating for Overall Bank Performance ..................................................... 31 5.2 Borrower Performance ........................................................................................................ 31 (a) Government Performance ................................................................................................ 31 (b) Implementing Agency or Agencies Performance ............................................................ 32 (c) Justification of Rating for Overall Borrower Performance .............................................. 32 6. LESSONS LEARNED.............................................................................................................. 32 7. COMMENTS ON ISSUES RAISED BY BORROWER/IMPLEMENTING AGENCIES/PARTNERS ............................................................................................................. 34 (a) Borrower/Implementing agencies .................................................................................... 34 (b) Cofinanciers ..................................................................................................................... 35 (c) Other partners and stakeholders ....................................................................................... 35 ANNEX 1: BANK LENDING AND IMPLEMENTATION SUPPORT/SUPERVISION PROCESSES................................................................................................................................. 36 ANNEX 2: SUMMARY OF BORROWER'S ICR AND/OR COMMENTS ON DRAFT ICR .. 38 Map of Chongqing-Dadukou District ........................................................................................... 46 2 DATA SHEET A. BASIC INFORMATION Chongqing-Dadukou Country: China Program Name: Fiscal Sustainability DPO Program ID: P157404 L/C/TF Number(s): IBRD-86620 ICR Date: 10/10/2018 ICR Type: Core ICR PEOPLE'S REPUBLIC Financing Instrument: DPL Borrower: OF CHINA Original Total Commitment: USD 200.00M Disbursed Amount: USD 200.00M Revised Amount: USD 200.00M Implementing Agencies: Government of Dadukou Cofinanciers and Other External Partners: B. KEY DATES Revised / Actual Process Date Process Original Date Date(s) 12/17/2015 Effectiveness: 12/31/2017 Concept Review: Appraisal: 05/03/2016 Restructuring(s): Approval: 01/10/2017 Mid-term Review: Closing: 12/31/2017 12/31/2017 C. RATINGS SUMMARY C.1 Performance Rating by ICR Outcomes: Satisfactory Risk to Development Outcome: Moderate Bank Performance: Satisfactory Borrower Performance: Satisfactory 3 C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Satisfactory Satisfactory Implementing Satisfactory Quality of Supervision: Agency/Agencies: Overall Bank Satisfactory Overall Borrower Satisfactory Performance: Performance: C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments (if Indicators Rating Performance any) Potential Problem Program No Quality at Entry (QEA): None at any time (Yes/No): Problem Program at any Quality of Supervision No None time (Yes/No): (QSA): DO rating before Closing/Inactive status: D. SECTOR AND THEME CODES Original Actual Sector Code (as % of total Bank financing) Public Administration Sub-National Government 100 100 Theme Code (as % of total Bank financing) Public Sector Management 67 67 Public Administration 67 67 Public Assets and Investment Management 33 33 Transparency, Accountability and Good 33 33 Governance Public Finance Management 33 33 Debt Management 33 33 4 E. BANK STAFF Positions At ICR At Approval Victoria Kwakwa Vice President: Victoria Kwakwa Bert Hofman Country Director: Bert Hofman Mathew A. Verghis, Robert Practice Manager/Manager: Deepak Mishra, Alma Kanani Taliercio John Litwack, Min Zhao Program Team Leader: John Litwack, Min Zhao ICR Team Leader: Lorena Vinuela ICR Primary Author: Lorena Vinuela William R. Dillinger John Litwack F. RESULTS FRAMEWORK ANALYSIS Program Development Objectives (from Project Appraisal Document) To support Chongqing's Dadukou District Government in achieving fiscal sustainability through a forward-looking, comprehensive and transparent public finance framework that integrates budget, public investment, and debt management. Revised Program Development Objectives (if any, as approved by original approving authority) N/A 5 PDO Indicator(s) Original Target Formally Actual Value Achieved Values (from Indicator Baseline Value Revised at Completion or approval Target Values Target Years documents) Indicator 1 : Dadukou District financing gap as a share of District GDP Value quantitative or -8.1 <-3.5 -3.4 Qualitative) Date achieved 12/31/2015 01/11/2017 01/11/2017 Comments Achieved and surpassed. The District’s financing gap as a share of GDP was -3.4 in (incl. % 2016, but in 2017 the District had a surplus of 4.3 of GDP. achievement) Indicator 2 : Dadukou executed outlays on investment projects in 2016 Value quantitative or 1.79 billion RMB <1.1 billion RMB 1.27 billion RMB Qualitative) Date achieved 12/31/2015 01/11/2017 01/11/2017 Comments Mostly achieved. While the target was not fully achieved, the District made significant (incl. % strides and reduced investment spending by 30 percent. achievement) Indicator 3 : Variance of executed investment in Dadukou District with capital investment plan Value quantitative or 0.514 <0.4 0.3 Qualitative) Date achieved 12/31/2015 01/11/2017 12/31/2017 Comments Achieved and surpassed. In 2017, the variance was 0.3, which is lower than the 0.4 (incl. % target. achievement) Indicator 4 : Annual report on public sector assets and liabilities published on an official website Value quantitative or No Yes Yes Qualitative) Date achieved 12/31/2015 01/11/2017 01/11/2017 Comments Achieved. It is expected that the practice of publishing an annual report on public (incl. % sector assets and liabilities will continue. achievement) 6 Indicator 5 : Share of projects executed by Jingiao and Dasheng that correspond to explicit commissioned contracts Value quantitative or 9 >30 99 Qualitative) Date achieved 12/31/2015 01/11/2017 01/11/2017 Comments Achieved and surpassed. By 2017, 100 percent of new projects executed by Jingiao (incl. % and Dasheng corresponded to explicitely commisioned contracts. achievement) G. RATINGS OF PROJECT PERFORMANCE IN ISRs Date ISR Actual Disbursements No. GEO IP Archived (USD millions) H. RESTRUCTURING (IF ANY) Not Applicable 7 1. PROJECT CONTEXT, DEVELOPMENT OBJECTIVES AND DESIGN 1.1 Context at Appraisal 1. This World Bank Development Policy Financing (DPF) for US$ 200 million assisted Chongqing Municipality and Dadukou District in their quest to put the finances of Dadukou on a solid and sustainable path. The program supported Dadukou District in adopting a Medium Term Fiscal Strategy and an integrated investment program aimed at rationalizing public investment and achieving fiscal sustainability, which entailed adjusting public investment policies. Dadukou District also introduced higher standards of transparency, becoming a model for other local governments in China. 2. China is now a high middle-income country, and well positioned to become a high- income country in the next decade. The country’s economic transformation over the past three decades has raised living standards and made China the world’s largest manufacturer and exporter. Real per capita GDP increased 24 times over 1978–2017, and more than 850 million people have been lifted out of poverty. All Millennium Development goals have either been reached or are within reach. While China’s exceptionally rapid growth and development in recent decades has served the country well, it has also been associated with economic, environmental and social imbalances. 3. China’s growth has gradually slowed in this period of transition, signaling what President Xi Jinping has called the “new normal.” Growth has moderated from the over 10 percent average annual rate that China experienced for three consecutive decades, falling to 6.9 percent by 2017. Against this backdrop, China’s economy has been steadily rebalancing toward more consumption-led growth concentrated in the service sector. 4. While growth in China still remains high by international standards, macroeconomic risks have increased in the last decade, including in the form of rapidly rising subnational debt. To stimulate economic growth since the global financial crisis of 2008, subnational governments in China have rapidly accumulated debt. Although subnational governments were not allowed to incur explicit deficits or borrow funds directly until 2015, they nevertheless accumulated debt quite rapidly in off-budget local government financing vehicles (LGFVs) that carried out public investments. In recent years, a number of local governments have begun to experience financial difficulties due to this rapid build-up in LGFV debt against the backdrop of an economic slowdown and declining marginal returns from investment. 5. China’s Government recognized the seriousness of this problem, and introduced a major reform in 2014 to bring subnational debt under control and reorient subnational officials and budgetary institutions toward fiscal / debt sustainability. Strong incentives at the subnational level of government to promote growth and investment have been an important ingredient of China’s successful economic development in recent decades. The budget reform has sought to alter the incentives and constraints of subnational governments toward the additional 8 objective of fiscal sustainability, while also improving transparency in local finance. The reform prohibited local governments from acquiring additional debt or issuing guarantees through LGFVs. Simultaneously, subnational governments were granted the right to borrow explicitly through bond issuances, albeit within strict limits. A bond swap program was launched to address the stock problem of accumulated legacy debt in the LGFVs. The 2014 reform also includes measures for creating and building institutions for more efficient and effective budgeting at the subnational level, including medium-term budgeting and higher standards of accounting and transparency. 6. As part of the efforts to implement the reform, the World Bank piloted development policy financing operations focused on budget reforms to achieve fiscal sustainability at the subnational level in Hunan Province and Chongqing Municipality. China’s Government selected Chongqing and Hunan as the pilot regions for the first World Bank development policy operations in China for a number of reasons, including a strong reformist orientation and a strong demand in those regions for cooperation with the World Bank to accelerate reforms. Two separate operations were requested as pilots for both a province-level government and a sub-provincial district government. The challenges of budget reform implementation for these two different levels of government have some important differences. 7. The political and economic context for the DPF operations in Hunan and Chongqing in 2015-2016 created some challenges for project design and implementation. The primary objective of the operations was to assist local governments in placing their finances on a fiscally sustainable path through implementation of key parts of the 2014 Budget Reform. Strictly following the revised Budget Law, this would entail moving all public investment finance explicitly on budget. However, a public-investment based fiscal stimulus pursued during 2015- 2016, at a time when explicit subnational government borrowing was subject to a tight cap, had the effect of temporarily extending a strong role for LGFVs in financing public investment off budget. In the course of preparing these operations, it became very clear that a meaningful debt sustainability framework at the local level must unavoidably involve a careful consideration of contingent liabilities that were continuing to accumulate in the LGFVs at a very fast pace. Thus, the design of the pilot operations ended up deviating to an important degree from the prevailing instructions on Budget Reform implementation that did not yet include a framework for managing these contingent liabilities. Political pressures in favor of higher local public investment also provided a challenging context for creating and implementing fiscal consolidation programs. Nevertheless, China’s government continued to encourage the World Bank, Hunan, and Chongqing to pursue these programs as individual pilots that could be studied to inform the reform process going forward. 8. Given the particular importance of local level finance for the success of the Budget Reform, Chongqing Municipality chose to concentrate the DPF program in the single pilot local government of Dadukou District in Chongqing Municipality. Chongqing is one of the four municipalities in China that has an elevated status equivalent to that of a province. 9 The municipality is comprised of 21 urban districts, 13 counties and 4 autonomous counties. Its total population is 30.2 million, with 18.4 million people in urban areas (2015). Dadukou is one of the nine central districts in Chongqing Municipality. The District has 330 thousand people and, like most other local governments in China, experienced a very rapid build‐up of LGFV debt in recent years. Dadukou District faced a particularly challenging economic situation when its primary source of growth and employment, a large steel factory, was relocated to another part of Chongqing to comply with the new municipal zoning plan. Dadukou has been undergoing a difficult transition to a service‐ oriented economy that houses an industrial park. By 2015, accumulated debts recognized as the direct responsibility of the government amounted to the equivalent of 66 percent of local GDP. The vast majority of these debts were contracted by the Dadukou LGFVs. 9. The District Government took decisive steps towards rebuilding Dadukou’s economic base, leading to a strong recovery in 2013‐2015. The land vacated by the steel plant was converted into the Jianqiao Industrial Park, and the District Government has pursued an ambitious program of public investment and land development that is focused on the IT sector, tourism, environmental protection technology, and residential housing. In this context, GDP growth rebounded strongly. The new growth has been concentrated in Dadukou’s tertiary sector. 10. This Development Policy Operation assisted Dadukou District develop the policies and institutions to achieve fiscal sustainability, greater efficiency in public investment, and enhanced transparency. With the assistance of the World Bank DPF, Dadukou has equipped itself with tools of debt sustainability analysis (DSA) to account for on‐ and off‐budget obligations and risks. A Medium Term Fiscal Strategy and integrated public investment plan are anchoring public expenditures and contingent liabilities to appropriate ceilings for fiscal sustainability and the better prioritization of projects. These are new institutions at the local level of government in China, where on and off‐budgetary public investment has been typically planned in a largely uncoordinated manner, without a comprehensive assessment of the implications for debt sustainability. As part of this operation, Dadukou District also adopted disclosure requirements for its public investment programs and financial / debt position that go well beyond the current standards in China. This includes information valuable to the Chongqing Municipal Administration for the effective province-level monitoring and regulation function envisioned in the budget reform. 11. Several possible forms of assistance were discussed with the China’s Government and Chongqing Municipality before deciding on development policy financing. The World Bank had already engaged at the subnational level in China on budgetary reforms through technical assistance in Shanghai. The China’s Government and World Bank agreed that a Development Policy Financing would be an appropriate vehicle for a deeper engagement for two primary reasons. First, experience in other countries, such as India, Brazil and Nigeria, with development financing suggests that a DPF can be an effective instrument for World Bank support to a comprehensive policy / reform program consistent with fiscal sustainability at the subnational level 10 that goes beyond a technical assistance program. This includes a series of development policy operations that helped the Indian state of Andhra Pradesh become a leader in subnational fiscal reform and adjustment. Development policy engagements in Lagos and Edo States in Nigeria had strong fiscal sustainability and medium-term budgetary components. A series of subnational development policy engagements in Brazil also focused on sustainable state-level finance. 12. As evidenced by the substance of this operation, the DPF has indeed provided a framework for a new level of World Bank engagement at the subnational level in China. A structured program built around prior actions and results indicators has served to focus energies and World Bank assistance on common ambitious objectives. Second, given the complicated financial situation in Dadukou District, the relatively cheap and longer‐term financing provided by the DPF alleviated some of the burden of the necessary short term fiscal adjustment. The deeper subnational engagement supported by this operation, as well as the simultaneous pilot in Hunan Province, enabled the Bank to expand its cooperation with the Central Government and other subnational governments in the areas of budget reform and fiscal sustainability. 13. A multi-tranche operation was also considered. Given that this operation supports institutional reforms that will take time to be realized, a programmatic engagement was naturally discussed. The China’s Government preferred to evaluate the results from this first DPF before considering options for further support which could be to Chongqing or for expanding the program to other provinces. While this operation was a stand‐alone single tranche operation, it was envisioned that cooperation between the World Bank, Chongqing Municipality, and Dadukou District would continue beyond the initial DPF. As described below, the engagement between the World Bank, Dadukou District, and Chongqing Municipality did become a de facto multi-year engagement. 1.2 Original Project Development Objectives (PDO) and Key Indicators 14. The Chongqing‐Dadukou District Development Policy Financing had as its Project Development Objective support to the District Government for achieving fiscal sustainability by developing a forward-looking, comprehensive and transparent public finance framework that integrates budget, public investment and debt management. 15. The key objectives and indicators included the following: • Pillar 1: Fiscal Sustainability o Objective: To develop and employ a medium-term fiscal / debt sustainability framework and budget for managing risks and ensuring fiscal sustainability of Dadukou’s public finance - Dadukou District financing gap as a share of District GDP (Baseline: 8.1 percent in 2015; Target: <3.5 percent in2016)) • Pillar 2: Capital Investment Plan 11 o Objective: To develop an integrated approach to capital budgeting to improve efficiency - Dadukou executed outlays on investment projects in 2016 (Baseline: 1.79 billion RMB in 2015; Target: <1.1 billion RMB in 2016) - Variance of executed investment in Dadukou District with capital investment plan (Baseline: 0.514 in 2015; Target: < 0.4 in 2017) • Pillar 3: Transparency o Objective: To enhance transparency and accountability in the use of budget resources - Annual report on public sector assets and liabilities on official website (Baseline: No in 2015; Target: Yes in 2016) - Share of projects executed by Jianqiao and Dasheng that correspond to explicit commissioned contracts (Baseline: 9%, in 2015; Target: >30% in 2016) 1.3 Revised PDO and Key Indicators, and reasons/justification 16. Not applicable. 1.4 Original Policy Areas Supported by the Program 17. The single tranche stand-alone development policy financing for the equivalent of US$ 200 million supported the Dadukou Government’s efforts to achieve fiscal sustainability by developing a forward-looking, comprehensive and transparent public finance framework integrating budget, public investment and debt management. The DPF had three pillars: (a) Fiscal Sustainability; (b) Capital Budgeting; and (c) Transparency. 18. Pillar 1: Fiscal Sustainability. The Dadukou Government, with the support of the World Bank team, developed a tailored debt sustainability framework that allows for a comprehensive evaluation of its fiscal strategy from the point of view of fiscal sustainability. This exercise took into full consideration existing fiscal arrangements in China’s district‐level governments. A complicating factor for developing this framework was the fact that LGFVs still played a major role in carrying out local public investment programs. District LGFV liabilities categorized as “commercial” thus continued to be tightly intertwined with the LGFVs’ public investment functions. An expected expanded role for public-private partnerships (PPPs) in the future also implies the need for the prudent management of associated contingent liabilities. In this context, it was agreed that Dadukou would adopt an approach to fiscal sustainability analysis that incorporates all public liabilities in the District that are related to public investment, including 12 those of LGFVs and PPPs. Following the complete transformation of the LGFVs into commercial SOEs, a clearer identification of those debts that imply contingent liabilities for the Dadukou Government will be possible. In the meantime, Dadukou’s fiscal sustainability analysis adopted a very prudent inclusive rather than exclusive approach. While the Budget Reform encourages all subnational governments to develop a medium term budgetary framework, there is still no mandatory timeline for implementation. Furthermore, this prescribed budgetary framework did not yet include contingent liabilities related to off-budget debt accumulated after 2014. Thus, Dadukou District is a true pioneer. 19. The Medium‐Term Fiscal Strategy Report was built on an agreed fiscal / debt sustainability framework and embodies a fiscal adjustment plan that was agreed with Chongqing Municipality and the World Bank team. Fiscal sustainability was defined as being satisfied if public liabilities in the district as a share of GDP decline or stabilize under a baseline scenario that reflects current official macroeconomic projections, and also stabilize under a stress test under which GDP growth is 2 percentage points slower and land revenues are 20 percent lower than projected. To reach this objective, Dadukou District froze the overall volume of outlays on public investment in a three-year rolling capital investment financing plan to an annual limit of RMB 1.1 billion. 20. Pillar 2: Capital Investment Plan. Dadukou prepared a 3‐Year Rolling Capital Investment Plan (CIP) that seeks to ensure that existing commitments are realized, viable projects are completed, and that all new projects are in line with fiscal sustainability. The Medium Term Fiscal Strategy set the annual commitments and new exposures stemming from planned capital projects. In formulating the three‐year rolling capital investment plan, Dadukou District provided priority to on‐going projects first, and selected new projects from the pipeline based on the rank of their readiness for implementation and relevance to the district development strategy. The readiness for implementation was judged on the basis of project ex ante evaluation, technical design and feasibility studies. The District Government carried out wide consultations with stakeholders, citizens and District People’s Congress representatives before finalizing the CIP. The CIP encompasses all public projects that require explicit financial commitments from the District at any given present or future date. The CIP in 2016 included 26 projects, with 35.2 percent of planned financing devoted to on‐going projects. Half of the new projects have duration of longer than one year. The CIP provides a comprehensive review of all future explicit and implicit obligations by the local government associated with investment projects and gives particular scrutiny to new projects in annual budgets going forward. 21. The program strengthened Dadukou’s regulations concerning the Examination and Approval System for capital projects with an eye toward promoting fiscal sustainability. The Finance Bureau ensures that aggregate financing for newly approved projects, together with net financing needs to complete on‐going projects, are in line with the MTFS‐DSA annual spending and debt targets. This includes outlays of the District budget as well as planning financing by off-budget entities, thus allowing for a systematic review of the future financial 13 implications of all new public investment commitments. With the adoption of this first integrated investment plan, Dadukou District places ceilings on the entire public investment program, on and off‐budget. The ceilings on commitments for 2017‐2018 are also pertinent, given the fact that local government contributions to investment projects often take the form of pledges of outlays for future years. This allows Dadukou to give fuller consideration of fiscal constraints and sustainability in public investment planning. 22. Through the DPF, Dadukou District institutionalized the annual preparation of the 3‐year rolling capital investment plan. This was expected to solidify strong cooperation between the District DRC and the Finance Bureau on public investment planning and finance, and to provide a framework for assessing and re‐assessing comprehensive commitments to public investment for a three year period going forward. This plan was also to be linked closely to the Medium Term Fiscal Strategy and debt sustainability. The efficiency and sustainability of public investment in local governments in China typically suffers from fragmentation in planning and implementation. The budget is managed by the Finance Bureau, while investment planning and execution is carried out primarily by the District Development and Reform Commission (DRC) and LGFVs. Project‐by‐project plans have their own financing schemes that are often disjoint from the budget. This can be associated with weak overall control over public investment spending and limitations for the cost‐benefit prioritization of projects. The reforms in Dadukou introduced a more integrated approach to capital budget planning under the overall ceiling prescribed by the MTEF. Under this approach, the District DRC and the Finance Bureau are cooperating closely on a capital investment plan that optimizes returns from public investment outlays that are now limited by the imposed ceilings. 23. Pillar 3: Transparency. Dadukou introduced the regular annual disclosure of assets and liabilities of the public sector, including public benefit SOEs (LGFVs), in addition to the requirements of the Central Ministry of Finance. This gives the public both more frequent and more complete access to relevant information on the District’s finances beyond what is currently required by the Central Government. The existing regulations at the time only required that a far less comprehensive report be prepared, and there was no requirement for disclosure. 24. The regular preparation of a Medium‐Term Fiscal Strategy linked to a DSA was to provide additional valuable information in this regard for the Chongqing Municipality. So would the capital investment plan that includes a comprehensive project‐ by‐project itemization for the budget year. While local governments in China are responsible for the majority of budgetary expenditures, public investments, and debt accumulation, the information available to the public and higher levels of government remains limited. Under the budget reform, Chinese provinces are instructed to improve their monitoring of the financial health of local governments. The provincial‐ level early warning system for local governments is being built on 7 indicators from information that is observable at the provincial level, including the size of (explicit) debt stock and debt servicing relative to expenditures and assets. These indicators provide valuable information, but still do not account for all sources of fiscal risk at the local level. Limited information exists at the 14 provincial level on local governments for public investments not reflected in the budget and their associated contingent liabilities, the projected economic situation in the locality, and other measures of the capacity of local governments to shoulder debt. 25. The Dadukou Government also established a clear division between government and commercial activities, incomes, expenses, assets, and liabilities in the two LGFVs: Dasheng and Jianqiao. Dadukou State‐owned Assets Supervision and Administration Office issued a Decree to instruct Dasheng and Jianqiao to carry out such a division. An independent accounting firm was given the responsibility for verifying the compliance of the operation with the Circular. It was expected that this would incentivize the Government to finance public investment on budget, and that the LGFVs would work according to explicit commissioned contracts with Dadukou District. 26. As part of the DPF Program, Dadukou District took a major step toward the separation of LGFVs from government by dividing the assets and liabilities of each of its two LGFVs into government and commercial components. A major goal of the Budget Reform is to convert local government financing vehicles into strictly commercial state‐owned enterprises, thereby providing a clear divide between government and LGFV accounts. While this is a general goal, progress across China has so far been mixed. The inventory of local government debt taken in 2014 made an important distinction between government and commercial debt in LGFVs, making the former an explicit responsibility of local governments. Assets that don’t generate revenues or commercial interest and liabilities emanating from financing public investments that have received verification by the Government Audit Office were brought explicitly on the government’s account. Starting from 2015, the financing of public investments by LGFVs are either to be carried out explicitly on a commission basis or recorded entirely on the Government’s account. In this endeavor, the commercial sides of the LGFVs thus created should be genuine commercially viable entities. Dadukou District has been an important pioneer in this regard. 1.5 Revised Policy Areas 27. Not applicable. 1.6 Other significant changes 28. Not applicable. 15 2. KEY FACTORS AFFECTING IMPLEMENTATION AND OUTCOMES 2.1 Program Performance 29. The single tranche of USD 200 million was released on December 1, 2017. No waiver was requested (see Table 1). The Bank provided substantial technical assistance through multiple missions. Table 1: Tranche Amount and Release Date Tranche # Amount Expected Release Actual Release Release Date Date Tranche I USD 200 million December 1, 2017 Regular 30. The prior actions are listed in Table 2. Table 2: Policy Matrix Prior Actions Status Pillar 1: Fiscal Sustainability Prior action #1: The Government of Dadukou District has adopted and published a Met medium‐term fiscal strategy, grounded in a debt sustainability analysis, which sets a target for district‐level public investment financing that is consistent with debt sustainability. Pillar 2: Capital Investment Plan Prior action #2: The Government of Dadukou District has submitted to Dadukou District Met People’s Congress an annual budget for 2016 that corresponds to a Medium -term Fiscal Strategy plan which is consistent with debt sustainability. Prior action #3: The Government of Dadukou District has issued a three‐year rolling Met capital investment plan that is consistent with the ceilings on public investment outlays in the Medium‐Term Fiscal Strategy for public investment projects during 2016, and for commitments made in 2016 for public investment outlays in the years 2017‐2018. Prior action #4: The Government of Dadukou District has issued a decree that specifies Met the time frame and division of institutional responsibilities for the annual formulation of a three year rolling capital investment plan, beginning in 2016. Pillar 4: Transparency Prior action #5: The Government of Dadukou District has adopted a decree for regular Met annual disclosure of assets and liabilities of the public sector, including public benefit state–owned enterprises. Prior action #6: The Government of Dadukou District has issued a regulation which sets Met forth a clear division between government and commercial activities, incomes, expenses, assets, and liabilities of its two urban development investment corporations, namely Dasheng and Jianqiao. 31. At the time of appraisal, the financial situation of the District was quite difficult. As of 2015, the direct government debt of Dadukou District stood at 10.5 billion RMB, equivalent to 66 percent of local GDP or 170 percent of local revenues. In addition to this direct debt, Dasheng and Jianqiao, the two LGFVs in Dadukou, had significant additional liabilities (debt and other 16 payables), many of which were tied to land development. While public sector debt accumulated by the LGFVs prior to 2015 had already been included in the measure of direct government debt, such liabilities continued to accumulate at a rapid pace in 2015 and 2016. Furthermore, the LGFVs also had significant liabilities in the form of medium-long term payables that had yet to enter public sector debt accounting. The total liabilities in Dadukou related to public investment, including direct government debt and additional public investment-related liabilities of the LGFVs, stood at RMB 25.4 billion in 2015, which amounted to 159 percent of local GDP. In addition, it turned out that the LGFVs had off-balance sheet liabilities at the time equal to another RMB 1.5 billion that had not yet been accounted for at the time of appraisal. These additional liabilities were subsequently added to the coverage of comprehensive liabilities and the debt sustainability analysis. 32. The continual rapid accumulation of public sector liabilities in the LGFVs, despite the provision in the revised Budget Law 2016 that essentially forbid this practice, was very common for local governments in China during the fiscal stimulus pursued in 2015-2016. Quotas for new local government bond issues proved inadequate to meet political pressures for increasing levels of local public investment, and commercial banks were essentially granted permission by Beijing to continue refinancing LGFVs. The design of the DPF program therefore had to confront a fundamental challenge. In light of the Budget Reform, LGFV borrowing was no longer classified as government debt and therefore did not enter official debt accounting. Yet it remained the greatest challenge to the sustainability of local finances. In the course of project preparation, It therefore became clear very quickly that a meaningful framework for achieving fiscal sustainability in Dadukou could not avoid the direct consideration of LGFV finances and liabilities. The design of the DPF therefore evolved from an anticipated assistance in implementing the strict provisions of the 2014 Budget Reform to a pilot that could, in part, demonstrate how a meaningful fiscal sustainability framework can be put in place that fully recognized the present reality of local government finance in China. It was hoped that this approach could provide important lessons for moving forward on budget reform and achieving fiscal sustainability at the subnational level throughout the country. 33. Four of the six prior actions were largely directed at the problem of increasing indebtedness of the District and the imperative of achieving fiscal sustainability: (i) the adoption of a sustainable fiscal strategy for the District; (ii) the adoption of an annual budget consistent with that strategy; (iii) the development of a capital investment plan consistent with that strategy; and (iv) the establishment of an institutional mechanism to ensure that future capital spending was consistent with fiscal sustainability. In addition, the sixth prior action, requiring the division of the LGFVs’ liabilities between public benefit and commercial debts, was also indirectly related to the goal of bringing their borrowing under control. 34. Pillar 1: Fiscal Sustainability. Pillar 1 involved an extensive process of gathering and consolidating information on public sector investment, financing, debt, assets, and liabilities. This information was used to inform a debt sustainability analysis. The results of this analysis were 17 rather sobering, implying an imperative of reducing significantly planned public investment outlays over the next three years to put Dadukou District on a fiscally sustainable path. This was reflected in a Medium Term Fiscal Strategy that reduced public investment outlays from RMB 1.79 billion in 2015 to a planned RMB 1.1 billion annually during the next three years. Furthermore, RMB 1.1 billion became an active ceiling on aggregate investment for the year 2016. Investment outlays for subsequent years could be revised in subsequent medium-term strategies that update the debt sustainability analysis. 35. Pillar 2: Capital Investment Plan. The three-year rolling capital investment plan that captures expected public investment from all sources of finance, both on and off budget, was an important innovation in the DPF program. Formerly, public investment planning had been rather fragmented, often pursued independently by different government bodies and the LGFVs. A single integrated plan became the target of the ceiling on annual public investment outlays determined under Pillar 1. The integration of capital investment planning was also intended to have an important impact on the efficiency of public investment in the District through the selection and execution of individual projects. Progress on this reform was to be measured by tracking the difference between planned investment spending and actual investment (on a project by project basis) each year. 36. Pillar 3: Transparency. The DPF also intended to strengthen financial accountability through improved transparency, and to provide clarity with regard to the LGFVs activities along with the government budget. At the time of project preparation, provinces were improving their monitoring of the financial health of local governments based on seven indicators including the size of their (explicit) debt stock and debt service relative to expenditures and revenues. Central regulations also encouraged local governments to compile comprehensive government financial reports on a trial basis. But the monitoring of subnational debt did not include information on the LGFVs, nor did the central government indicate for local governments to disclose this information to the public. To enhance their financial accountability and invite public scrutiny of the government’s public liabilities, Prior Action 5 required Dadukou to issue a decree for the regular annual disclosure of consolidated assets and liabilities of the public sector, including those of the LGFVs. 37. In addition to disclosure of more information to the public, the transparency pillar included an accounting separation of government (public sector) and commercial operations of the LGFVs. At the time of project preparation, subnational government debts incurred by LGFVs were being swapped with government bonds, and thereby being stripped away from LGFV balance sheets. However, the associated public assets remained on LGFV balances. This gave distorted information about the true creditworthiness of LGFVs, thus and enabling them to borrow more than they could otherwise. Prior Action 6, which required a clear accounting separation of commercial operations and governmental operations, not only revealed their true financial status of the two LGFVs, but also paved the way for their ultimate restructuring and commercialization. 18 As part of this reform, all new public projects taken on by the LGFVs were done on the basis of explicit commissioned contracts with Dadukou District. 2.2 Major Factors Affecting Implementation 38. The operation was ambitious but achieved its objectives. The successful reform implementation required close cooperation and the support of multiple levels of government (Central, Municipality, and District) and of multiple agencies within the Dadukou District, particularly the Finance Bureau in charge of the budget and the Development and Reform Commission (DRC) in charge of the investment planning and economic development targets. Because it was one of the first two development policy programs in China, there was limited experience to build on and implementation risks were high, particularly for a capacity-constrained local government. 39. The main factors that had a positive impact on the implementation of the program can be grouped into three broad categories: i) strong political commitment from Dadukou, Chongqing, and Beijing; ii) soundness of the background analysis, and iii) design of the operation to reflect the complex reality at the local level during implementation of the budget reform in 2015- 2016. 40. Strong political commitment from Dadukou, Chongqing, and Beijing. As indicated previously, the achievement of a meaningful framework for fiscal sustainability in Dadukou District during 2016 required an ambitious and innovative program design that went well beyond prevailing official instructions for implementation of the budget reform. The results of the DSA also suggested a significant reduction in District public investment outlays at a time when a fiscal stimulus was a national priority. Securing official approval and motivation for such a program was therefore not without challenges. In the end, it could not have been a success without a high level of motivation within Dadukou, and without strong commitment from both Chongqing Municipality and the Ministry of Finance to let this operation go forward as a pilot. Government officials highlighted the critical role that the World Bank team played in helping the District mobilize external and internal support for the challenging reforms. The Bank played an important part in explaining the consequence of delaying or diluting the policy actions and helped create the political space for the implementation of a much more ambitious program. Moreover, the inclusion of actions in the DPL created the platform for inter-departmental cooperation and supported the dialogue with the Municipality. The program gave the reforms greater visibility and elevated them in the agendas of Chongqing Municipality and the Central Government. 41. Soundness of the background analysis. The complexity of the economic and political situation in Dadukou District in 2015-2016, and the need for an innovative approach to achieve the objectives of the operation, required not only a team with extensive background in subnational finance in China and similar countries, but also the skills to be able to assess the situation and propose a compelling program. The accumulated knowledge from previous World Bank 19 engagements on subnational fiscal issues in China, as well a knowledge brought from the experience of other countries, proved invaluable in this respect. Designing and implementing a successful program could not have been achieved with hard collaborative work between the World Bank team and Dadukou District. 42. Design of the operation to reflect the complex reality at the local level during implementation of the budget reform in 2015-2016. The World Bank team had the primary mandate for this operation to assist Dadukou District with a program to put its finances on a fiscally sustainable path. While it was originally envisioned that this would take the form of assisting Dadukou District with the strict implementation of key parts of the national budget reform, this would not have been adequate for the achievement of this central objective. In particular, the most important risks to fiscal sustainability in Dadukou were still coming from the activities of its LGFVs and related contingent liabilities. The decision to move forward with a strong ambitious program on a pilot basis that proposed solutions for genuine current problems on the ground boosted the motivation for implementation of the program within Dadukou District. The demonstration effect eventually boosted the prestige of the District and fed into municipal and national reforms that proved key for the sustainability of the new arrangements. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization 43. M&E Design. The monitoring and evaluation framework largely reflected prior actions of the operation that required the gathering of comprehensive information on public sector assets and liabilities, formulating a comprehensive capital investment plan, and working together within the government to assess capital projects and monitor fulfilment. The day-to-day M&E was carried out by the Finance Bureau, although with strong cooperation from the Development and Reform Commission and the LGFVs that reflects a new level of cooperation and coordination within Dadukou District. Monitoring the results indicators required utilizing new analytical and organizational capacities put in place under the DPF program. This includes tracking closely the evolution of comprehensive public sector liabilities and implementation of the public investment financing plan. Prior actions and results indicators in the transparency pillar were designed to naturally share M&E results with stakeholders. In virtually every case, the M&E for the DPF program represented activities that Dadukou District is sustaining as part of its own management framework in the aftermath of the operation. Chongqing Municipality is also scaling up these practices to other local governments in its jurisdiction. 44. M&E Implementation. As the implementing agency, the Finance Bureau maintained a close dialog with the Bank. They were responsible for organizing the preparatory work for periodic supervision missions. The monitoring of the program was based on expected results for each component. There were dedicated groups that monitored the advances of the reforms in each of the results of the subcomponents. As anticipated, Dadukou District developed new analytical capacity to collect and analyze debt and fiscal data. Performance was excellent in every respect. 20 45. M&E utilization. Part of M&E utilization was embedded in the DPL program. Once information was collected together on comprehensive public sector assets and liabilities of Dadukou District, this information was used for a debt sustainability analysis that, in turn, led to a moderation of plans in the District for public investment outlays during the next three years. These findings were communicated to stakeholders through the publication of budgetary reports, some of which can also be associated with the DPF program. The DPF M&E has become a permanent activity within Dadukou District and other local governments in Chongqing Municipality with implications for the allocation of public resources. 2.4 Expected Next Phase/Follow-up Operation 46. The World Bank will continue to cooperate with Dadukou District and Chongqing Municipality on the development of monitoring and regulation of local governments in debt management, although there is no specific follow up operation foreseen. It is expected that the use of debt sustainability analysis and capital investment financing plans will continue to be scaled up to the other districts of the Municipality. The World Bank is also continuing work according to a memorandum with China’s Fiscal Academy of the Ministry of Finance for programmatic work on identifying the most promising directions for the continuing budget reform, building partly on the experience of Dadukou District. 3. ASSESSMENT OF OUTCOMES 3.1 Relevance of Objectives, Design and Implementation Rating: High 47. The objectives of the operation were highly relevant for China’s development priorities and the Country Partnership Strategy. They are important for achieving fiscal sustainability and improving the efficiency of capital spending at the local level in China. These are among the most important reform directions in China for future stability and growth in the country, and, by implication, in the world economy. While China is making notable progress on implementing the Budget Reform and placing local government finance on a fiscally sustainable foundation, this difficult process is far from over, and will remain one of the most important reform directions in years to come. The operation is aligned with the previous FY2013-FY2016 Country Partnership Strategy’s theme 2: “promoting more inclusive development (Report 67566-CN).” In particular, this CPS notes the importance going forward for “integrating policies and program administration” for China’s future developmental success. The China Performance and Learning Review (Report 95709-CN)) of January, 2016 noted that future IBRD lending in China may include PforR and DPO instruments. As recognized in discussions around the forthcoming new China Country Partnership Strategy, a primary focus of the World Bank will be supporting China 21 in mitigating remaining institutional weaknesses. Institutions for fiscal and debt sustainability remain a very constructive focus in this regard, as a rich world experience can be usefully brought to bear on assistance to China. Correspondingly, the operation fits directly in the new draft CPS Engagement Area Three, Objective 3.2: “demonstrating approaches to more effective and sustainable fiscal management and infrastructure financing.” 48. The design of the operation required an innovative approach to make it applicable and relevant for China and Dadukou in 2015-2016. The original intention was to assist Dadukou District in achieving fiscal sustainability through implementation of institutional changes prescribed in the 2014 Budget Law. However, accounting for the reality on the ground in China, it soon became clear that a meaningful framework for achieving fiscal sustainability would require a somewhat different approach that involved a comprehensive assessment of risks on and off budget and coordinated efforts between different departments to place this District on a fiscally sustainable path. The fact that Chongqing Municipality is scaling up elements of this approach, while central government reform instructions and guidelines in 2017-2018 have also embraced parts of the approach, speaks for the high relevance of the design. A strong argument can be made that the implementation of this program had a measurable impact not only on Dadukou and Chongqing, but on the World Bank policy dialog in China, and, possibly, on the future course of budget reform in the country. The relevance of design is therefore rated “high.” 3.2 Achievement of Program Development Objectives 49. (1) Developing and employing a medium term fiscal / debt sustainability framework for managing risks and ensuring the fiscal sustainability of Dadukou’s public finances. This framework, which involved a comprehensive DSA, Medium Term Fiscal Strategy, and three-year rolling capital budget was employed successfully in Dadukou District, and remains in place today. The District’s financial results for 2016 and 2017 suggest that the DPF did indeed have a positive impact on the sustainability of its finances. Table 3 compares the District’s actual financial results for 2016 and 2017 with projections implied by the baseline scenario of the 2016 DSA, as well as more recent revised financial projections for the period 2018-2020. Although the program was not presented to the Board until January 2017, most of the project preparation occurred in late 2015 and early 2016, with an eye toward satisfying the prior actions in 2016. Thus, it is reasonable to attribute results in both 2016 and 2017 to the program. Table 3: Dadukou Financial Indicators (Projected and Actual) 2015 2016 2017 2018 2019 2020 Investment spending (RMB billions) Projected: 2016 DSA baseline 1.79 1.10 1.10 1.10 1.10 1.10 Actual 1.79 1.27 1.31 1.27* 1.25* 1.27* Financing gap (% GDP) 22 Projected: 2016 DSA baseline -8.0 -2.3 +7.4 +1.3 +1.4 +1.2 Actual -8.0 -3.4 +4.3 -6.2* -3.1* +5.5* Comprehensive Debt/GDP (%) Projected: 2016 DSA baseline 159 153 135 125 118 111 Actual 153 177 164 159* 156* 145* District capital investment plan for 2018-2020. Excludes spending by Land Reserve Center on land development. * revised WB DSA projections (v 41) as of June 2018. 50. Overall, the District showed significant improvements in two key fiscal indicators, although not as marked as expected in the baseline scenario of the DSA based on the District’s own (very ambitious) projections in early 2016. As shown in Table 3, investment spending (results indicator B1) in 2016 and 2017 was much lower than in 2015, although not quite as low as targeted for the DSA results indicator in 2016. Following a recovery in land revenues, Dadukou subsequently expanded its planned public investment slightly beyond the 1.1 billion ceiling made in the 2016, but still well within bounds for achieving debt sustainability. Actual investment spending in 2017 was RMB 1.31 billion and is expected at RMB 1.27 billion in 2018. By the same token, the District’s financing gap (results indicator A) did not improve quite as quickly in 2016 as projected in the 2016 DSA baseline scenario due largely to the postponement of planned land sales during that year when land markets were sluggish. Dadukou nevertheless fulfilled the 2016 target results indicator for the DPF program for the financing gap of less than 3.5 percent of GDP, which is also better than in the 2016 DSA stress test scenario projection (3.6 percent). 51. Following the recovery in land markets and land revenues, Dadukou’s financing gap went into surplus in 2017. As shown in Table 3, a negative financing gap reappears in 2018 at 6.6 percent of GDP. However, this decline is due to a statistical artifact from a positive reform conducted in 2018 that brought current land development costs on budget. Before 2018, LGFVs incurred these costs and were reimbursed later by the budget. The DSA counted these costs only at the time of reimbursement. In 2018, by contrast, land costs amounting to both reimbursements and new land development needed to be counted as current fiscal expenditures. While this is expected to generate a formal financing gap of 6.6 percent of GDP for the year, the financing gap would have actually been a surplus of 3.9 percent if only reimbursements to the LGFVs had been counted in 2018 as in 2017. Some reimbursements to the LGFVs for past costs will be also conducted in 2019, when a formal financing gap deficit of 3.1 percent is expected. Beginning in 2020, the accounting of land costs will essentially be back to normal, as reimbursements of LGFVs will no longer be necessary. A financing gap surplus is expected at 5.5 percent of GDP. Since this temporary widening of the fiscal gap is a statistical artifact, none of this affects the comprehensive debt/GDP ratio, which is declining over time as expected, even if not as quickly as in the baseline 2016 DSA. The measure of the stock of comprehensive debt/GDP was considerably higher at end-2016 than anticipated. This was due to two primary factors: (a) planned land sales 23 for 2016 were not realized and postponed to 2017 due to sluggish land markets and (b) the original DSA missed some off-balance sheet liabilities of the LGFVs that were later added to the stock of comprehensive debt. 52. The program critically assisted Dadukou’s capacity to bring its debt under control in a number of ways. It assisted the development of a debt sustainability analysis, a three-year rolling capital investment plan, and the establishment of an interagency committee responsible for approving all investment projects and the investment plan. The DSA and capital investment plan allowed the District to obtain a comprehensive view of its entire liabilities, including those of its LGFVs, and fix a level of investment spending that was consistent with a reduction in debt to sustainable levels. Importantly, the DSA also provided the District (and its Finance Bureau in particular) with an objective basis for resisting political pressures to increase investment spending beyond sustainable levels. Decisions about the level of spending of ‘public benefit’ projects by the LGFVs are restrained by the spending ceilings established in the DSA-informed Medium Term Strategy. Another clear impact of the program is that the annual investment ceiling is determined, following the DSA, by an inter-agency committee consisting of the Finance Bureau, the investment authority, and the LGFVs. This committee was brought into being by Prior Action 4. Finally, the DSA facilitated a dialog under which Chongqing Municipality adjusted profit-sharing rules governing municipally-owned LGFVs operating within Dadukou District in the interest of ensuring sufficient revenue flows to Dadukou for achieving fiscal sustainability. 53. It is also likely that the changes in the budget relationship between the District Government and the LGFVs—prompted by the program—will reduce the likelihood of uncontrolled LGFV spending and borrowing for public benefit projects in the future. The reform requires most public benefit investments undertaken by LGFVs to be financed through direct cash transfers from the Dadukou Government’s budget, rather than through off budget borrowing. LGFVs are to be paid in installments on the basis of work completed (although they may finance start-up costs from their own capital or by short term borrowing). As described earlier, Results Indicator C tracked progress on this reform: the share of projects executed by Jianqiao and Dasheng that correspond to explicit commissioned contracts. Note that this indicator applies only to new projects. Although few new projects have been commissioned to the two LGFVs, almost all of those executed have taken the form of explicit commissioned contracts, well over the results indicator target of 30 percent. 1 Now all new projects must involve explicit commissioned contracts. 54. The technical tools and institutional framework for controlling the District’s debt are now in place. Dadukou continues to update its Medium Term Fiscal Strategy and three-year rolling capital financing plan. The Finance Bureau and DRC continue to cooperate in closely 1 In a related reform, the land development responsibilities of the LGFVs have now been transferred to an on-budget entity-the land reserve center (LRC). As in the past, the receipts and expenditures arising from land development are reported in a separate budget. Any positive cash flow generated by LRC activities may be transferred to Dadukou’s fiscal budget or spent on public benefit investments. 24 monitoring and controlling the level of local borrowing. They examine the fiscal budget (governing recurrent on-budget revenues and expenditures), the government fund budget (governing the revenues and expenditures), and the capital investment plan. Taken together, this suggests that the measures aimed at maintaining control over District’s finances are likely to be sustained. 55. (2) Developing an integrated approach to capital investment planning to improve efficiency. This task involved both the formulation of an integrated three-year rolling capital investment plan and a new institutional structure for integrated capital investment planning that involved the finance bureau, DRC, the mayor’s office, and the LGFVs. For the first time, Dadukou introduced a unified framework for selecting and prioritizing investment projects in line with the District’s development priorities. This contrasts with the former practice when public investment projects were approved and launched in a rather fragmented manner by different departments or corporate entities. To measure part of the impact on efficiency, the operation chose a results indicator that measured budget realism, i.e. the variance in actual investment outcomes from the original plan. In the base year, the implied variance was quite high: 0.5. It was even higher in 2016 (0.9) although this reflected (what is expected to be) a one-time transitional phenomenon. In putting together the 2016 capital investment plan, the District followed a common former practice of being inclusive of almost all proposed projects with good feasibility studies. However, during the course of the year, under the new tight constraint placed on aggregate public investment, the District realized that all of the available resources would need to be concentrated only in the highest priority projects. That led to a major reallocation away from lower priority projects, many of which did not get financing at all, to those of high priority. Thus, under a hard budget constraint, the District Government felt compelled to drop many projects in order to comply with the debt ceiling imposed for fiscal sustainability. That made the levels of project-by-project spending in 2016 far different from what was originally planned. This became apparent very early in 2016, and Dadukou District pledged to make capital investment planning project-by-project more realistic in 2017. Thus, the results indicator chosen for the DPF program uses the year 2017. As expected, measures undertaken by the District Government improved significantly the project-by- project correlation between the capital investment plan and investment outcomes in 2017. Dadukou made a strong effort to draft a more realistic project-by-project allocation in the capital investment plan. In addition, there was stricter management of construction; projects were not included in the capital investment plan until they were shovel ready. In doing this, Dadukou achieved a variance of 0.3 in 2017, thereby comfortably satisfying the results indicator of less than 0.4. 56. (3) Enhancing accountability and transparency in the use of public resources. Activities under this pillar revolved around the preparation and disclosure of comprehensive Dadukou District financial reports that include the LGFVs and the issued regulation that provides a clear accounting separation of government and commercial assets and liabilities. New public projects taken on by LGFVs now corresponded to explicit commissioned contracts. As of early June, 2018, the most recent report on public sector assets and liabilities on District website covered the year 25 2016. The District expected that the report for 2017 would be published in 2018, although some expected changes in central government accounting guidelines was so far delaying the release. There is, as yet, no evidence that the public disclosure of the District’s assets and liabilities has provoked much public response. Dadukou’s pioneering separation of assets and liabilities in the LGFVs provided inspiration for Chongqing Municipality to scale up this approach to other local governments. This activity is now on hold, however, at the request of the Central Government pending a new national agenda for a careful inventory of public sector assets. This temporary delay, as well as the delay for further disclosure of comprehensive financial reports do not imply a loss of momentum for the directions pursued in the DPF program. On the contrary, at the time of the operation, there were no national regulations for such integrated comprehensive financial reporting or for separating government and commercial assets/liabilities in LGFVs. The fact that these regulations are emerging now is a national move in the directions pioneered in this operation and the simultaneous operation in Hunan Province. 57. Following the spirit of this operation, Dadukou continues to take further measures to enhance transparency and accountability. Dadukou is not only still producing capital financing plans anchored to the Medium Term Fiscal Strategy and DSA, but is also now holding open consultations with citizen representatives, parliamentarians, and sectoral experts, and is publishing draft plans for public scrutiny. 58. The positive outcomes in Dadukou under all three pillars are strongly related to the DPF engagement. The development of the comprehensive debt sustainability analysis tool (DSA) was a direct result of the operation. Although District staff were involved, this was largely the initiative of the Bank team. The DSA allowed the province to (1) obtain a comprehensive view of its entire liabilities, including those of its LGFVs and (2) fix a level of future borrowing that was consistent with fiscal sustainability. Importantly, the DSA provided the District with an objective basis for resisting political pressures to increase investment spending beyond sustainable levels. It also significantly informed discussions with Chongqing Municipality on appropriate revenue- sharing arrangements that would be consistent with sustainable finances in Dadukou. 59. As had been hoped at the time of preparation, this operation proved catalytic for reform throughout Chongqing Municipality, and, together with the concurrent operation in Hunan Province, helped inform the Central Government’s reform agenda. Many of the practices piloted in Dadukou were subsequently endorsed by Chongqing Municipality, and have been scaled up to the other districts and counties. The Chongqing Finance Bureau established a computerized information system to monitor the comprehensive liabilities of all its subordinated districts and counties, and imposed ceilings for the public investments in each district/county. Chongqing Municipality also established a steering committee to review all major public investment projects, and granted the Finance Bureau the power to reject projects in the interest of fiscal sustainability. In addition, Dadukou’s approach to the separation of the accounting for commercial operations and governmental operations in LGFVs was adopted by Chongqing Municipality, although this practice was temporarily suspended due to a request form the central 26 Ministry of Finance to first conduct a careful inventory of public assets. As for the Central Government, the practice of a three-year rolling capital financing plan anchored to a medium-term fiscal strategy was officially endorsed by China Communist Party and the State Council in July 2016, and recommended for implementation in all local governments. The Central Government also introduced efforts to monitor local government liabilities in a more comprehensive manner, while tightening the regulations for new financing instruments such as PPPs, industrial funds and fiscal commitments. 3.3 Efficiency 60. Not applicable 3.4 Justification of Overall Outcome Rating Overall Rating: Satisfactory 61. Achievement of the PDOs is rated satisfactory. The operation identified five results to be attained by the end of 2017. Four were fully met and the other was mostly achieved. Out of those fully met, three exceeded the targets. The demonstration impact of this project beyond Dadukou District was also significant. Dadukou piloted and has sustained reforms from the DPF program, including a Medium Term Fiscal Strategy based on a comprehensive DSA and a three- year rolling capital investment budget. The District continues to use these instruments to place a cap on aggregate annual public investment outlays. The Finance Bureau and DRC now work together under the supervision of a single deputy mayor toward achieving debt sustainability and prioritizing public investment projects. These, as well as reforms in reporting of comprehensive public finances and the separation of government and commercial assets/liabilities in the LGFVs, were considered successful enough by Chongqing Municipality to scale up to other local governments. The national reform agenda has also moved in this direction. 3.5 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development 62. The pillars of this operation were not directly related to these issues. However, this operation was relevant for achieving fiscal sustainability, more efficient budgetary outcomes, and greater transparency in subnational finance. These issues have implications for the quality of social development and poverty alleviation. 27 (b) Institutional Change/Strengthening 63. This operation was very much about institutional change. Under the program, Dadukou District built new institutions for financial and budgetary management, which include debt sustainability analysis, a medium term fiscal framework, an integrated capital financing plan, a debt management framework, integration of the functions of the finance and economic planning departments, and higher standards of transparency. In the course of the operation, Dadukou District has built capacity in all of these areas, and has correspondingly changed the manner in which it operates. For example, the integration of the budgeting and investment functions in the Dadukou administration has been institutionalized to a large degree. To ensure the alignment of the public investment plan with the MTFS-DSA, Dadukou has now designated one vice mayor to supervise both the Finance Bureau and DRC (investment). The Finance Bureau now routinely proposes aggregate envelops for public investment before DRC puts together a public investment plan. Overall, the Institutional developments changed budgetary and planning processes, modernized organizational arrangements, created new norms and procedures, and applied new knowledge and information. Participants acknowledge that the institutional changes are well entrenched and not likely to be reversed. (c) Other Unintended Outcomes and Impacts 64. The strength with which Dadukou was able to sustain and extend the DPF program was not entirely expected at the time of project closing. During the time of project implementation, Dadukou District faced political headwinds pushing in the direction of a public investment-based stimulus at a time when consolidation was essential for achieving debt sustainability. In addition, some aspects of the DPF-backed reforms did not yet find reflection in central government reform guidelines. Third, Dadukou District was just beginning to build strong capacity for debt sustainability analysis at the time of project closing. At this time, Dadukou District also experienced a significant turnover in personnel, including the Mayor who had been the primary counterpart for the operation. For all of these reasons, the team had some concerns about the sustainability of the DPF reforms in Dadukou in the aftermath of the operation. Fortunately, subsequent adjustments by the Central Government and Municipality of conditions and instructions for budget reform implementation were very consistent with the directions of the DPF program. This gave Dadukou District encouragement as an example of the local government in China that had already pioneered a new approach to achieving debt sustainability. The new guidelines, and some uncertainty surrounding them, also caused a temporary delay in extending two aspects of the program: (a) publication of comprehensive budget reports and (b) the separation of government and LGFV finances. While new Central Government guidelines should have strong similarities with what Dadukou had pioneered, they will probably not be identical to those of the DPF program. In these two cases, Dadukou felt compelled to take a temporary pause to wait and see what would materialize, and to ensure that they are in compliance with regulations. Nevertheless, the favorable trends in Central Government and Chongqing Municipal policies 28 helped to create the environment for Dadukou to exceed a number of the results indicators and continue the basic thrust of reforms in the aftermath of the operation. 3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops 65. Not applicable. 4. ASSESSMENT OF RISK TO DEVELOPMENT OUTCOME Rating: Moderate 66. The original Program Document identified several possible sources of risk to the continued fulfillment of the development objectives. They were mainly related to possible deteriorating macro and fiscal conditions, governance and political issues, and technical design and implementation capacity. These risks have not yet materialized. 67. There are three primary risks to the sustainability of the reforms supported by the operation: (1) the policy priorities emanating from Beijing could change, (2) priorities within the Dadukou leadership could change, and (3) limited capacity within the Dadukou District administration. The latter two risks are related to the fact that Dadukou, like many other local governments in China, commonly experiences a significant turnover in personnel and leadership. Since the implementation of the DPF, a number of relevant positions in the government and Finance Bureau have changed. The strong continuity of reforms under these conditions reflects encouragement by the Chongqing Municipality and Beijing for Dadukou to continue to move forward in this manner. The World Bank also prepared for Dadukou a customized manual for sustaining the DSA tool even during the time that administration officials may not have completely mastered it. 68. As of the fourth quarter of 2018, the priorities of Beijing are again moving toward a possible fiscal stimulus to offset the headwinds brought on by the current trade and investment tensions with the US. The hope is that, if a major fiscal stimulus is carried out, China will account for the lessons of 2015-2016 and not pursue it essentially as an unfunded mandate for subnational governments to increase public investment. While the scenario of a repeat of 2015- 2016, which derailed the country from budget reform implementation to a significant extent, is unlikely, it cannot be ruled out. This would, in turn, challenge the ability of Chongqing Municipality and Dadukou to sustain or expand budget reforms in the spirit of the DPF, and also make it more likely that political changes in Dadukou District would lower the priority on measures to ensure fiscal sustainability relative to other objectives. Even in the event that these latter risks materialize, it is expected that this would delay rather than negate the progress that Chongqing and Dadukou continue to make in budget reform. The imperative of achieving fiscal sustainability at the subnational level in China will remain. 29 5. ASSESSMENT OF BANK AND BORROWER PERFORMANCE 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Satisfactory 69. The Bank was very responsive and worked closely with both Chongqing Municipal Government and with Dadukou District during the preparation of the loan. Having worked closely with China’s Government for many years on interbudgetary relations and budget reform, the World Bank proved an ideal partner for this operation. Most recently, prior to the DPF operation, the World Bank partnered with the Development Research Center of the State Council on the flagship report, Urban China (IBRD 2014), which has a chapter devoted to the reform of local government finance. The Bank had also recently provided technical assistance to Shanghai Municipality on questions of fiscal sustainability. The Bank provided substantial advisory support in the design of the DPF program. The preparation work conducted by the Bank was careful and thorough and involved significant direct technical assistance from its staff to the District. As in the Hunan DPL, during program preparation, the Bank mobilized some of the best experts in each of the areas and brought to bear relevant knowledge and lessons accumulated in China and other countries (Brazil, India, and Nigeria). The result was a well-focused program with strong links to the Budget Reform agenda and the broader engagement with the Central Government. (b) Quality of Supervision Rating: Satisfactory 70. One of the highlights of the process was the quality of the Ba nk’s supervision. The success of the program can be partly attributed to the intensive and continuous presence of the Bank throughout implementation. Continuous interaction and the supervision missions ensured more consistent progress towards achieving the result targets. The Bank took a total of eight missions to Chongqing-Dadukou during project preparation and supervision. Technical staff took longer missions for purposes of training, and Dadukou Financial Bureau staff took a training mission to the World Bank office in Beijing. There was an ongoing dialogue, as evidenced by mission aide memoires, on many facets of the program. There was a focus on ensuring results and on the measures needed to move the program forward. The staff followed up on indications of difficulties and the technical needs of the District. The follow-up included the preparation of a customized DSA user manual for Dadukou District. There is recognition that the technical assistance was a source of considerable help to the Government in overcoming implementation obstacles and finding solutions to several problems. Strong supervision was present in all pillars of the program. The nature of the support provided under each component varied according to 30 needs. The assistance covered broad policy issues, norms, regulations, and the updating of the DSA. These inputs were particularly valuable as the team had access to high level decision makers. (c) Justification of Rating for Overall Bank Performance Rating: Satisfactory 71. The overall Bank’s performance was commendable for its close involvement during the preparation and implementation of the program supported. The Bank’s engagement and support to Chongqing Municipality and Dadukou District under this operation was widely recognized by the authorities, who viewed it as crucial for their success. They appreciated not only the responsiveness at preparation, but also the quality and manner in which advice and support were provided throughout. They noted the professionalism of Bank staff and the respectful approach taken in understanding the Province’s priorities and specific needs. The authorities also pointed to the critical role of the Bank’s oversight and scrutiny. The constant inquiries by the Bank and the on-going exchange of views led the authorities to examine in greater detail the work being done and to be more self-critical. In many instances, in response to Bank’s concerns, the authorities adapted their approach to take into consideration the recommendations. 5.2 Borrower Performance (a) Government Performance Rating: Satisfactory 72. The Dadukou District’s authorities were persistent in implementing the reforms and in showing progress. The program included many measures that required perseverance and tenacity to make them effective. Some of the measures were politically challenging. For example, the adoption of a fiscal sustainability model entailed a sharp change reduction public investment beyond what was initially anticipated and encountered resistance. Achieving debt sustainability also involved a complex dialogue with Chongqing Municipality over revenue sharing. The Dadukou administration had to garner the support and participation of all executing agencies, and had to begin to integrate budgeting and planning, a task that required strong persuasive powers. 73. The Dadukou District leadership and staff worked long and hard under difficult conditions to implement reforms to make this operation a success. Given the political priority of a public investment stimulus in China at the time, pursuing some of the objectives of the DPF essentially required swimming against the current with some risk to performance evaluations and career prospects. The flexibility of Chongqing Municipality and the Central Government to allow Dadukou to adopt new ideas and practices, some of which were not entirely consistent with prevailing regulations, was also quite important. 31 (b) Implementing Agency or Agencies Performance Rating: Satisfactory 74. The primary responsibility for the administration of the loan rested with Finance Bureau that coordinated all activities under the program and was responsible for the implementation of several of the actions. Its performance was excellent. It had a dedicated team that supervised the compliance with the commitments under the loan. The team was central to the efficient communication that took place between the Bank staff and the Dadukou administration, and it also organized and facilitated the supervision missions. The Bureau was also fully committed to the part of the program that was under its complete responsibility. Together with the DRC, and with the support of the Mayor, it introduced the regulations and monitoring system. Dadukou’s consistent performance owes much to the continuity of the leadership team, who oversaw the DPL from its inception almost to conclusion. The undertaking was taxing and required considerable mobilization and political ability. (c) Justification of Rating for Overall Borrower Performance Rating: Satisfactory 75. The overall performance by the borrower is considered to be satisfactory because of the considerable achievements in most components of the loan and the catalytic effect that the program had on policies in Chongqing municipality and the national reform agenda. All components were managed successfully. 6. LESSONS LEARNED 76. This operation supports the view that the DPF can be a very effective instrument for facilitating deep cooperation around policies and reforms. The World Bank has long been engaged with subnational governments on budget reforms through technical assistance. Yet the TA instrument never provided such a special context that essentially unites the Bank and client teams around the achievement of specific reforms and policies under the discipline of a time line. Chongqing Municipality and Dadukou District were highly motivated to make this first DPF operation in China a success. Thus, a level of cooperation was achieved that would not have been possible simply under technical assistance. 77. Fortunately, the absence of an explicit programmatic DPF did not prevent what became a necessary multi-year engagement. Given the inherent multi-year nature of the complex institutional reforms embodied in the program, a number of years were needed for the achievements of the DPF. The World Bank, Dadukou District, and Chongqing Municipality had already been closely engaged for more than one year before the World Bank Board approved the operation in January, 2017. Close engagement on implementation of the program and 32 strengthening the new institutions continued throughout 2017. As the national and municipal reform programs began scaling up elements of the program, Dadukou District had a natural interest to remain closely engagement with the Bank team during 2018 as well. Thus, the fact that the operation was formally only a one tranche non-programmatic engagement, the high interest of the client in achieving and strengthening reforms provided the context for what became a genuine programmatic engagement. 78. This DPF also reaffirms the critical role of the Central Government for facilitating an environment where significant and valuable experimentation can occur. The Ministry of Finance in China lobbied very hard for several years for this type of operation that would link World Bank teams and subnational governments around realizing objectives in budget reform. The Ministry of Finance was important for creating conditions under which needed information could be shared with the World Bank team. Even when the directions of the operation began to deviate from current national instructions for budget reform, the Ministry of Finance continued to defend and support the operation as a pilot to be studied. The strong motivation of the central Ministry of Finance for conducting and defending the operation was essential for creating an environment where something of this nature can be achieved in China. 79. Working for the first time at the level of a local (sub-provincial) government on debt sustainability issues provided a few important lessons. Given that a strong majority of public expenditures in China are realized at the sub-provincial level, the opportunity to pilot approaches to reform and debt sustainability at that level was quite important. Relative a central government or even a larger provincial government in China, a district-level government generally has both lower capacity and less flexibility. Developing a meaningful agenda for attaining fiscal sustainability and greater public sector efficiency at the district level in China was a major learning experience for the World Bank team as well as Dadukou District. The program required an approach that was tailored to the specific reality of district-level finance in China. 80. A more simplified approach will be needed to scale up the success of Dadukou to other parts of China. Completing comprehensive debt sustainability assessments in this and the simultaneous DPF in Chongqing were difficult, given the current complexities surrounding subnational finance in China. It involved the close engagement and work of World Bank specialists. Even under these conditions, the exercise proved quite difficult and, as indicated in the discussion above, continual efforts to make the DSA as comprehensive as possible did not prevent missing some off-balance sheet liabilities of the LGFVs that needed to be added to the debt stock at a later stage. In addition, different local governments in China differ considerably with respect to the scope and organization of off-budget liabilities and contingent liabilities. While the World Bank prepared a customized DSA manual for Dadukou, this clearly cannot be done for every local government in China. While the careful and comprehensive assessments were appropriate for the initial pilot in Dadukou, it became clear in the course of the operation that a more simplified framework will be needed for scaling up these practices in local governments throughout China. For this reason, the World Bank team has begun work on a simplified template 33 that could be filled out by local governments for use at the provincial level for assessing financial risks in local governments, including those coming from contingent liabilities. This is part of current cooperative work between the World Bank and the Fiscal Academy of the Ministry of Finance in Beijing. 81. The combination of (often changing) municipal and central- level regulations and mandates creates a complicated context for local governments in China to ensure fiscal sustainability. This is particular the case due to the fact that unfunded expenditure mandates from higher levels of government are still common in China. For the case of Dadukou District, achieving fiscal sustainability required not only major adjustments in the District Government’s own program, but an additional agreement with Chongqing Municipality, facilitated by the DPF, to allow more LGFV revenues generated within Dadukou to remain in the district. Given the pilot nature of the operation, Chongqing Municipality and the Central Government allowed Dadukou to move in directions that were not yet an explicit part of the reform agenda. At the close of the operation, however, Dadukou needed to move into strict compliance with central and municipal directives. Fortunately, these regulations moved in directions highly consistent with the directions of the DPF program. Even in this favorable context, Dadukou needed to delay further implementation of comprehensive financial disclosure and the balance sheet separation of the LGFVs pending forthcoming central guidance on how these tasks will be carried out in the national reform agenda. This operation, as well as the simultaneous operation in Hunan Province, strongly suggest that more stability and predictability are needed in both intergovernmental transfers and expenditure mandates from higher levels of government to achieve high quality medium-term budgeting and debt sustainability frameworks at lower levels of government. 82. This operation also demonstrated important potential links between World Bank projects and policy dialog with the government. The experience of this operation, as well as the one in Hunan Province, improved greatly the Bank’s own knowledge of important budget reform issues at the subnational level and deepened the ability of the Bank team to engage with the Central Government on budget reform. While there is no proof of a causal relationship, a number of the practices pioneered in Dadukou District under the operation, as well as policy recommendations made by the Bank that were informed by this operation, have been echoed in budget reform initiatives of the Central Government beginning in the second half of 2016. Some of these initiatives have arguably revitalized the budget reform in China. 7. COMMENTS ON ISSUES RAISED BY BORROWER/IMPLEMENTING AGENCIES/PARTNERS (a) Borrower/Implementing agencies 83. The Dadukou administration echoes the concern of the Bank team over the complexity of the DSA, and of the difficulty of building and sustaining capacity to run it properly. Over the course of the operation, Dadukou District built important capacity in debt 34 sustainability analysis and can now run the model developed together with the World Bank team. They are also currently assisted by a customized DSA manual prepared by the World Bank. Nevertheless, changing circumstances will likely require adjusting the model in significant ways. The high turnover rate of personnel, and regulations that severely hiring additional specialists in the administration for maintaining the DSA, present real challenges for Dadukou going forward, not to mention other local governments in China that did not have such a World Bank engagement. For this reason, the World Bank is currently working with the Fiscal Academy of the Ministry of Finance in Beijing on a simplified methodology that would allow provinces in China to gather essential information to make a meaningful assessment of fiscal sustainability of their local governments. Going forward, province-level governments, which generally have higher capacity and are now responsible for the financial health of their local governments, will likely do most of the challenging work in debt sustainability analysis. (b) Cofinanciers 2. Not applicable. (c) Other partners and stakeholders 84. Not applicable. 35 ANNEX 1: BANK LENDING AND IMPLEMENTATION SUPPORT/SUPERVISION PROCESSES (a) Task Team members Names Title Unit Responsibility/Specialty Lending John Litwack Lead Economist GMTP1 Macro-economic and Fiscal Management / Team Leader Min Zhao Senior Economist GGOEA Public Financial Management / Team Leader Christoph T F Ungerer Economist GMTE3 Debt Management Luan Zhao Economist GMTP1 Macro-economic Management Kai-Alexander Kaiser Senior Economist GGOEA Public Investment Management Lili Liu Lead Economist GGOGI Debt Management Abha Prasad Program Leader LCC3C Debt Management Jay-Hyung Kim Adviser GGOAS Public Investment Management Juan Pradelli Consultant GMTP2 Debt Management Alejandro Alcala Gerez Senior Counsel LEG Legal Regis Cunningham Senior Financial GGODZ Financial Management Management Specialist Haixia Li Senior Financial GGOEA Financial Management Management Specialist Yu Shang Program Assistant EACCF Administrative and Client Support Lin Yang Program Assistant EACCF Administrative and Client Support Yunxia Chao Consultant GMTP1 Data Analysis Supervision John Litwack Lead Economist GMTP1 Macro-economic and Fiscal Management / Team Leader 36 Min Zhao Senior Economist GGOEA Public Financial Management / Team Leader Luan Zhao Economist GMTP1 Macro-economic Management Regis Cunningham Senior Financial GGODZ Financial Management Management Specialist Yi Dong Senior Financial GGOEA Financial Management Management Specialist William Dillinger Consultant GMTP1 Intergovernmental Fiscal Relations Lorena Vinuela Senior Public Sector GGOEW Intergovernmental Fiscal Specialist Relations Yu Shang Program Assistant EACCF Administrative and Client Support Lin Yang Program Assistant EACCF Administrative and Client Support Li Du Consultant GMTP1 DSA Yunxia Chao Consultant GMTP1 Data Analysis (b) Staff Time and Cost Staff Time and Cost (Bank Budget Only) Stage US$ Thousands (including travel No. of staff weeks and consultant costs) Lending 17.65 118.33 Supervision/ICR 95.41 9.08 Total: 26.73 213.74 37 ANNEX 2: SUMMARY OF BORROWER'S ICR AND/OR COMMENTS ON DRAFT ICR Distinguished the Expert Team of the World Bank, China’s new Budget Law, which took effect on January 1, 2015, envisions a comprehensive, rule- based, open and transparent budget regime. It puts forward new and higher standards for fiscal management by subnational government, clearly stipulating that subnational governments should borrow money within their respective budget limits. On January 23, 2015, China’s cabinet promulgated the Opinions of the State Council on Implementing Management of Medium Term Fiscal Planning (Guo Fa [2015] No.3), aiming to play the role of fiscal functions and achieve fiscal sustainability. In this context, with approval from both the State Council and the World Bank, Dadukou District took the lead in integrating its fiscal reform with a World Bank DPF program. Through this program, we aim to establish a public finance regime that includes a medium term fiscal framework, public investment budgeting, and regular publication of balance statements of public institutions, so as to improve the public investment efficiency (in particular infrastructure investment efficiency) and debt management level, further laying a solid foundation for further fiscal reforms in the future. Dadukou District DPL Program is the first DPL of the World Bank at the prefecture-level government and also the first application for DPL lending instrument in China. This program aims to promote fiscal system reform in Dadukou District and achieve development goals by providing the District Government with general budget support. The implementation and completion of the DPL Program are summarized as below. I. Program Background and Completion (I) Background of DPL Program Dadukou District, one of the nine urban districts of Chongqing Municipality, accommodated a population of 330,000 and generated a GDP of RMB 15.97 billion in 2015. During the 12th Five- Year Plan (FYP) period, the Dadukou District faced multiple challenges, including a macroeconomic slowdown, relocation of the Chongqing Iron and Steel Company and the resulting pressure to transform and upgrade its economy. Relocation of the Chongqing Iron and Steel Company had reduced the District’s economic output by 28.3% between 2010 and 2012. In recent years, however, with support from both the Central Government and the Chongqing Municipal Government, Dadukou District has stepped up its effort to nurture new industries and new drivers of economic growth. The annual growth rate has quickly rebounded to 7.1%, 9.1%, and 10% in 2013, 2014 and 2015, respectively. In line with the national economic environment, the Dadukou District set an annual real GDP growth target of 9% for the 13th FYP plan period. The District Government spent a total of RMB 10.11 billion on public investment during the 12th FYP period, 38 averaging RMB 2.022 billion per year, and accounting for 13.2% of the District’s total investment (RMB 76.56 billion) in fixed assets over this period. Looking from the investment categories, this investment mainly focused on infrastructure, low-income housing and projects to improve people’s livelihood. Due to limited fiscal revenues, influence from the macro economy, increasing mandatory expenditure and unchecked public investment, the Dadukou District has accumulated in the past decade significant government debts associated with infrastructure projects, the transformation of old neighborhoods, and the construction of an industrial park. By the end of 2015, the direct government debt of Dadukou District totaled RMB 10.54 billion, both debt servicing ratio (177% of its fiscal revenue) and debt ratio (65.9% of local GDP) are high. The fiscal sustainability faces challenges, which may affect the future economic and social development. It is, therefore, a priority for the Dadukou District to strive for fiscal sustainability by controlling government investment at a reasonable level. This World Bank DPL program not only fits well the general agenda of ongoing fiscal reforms, but also provides the means and technical support for addressing the District’s problems regarding fiscal sustainability. (II) Completion of Prior Actions The DPL program focuses on three aspects: fiscal sustainability, public investment budgeting, and fiscal transparency. These three aspects are complementary with one another: the Medium Term Fiscal Framework aiming at fiscal sustainability is the basis and prerequisite for developing a three-year rolling Capital Investment Plan, while fiscal transparency can help to ensure the effective implementation of the first two. The fiscal reform and the DPL program share the same general objectives -- namely, the District Government shall, by adopting a Medium Term Fiscal Strategy, strengthen budget management and improve the efficiency of public investment, which will in turn help advancing economic development, improving public services, and benefiting the residents of Dadukou District. The District had implemented these six prior actions as per the World Bank’s requirements in 2016. 1. Dadukou District adopted and published the Medium-Term Fiscal and Public Investment Strategy Report, grounded in a debt sustainability analysis, which sets a target for district-level public investment financing in line with the requirements of debt sustainability. Meanwhile, the Expanded Report of Dadukou District for Medium-term Fiscal Framework and Debt Sustainability Analysis was formulated. 2. The Dadukou District People’s Congress submitted The Report of Dadukou District on 2015 Fiscal Budget Implementation and 2016 Fiscal Budget Draft and its appendix that corresponded to a medium-term fiscal strategy plan and in line with the fiscal and debt sustainability. 39 3. On April 26, 2016, we drafted the Three-Year Rolling Investment Scheme Report (Du Fa Gai Fa [2016] No. 73). This scheme met the upper limit of 2016 public investment set in the medium-term fiscal strategy and upper-limit of 2016 for 2017-2018 investment commitment. 4. On April 29, 2016, the Measures of Dadukou District for the Administration of Government Investment Projects (amendment)(Dadukou Fu Fa [2016] No. 6) was issued, which specifies to, starting from 2016, draft the three-year rolling investment plan every year, as well as schedule and division of tasks among related agencies. 5. On April 27, 2016, the Notice of Issuing the Implementation Plan of Dadukou District Government for Disclosing the Comprehensive Financial Report Information (Du Cai Fa [2016] No. 54) was issued. 2015 Report of Dadukou District, Chongqing Municipality for the Balance Statement of Public Sector was drafted and released as per related guidelines issued by the Ministry of Finance and the requirements of the World Bank. 6. On April 17, 2016, Dadukou District promulgated the Notice of Guiding Opinions on State- owned Enterprises Adopting Ledger Accounting (Du Guo Zi Wei [2016] No. 8) was promulgated, which clearly classifies the government and commercial nature of commercial activity, income, expenditure, assets and liabilities of Dasheng Company and Jianqiao Company. From 2016, these two platform companies officially adopted the ledger accounting and the third party agency issued the audit opinions on the ledger account financial report in the first quarter. II. The Implementation of Project Result Indicators (I) This program aims to: 1. Develop and employ a medium term fiscal / debt sustainability framework for managing risks, and ensure the fiscal sustainability of Dadukou’s public finance. The Project Construction Objectives Level: Dadukou District financing gap as a share of District GDP. 2015 baseline 8.1%, 2016 target <3.5%. Financing gap = (total fiscal revenue - total fiscal expenditure ) - (total public investment - public investment expenditure within the fiscal budget) = basic fiscal surplus - extra-budgetary public investment where, total fiscal revenue/expenditure is equal to the sum of three budget revenues (i.e. public budget, government fund and state capital operation budget) /expenditure. The revenue excludes bond re-lending revenue and expenditure excludes debt repaying capital with interest. Notes: 1. Total fiscal revenue/expenditure is equal to the sum of three budget revenues (i.e. public budget, government fund and state capital operation budget) /expenditure (excluding last year's balance and only fiscal income and expenditure in the year). The revenue excludes bond re-lending 40 revenue and expenditure excludes debt repaying capital with interest (by following the international analysis practice, in the DSA analysis, the debt revenue/expenditure is excluded from the fiscal revenue and expenditure statement and analyzed in a separate module). 2. The financing gap represents that the total fiscal balance doesn’t cover the extra-budget public investment (the financing needs of the platform company). 2. Develop an integrated public investment plan and improve efficiency (1) The Project Construction Objectives Level: Dadukou executed outlays on investment projects in 2016. The baseline RMB1.79 billion in 2015 and 2016 goal < RMB1.1 billion. (2) The Project Construction Objectives Level: Variance of executed investment in Dadukou District with capital investment plan. 2015 baseline 0.514, 2016 target <0.4 The specific calculation steps are as follows: a. The difference between the actual investment and the planned investment of each project is equal to the absolute value of the difference between the actual investment amount and the planned investment amount of each project, divided by the planned investment amount of each project; b. The weight of each project in the total planned investment is dividing the planned investment of each project by the total planned investment of all projects; c. The result indicator is equal to the weighted average of all items (a total of N items) and then weighted again. 3. Enhance transparency and accountability in the use of budget resources (1) The Project Construction Objectives Level: Annual balance statement of public sector released on the official website. 2015 baseline “Nil”, 2016 target “release the report”. (2) The Project Construction Objectives Level: Share of projects executed by Jianqiao and Dasheng that correspond to explicit commissioned contracts 2015 baseline 9%, 2016 target >30%. (II) Completion of five result indicators 1. In 2017, Dadukou District financing gap as a share of District GDP is controlled within the target value. 41 2. In 2017, the planned government investment was RMB1.28 billion and completed investment was RMB1.31 billion, accounted for 102.3% of annual planned investment and exceeded 2.3 percentage points. This was mainly because J1-6 resettlement house caused larger social contradiction. The district government adjusted the construction plan, accelerated the investment and increased by RMB50 million compared to the beginning of the year. In 2017, the variance of executed investment to planned investment was 0.29%, effectively controlled within the target value. 3. In 2017, first, we drafted the comprehensive financial report for 2016 as per the central deployment by the Ministry of Finance and released online. Second, when Jianqiao and Dasheng Company have new government-invested projects, they signed the construction commission agreement with related government department. III. Experience and Achievements of Implementing the World Bank Reform (I) Establish the coordinated mechanism for economic development and debt prevention and control. The introduction of the World Bank’s DPL model provides quantitative analysis on how to match up the future financing demand with debt servicing capacity and possible debt risks. We scientifically and reasonably draft the fiscal expenditure and public investment scale on a basis of our economic development, debt level, public investment scale, land transfer and fiscal revenue and expenditure, in line with the trend of medium and long-term debt risks, as well as expected economic downturn and reducing land revenue. Within the limit of debt management and control, we also draft annual investment and financing plan and ensure our economic development in response to the debt prevention and control. The three-year rolling investment scheme is drafted led by the district development and reform committee. The district financial bureau drafts annual capital balance plan and three-year financial plan in line with district-wide land expropriation plan and capital needs for repaying capital with interest and other payment. On a basis of affordable and sustainable fiscal revenues, the district financial bureau scientifically sets annual debt scale and limit of newly increased financing amount by district-wide state-owned enterprises. In annual implementation, we reasonably control the scale and timing of borrowing, and prevent unscheduled and excessive borrowing. (II) Establish and improve the coordinated management and control mechanism of state-owned enterprises based on capital management. We accelerate the reform of the classification and integration of state-owned enterprises, and enhance the capacity building of enterprises. First, we speed up the liquidation of assets and separating debts of state owned enterprises, and ensure realize the goal by the end of 2018 that current financing platforms are integrated to the public welfare project owner and commercial state-owned enterprises. In the process of state-enterprise reform, we allocate more capitals to high-quality assets that could generate operating revenues while separating public welfare assets. 42 We encourage transferred real estate development company, property operation company, security service company and fund management company of commercial state-owned enterprises to operate in the market and earn profits through business operation. Second, we fully supervise state enterprise accounts, centrally coordinate the debts and dynamically monitor the fund use on the financing platform. We reasonably control the pace of newly increased debt financing, coordinately draft the fund utilization plan, give the priority to the debts of state-owned enterprises for public welfare project construction, and orderly guarantee newly-built government-financed public welfare projects. Third, we improve the corporate governance structure of state-owned enterprises, establish an internal examination and approval system for the fund usage, a supervision and inspection system, a debt repayment and performance assessment system, to ensure the sustained and healthy development of enterprises. Meanwhile, based on legitimate and compliant practices, relevant departments accelerate the enterprise development by giving policy and business support. In addition, we actively explore the way of introducing third-party strategic investors and inject impetus into corporate development through attracting the participation of capable social capital, high quality talent and cutting-edge operating concepts, as well as abundant social resources in the enterprise operation and management process. (III) Establishing the long-term mechanism for increasing revenue through multiple measures To consolidate the payment sources of debt service, we expand income scale fromthe area of industry, land and enterprises. First, we deploy long-term expansion of income sources. We actively implement the fiscal policy and strongly support “four pillar industries” (i.e. big data intelligence, eco-environmental protection, big health bio-pharmecetucial, cultural & entertainment tourism), continuously support business invitation and major project construction in “four major blocks” (i.e. Binjiang, Jiugongmiao Business Cycle, Funiuxi and Jianqiao Park), accelerate the development of related regions and industries and cultivate new growth engine. We will better and flexibly use the supportive funds and fiscal policy, accelerate the development of private economy and self-employed economy, support the transformation of traditional industry and improve the quality of the service industry, promote the economic restructuring and consolidate the tax base. Second, we intensively explore the potential of land resources. On the one hand, attract the investment centered on land. We will fully leverage the policy and brand advantages of municipal departments and reservation institutions, strengthen the departmental coordination across the District, coordinate the land parcel planning by considering the market requirements for related land parcel indicators, make prior adjustment, construct surrounding supporting infrastructure, increase the attractiveness to large developer brands and maximize the land unit price. Meanwhile, we will emphasize the sustainability of land transfer revenue and focus on the service industry and strategic new emerging industries, select the projects with strategic significance and development potential, and realize sustainable project revenue. On the other hand, we will make a breakthrough in total land supply. Binjiang Bay Area around Jin’ao Mountain (formerly Xiaonanhai Area) is the major land for transfer in the District. We will actively adjust 43 the greening land planning, strengthen the coordination of municipal departments and increase the land ratio from 22% to 40%. (IV) Clarify the accountability and create the joint management mechanism. As per related risk mitigation requirements, we willformulate risk mitigation plan and clarify the accountability of various departments. Various towns/streets, departments and organizations strengthen cooperation, strengthen government debt risk prevention and control and do a better job in various mitigation tasks. On a basis of principles of “who in charge will hold the accountability and who borrow will be responsible for repaying”, various state-owned enterprises formulate specific measures for debt management and control and risk mitigation, clarify timetable and roadmap and organize the implementation of management and control plan. First, we pay attention to maintain the safety of debt capital chain. The accountabilities of the platform company and the financial bureau of the District are clarified in repaying the principals and interests, as well as the accountabilities of district platform company, reserve center and economic cooperation and exchange office in capital revenues, so as to ensure the implementation and cooperation alongside the sustainable chain. Second, we pay attention to the debt source. The accountability of district development and reform committee and district financial bureau is specified in balancing annual government investment fund, as well as the accountability of district platform company in capital allocation between the public welfare projects and operating projects, so as to prevent from increasing hidden government debts. The specific requirement is posed for district-wide public institutions and prevent them from borrowing loans through enterprises, to cut off the channel of increasing hidden government debts. Third, we pay attention to early warning alert. We clarify that the district financial bureau is responsible for daily risk monitoring, collecting related information per month and quarter and making regular reports, analyzing the debt serving ratio, debt ratio, newly increased debt serving ratio, debt service ratio and overdue debt ratio based on the World Bank model, promptly assessing the debt risk profile and giving appropriate warning. We establish the early warning mechanism for internal enterprise debts and clarify the early warning standards. The regions with cash coverage lower than 100% or asset-debt ratio higher than 70% shall promptly report to the debt management leadership group, preventing capital chain rupture and regional and systematic debt risks. IV. The Support from the World Bank Team in the Program Process Since 2015, the World Bank offered great support to the District in such aspects as professional technology application, implementing the reform measures and capital use. During the project preparation, implementation and assessment stage, the World Bank expert’s professionalism and dedication impressed us, highly recognized and praised by our organizations. In the project preparation and implementation stage, the World Bank experts provided valuable opinions and suggestions for improving various report materials and patiently guided us to complete various prior tasks. In the evaluation project stage, the World Bank inspection team regularly sent experts to inspect, guided the work onsite and helped us to achieve the program goals. We hereby thank 44 all experts and employees from the World Bank for their efforts to make DPL program possible in Dadukou District! 45 Map of Chongqing-Dadukou District 46