Report No. 39810-IN India Himachal Pradesh Accelerating Development and Sustaining Success in a Hill State July 04, 2007 Poverty Reduction and Economic Management India Country Management Unit South Asia Region Document of the World Bank Team andAcknowledrrements This Economic Report was preparedbyAnanya Basu(SASPF) andMohanNagarajan(SASPF). Paramita Dasgupta (SASPF) and Ananya Basu (SASPF) were co-Team Leaders till December, 2006. The work was carried out under the overall direction and management o f Sadiq Ahmed (SASPF), Fayez Omar (SACIA), and Kapil Kapoor (SASPF). The team i s particularly grateful for valuable formal peer review comments from Sudarshan Gooptu (EASPR), Stephen Howes (AUSAID), and Vinaya Swaroop (SASPF) which have informed this Report. Comments, advice, and suggestions from Dipak Dasgupta (SASPF), V.J. Ravishankar (SASPF), and Deepak Mishra (SASPF) are gratefully acknowledged. Shiny Jaison (SASPF) provided valuable team assistance. Team members who provided technical contributions underlyingthis Report are Daniel Sellen (SASAR, Agriculture and Irrigation), Philip O'Keefe (SASHD, Social Protection), Pier Vickers (SASEI, Roads), MohanNagarajan (SASPF, Fiscal), Vikram Chand (SASPF, Governance), Sunil Khosla (SASEI, Power), Richard Damania (SASES, Forestry and Environment), Sonia Chand Sandhu (SASES, Forestry and Environment), Ananya Basu (Growth and MDGOverview), Michael Haney (SASEI, Power), Rajni Khanna (SASPF, Public Sector Enterprises), Paramita Dasgupta (Tourism), Inderbir Dhingra (SASFP, Private Sector Development), Tanuj Mathur (SARFM, FinancialManagement), Ashish Bhateja (SARPS, Procurement), Sangeeta Goyal (SASHD, Education), Rajeev Ahuja (SASHD, Health), K e Fang (SASEI, UrbanDevelopment), AshishNarain (SASPF, Labor and Employment), Puja Vasudeva Dutta (SASHD, Social Protection), Rohit Mittal (SASEI, Power), Neha Kaul (SASPF, Fiscal and Research Assistance), Prachi Seth (SASAR, Watershed Development), and T.C. Jain (Consultant, Agriculture and Irrigation). Inaddition, the consultant firmofInfrastructureProfessionals Enterprise Ltd.prepared abackground consultancy report on tourism development inthe state, which has informed the Report. The Report could not have been prepared without the close cooperation o f the Government of Himachal Pradesh. The team i s grateful to representatives o f civil society, non-governmental organizations, academics, and private sector firms inHimachal Pradesh with whom a wide range o f consultations were undertaken. ExecutiveSummary ........................................................................................................................................ i Chapter 1 Himachal Pradesh:A Statewith a Di@wence .............................................................................................. i 1 B. Key Development Priorities inthe MediumTerm: ConsolidationandInclusion............................ A. State Background and Recent Performance ..................................................................................... 6 C . Towards a Development Strategy for the State................................................................................ 9 Chapter 2 CreatingFiscal Spce toRealize theState'sDevelopment Vision ............................................................. 11 A. Strengthening OwnRevenuePerformance .................................................................................... 12 B. Controlling Expenditure and Improving its Composition.............................................................. 15 C. D. RefiningMediumTermFiscalProjections .................................................................................... Managing Debt and Contingent Liabilities .................................................................................... 19 21 E. F. Improving the Budget FormulationProcess................................................................................... 22 StrengtheningPublicFinancialManagement and Procurement Systems...................................... 23 Chapter 3 Improving theInwstmmt Climatefor Private Sector ................................................................................. A. 26 B. Challenges inIndustrialization....................................................................................................... 26 Improving the Business Environment............................................................................................ 28 Chapter 4 ExploitingEmerging Opportatniiiesfar RevenueMobilization. Growth. and Employment ........................36 A. B. Exploiting the Untapped Hydropower Potential............................................................................ 36 C. PromotingHighValue-Added Cultivation inAgriculture and Allied Sectors............................... 39 Developingthe State's Tourism Potential...................................................................................... 44 Chapter 5 Promoting theInstitutionalEnvironmentfor Inclusive Growik .................................................................. A. 50 B. Enhancing the Effectiveness of the Civil Services......................................................................... 51 Strengthening Institutions for Transparency and Accountability................................................... 54 C. PromotingDecentralization to Improve LocalProvision of Services............................................ 57 Chapter 6 StrengtheningHuman Dwlopmertt and SocialProtectionStrategies ....................................................... 59 A. B. Education........................................................................................................................................ 59 Health............................................................................................................................................. 62 C . Social Protection ............................................................................................................................ 64 Chapter 7 PromotingEnvironmentally SustainableDevelopment ............................................................................... 68 A. Improvingthe InstitutionalApproach for Environment Management.,......................................... 68 B. Sustainable Hydropower Development .......................................................................................... 72 Chapter 8 Implementingand SequencingtheReform Age~da ..................................................................................... 77 A. ProposedReformOptions .............................................................................................................. 77 B. Political Economy Considerations ................................................................................................. 83 ListsfAnnexes Annex 1: New InitiativesandReforms hoposedby GoHP ....................................................................... 8~ Annex 2: Some HumanDevelopment Outcome andAccess Indicators, HPand Other States ...................95 Annex 3: Technical Note:on Estimation ofVulnerability 96 Annex 4: DetailsofLoss-Making PSEs ...................................................................................................... ........................................................................... 99 Annex 5: FiscalProjections and Debt Sustainability Analysis 100 Annex 6: Fiscal Data for HP ..................................................................................................................... ................................................................. 103 Annex 7: Preliminary Assessment ofPublic FinancialManagement andProcurement ........................... 105 List ofReferences ...................................................................................................................................... 116 ListofFigures Figure 1. 1:Recent Performance inReal Economic Growth and Diversification inHP .............................. 3 Figure 1.2: Will HP Attain Selected Millennium Development Goals? ...................................................... 4 Figure 1.3: HighCentral Grants and Social Spending inHP....................................................................... 5 Figure 1.4: Real Sub-sectoral GrowthRates inHP, 1993-94 to 2005-06.................................................... Figure 1. 5: Structure o f Job Creation and Working PopulationinHP......................................................... 7 Figure 1. 6: Some Examples o f Differential Indicatorso f Social Outcomes and Access ............................. 7 8 Figure 2. 1: Recent Fiscal Trends inHP ..................................................................................................... 11 Figure 2.2: Expenditure Composition inHP and Selected States .............................................................. Figure 2. 3: Debt Crisis inHP..................................................................................................................... 15 19 Figure 3. 1:Key Challenges inIndustrialDevelopment............................................................................. 27 Figure 2.4: Optimistic Projections under GoHP's MTFP.......................................................................... 21 Figure 3.2: Major Constraints for the Private Sector ................................................................................. 28 Figure 3.3: Poor Rural Connectivity inHP................................................................................................ 28 Figure 3.4: Labor Force and Unemployment Structure by EducationLevel ............................................. Figure 3. 5: HP's Trends inUrbanization ................................................................................................... 30 33 Figure 3. 6: Financial Challenges inUrbanDevelopment.......................................................................... Figure 4. 1:UntappedPotentialinHydropower, but Good Outcomes inPower Connectivity ..................34 36 Figure 4.2: Projected Revenues from Royalty Power ................................................................................ 37 Figure 4.3: Financial Challenges facing HPSEB ....................................................................................... 38 Figure 4.4: L o w IrrigatedArea and L o w Yield o f Traditional Food Crops inHP..................................... 40 Figure 4. 6: HP's Challenges inTourism .................................................................................................... Figure 4. 5: Cost Recovery Issues inIrrigation and Public Health............................................................. 43 45 Figure 4.8: Constraints to Development o f Tourism Potential inHP ........................................................ Figure 4. 7: Findingsfrom HP Tourist Survey, 2002.................................................................................. 45 46 Figure 5. 1:Relative Ranking o f Public Service Delivery inIndian States, 2003-04 ................................. 50 Figure 5.2: Patterns and OverstaffinginHP's Civil Services .................................................................... 51 Figure 5.3: L o w Compliance under RTI, 2005 .......................................................................................... 55 Figure 6. 1:Educational Outcomes and Spending inHP Compared to National Averages........................ Figure 5.4: L o w Corruption but Declining Conviction Rates inHP.......................................................... 56 59 Figure 6.2: Teacher Absenteeism inHP and Other States ......................................................................... 60 Figure 6. 3: Dependence on the Public Sector for Health Services............................................................. 63 Figure 6.4: Insurance.................................................................................................................................. 64 Figure 6. 5: Geographic and HouseholdLevel Targeting o fProgrammes.................................................. Figure 7. 1:Recent EnvironmentalDegradationinHP............................................................................... 65 Figure 8. 1: Proposed Elements inHP's Development Strategy................................................................. 68 78 Table 1. 1:Local Context. Key Indicators. and Location o f HP ................................................................... Table 1.2: Summary o f Key Millennium Development Goals for HP......................................................... 2 Table 2. 1: User Charges inHP compared to Other States ......................................................................... 4 14 51 Table 6. 1: Coverage and Benefit o f SelectedProgrammes ........................................................................ Table 5. 1: Comparative Size o f Civil Service inSelected Indian States.................................................... 64 ListafBoxes Box 2. 1: Essential Ingredients o f Performance Budgeting ........................................................................ 18 Box 2.2: Zero-Based Investment Review in Orissa ................................................................................... Box 3. 1: Special Incentives for HP's IndustrialDevelopment................................................................... 19 26 Box 5. 1:Wage and HiringRestraint to Control the Size o fthe Civil Service Wage Bill.......................... Box 4. 1:Kerala's Approach to Tourism Development.............................................................................. 48 52 Box 5.3: Community ParticipationinHospital Management .................................................................... Box 5.2: E-Governance Initiatives inOther States ................................................................................... 56 58 Box 6. 1: Measures to Curb Teacher Absenteeism inOther States............................................................. 61 Box 6.2: Findingsfrom an Evaluation o f Social Pension Schemes inKamataka...................................... Box 7. 1:World Bank Involvement inEnvironment Management............................................................. 66 72 ExecutiveSummary 1. This Economic Report is the first bythe WorldBank on the economy o fHimachalPradesh(HP), and the first on a hillstate inIndia. It comes inthe context of a request by the Government of Himachal Pradesh(GoHP) to assess the state's progress and longer-termprospects. The study has been prepared as the initial step towards enhancing the Bank's understandingo fthe development priorities and key constraints for HP. 2. HPi s a unique state inmanyrespects-most importantly because o f the enormous success it has achieved over the past three decades, despite severe structural disadvantages o frelative remoteness, environmental fragility, and a difficult hillterrain, characteristic o f Himalayan states inIndia. The study sets out to document, first, the remarkable success that the state has achieved interms o f sustained growth and human development, and the underlying reasons interms of supportive policies and social cohesion. Inthis respect, HPmakes an important contributionto lessons o f success for the other nine Himalayan hill states inIndia. The second, and more extensive part o f the Report, i s forward-loohng. It describes how it mightbe possible to buildon the past success that HPhas achieved, and, at the same time, address some crucial economic and social transitions that will be essential for the state to firmly secure its kture: (i)sustained increase inincomelevels alongwith an a enabling environment for the private sector; (ii) the creation o f suitablejobs based on enhancedproductivity and s h l l s o f its young labor force that can shift from public to private sector employment; and (iii) utilization o f the naturalresources like hydropower, forests, and water resources wisely and well. There i s every reason to be confident that HP can meet these challenges. The state's past enviable track record i s testimony to the ability o f its people and leadership to forge a social consensus and compact necessary to achieve such goals. 3. Based on the materials that were available, the Report seeks to provide an analysis o f HP's current economic situation, and to lay out a menu o freform options that can help build on HP's considerable strengths and opportunities, and address some o f the main challenges ahead. More consultations and discussions are plannedinthe coming months inorder to support additional work that may be needed to deepen the analysis in sectors and areas such as s h l l development, urbanization, forestry, and tourism. Himachal Pradesh: A "Unique" State with a Successful Past but an Uncertain Future 4. HPhas some specific characteristics that set it apart from other Indian states. Iti s a relatively small state, with ahilly terrain, a supply o fperennial rivers, and significant forest cover. Onthe one hand, the salubrious climate, abundant water resources, and natural touristic ambience can contribute to the expansion o f important sectors like horticulture, tourism, and hydropower. On the other hand, HP faces specific development challenges arising from its highelevation, topography, resource dependence, and ecological vulnerability-as well as from a changing and more competitive international environment. The Government o f India (GoI) has given HP the status o f a "special category" state inrecognition o f these unique constraints, under which the state i s the recipient o f special central grants and incentives that have been instrumental to its development. 5. The state has several significant achievements, in spite o f its natural constraints. After two decades o f slow growth since it was granted full statehoodin 1971, HPhas registered more rapid growth than the national average since the 199Os, andthe economy has shown increasing signs of diversification. The state i s ahead of Indian averages for most indicators o fhuman development, and on track to meet a majority o f its Millennium Development Goals. Infact, HP i s performing better than several more developed states inthe plains along several dimensions o f social and economic progress. 6. Supportive government policies, a transparent and accessible administration, a peacefulpolitical environment, and central support have contributedto the state's development. Inparticular, from a focus on buildingtransport and infrastructure facilities immediately after its formation in 1971,HP has graduallyassigned priority to expenditures inthe social sectors, which has considerably expanded the availability o fbasic social 1 infrastructure and amenities, and helpedbuildan educated and healthy population. HPhas achievedper capita social sector expenditure which i s currently about double the all-States average inIndia. The initial infrastructure investments have also started yielding dividends interms o f higher growth. Underlying this remarkable achievement has been an implicit social compact and cohesion that has stood HPwell inthe past and will continue to do so inthe future. Inparticular, the state has benefited from wise leadership throughout the past several decades, irrespective o fpolitical affiliations-and that, inturn, has been based on strong public support for policies that have encouraged social development, and delivery o f public services. Central assistance has been important inthe process, but primarily because the state has managed it well to further development. 7. However, the sustainability o fHP's success for the future will depend on addressing three major transitions that the state faces. To a great extent, the state may be reaching the limits o f one o f its traditional sources or engmes o f its growth and social development: one that i s heavily dependent on public spending, financed by borrowing and central assistance. It i s thus important for the state to look towards self sufficiency in meetingits challenges. 8. The first important transitioni s to shiftthe growthstrategy inHP from one that i s still far too heavily dependent on public expenditures and debt-to an increasing focus on the broad-based contribution from other sources o f growth, with an enabling environment for the private sector. To an important extent, the state has already begun to move inthis direction: the primary sector has seen signs of diversification to highvalue cultivation, while the secondary and tertiary sectors have seen impressive expansion inrecent years. However, muchmore needs to be done, and a critical role will be playedby growth inemerging sectors like tourism. At the same time, the very heavy burdeno f the state's debt and current expenditures will necessitate a sustained turnaround inits fiscal position. As they exist, any reduction o fprivileges as a "special category" state or other fiscal risks such as wage revision following the Sixth Pay Commission awards could hurt HP's already precarious fiscal situation. The argument, therefore, i s not for continueddependency, but for charting a course that will make the state more self sufficient. A fiscal turnaround will be crucial to create the necessary fiscal space for the state to invest inthe basic development needs on a sustainable basis, and hence achieve its considerable untapped growth potential. 9. The second crucial transition i s to create the productiveemploymentopportunitiesfor HP's young and increasingly educated labor force, so that reliance on the public sector as an employer o f last resort goes down. A better growth strategy and improvements inthe investment climate will play a crucial role, as will efforts to strengthen the quality and skdls base o f the state's labor force inorder to ensure the outcome o f goodjobs that the state needs to sustain incomes. Achieving this while improving the quality o fpublic administration i s a central challenge. The immediatepolitical economy pressures to addjobs inthe public sector will remain acute. However, this will need very careful management as, inthe end, providing more unproductivepublic sector jobs will be self-defeating. Failureto meet suchpre-conditions risktwo additionalproblems: (i) unmet high expectations o f a young labor force that could add to the fiscal burden for the state which already functions as an employer o f last resort; and (ii)inability to transform the gains inthe quantity o f education per headto an appreciable improvement inincomes that can come only from a significant upgradation inthe supply o f skills and education. 10. The thirdcritical transition that HPwill needto make i s to better manage its environment and natural resources. This musttake severalkey directions. The potential for hydropower development, which is being realized at an accelerating pace, has to bejudiciously and prudently managed to support the desired fiscal outturns and to invest inthe future o f the state. At the same time, the downside effects o f hydropower development on the environment, especially reduced water for downstream uses, will require much improved attention to ensure that society as a whole benefits, and that development i s sustainable. Furthermore, a broader environmentally sustainable strategy will be essential, for forestry development, community projects, urban management, and water supply. Failure to take action against environmental degradation ina society dependent on its natural resourcebase could ultimately threaten future growth prospects. It i s critical to address these challenges before they start to impact on the state's successful socio-economic performance. 11 11. Meeting these three transition challenges will not be easy. Difficult choices inpublic policies will be needed, that mark some break from HP's past development strategies. The role o fthe state, inparticular, must change increasingly from a direct provider o f services andjobs to being an enabler o f HP's human and natural resource development potential, and one where the core functions will needto be strengthened and its key institutionsrevamped towards a modem developmental state. Ifthese three transitions are achieved successfully, HPcouldbecome the first hill state inIndia that is able to achieve sustainable andaccelerated growth with broadly-based social development. 12. The Approach Paper to HP's Eleventh Five Year Plan (2007-12) seeks to move the state inthe direction o f fiscal self sufficiency and towards the ends o f broader social and economic development. The articulated development priorities for the state are faster and sustainable growth, and inclusive development. HP's development priorities are a function o f its unique socio-economic characteristics. Unlike the states inthe plains, GoHP recognizes that growth opportunities lie insome specific sub-sectors inwhich the state has natural advantages. Even though human development indicators are among the best inthe country, the state seeks to further improve living standards, especially for disadvantaged sections and inremote areas where there are issues o f access to public services. Key Development Challenges and Policy Options Transforming Growth by Creating the Fiscal Space to Finance the State's Development Vision 13. The major constraint faced by the state inrealizing its development vision i s insufficient fiscal resources to finance its priorities. Improved expenditure composition and revenue efficiency will be the basis for the creation o f fiscal space. Some recent positive developments-in terms o f increasednon tax revenue from the sale o froyalty power andthe state's 25 percent equity inthe Nathpa Jhakri Hydropower project in2004-05, higher tax revenue from the introduction o f the Value Added Tax (VAT) since 2005-06, expanded central grants under the Twelfth Finance Commission (TFC) award in2005-06, and compression o f expenditure-have brought fiscal deficits down from over 12percent in2002-03 to about 4 percent in2005-06. These efforts provide the springboard for deepening the fiscal turnaround. 14. First,own tax revenueneeds to be enhanced bymeasures like: (i) improvement o f administrative efJiciency o fthe system by modernizing tax administrationandpluggingwealmesses inimplementationinareas such as VAT or stamp duty; (ii) simplzjication and rationalization o frates comparable to other states (e.g., excise taxes, motor vehicles tax, registration duty, electricity duty); and (iii) introduction o f new and innovative taxes like the "green tax" or the Professions tax. 15. At the same time, nontax revenueneeds to be expanded, with a major source identifiedas the state's natural hydropowerpotential. It is estimated that revenues from the sale o froyalty power and/or a share o fthe power generated proportional to equity invested by GoHP inhydro projects with other partners (e.g., Go1inthe case o f Satluj Jal Vidyut Nigam) could be above 2 percent o f GSDP by 2013. These revenues would be more than 15 percent o f HP's current level o frevenue receipts and more than double the current level o f own non-tax revenues. However, efforts should not be confined to the hydropower resources alone. Comparisons show potential for raisingroyalty from user charges, inparticular. This requires a depoliticizedinstitutional mechanism that can periodically decide on appropriate user charges. 16. Expenditure compression efforts should be married with efforts to improve its composition-so as to containsalaries andpensions inparticular, and gradually phase out non-merit subsidies, while expenditure i s reallocated towards non-wage O&M and capital expenditure incritical sectors, on the basis o f fully budgeted maintenance plans for fixed assets. A formal process to critically review and rationalize ongoing programmes that institutionalizes zero basedreviews-possibly by establishing some form o f anExpenditureReview Committee-would be a useful supplement to the existing annual budget process, and will also help ensure efficiency o f ongoing initiatives. ... 111 17. Inaddition, thestateneedstobettermanagedebtandcontingentliabilities. HPisadebt-stressedstate, with an unsustainably highdebt stock o f about 74percent o fGross State Domestic Product and movingtowards sustainability could help contain interest payments. Approximately 45 percent o fthe state's highcost debt stock comes up for repayment over the next five years, presenting a good opportunity to the state to restructure high cost debt. Fiscal risks from the operations o fpoorly performing state owned enterprises and boards must be minimizedby implementing a reform strategy for these entities already outlinedby GoHP in2000. Moreover, an institutionalmechanismto evaluate contingent risks and eliminate off-budget borrowings mustbe developed. The risk weighted guarantee exposure can be limitedby suitably amending the ceiling under the HP Fiscal Responsibility and Budget Management Act. 18. The state has producedMediumTermFiscalProjections(MTFP) that were tabled along with the Budget for 2006-07, but these are basedon very optimistic assumptions. The state needs to refine the MTFPby strengthening policy linksand demonstrating prioritization through reallocation o f expenditure, for instance to capital outlay and non-wage Operations and Maintenance (O&M), besides being consistent with TFC recommendations. Changingthe Roleofthe Stateto EncourageProductiveEmploymentand SuitableJobs 19. Even though HPhas grown marginally faster than the rest o fthe country since the 1990s, this performance follows two decades o f slower growth-and the state needs to consolidate and sustain this performance ifit i s to move towards self sufficiency. HP has been unable to tap the full growth potential in sectors like tourism and horticulture, inwhich it has significant natural advantages. While manufacturinghas grown inrecent years, this i s largely on account o f special tax incentives that have attracted investments inthe border districts near Punjab and Haryana. These investments may dry up once the sops are phasedout in2010, unless steps are taken to improve the business environment. 20. L o w productivity o f employment and a mismatchbetween sktlls and opportunities i s a related concern for policy-makers. Despite signs o f diversification, 70 percent o fthe population still depends on the apculture and allied sectors-which providesjust 22 percent o fGross State Domestic Product (GSDP). Though manufacturing employment has been generated inthe industrial belts as a result o fthe state's industrialization strategy and central tax sops, there i s evidence o f a mismatch between skills requiredby upcoming industries and the education provided inthe state. Consequently the public sector still remains the preferred source o f organized sector employment, contributing to fiscal pressures. 21. Inorder to addressthese challenges, GoHPneeds to adopt atwo-fold strategy. > Improving the General BusinessEnvironmentfor Private Sector Participation. Privateindustry representativescite slulls o f available workers and poor infrastructural facilities as key factors affecting the investment climate. At the same time, unemploymentrates among the educated graduates and post-graduates are rising. Accordingly, GoHP needs to focus on assessingandprojectingthe slull needs o fthe secondary and tertiary sectors; better matching the provision o f technical and vocational training opportunities to market opportunities; and on improving the general quality o f education with a view to increasing employability. Simultaneously, the state should step up efforts to alleviate infrastructural constraints, especially inrural areas and around the upcoming industrial agglomerations. Improvedconnectivity could help attract the private sector to remote districts. Since most secondary and tertiary sector industries tend to come up inan urban environment, promoting the development o furban infrastructure can also help to improve the business climate. > Encouraging the "Right"Sectors. The state's natural situation makes it an unlikely candidate for a strategy based on heavy industriesor traditional agriculture. Growth and employment potential inhighvalue- added sectors like tourism and horticulture should be exploited-not only by encouragmg private investment, but also by directly addressing specific constraints to the productive expansion o f these sectors. For example, efforts to improve air connectivity, andrevampingthe marketing andbranding strategy to project HPas an attractive iv destination for health or eco-tourism would be particularly important for the tourism sector which has so far failed to attract high-end customers. Activation o f the recently established Tourism Development Board would help promote inter-departmental coordination. Inorder to promote sustainable growth inagriculture, it i s important to focus on the: (i)expansion and intensificationo f irrigation, with particular attention to rationalizing user charges which cover only about 2.5 percent o f O&M costs, and movingtoward farmer management o f schemes; (ii) rationalization o fthe subsidy regime, which is inconsistent inits focus on organic farming on one hand and chemical inputson the other; (iii) modernizationo fresearch and extension services; (iv) acceleration o f the process o f diversification into highvalue crops; and (v) promotion o fbetter marketing, with involvement o f privateparties. Strengthening the Institutional Environment for Inclusive Growth 22. While HPhas recorded impressive achievements inhuman development based on objective indicators, there are avenues to improve governance and public administration. Infact, user satisfaction surveys show that there i s room for better public service delivery as well. Appropriate measures as outlinedbelow would also help contain the fiscal pressures, and improve public administration and transparency. 9 Inordertoenhanceadministrative efficiency, thestatecould: (i) stafing ratios, whichareamong reduce the highest inthe country at about 4.5 civil servants per 100population, and resulting fiscal pressures-based on a departmental review o fpositions, units, and humanresource needs; (ii) rationalizegovernment by clustering related departments, instead o f ad hoc clustering o fportfolios across various levels o f government, and by improving the speed and transparency o f file movement; and (iii) improve the tenure andstability o f civil servants to promote effective implementationo fprogrammes by enforcing the average tenure o f a minimumo fthree years, consistent with HP's transfer policy, while discouraging politicization o f transfers and recruitment. 9 Although corruption appears to be low inthe state as per the Transparency Internationalindicators which identify HP as the second least corrupt state inIndia, transparency and accountability canbe improved by: (i) aggressively implementingthe relatively less-used central Right to Information (RTI) Act; (ii) strengthening the powers and capacity o f the Lok Ayukta; and (iii) reverse signs o f weakeningpolice capacity-as reflectedin declining overall conviction rates inrecent years-to enable the Department to provide effective law and order services. E-governance can be a usehl tool for simplifyingtransactions and making it easier for the population to access government services, and the sector should be strengthenedby focusing on a few flagship projects o fthe 40-odd e-governance projects at present, along withbusiness process reengineering where appropriate. 9 There are some issues around skills and quality o f local providers-especially inhealth, where specialists are inshort supply inremote areas, and ineducation, where teacher absenteeism and lack o f appropriate teacher training impact on service delivery. Inorder to improve delivery mechanisms, the state needs to: (i)promote decentralization, which could strengthen Panchayati Raj Institutions' control over local level providers; and (ii) provide in-service and pre-service trainingto providers to equip them to deliver quality services. Improving HumanDevelopment and Social ProtectionStrategies 23. Poverty rates are low at under 10percent, and social development indicators are good ingeneral-in many cases, better than inricher states. However, the state faces the challenge o fpromoting inclusive development for disadvantaged groups and remote areas. Inaddition, there are some "second generation'' problems inview o f economic development and diversification-which include issues around quality and private participation, for example. These go beyond basic "first generation" issues o f access to services that affect other less-developed states. V 9 Social infrastructure facilities-including Primary Health Centers in some areas, school buildings and toilet facilities-need to be developed, and the state could experiment with pilot initiatives like mobile unitsor telemedicine to reduce fiscal costs o fprovision o f static units. 9 Public private partnerships-such as encouragement to private universities andmedical facilities- could be an important avenue to strengthen delivery mechanisms. These could reduce fiscal pressures, as well as improve service quality. 9 The social protection system faces the challenges of: (i) improving existingsafety nets through better administration andrecordkeeping, stronger involvement o f PRIs, and periodic impact evaluations going beyond concurrent ex-post evaluations undertaken at present; (ii) developing a social care strategy for the state's hture needs, inpartnership with private partners and civil society, and (iii) expanding social security to the unorganized sector, which is particularly under-served interms o f health and crop insurance. ImprovingInstitutionsto Manage Environmental Assets 24. HP's rich and varied natural heritage provide both opportunities and risks to its development strategy. Natural resources are a critical, ifunderutilized, engine for accelerating growth and poverty reduction. At the same time, resource dependence renders the economy highlyvulnerable to the consequences o f environmental degradation. 25. The current approach to environmental management i s fragmented and it i s treated as a "clearance" requirement to be obtained from, for example, the Forest Departmentor the State Pollution Control Board. Problems tend to be addressed retrospectively only when they become highlyvisible. Current development patterns raise concerns about the efficiency, competitiveness, and sustainability o fresource use-especially given the fragility o f the states resources. Prudent economic management calls for environmental issues to be fully integrated into economic policy and mainstreamed invarious sectoral activities-especially insectors like tourism, manufacturing, hydropower, industry, and forestry, where activities can have significant impacts on the eco-system. 9 The institutional approach to environment management should be improved, particularly by: (i) promoting inter-departmental coordination to ensure convergence o f environmental objectives and minimize intersectoral conflicts; (ii) strengthening the Environment Department, which i s currently at a very nascent stage with insufficient capacity andpowers, inorder to capitalize onthe state's comparative advantages and use environmental resources as growth drivers; (iii) improving the information database, at least inkey sectors which have wide environmental consequences; and (iv) preparing an Environment Policy supportingdevelopment goals, and providing a holistic view o f the growth-generating potential o fnaturalresources, as well as the limits and carrying capacity o f key resources. P However, beyond organizational structures, there i s a greater need for more innovative reforms in environment management. For example, an area based environment management approach, provides one way o f clustering the pollution footprint o findustries, and could be a valuable tool for a fragile h111 economy like HP. Expandingpublicparticipation-for example, by encouraging community involvement inthe context o f specific development projects, and buildingthe capacity o f government agencies for more effective public consultation- is another avenue that GoHP must explore, since public participation inenvironmental decision making i s typically low inthe state. Environment management i s particularly important inthe context o f development o f hydropower resources. Tapping Hydropower ResourcesEfficiently and Sustainably 26. Hydropower has huge untapped potential on account of the state's supply o f five perennial rivers. Judicious exploitation o fthe unrealized potential o f over 12,000 MW inan environmentally sustainable manner vi assumesparticular significance, notjust as a source o f "green energy" than can help alleviate the power shortage intheNorthernGnd, butalso asa critical source ofnon-tax revenue as described earlier. Revenuesfromthe sale o f free power available to the state from ongoing and new hydropower projects alone couldreachRs. 9-11billion by2012-13. 27. Given that a number o fnew hydroprojects involving various public and private players are expected to come up, it i s important to proceed expeditiously with reforms inthis sector, since lack o f clarity can be detrimental to the investment climate. Key actions that require attention include: (i) setting up institutional mechanisms for sustainable hydropower development-including integrated planning based on river basins as against the current piece-meal approach o f development o f individual projects, and mechanisms to monitor and implement environment management activities related to hydropower development to ensure that these activities are completed beforeprojects are commissioned; (ii) carrying out a strategy study on the model HP should follow inbuildingupnewhydropowerprojects as well as for tradingpower, andonmanagingthe revenuesflowing from the hydropower development to ensure maximumbenefit to the state and for those affectedby development; (iii) implementationo f the Electricity Act o f 2003, including appropriate institutional restructuringo f the HP State Electricity Board (HPSEB), separation o fthe trading function from the transmission function, and facilitation of open access. A PossibleReform Agenda 28. Policy suggestions can only be a first step-it i s critical to implement the policies that can help the state realize its development goals. GoHP needs to craft an overarching programme for the state to guide reform, identifying the policies that it would like to implement. This agenda should be communicatedacross government and stakeholders inorder to build support for its implementation. 29. It isparticularly important to pay close attention to the sequencingandprioritization o freforms, andto move more rapidly on policies where there i s likely to be quicker and visible returns. Accordingly, the Report suggests a menu o freforms that GoHP could consider over the next few months, based on GoHP's own vision, and under consideration by the government. It i s proposed that GoHP and the Bank use this for further discussions. 30. Given the complexity o f the task, a flexible approach to prioritization and sequencing i s suggested-by which GoHP identifies those reforms which are the most pressing, implementable, and likely to yield significant returns, inorder to develop a cohesive programme that i s reflective o f and consistent with the state's vision. As a first step, this assessment suggests that GoHP address the fiscal constraints on a priority basis-backed by governance reform measures to curb the salary bill. At the same time, it would be important for GoHP to take steps towards malung the transition from a state-ledto a private sector oriented economy, and it i s important to signal clear intent inthis area. Inorder to address employment issues, GoHP should begin the process o f assessing and projecting slulls and education requirements. The state should take steps to promote sectors with untappedpotential-and could consider measures for hydropower and tourism development as priorities. Simultaneously, measures to conserve and protect the environmental heritage-both inthe context ofhydropower development, and interms beginning the process o f developingan Environment Policy-should also receive priority attention. 31. Itis also importantto keep inmindthat deeper institutionalreforms identifiedinthis Report will need more time and careful preparation, and can form the basis for more intensive dialogue. Infact, even the near term reforms proposedby the Report are initial steps that buildtowards reforms to be implemented over the medium term. Hence, these should not be considered "one-off' measures-but as part o f a longer term reformvision. 32. It is to benotedthat, subsequent to the preparation o fthe Economic Report, severalreforms measures and commendable new initiatives have been proposed in selected priority areas. These reform measures, as well as some data updates, are discussed inAnnex 1. vii A Menu of Near Term Reform Options (Priority Measures proposed by the Assessment as on December, 2006) SustainingGrowth throughFiscal Recovery The state mustrefme its mediumterm fiscal projections, incorporating a clear policy basis demonstrating expenditure reallocation to capital outlay andnon-wage O&M incritical areas, to reflect stronger reform outcomes consistent with TFC recommendations. These could incorporate analyses o f different scenarios and downside stresstests. Inorder to enhanceown-tax revenues,the statecould: (i) from a specific to anadvaloremexcise duty switch structure, as inMaharashtra; (ii) simplifythe licensefee structure for alcoholvending; (iii) a initiate comprehensive review o fthe revenue implication o fthe current motor vehicle tax regime; (iv) re-introduce the Professions Tax; (v) beginevaluation o f VATimplementation with a view towards improving the administration; and(vi) initiate ananalysis of stamp duty evasion andtheir revenue impact to prepare for more fundamental reform. Inorder to enhancenon-tax revenuesfromusercharges, GoHP couldestablishaPublic TariffCommission for various services like transport, education, health, water, and irrigationinorder to depoliticize the determination o f user charges. Inordertocurbandimprovethecompositionofexpenditure, the state could: (i) implementaneffective wage and hiring policy consistent with fiscal sustainability ;(ii)completepension projections for government and public sector agencies, andbegin annualbudgeting on anactuarial basis; (iii) reducepower subsidies, and delink it from the power tariff; (iv) introduce a contributorypension scheme at par with government employees for new employees, with pensionable pay, inPublic Sector Boards, Corporations, Universities, and Local Bodies; (v) appoint a Committee to examine containment ofexpenditure under subsidies and a gradual phase out o fnon-merit subsidies; (vi) initiate the process o f identifyingschemesthat have lost relevance, and restructuringandrationalizing themby constituting anExpenditure Review Committee to critique ongoing programmes; (vii) andreallocate expenditure towards nonwage O&M expenditure incritical sectors, and capital outlay. Intheareaofmanagementofdebtandcontingent liabilities, GoHPcould: (i) off-budget borrowings merge with budgetedborrowings, andeliminate future off-budget borrowings; (ii) weight guarantees andbegin risk reportingthem; (iii) revise the targetfor risk-weightedguarantees under the FRBMafter eliminating off- budget borrowings; (iv) establish a set offormal rules to govern eligibility o fPublic Sector Enterprises (PSEs), cooperatives, andstatutory boards for government guarantees, takinginto account financial statements, record o fprofitability, performance onpast guarantees, priorities o f government, etc.; and (v) makeprogress towards the implementation o fthe reformstrategy for state-owned PSEs outlined bythe government inits order dated October 20,2000, includinginitiationo f the preparationo f a turnaroundplanfor the HP Road Transport Corporation. Inorder to modernize tax administration, the state shouldinitiate steps towards: (i) creating the necessary organizational basis for separating and strengthening the key tax administration functions; (ii) introducing multiyear strategicplanningprocesses underlying annual businessplans; (iii) improving the accountability mechanism to move from collection-based accountability to wider reforms; (iv) strengthening the human resources inthe Excise andTaxation Department; and (v) makingthe Excise and Taxation Department the basis for a untfied tax collection system. Inthe areaofpublic financialmanagement andprocurement,GoHP could: (i) modernize theHimachal Pradesh Financial Rules, 1971,which need to be updated and simplified, (ii) replace the existing Procedure & Rules for the Purchase o f Storeswith apublicprocurement law that can apply to all procurement undertaken usingpublic funds (goods, works andservices), andwhichcanbepilotedin2-3 departments andPSEsto ascertain the benefits; and (iii)roll out treasury computerization to cover the entire state. viii Inordertostrengthenthebudgetformulation process,afiscalstrategypapercouldbepresentedtothe Cabinet preceding the budgetpreparationprocess, communicating departmental expenditure ceilings andfiscal projections as part o f the budget call circular. Improving theInvestment Climatefor theStatefor Private SectorDevelopment Itisparticularlyimportantto undertake astudyto identifythe extent ofskills gapsand mismatches,including a skills-mapping exercise, to identifyparticular sectors which would emerge inthe near future, so that skill requirements couldbe projected. Intheroadssector,GoHPisundertakinganassessmentofthecostsandbenefits oftheganglaborsystem,and recommendations from this shouldbe finalized for implementation. Tappingthe Growth Potential in the "Right" Sectors Inordertopromotesustainabledevelopmentinagriculture, GoHP could: (i) andrationalizethe review subsidy regime,especially inview o finconsistency betweenencouragement to organic farming andsubsidies to the consumption o fchemicalfertilizers andpesticides; (ii) prepare a strategy with animplementation time table andprogress indicators, aimed at increasing currently low user charges to reachfull cost recovery within a designated time period, andan action planfor devolving suitable irrigation schemesto beneficiary farmers. The state should activate and empower the Tourism Development Boardthat has beenrecently established under the chairmanship o f the ChiefMinister as a forum for better inter-sectoral coordination andstrategic approach for tourism development inthe state. Improving theInstitutional Environmentfor Inclusive Growth Inorder to tackle theproblemofoverstaffing andhighwage bill,GoHP could: (i) astrict ban onenforce recruitment, especially for non-regular employees as well as Class IVemployees inthe regular civil service, andwork-charged andpart-timeworkers inoverstaffed departments, andcurb regularization; (ii) identzfi redundantposts byconductingfunctional reviews inmajor departments, assessingwhether current staffing patterns exceedestablished norms, revise existing norms to take into account technological improvements, and identify posts that could be outsourcedto the private sector; (iii) establish an HP Pay Commissionto decouple salary structures from those inPunjab, that would, over time, chart an independent course for determining the state's salary structure inview o fpolitical sensitivities; and (iv) implement a VoluntaryRetirementScheme (VRS) for government employeeswho wishto leave government service andcompulsory retirement provisions inthe All-India Service Rulesto remove inefficient staff from service. Inordertopromotetransparency and accountability, (i) suo-motu provisionsoftheRTIshouldbe the aggressively implemented, especially through posting o f suo-motu information on the web, andproviding departmental websites to those still lacking the same; (ii) LokAyukta shouldbe strengthened by amending the the Lok Ayukta Act to allow for suo-motu powers to take action incases without a formal complaint, by providing qualified legalandother staff to assisthim, andbywideningthe definitiono f corruption to include grievances arising out o fmaladministration; and (iii) the recent weakening ofpolice capacity, as demonstrated indecliningconvictionrates, shouldbereversedbyimplementingtherecent SupremeCourtdirectiveto create a State Security Commission to insulate the force from politicalpressures, andenforce a minimumtenure o f three years for the Director General o fPolice andsenior officers. For administrative rationalization, GoHP could: (i) review currentfunctional clustering o f administrative responsibilities, with a view to clustering like Departments; and (ii) strictly enforce the minimumthree-year tenuresas per HP's transfer policy, by establishing statutory committees to authorize transfers andpostings for senior officers, and creating- a stability index to ensurethat the averagetenure o f the I A S cadre as a whole does - not fall below three years. ix 4 Ine-governance,prioritiesforthe ITDepartment-fiom among the 40-odd projects underway-should be clarified, andimplementation should be sequencedbased on departmental capacity andneed. StrengtheningHuman Developmentand SocialProtection Strategies 4 Ineducation, itis importantto implement measuresunderconsideration topartner with theprivatesector in the provision o ftechnical andhigher education-like usingprivate parties to providetechnical andvocational education using the state's existingeducational infrastructure. 4 Inhealth,astudyproposedbyGoHPonassessingtheefficacyofmobilevs.static unitscouldcontribute towards addressing the problem o fhealth service delivery inremote areas. 4 Insocialprotection, the statecould: (i) out arapid review ofadministrationandrecord-keeping inkey carry social protectionprogrammes, inorder to develop options for improved performance; and(ii) a third initiate partyimpactevaluation o f social pensions-the single largest intervention for the poor inthe state. PromotingEnvironmentalSustainability 4 GoHP could strengthen the Environment Department anddevelop capabilities which would help to systematically assess how the state can maximize its natural advantage, and to ensure application o f environment norms across sectors. 4 GoHP could initiate an institutionaland "gap" analysis of the environment sector that could feed into the subsequentpreparationo f anEnvironment Policy. This would include: (i) assessment o f environmental pressuresinvarious areas inthe state; (ii) identification o fregulatory, institutional, andpolicy gaps leadingto these pressures; (iii)assessment o fworkload andimplementation capacity for the Environment Department, Forest Department, and the State PollutionControl Board; (iv) strengthening o f compliance and efficiency by assessingalternative ways o fimplementation o f development projects; and(v) assessmento fadequacy o fthe existing range o fpolicy instruments andfeasibility o fusingnew ones that target the systemic androot causes o fpolicy failure. Managing theHydropower PotentialEfficiently andSustainably 4 The state should set up an institutionalmechanism (including its structure andfunctioning) to monitor and implementenvironmentmanagement activities (catchment areatreatment plan, compensatory afforestation, conservation o fwildlife, etc.) relatedto sustainable hydropower development inHP, inorder to ensure that these activities are completed ina time bound manner before the projects are commissioned. Implementation o f activities canbe outsourced to either the developers themselves or private contractors, through discrete time bound contracts with periodicalmonitoringandevaluationo fperformance bythe regulator andthe developers. 4 Inordertooptimizethereturnsfromthehydropowerresourceswithdueregardtotherisksinvolved, and better managehydrorevenues, a strategy study shouldbe undertaken to (i) the modelthat state should assess follow inbuildingupnew hydropower projects-through state/central/private/Joint Venture routes or a combination o fthese; and (ii) recommendbest utilizationo fthe hydropower revenues to ensure optimum benefit for the state andaffected people. 4 Inorder to encourageintegratedriverbasinplanning, the statecouldfacilitate theproposedstudyonSatluj river basinwith a view to developing a time-bound actionplanbased on recommendations emergingfrom the study. 4 Itis important to implement recommendations o fthe Electricity Act 2003, includingfacilitation o fopen access,-separationofpower trading function from the transmission function, and appropriate restrucGringo f HPSEB. X - - Chapter 1 HimachalPradesh:A Statewith a Difference 1. This Economic Report, preparedover September through December 2006, i s aimed at enhancing the World Bank's understanding o f the development priorities and key constraints for the hill state o f Himachal Pradesh (HP), with a view to identifying strategic policy options for the Government o fHimachal Pradesh (GoHP). This is also the Bank`s first cross-sectoral assessment for any o f India's "special category" states, as well as the first comprehensive study undertaken for any o f the country's hill states. 2. The Report i s basedon the Bank's analysis o f HP's considerable potential and opportunities, as well as the key challenges facing the state. It is primarily a forward-loolung assessment o fpossible reform priorities and actions that the state can consider inthe short-to-medium term to help realize its development vision. The assessmentdraws largely on existing data and informationthat was available tillDecember, 2006, supplemented by discussions with officials o f (GoHP), and members o f academia, civil society, and industrygroups.' 3. The Report i s structured as follows. Chapter 1presents a briefreview o f the state's recent performance, and overall development vision interms o f sustainable growth and inclusive development. Chapter 2 examines the challenges and options in sustaining and assisting the state's fiscal recovery, inorder to create fiscal space to help realize the state's development vision. Chapter 3 analyzes some o f the key constraints to private sector participation, which leaves HP dependent on the public sector. Chapter 4 looks at ways inwhich HP can exploit untapped potentialinsectors like hydropower, horticulture, andtourism, where it has natural advantages. Chapter 5 analyzes the key issues facing HP interms o f governance and public administration, and recommends measures to improve the institutional environment. Chapter 6 looks at outstanding issues inthe human development and social protection sectors, where the state boasts o fparticularly impressive achievements. Chapter 7 highlightsthe importance o f conserving the environmental heritage, given that the state's future potentiallies inmainly its natural resources. Chapter 8 lays out a menu o fnear term reform options that can help buildon HP's strengths, and address some o fthe constraints. A. StateBackgroundand RecentPerformance A "Unique"State in theIndian Context 4. HPhas some specific distinctive characteristics that set it apart from other Indian states. First,it i s a relatively young state inthe Indian union. Ithas existed since 1948 as a Chief Commissioner's Province comprising o f 30 princely states, and a state area reorganization transferred parts o f Punjab to HP in 1966. The state, which currently comprises o f 12districts, was granted full statehood in 1971. Second, HP i s a small state both interms o f area and population. It has a population o f about 6.6 million which i s well under one percent o f the Indian total, o f which above 90 percent still reside inrural areas. The state accounts for only about 1.6 percent o f the national geographical area. Third, it i s geographicallydifferent from most Indian states located intheplains. HPis largelymountainous, except for a few pocketsborderingPunjab andHaryana-with altitudes spanning from 400 meters to almost 7000 meters above sea level.2 Of the aggregate geographical area, almost two-thirds are officially classified as forests-though actual forest cover i s lower. The hilly terrain and forest cover contributeto low availability o f land for agriculture, and net sown area is only about 15 percent o f the total. The populationdensity inthe state-at around 110per sq. km.-is significantly lower than the national figure of 320 per sq. km., largely due to relatively low and scattered population inthe hill and forest areas. 'Annex 1 provides an update o fpolicy options proposed by GoHP following preparation ofthis Report. Physiographically the state is divided into four regions: the Shivalik Hills have a relatively low average elevation o f 1,000 meters and are characterizedby a network o f streams, the Lesser Himalayas rise to an average o f 3,300 meters and support rich forests, much o f the Greater Himalayas lie above the tree-line with elevations o f 5,500, and the Trans-Himalayan zone is the geographic continuum of Tibet, marked by cold alpine deserts. 1 Table 1.1: Local Context, Key Indicators, and Location of Hp NumberofAdministrative Districts 12 LOCATIONOF HlYACHALPRADF*uI Next StateAssembly Elections Due 2008 ININDIA Population (Million, 2005-06) 6.6 PercentageRuralPopulation 90.2 PercentageScheduledCastesandTribes 28.7 968 55.7 Nominal GSDP (Rs. Billions, 2005-06) 223.8 ARABIAN E U BAY OF BEYOIL Per Capita (Rs., 2005-06) 33,825 Congress StateCapital Shimla 8 - 5. HP's unique characteristicspresent several important development opportunities which the state can exploit. It i s rich innaturalresources with abundant water supplies, minerals, forests, biodiversity, and fertile soils. The rich and varied forests are a crucial livelihood resource that protectthe soil and provide fuel, fodder, and a wide variety o fnon-timber forest products. Forests are also important for protecting the many rivers that flow beyond the state to serve the Indo-Gangetic plains. The Himalayan region i s one o f the world's priority biodiversity areas, and HP i s one o f the few Indian states with virginprimary forests. The parts under rainforests and alpine forests are home to some endangeredwildlife species. The state i s richinflora and fauna, withmany glaciers, passes, meadows, and treklung routes. The salubrious climate, supply o fperennial rivers, and natural touristic ambience can contribute to the expansion o f important sectors like horticulture, tourism, and hydropower. 6. At the sametime, these special characteristics also pose several constraints to development-on the basis o f which HPhas been conferred the status o f a "special category" state by the Government o f India (GoI).~ HPconfronts environmental problems that are common across the country-such as pollution, soil degradation, and declining forest quality-but with its highlevel o f dependence on natural resources, it i s especially vulnerable to the consequences o f environmental decay. The ability to diversify the economy i s limitedby ruggedtopography and poor market access, which render large scale industrializationcostlier and more difficult than elsewhere inIndia. The state's mountainous terrain and remoteness o fmuch o fthe population increase the difficulties o f infrastructure development, urbanization, traditional agriculture, and efficient public service delivery. Inaddition, pockets o fpoverty remain inremote areas, the small population implies a limitedtax base, and inadequate infrastructure limitsthe opportunities for private sector development. Go1has given HP the status o f a "special category" state inrecognition o f these specific constraints, under which the state i s the recipient o f special central grants and incentives that have been instrumental to its development. 7. On account o fHP's uniqueness, the more developed states inthe Indianplains can only provide limited guidance for HP's progress, and the state needs to chart its own course. HP faces specific development challenges arising from its highelevation, topography, resource dependence, and ecological vulnerability-as well as from a changingand more competitive international environment. Inorder to unleash its full potential, there i s a need for the state to play to its considerable strengths and capitalize upon its comparative advantages which lie inits abundant naturalresources that have to be sustained. "Special category" states are those havingcharacteristics like strategic border locations, hilly terrain, inadequate infrastructure, large tribal population, and limited resource bases compared to development needs. There are eleven "special category" states in India. 2 9. The slate e ~ ~ ~ ~slower growthdthan the rest ofthe c o ~~n ~~ rthei 1970sand 1 r i ~ e ~ n ~ 9 (Ftgure~ ~ ~ 1.I>. had a ueak s o c i o - e c o n o ~base~when it was formed, partly on a IIP ~ ~ ~ ~ ~of prior neglect due to its o ~ t ~ e o ~ r ~ ~~hoincsa~~a ~T~ht o ~ ~ lbegan with highcr per capita ~ n c o ande better social ~ ~ d ~ e a~~~oi irisp a r e d s . at i ~ to the rest of the country, it was seriously d~sadv~nCag~d c mof i n f ~ a s ~ ~andcdc~endedh e a ~ ~onythe in~ s ~ ~ ~ c e ~ I primary sector nhtch e o ~ ~ ~ bau ~~e~d60 s ~ o percent ofCross State ~ o Product~(CSDP)~ 1111971, HPhad ~ ~ ~ c a c t u ~ falluri ~ a ~ g ~ br ~e ahlnatiiinaI~average pcr oapiea i ~ ~ y l~~~ ~ ~ ~in ~the earlyef 9 s9 ~ s - p a due to initial ~ ~ ~ ~ i n ~ e ~ ~ inbasicnphysical and soeta1 ~ n ~ a s t ~which ~ n ~ e ~ ~ ~ c ~did~not eshow i ~ ~ e d i aresufts interms of growth. r t e IO. C>wrthe last decade, houever, Hi)has achieved higher levels and growthrates intneorne e o ~ ~ a rtod c the average Indianstate, and the ~ c o n isoshes~irig ~ n ~ r c asignsn~g ~ ~ ~ ~ ~ e ~r s~~ ~~1.1g ~~fan fact,ei o n ~ ~ ~ i>. r~ XIP has gottn Faster than states like Punjab, Lia~yana,~ ~ a ~ a r'l'amilhNadu, and A n d ~~;~desh a s ~ ~ ~ r ~ d~~~~~~ this period (Figure 1.X ). 'X'Itc s e ~ andutertiary~sectors have e ~ p ~ more~daep ~ithan the p ~ t ~ a c ~ ~ ~ ~ ~ d ~ ~ ~ e c ~ o ~ - hby tax e~ ~ e ~ p tand ~ n s e l ~ ~ ~special ~ n c e n ~ i sinces20113 that have a~~cactedn ~ ~ e s ~innthesc~ ~ ~ e ~ i e n sectm.* Xn c ~ ~the~share ufthc~primary, sectctr has d ~ a ~ ~ ~ ~ ~ r 32.1 percent of CSDP~in 1 9 ~ 3 - 9 ~ ~o ~~ d ~ e to 21.4 percent tn 2005-06- c o ~ p a r a to~the Indianaverage o f about 19.6 percent (F~gttre1.1). ~ e 3 PositiveAchievements inHumanDevelopment 11. HPhas human development and access indicators that are mostlybetter than the national averages on aggregate-and better than inricher states, despite the physical constraint^.^ Infact, ifrecent linear rates o f change are maintained, the state i s on track to attain---or has already attained-several important Millennium Development Goals (MDG) (Figure 2, andTable 2). However, concentrated efforts are neededto provide access to reproductive health services for all by 2015-where the MDGtarget may not be met on current trend. 16.0% m - 18% - 60 ,,* 100% f4 4A>....--.-.` ` `, - 14% - 45 - 75% 12.5% ..\-.. ,,;,- I ,--. - 30 ; - ` ' ~ ~ 5 0 . 2 % - 50% - 10% qb 15 40.2% - 25% 9.1% --._. *`A,&> 25.6% I ?6% , 8 0 I I 0% Table 1.2: Su oals for HP Halve,between 1990and2015, the Povertyhas declinedfrom 12.5%in 1987-8to Possible. proportionof the poor. 9.1% in 1999-0. Achieveuniversalprimaryeducationby Enrollmentfor 6-10year-olds hasrisenfrom Possible. 2015. 93%to 97%between 1993-94and 1999-00, and for 11-14year-oldsfrom 88% to 94%. Eliminategender gaps ineducationby + For 6-10year-olds, female andmale + Already achieved. 2005. + enrollmentrates were 97%in 1999-00. For 11-14year-olds, female to male + Possibleby 2008. enrollmentratiohasgone up from .902 in 1993-94to .938 in 1999-00. Reduceinfant andchild mortality ratesby CMRhasfallenfrom 69.1per 1,000 in 1992-93 Possible. two-thirdsbetween 1990and2015. to 42.4 per 1,000 in 1998-99. IMRhasfallen from 55.8 per 1,000 in 1992-93to 36per 1,000 in2005-06 Access to reproductivehealthservices for Birthsattendedby ahealthprofessionalhave Unlikely. Projectedto bejust under all by2015 gone up from 25.6% in 1992-93to 50.2%in 75% in2015. 2005-06. Reduceby halfthe proportiono fpeople Populationwithout access to safe water has Alreadyachieved. without safe drinking water between 1990 fallen from 42.4% in 1992-93to 22.6% in1988- and2015. 99. Note Likelihood of attainingMDGs based on linear projectionsfrom available time senes data (National Siple Survey and National Family Health Survey), recent availableyears. Poverty numbersfrom Deaton and Dreze (2002). ImpressiveExpansionof Physicaland SocialInfrastructure 12. The state has already achieved impressive expansion ininfrastructuralfacilities such as electrification, banking, post office facilities, and teledensity.6 All o f HP's villages are electrified. Power generation inthe See Annex 2 for an overview of key social indicators. Basedonthese measures, anIndia Today surveyranksHP as secondonly to Punjabamong Indianstates. Pleasesee "The Leaders' LastHurrah",September 11,2006, issue. 4 ta social sector expenditures. Infact, recent data show that per capita grants-along with per capita social spending-have beenrising over time (Figure 1.3). Other central incentives-like central tax sops to attract industries-have contributed to recent growthinthe secondary and tertiary sectors.' While these special benefits mighthave contributed to the absence o f hardreformsby providing a soft budget constraint to HP, their role inthe state's achievements should not be under-valued. 16. Inaddition, HPhas alsobeenhelpedbypolitical economy factors andsocial cohesion. First,the state has consistently supportednational political parties, and has alignedwith the party inpower at the centre. This has possibly contributed to the centre being favorably disposed towards HP's development needs. At the same time, since the 1980s, major national parties have alternated inpower inthe HP legislature.* This voting pattern has likely contributed to the responsiveness o f the administration, by preventing the creation o f a monolithic power base which a single political party can take for granted as a vote bank. The different state administrations, irrespective o f political affiliations, have all had a common focus on social development inHp. Second, the state has benefited from relative political peace and social stability. The absence o f insurgency and strife-which has affected states such as those inthe north-east and neighboring Jammu and Kashmir-has helpedcreate an atmosphere where social development has not been constrained. B. Key DevelopmentPrioritiesinthe MediumTerm: ConsolidationandInclusion 17. Looking forward, GoHP appreciates that there is an unfinished agenda in spite o fthe recent success. Accordingly, the Approach Paper to HP's EleventhFive Year Plan (2007-12) seeks to achieve the twin objectives o f faster growth and inclusive development over the medium term. The articulated Plan objectives are provision o f essential social services-specially to disadvantagedgroups, increasing farm incomes, developingvital infrastructure, protectingthe environment, and improving governance. A vital thrust area identifiedby GoHP i s the needto tackle the unemployment problem, and provide suitable employment opportunities to the educated youth o f the state. 18. HP's development priorities are a function o fits unique socio-economic characteristics. Unlike the states inthe plains, GoHP recognizes that growth opportunities lie in some specific sub-sectors where it has natural advantages. Eventhough human development indicators are among the best inthe country, the state appreciates that there room for further progress-and seeks to further improve living standards, especially for disadvantaged sections andremote areas. Sustaining and Enhancing Growth Performance 19. While HPhas been growing marginally faster than national averages on aggregate over the last decade, this follows two decadeso fslower growth-and itmaynotbe at a "steady state" sustainable growth equilibrium as yet. First,there are highpotential sectors that could contribute to more rapid growth. Inparticular, there are sub-sectors like forestry and hospitality that have grown slower than aggregate GSDP despite the state's natural advantages (Figure 1.4). Second, sub-sectors like manufacturinghave been growth drivers inthe recent past, helpedby historical tax sops and other benefits which have attractednew industries, especially inthe districts borderingPunjab andHaryana. Itwill be important to sustainthis goodperformance, andretain the new industries after the benefits are phased out in2010. Third, HP still needs to catch up with more developed states like Punjab, Haryana, Gujarat, Tamil Nadu, and Karnataka interms o f per capita income levels. 20. The government aims to achieve an annual growth rate o f 8.5 percent duringthe Eleventh Plan. Inorder to achieve this, the state seeks to focus more on capitalizingon its comparative advantage, by increasing the productivity and economic value o f its natural assets, and specializing in sectors where it can compete effectively ina globalizedeconomy. '*See Chapter 3 for a discussion of tax incentives. See http://www.worldstatesrnen.org/hdia states.htm1. 6 7 s C. Towards a Development Strategy for the State 26. HPhas several impressive achievements to its credit. Although a "special category" state, it has acquired many of the characteristics o f a middle income Indian state. For instance, its per capita GSDP exceeds that o fmany developed states such as Kerala and Andhra Pradesh. Ithas grown faster than the national average inrecent years, andhasachieved levels o fsocial outcomes andinfrastructure that are better thaninricher states for several indicators. 27. However, these achievements mask several problems for the state. Unlike the developed states, HP's achievements havebeen largely ledby the public sector, influenced by its status as a "special category" state which entitles it to liberal central government grants and, more recently, industrial investment incentives. On one hand, the soft budget constraint from a liberal devolution regime, combinedwith some farsighted planning, has provedbeneficial inmaking HP the leading "special category" state inIndia inmany respects. Collaterally, benefits from generous transfers and grants from the central government that softened the budget constraint may have heldback the implementationo fbold fiscal reforminitiatives by GoHP and contributedto fiscal indiscipline. This has created other difficulties such as high debt, and, more importantly, a political consensus around the role o f the state. Ithas also resulted ina policy logiam, and excessive reliance on the central government for development-with little policy initiative that can harness the state's many natural advantages for development. 28. GoHP recognizes that state-led development has certain limits, and generous financial flows from the central government cannot be assumed indefinitely-especially as HP's development achievements influence central devolution to redistribute resources progressively to weaker states. The special tax incentives that have promoted industrial growth are also due to be phased out gradually by 2010. At the same time, past state involvement has raised expectations o f economic development which could be difficult to fulfill ifcentral support i s phasedout-unless GoHP undertakesreforms, and devises alternate strategies to move the state from being a provider to a facilitator and regulator. Most fast growing states have embraced this need for reorienting government. HPmust undertake the transitionto take advantage o fnew opportunities to tackle the state's development challenges. 29. The assessment finds that, inorder to realize its development priorities, the state has to overcome several inter-related challenges and come up with a coherent strategy to address them. Despite significant achievements, HP cannot afford to rest on its laurels, andmust work towards sustaining and leveragingthe gains ithas already made. 30. The key challenge faced by the state at present i s insufficient fiscal space to finance the development vision. While there are recent signs o fa fiscal recovery, this has to be maintained. Fiscal resources can finance a variety o f development priorities-such as critical infrastructure that i s more costly to construct than inthe plains, investments that can help exploit the untappedpotential insectors inwhich HP has a comparative advantage, and social sector expenditures to improve delivery o fpublic services and promote inclusive development. 31. At the same time, inorder to realizeHP's true development potential, GoHP mustprovide an enabling policy framework that promotes growth and economic opportunities. Better infrastructure andrelevant skdls development for the population can reduce constraints to private sector participation, and, inturn, help reduce the populations' current dependence on the public sector for services and employment opportunities-which could lead to a virtuous cycle interms of freeing up additional fiscal resources. Given that the terrain i s unlikely to promote a growth model basedon traditional agriculture or heavy industry, opportunities and potential invarious sectors inwhich the state has a natural comparative advantage-such as tourism and hydropower-need to be leveraged. Despite good objective indicators o fhuman development, there i s scope to improve some aspects o f public administrationand service delivery. It is particularly important for GoHP to 9 protect its environmental wealth while pursuing its development agenda, since much of HP's future growth prospects are critically linked to its natural heritage which is its strength. 32. The Report analyzes a number of constraints that require dynamic policy changes, institutional capacity building,privateparticipation, andinfrastructure creation. Itoffers some short andmediumterms policy recommendations, based on an evaluation of critical challenges and existing opportunities. Talung the necessary policy measures will put the state on a pathtowards sustainable development, and help preserve and maintain the state's commendable achievements. 10 A. Strengthening OwnRevenue Performance 3. The state's revenue performance has been improving but the process has been slow. HP is highly sensitive to central devolution inthe form o f grants and shared taxes, and these averaged about 70 percent o f GoHP's revenues. However, there has been a recent favorable shift inrevenue dependency, as described above, and this needs to be consolidated. Measuresto Enhance Own TaxRevenues Rationalizingand Adjusting Tax Rates 4. H P ' s aggregate own tax revenue has improved gradually, and, at about 6.2 percent o f GSDP, i s comparable to the national average o f 6.1 percent. However, other states with similar per capita incomes have higher own tax to GSDP ratio-like Punjabwith 8.3 percent or Karnatakawith 12percent in2005-06. The state could look at the following measures to improve performance. Sales tax-largely VAT-is the main source o fowntaxes, butgains from this may be dryingout following two years of implementation. The yield from this tax i s also lower than the national average o f 3.7 percent o f GDP. Given that the VAT has completed nearly two years inthe state, it may be useful for GoHP to consider an external evaluation o f VAT implementationwith a view to streamlining and strengthening VAT administration, making the department taxpayer hendly, and preventing tax fraud. This evaluation could include value chain analysis, VAT assessment, system o f refund, use o f nationally harmonizeddefinition o f goods, fraud risk analysis, VAT threshold limit, etc. Excise duty on liquor is the second major source o ftax revenues, and does better at more than double the national yield. However, the system i s presently structured as specific duties classifiedineight categories, with sub-categories-malung the system complex to administer and open to subjective interpretation o fthe category o f duty to levy. Given the complexity, GoHP could consider steps to switch from a specific to an ad-valorem excise duty structure following the Maharashtra example, and simplifythe license fee structure for alcohol vending. Stamp and registration duties, at 0.3 percent o f GSDP, are almost halfthe national yield of 0.6 percent o f GDP-but downward revision instamp duty has resulted ina small increase inrevenue." In HP, these charges could potentially amount to a tenth o fproperty value, higher than inmost other states.'* GoHP could undertake an analysis o f stamp duty evasion schemes and their revenue impact to prepare for a more fundamental reform o f the stamp duty system, and reduce registration fees on par with other states. The motor vehicles tax inHP i s lower than inother states, and could be a source o f lost re~enue.'~ GoHP could: (i) conduct a comprehensive study o fthe revenue implication o fthe current motor vehicle tax regime, and raise the lifetime tax rate gradually as inother states; (ii) periodically revise the specific rates o f the motor vehicle tax which have not beenrevisedsince 2001; (iii) revamp fees for permits, As part o fthe fiscal reform programme, stamp duties were reduced to a uniform 8 percent of sale deed inApril 2005 from 12 percent (effective from April 24, 1991). This led to a small increase inrevenue from this source. Inadditionto the 8 percent stamp duty, registration fee under the IndianRegistration Act, 1908, as applicable to HP, at the rate of2 percent on the value o f consideration, subject to a maximum o f Rs.25,OOO i s also levied. Most states levy only 1 percent registration fee. l3Non-transport vehicles are subject to one time tax, while transport vehicles are subject to an annual tax. Inaddition, HP levies a special road tax on transport vehicles. The current level o f the one time tax is 2 percent on the price o fpersonal vehicles such as cars and 1.5-3 percent on the price oftwo wheelers. The one time tax is considerably lower than inother states where it could range between 6 percent and 8 percent o f the price ofthe vehicle. Transport vehicles are charged an annual specific tax depending on the nature o fthe vehicle. 12 registration, licenses, and fitness certificates, and increasing revenue collection from road tolls. A 'green tax' on older and more polluting vehicles could also be introduced. Taxes on goods and passengerscollectedby the Excise and Taxation Departmenthave declined from 20 percent o f tax revenues inthe late 1990sto about 3 percent currently-following the introduction o f a special roads tax for transport vehicles. The state could consider merging the goods and passengers tax with the special roads tax. HP has an electricity duty at the flat rate o f 6 paise per unit consumed inbulkuse and 33 paise per unit on consumption by industries, as last revisedinthe 2005-06 Budget. The tax take from this source has been uneven over the years and constituted below 4 percent of tax revenue in2005-06. The electricity duty couldbe folded into VAT, gwen low and unevenintake from it. Inaddition, the state leviesanumber o fminortaxes suchas landrevenue, andthere are administrative costs involved. The state needs to study the administrative cost o fminor taxes and either devolve them to local bodies or withdraw them ifthe costs o f administrationdo not make them worthwhile. HPi s one o f only five states inIndianot to have a professionstax, andthis denotes potentiallost revenue.14 The state could reintroduce this tax. While most states levy, collect, and devolve the tax to local bodies, six states have assigned the tax to municipalities to levy and collect. HPmay consider an appropriate model to collect the tax. Modernizing Tax Administration 5. GoHP should also look into modernizingtax administration following international examples. At present, the revenue administrationsystem i s somewhat complex, with several revenue-collecting agencies in different departments. The various tax collecting agencies currently report to different Secretaries inthe government. There i s no comprehensive uniform accountability mechanism, and accountability i s based exclusively on collection results. The key Excise andTaxation Department has a territorial rather than functional organization structure, and requires more qualified and senior staff. 6. Overall responsibility for revenue collection could be streamlined and consolidated inone dedicated collection agency. This agency would have the overallresponsibility for managing compliance and implementing the tax system. The Excise and Taxation Department could be the basis for a unified tax collection system inHP. Other revenue-collecting agencies would then concentrate on their core, non-collection functions. Such reformrequires carefulpreparation, however. As preparatory and more short-term measures, assessmentand collection functions o f different departments can be co-located (e.g., by creating integrated check posts), and procedures can be harmonized (e.g., by unifyingreal property valuation for stamp duty and urban landtax purposes). 7. Reporting and accountabilitymechanisms could be improved. A modernizedtax administration should report on a regular basis to a government Secretary incharge o frevenue collection. Performance measures shouldreflect broader reform priorities andnot focus exclusively on collection results. For example, important measures o fthe performance o fthe tax administration could include the quality o f services and informationprovided to taxpayers, a broadening o f the tax net, or reduction o fthe time required for registration o f a business for tax purposes. 8. The capacityand organizationalstructure of the Excise and Taxation Department needs to be strengthened and streamlined before it can be charged with additionalassessment and collection tasks. Moving from a territorial to afunctional structure inthe Excise and Taxation Department i s probably the single most 14The others are Arunachal Pradesh, Punjab, Jammu and Kashmir, and Jharkhand. 13 important initiative the government can take to reformtax administration. The reorganization would have to be carriedout at the headquarters and territorial levels. It would create the necessary organizational basis for separating and strengthening the key tax administrationfunctions o fregistration, audit, collection, and taxpayer services. The human resource situation o f the Department also needs to be addressed-since a professional and specialized tax administration requires an appropriate level o f highlyqualified staff. This indicates a need for increasingthe percentage o f senior staff at officer level inthe administration. 9. The planningprocessmustbe strengthened. Modemrevenue administrations indeveloped and developing countries have introducedregular, multi-year, strategic planningprocesses, often spanning a five- year period. These define the mission and vision o f the revenue administration, identify the challenges to address inthe planningperiod, as well as reformpriorities. The strategc plan i s then translated into annual business plans for the tax administration. Introducingregular multi-year strategic planning for tax administration reforminHp couldbe beneficial. Measures to Enhance Own Non-Tax Revenues 10. H P ' s non-tax revenue averaged below 2 percent o f GSDP inthe 1990s, but there was a shift from 2004- 05 due to receipts from sale o froyalty power that the state i s eligible for from all new projects under the state's hydropower p01icy.'~ The state also gets 22 percent o fpower generatedat generation cost from the Nathpa Jhakri project inproportionto its equity share inthat project.16 Inorder to enhance revenues from this source, the state has two options. Under the first option, the state allows private participation under a transparent investment policy andregulatory environment and enjoys the benefit o f 12percent royalty power. Under the second, the state could investjointly with other partners and get a share o f the power generatedproportional to equity invested, inaddition to the royalty power. The latter course would require the creation o f fiscal space for the necessary investment, besides bearingthe risk o f project completion. 11. The story on user charges i s mixed. Irrigation charges were revisedinJune 2005. Although the stated policy is to revise irrigation and water charges by 10percent annually, this i s not regularly implemented. Ina retrograde move inM a y 2003, GoHP abolished user charges levied inhospitals and health institutions and restored the position o f tariffs as on March 24, 1998. The Rogi Kalyan Samitis, set up invarious hospitals to provide a measure o f autonomy to hospitals to determine user fees, have also been abolished. A review o f health andhigher education charges levied inHP and a few peer group states chosen on per capita and similar status basis (hillstates) shows that there may be scope for restructuringuser charges (Table 2.1). Of importance i s a detailed analysis o f the cost o fproviding different services, user charge comparisons across states, and public consultations for regular revision o ftariff. BloodCulture Test 100 70 100 50 NA ECG 30 25 40 150 30 X-Ray(Chest) 15 50 30 50 40 Ultra Sound 15 70 200 250 75 arn I Girls' Higher Secondary Education Free Free Free Free Free Boys' Higher Secondary Education 180 240 Free 120 200 Notes: From government websites and www.inidastat com l5 The state gets free royalty power from eight projects: Bairasual, Chamera Iand 11, Shaman, RSD, Malana, BaspaI1and Nathpa Jhakri. l6In 2005-06, proceeds fromthe sale of power amountedto Rs. 2.47 billion. The receipt projected in2006-07 is even larger at Rs. 5.46 billion. 14 13, Total ~ x p e n ~ ~ as~ai rshare of GSDP has dec~~nedrecent years fsoni 32 percent in 2 0 0 ~to- about t e in ~ ~ fi` not bc nsori` lift of f 15. The government requires an effective wage and hiringpolicy that i s consistent with fiscal sustainability.'8 Elements o f such a policy should includereviewing staffing norms for various departments, identification of vacant positions and implementing a hiringfreeze against vacant positions except incritical areas, reallocatiodclosureso f vacant posts, budgetingonly against staffed positions, reviewing the policy for regularization o f work charged, daily work charged and temporary employees, Pay Commission implementation, delinkmg automatic inflation indexation o f salaries to central announcements, reviewing systemof grants inaidto educational institutions, etc. PensionsandRetirementBenefits 16. Pensions are an increasing fiscal burden, havingrisen from about 8 percent o f expenditure in2002-03 to over 9 percent at present. InAugust 2006, the state introduceda Contributory Pension scheme for new employees joining service after May 15,2003, and it follows the Go1pattern of contribution^.'^ However, the impact o fthe new pension scheme will be felt over the longer term, and, till then, the state will have to contend with pension expenditure under the Defined Benefit scheme for employees hiredprior to May 15,2003. Since provisions under the Defined Benefit systems are totally unfunded, all recurring costs have to be paid out o f revenue, and this will have fiscal implications. Moreover, there has been ad hoc wage indexation historically, with pensions for retiredworkers adjusted onthe basis o frevisedwages o fthe last post heldprior to retirement, inline withrecommendations fromthe Pay Commissionapproximatelyevery tenyears. Given that the primary purpose o f any post-retirement indexationi s to preserve the real value o fpensions, some contractual safeguard i s needed to confirm that post-retirement indexationwill only be provided for price changes, and that GoHP will not grant wage indexation any time inthe future. 17. Inthis area, the state could: (i) undertake and completepension projections for government and public sector agencies and begin annual budgetingon actuarial basis;20(ii) indexpensions automatically to price increases instead o f ad hoc wage indexation every ten years through the Pay Commission; (iii) consider the scope for expanding the defined Contributory pension fundpool through voluntary or mandatoryswitching options, and especially entice younger workers who joined before May 15,2003 to switch to the newly introduced scheme; and (iv) introduce contributorypension schemes for new employees inpublic sector corporations, boards, universities, local bodies, etc. Subsidiesand Transfers 18. Subsidies and transfers account for about 7 percent o f total expenditure, up from 6 percent in2003-04. Two large elements determine the level of explicit subsidies: power and transport subsidies. First, GoHP subsidized the Himachal Pradesh Electricity Board (HPSEB) Rs. 500 million in2005-06 and i s providing the utilityRs.2448.7 million in2006-07.21 Although relatively small comparedto other states, these are important financialresource inHP's context and can be put to better use. The economic basis to the state's decision to maintain the power tariff that existed prior to the 2005 order o f the Himachal PradeshElectricity Regulatory Commission (HPERC) is unclear.22 The Himachal Road Transport Corporation (HRTC) i s another entity that See Chapter 5 for staffingrelatedissues. The employeecontributes10percent ofBasic PayandDearnessAllowancetowards his pensionbenefitsandthe statematchesthe contribution. 2oThis has been under considerationfrom 2004, with World Bank assistance. The exercisehasnotbeencompleted andwill needto be expandedto cover Statutory Boards, Corporations, Universitiesandaidedinstitutionsand Local Bodiesfrom whereinGoHP could experience`moral hazard' as these agencies are closelylinkedwith the Governmentandfollow the Government's pensionrules. Knowing future pensionliabilities is critical to planfor long-termfiscal sustainabilitybecauseof the current practiceof adhoc incrementalbudgetingto forecast pensionexpenditure 21These figures needto bereconfirmedwith GoHP. 22 Subsidieswill affect the commercialdisciplineinHPSEBby notmakingit responsiblefor its revenue. Inaddition,thebenefit, productivity,andtargetingof the subsidy is at best uncertain. Evenifthe subsidy is to beprovidedsuch subsidy shouldbedirect and transparentandnot use thepower tariffas a subsidy instrument. 16 receivedan annual subsidy o f about Rs. 480 million over the last three years.23 Bus fares have not been revised since 1999. 24 The 2005-06 Budget suggests a time frame o f 4-5 years for HRTCto financially break even, but the turnaround plan is unclear at the moment. 19. Inthis area, the statecouldconsider: (i) reducing thepower subsidy, and delinlung the subsidy from the power tariff; (ii) preparing and implementinga turnaroundplanfor HRTC, which is an important consumer o f subsidies; (iii) appointing and activatinga Committee of Experts to present a roadmap for subsidy containment and a gradual phase out o fnon-merit subsidies, as announced inthe 2005-06 Budget; and (iv) preparingan annual report on explicit and implicit subsidies which would add to fiscal transparency, result inpublic debate, and help create a climate for better targeting, and also support the Public Tariff Commission indetermining user charges. InterestPayments 20. The highdebt stock has resulted inthe share o f interest expenditure intotal expenditure doubling from 13 percent inthe early 1990s to 26 percent in2004-05. HP, like other states, has been a beneficiary o f the debt swap, interest reset, and debt prepayment schemes that Go1operated between 2002-03 and 2004-05.25 By enacting the Himachal Pradesh Fiscal Responsibility and Budget Management Act (FRBM)in2005, the state got access to the Go1debt relief scheme structured by the TFC. Under the scheme, Rs. 8.24 billion o f Go1loans were restructured, carrying an interest rate o f 7.5 percent repayable over 20 years. GoHP will, as a consequence, benefit from a reduction ininterest expenditure to the extent o f Rs. 1.35 billion over the period 2005-06 to 2009-10 on its outstanding Go1loans. Inaddition, ifthe state is able to stay on the fiscal consolidationpath and achieve the level o f annual adjustment inthe revenue deficit as recommended by the TFC, Rs.0.41 billioninannual repayment o f Go1loans would be written-off for five years. However, these measures must be supplementedby aggressive measures to reduce annual borrowing and restructure highcost debt. NonWage Operation andMaintenance 21. Expenditure onnon-wage O&M as share o ftotal expenditure virtually halvedbetween the beginning of the 1990s and2004-05, going from 22 percent to 10percent. Non-maintenance o f assets will ultimately result in poor service delivery and higher costs ofreplacement. There are encouraging indicationso f intent inthe 2005- 06 Budget speech, and earmarked allocations from the TFC for maintenance o froads, buildings,and forests will see higher expenditure inthis area. 22. A more systematic approachwould focus on development ofmaintenanceplans for fixed assets such as roads, buildings, and equipment, and fully budget for these annually. Inother sectors, assessment o f service delivery gaps incritical areas such as inhealth, education, agriculture, police, or thejudiciary should dnve resource allocation. Since the axe o f expenditure typically falls on maintenance heads in favor o f salary heads, some measures to prevent this may be necessary. There could be efforts to: (i) separate and protect the salary budget for an agreed staffingplan including temporaries (rather than posts); (ii) discourage reallocation from non-salary heads; (iii) resources according to the worlung season insome departments; and (iv) release 23HRTCprovidesfree travelto handicapped,presscorrespondents,public andformer public representatives,freedomfighters, national awardees, war widows, andgallantryawardwinners. Studentsandgovernmentemployeesget concessionaltravel, as do police officials andjail wardens. 24Occasionally, HRTC also requiresother fiscal support fromon and off-budgetsources. For instance,in2005-06 the HRTC was providedan off-budget loanofRs. 680million throughthe HimachalPradeshInfrastructureDevelopmentBoardto paythe Provident Fundliabilities ofthe Corporation.The Corporationwith an operatingratio of 1.2 is unableto meet its operatingcosts. Incomparison with Punjab, Kamataka, Rajasthan andMaharashtrastate ownedtransport utilities, HimachalandPunjabhadoperating ratios (operating costs to operatingrevenue) over 1. Othershadoperatingratio of 0.8. 25Underthe arrangement, the staterestructuredits debt portfolio with lower costborrowingto the extent ofRs. 35 billion, saving interest expenditure ofabout Rs. 1S O billion per annum. The carryingcost ofdebt therefore declined from 11.6percentofon budget debt stock in2001-02to 8.3 percent in2005-06. 17 expenditure allocation according to service delivery norms. This will be critical to the achievement o f output under the new performance measurement system that GoHP wants to put inplace from this year. (Box 2.1). Box2.1: EssentialIngredientsofPerformanieBudgeting Fourrequisitesfor performancebudgetingsystemsare: 9 A frameworkof strategy, priorities, andobjectivescoveringpublicexpenditure; 9 Performancecriteriafor efficiency, effectiveness, impactwhich are regularlymonitored; 9 Annualreportsofinputsandoutcomesinforming budgetdecisions; 9 Programmebudgetingwith allocationsbased onperformanceanddesiredresults. Additionally, it isimportantto usefeedbackfrommonitoring andevaluationto usebudgetedresourcesmoreefficiently. Experience omSingaporeandMalavsia SingaporeandMalaysiahavepioneeredperformancebudgetinginAsia. InSingapore,performancebudgetingwas first introducedinthe 1970s. This was complementedin 1989by the delegationof authorityto ministries to managetheir budgetswithout referring expendituredecisionsto the Ministry of Financeand, in 1991, by theintroductionof a d managementaccountingand informationsystempermittingaccrualaccounting. This was followed bythe launcho results. The featuresofthe system are: 9 The use, for all programmes,ofperformanceindicatorsandtargets-covering inputs, costs andactivity levels, outputs and outcomes; 9 Conversionofprogrammecost centres into autonomousagencies-subject to outputbasedbudgetingwith flexibility in resourcedeployment; 9 Performanceincentivesinthe form of the ght to retainhalfof the unbudgetedefficiency gains; 9 Zero basedvalue for moneyaudits ofexpenditureprogrammesbythe Auditor General's office. Malaysia's modifiedbudgetarysystembuilt onthe samebase ofprogrammeandperformancebudgetingusedinSingapore, and introducedgreater fiscalcertaintyfor planningpurposes, devolutionoffinancial responsibility,programmeagreements withresults orientation, andcyclesofprogrammeperformancereviews. The Malaysianbudgetprocessis intwo parts: first, an examinationof performanceachievablewitha `base' budgetwithunchangedwlicies, andthenthe performanceandexpenditureeffects ofnewpolicies. Capital Expenditure 23. HP appears to incur higher capital expenditure as proportion o f GSDP than other states, partly on account of: (i) lower GSDP and higher share o f Centrally Sponsored Schemes (CSS) that are determined on normative principles; and (ii) higher cost o f provision because o fthe difficult terrain and remoteness. However, inrecentyears, capitalexpenditureas a share o fGSDPhas declinedto abouthalfits value in1990-91. The emphasis on the social sector has expanded current expenditure at the expense o f capital expenditure.26 As the fiscal deficit expanded, capital expenditure either shrank or remainedconstant (Figure 2.1). This suggests that most o f the incremental borrowing was usedto finance the current deficit. 24. Increasing capital expenditure to meet the state's infrastructure demand i s constrained by the availability o f fiscal space, and GoHP got around this after the mid-1990s byborrowing off-budget for supporting infrastructure investments and for financing the budgetary deficit. Although the state has now declared that there will be no off-budget borrowings, GoHP expects to borrow off-budget to finance its hydropower energy investments under the Eleventh Five Year Plan. Off-budget borrowing inthe absence o f fiscal space will result infiscal crisis andloss ofcreditworthiness. They are also subjectto lesser scrutiny andlower accountability. Going forward all capital investments to be supported by GoHP mustbe budgeted for. 25. The fiscal strategy of the state must focus on the creation o fbudgetary fiscal space for priority investment. To enable this, expenditure prioritization i s necessary along with restructuring. First, GoHP can 26GoHPkept a substantialamountof committedexpenditureon salaries, pensions, andmaintenanceunder the Planinsteadof transfemngthe expenditure to non-planheadsat the end o fthe Planperiod. This artificially inflatedPlansize. Over 2003-04 and2004- 05, the government transferred Rs. 10.21 billion (such liabilities at the end of 2001-02) to non-planheadsof expenditure. This reduced the annualPlansize, butmost of it is now investment. 18 follow up on its expressed intention inits 2005-06 Budget to rationalize and restructure schemes that have lost their relevance (Box 2.2). Second, the fiscal gains from such rationalization may be budgeted on infrastructure projects that are `lust mile' innature, and canbe completed with some additional resources. The focus should be on completing on going projects. Third, projects that are going to see little allocation and are accommodated for considerations other thaneconomic should not be included inthe budget. A number o f such projects with meager allocations can together appropriate a visible amount o fresources that could be better spent. Box 2.2: Zero-Based InvestmentReview inOrissa Severalinfiastructureprojectstakenupbythe Orissagovernmentwere languishingdue to lack ofmonitoring andeffective implementation. Consequently, the government, in2002-03, launchedan exercisecalledZero BasedInvestmentReview(ZBI) ledby a high-poweredcommitteeheadedbythe ChiefSecretary. The ZBI reviewrequiredeachdepartmentto placetheprojectsunderfour categories: (i) fillfimdingforfasttrackcompletion;(ii) fundingon slower track for thepresent, which could graduate to fast-track inthe Future; (iii) minimal funding edesign or restructuring;and(iv) scrap or shelve indefinitely. While inthe first phase, the review was limited to projectdschemescostingRs. 40 million andabove, and, in2004-05 (secondphase), projectscostingRs. 10million andabovewere alsotakenupfor completion. Duringthelastfour years of implementationofthe scheme, out of257 identifiedprojects, as manyas 90 projectshavebeencompleted up to December2005. Year wise allocationofbudget andprojectcompletiondetailsis giveninthe table below. 2003-04 19.27 60 24 2004-05 13.81 41 19 2005-06 18.29 115 30 otal 6030 257 90 Fortimely completionoftheidentified projects, concerneddepartmentshavebeen allowedto makenecessaryprovision inthe -ndget, and, incase of emergency, havebeen allowedreallocationof fundswithinthe overallbudgetaryallocation. The success of this exercise showsthat when the total budgetallocationisheldconstant,positiveincentivesare createdfor departmentsto reallocate funds to priority projectsrather thanhide"white elephants" to protectbudgetaryresources. Reviewmeetingschairedbythe FinanceMinisteror Finance Secretaryare heldto overseethe performanceof agenciesexecutingthe work andenforce terms ofthe contract. C. Managing Debt and Contingent Liabilities 26. The most visible aspect o f GoHP's fiscal problems i s the highdebt to GSDP ratio o f about 74 percent including off-budget borrowings, and the highdebt per capita (Figure 2.3). The debt i s unsustainable and higher than the average for Indian states of about a quarter o f GSDP. Go1guidelines classify HP as debt stressed." Breakdown o f debt shows that 77 percent is relatively expensive internal debt comprising small savings loans, financial institutionborrowings, off-budget borrowings, etc. About 6 percent was sourced from the Central Government and 17 percent was from Insurance and Provident Funds. The state has taken advantage o f opportunities to prepay, restructure at lower interest rates, and swap debt, as described earlier. Highcost loans (canying coupon rates 10percent and above) constitute almost a fiftho f the outstanding debt stock o f Rs. 188 billion as on March 31,2006. Approximately 45 percent o f this stock i s up for repayment over the next five years, presenting a good opportunity to the state for restructuringhighcost debt. 27. A debt sustainability analysis, describedbelow, shows that evenunder steady state conditions o fthe baseline, debt to GSDP will decline to 35 percent at best inthe next fifteen years.28 This will still be higher than national averages. 27Under GoI's criterion, any state with an interest to revenuereceiptsratio over 20 percent is debt stressed. HP hadaratio of 24 percent in2005-06. 28See Annex 5 for debt sustainabilityanalysiswith the newrevisedMTFP. 19 32. The state has produced~ e dTerm Fiscal ~so~~tct~ons that were tabled along with the i ~ ~ (MTFP) Budget for ~ ~ ~The~p ~ ~~ ? ~~have~been~reviseds'to i ~ c ~ ~ oE;,leventhPlantargets, but are based on e 7 ~ . ~~n r a t ~ sczrne ~ ~ t ~ ~~ ~s ss ~t nl e~~~ ~ t~2.4). ~l o n g ~ ~ ~ E. Improvingthe BudgetFormulationProcess 34. The state has a process inplace for budget formulation. Given the objectives o f the FRBM,the challenge is to modify the budget formulation process and associated documentation to better linkpolicy goals and resource allocation, and to embed the medium-term perspective inbudgeting. 35. +++ The process o f annual budgetpreparation should ideally follow the following stages: Assessment o f overall resource availability and adoption o f aggregate expenditure and revenue targets; Disaggregation o f aggregate targets into department targets; Preparation and distribution o fbudget guidelines, including department ceilings and their distribution to spending departments (`budget call circular'); Preparationo f submissions by spending departments; Review o f submissions by the Finance Department; Preparation of draft estimates; Legislative approval o f draft estimates. 36. HP's budget formulationprocess requires strengthening that would enable the Cabinet to review and prioritize competing policy, programme, and project proposals, and thereby allocate resources to departments based on availability. Budgeting inHP, as inother Indian states, follows the latter part o f the process, beginning with the budget call circular and submissionsbyline departments. The earlier stages-determination o f aggregate resource availability and department expenditure ceilings-are crucial for a credible budgetprocess. Aggregate targets must be agreed upon at the political level before budget elaboration can proceed. Inpractice, most budgets are incremental, talungthe previous year's allocation as base, adding a small percentage for inflation and some real growth. Incrementalbudgetingreflects a mismatchbetween policies and resources, and excessive focus on funding at the expense ofpolicy inbudget deliberations. 37. Each department must develop budget proposals within prior indicatedceilings. The key issues in arriving at the departmental ceilings are: (i)sequencingthe preparation of a medium termfiscal programme, which defines desired fiscal targets (the fiscal deficit, revenue deficit, and guarantee limits), and establishes broad multi-year parameters for the budget; (ii) preparingestimates of expenditureto implement ongoing policy, programme, and project commitments; (iii) deriving the estimate of thefiscal space over the medium term to accommodate new commitments consistent with the fiscal plan parameters; (iv) ensuring that decisions on new policy proposals are considered within the constraints defined by resource availability; and (v) preparinga full annual budget that i s consistent withthe medium term fiscal programme. The expectation i s that each department would take the resource ceiling as given and prioritize spending among its activities to achieve its objectives. 38. As a first step, the Finance Department canprepare broadexpenditureestimatesbasedon current policy, and examine its sensitivity to changes ineconomic estimates. The objective i s to gauge affordability over several years, and provide for early warning indicators if some programmes are likely to grow beyond affordable limits and explore policy options. The initial estimates would be a baseline, assuming continuation of current spending levels or laws-assuming no changes inpolicy. Two sets of estimates can be prepared-ne that assumes current levels o f discretionary spending and current laws o fmandatory spending, and another that assumes that current normative andother laws with implicit commitments are fully funded. This will help identify the `policy gap' or difference between current levels o fpublic spending and requirements to fill policy commitments (such as MDGs). 39. The revenue and expenditure estimates could form the basis for a fiscalpolicypaper for presentation to the Cabinet, and inform senior officials o f basic economic issues and linkages between government policies and outcomes. The objective i s to obtain a Cabinet decision on overall government revenue, expenditure, deficit policy, and fkamework. At this stage o fbudget formulation, the Cabinet could commit to a mediumterm fiscal 22 programme that defines the hard annual and medium term budget constraints. The mediumterm fiscal programme would have to be submitted for Cabinet discussion, and approval obtained by September or October inorder to establishthebroadparameters for revenue, deficit, andborrowing overthe nextthree years. 40. The budget formulationprocess would also needto enable the Cabinet to review andprioritize competingpolicy, programme, and project proposals, based on resource availability. Some sectoral allocations may have been developed inthe course o fthe fiscal policy discussions where key sectoral trends may havebeen identified as threats to policy or fiscal stability. The remainder o f funds needs to be allocated reflecting general policy directions of GoHP. Within sectors, it i s important to distinguishbetweendiscretionary and mandatory spending. The best estimate of mandatory spending for these programmes could receive full allocation, while discretionary programmes would receive residual amounts. This stage will generate a `development debate', clarifying policy issues andresolving programmerelatedtensions. Once approved by Cabinet, these indicative ceilings for each sectoddepartment would be transmitted to departments usually as part o f the annual budget call circular that initiates the budget process. 41. Havingreceivedsector or department indicative ceilings, each line department must develop its budget proposal. At this stage, departments are expectedto think strategically about their programmes, evaluate their existingprogrammes, and analyze what inputsor policy will best help them attain an objective by maximizing the effectiveness and efficiency o f spending. These reviews and plans shouldbe undertaken either as part o f the annual budget cycle or prior to it, and then fed into the resource allocation decisions inthe budget process. The budget requests to the Finance Department must separate existing programs from new requests, and apart from numbers, contain text explainingpolicy, changes inpolicy from the past, reallocation decisions, new objectives, and output and outcome targets associated with the resource levels and allocations. An important issue here i s for the line departments to develop capacity for policy and programme evaluation s h l l s through training. 42. A formalprocessto criticallyreview ongoingprogrammes aspart o fthe budgetprocesswill also help ensure their efficiency. Some state governments have undertaken a one-time zero-based budget review to rationalize government programs (Box 2.2 above). Establishingan Expenditure Review Committee (as in Australia) to critique ongoingprograms and rationalize would be a useful supplement to the existing annual budget process. 43. After receiving the requests, these mustbe reconciledwithresource ceilings and competing demands, and final policy and funding decisions should be reached. The Finance Department's role i s to provide critical analysis o f the line agency's request and conductingfair hearings o ftheir request. Line agencies must be questioned indetail about their requests, assumptions, and underlying data. The Finance Departmentmust report new programmes separately from ongoing programmes inthe interest o f fiscal transparency. The assessment should include reviews o f capital spending, progress incapital projects, and whether external and internal audit findings have been addressed by each line department. This must feed into the Finance Department's recommendations for funding. F. StrengtheningPublicFinancialManagement andProcurementSystems3j 44. The state's public financial management and procurement systems present both strengths and weaknesses. Going beyond budget formulation, the process o f approval of the budget by the state legislature i s well established, and recent budgets have been approved ina very timely manner. Transaction level controls over the budgeted expenditure are exercised. Interim and Annual Accounts are reconciled and prepared on a regular and timely basis. External audit i s comprehensive, regular, and reports are made available on a timely basis. The process o f legislative oversight over matters reported inthe audits i s discussed inthe fora o f the Public Accounts Committee (PAC), andrequired directions are issued for corrective action. At the same time, the state's public financial management system is inthe needo f modernizationinthe areas o fbudget 33See Annex 7. 23 management and execution, accounting and financial reporting, internal controls and audits, and legislative oversight. 45. The Budgetdocumentationprocess could be improved. Thepresentation o fthe document itself i s rather detailed, and not easily understood. Though there are attempts to summarize/explain the Budget details through an Explanatory Memorandum, the state could work on presentation aspects to enable the public to understand and analyze the complex budget. More importantly, budget documentation should be rationalized as outlined in the FRBMto achieve the fundamental shiftinapproach to budgeting and the quest for greater transparency. The Act proposes to introducepotentially valuable andrelevant informationto clarify the forward-loolung medium term fiscal program o f the state, an evaluation o fpast performance, andan assessment o f the conformity o f ongoing and proposed policies with the medium term programme. For greater transparency, it would be appropriate for GoHP to also reassess how the remainder o f the documentation on the budget could be rationalized and made more relevant for informing legislators and civil society about public policy andresource management. 46. Inaddition, thestatecouldbeginaprocessofmid-termreviewsandreportingasrequiredunderthe FRBM. The FinanceDepartment must strengthenwithin-year monitoringo fthe budget, prepare occasional reports for the Cabinet, andpropose corrective actions. As mandated inthe FRBM, a report on midterm turnout, risks to achieving budget targets, and corrective measures should be tabled inthe Legislature, and be publicizedthroughthe state website to informpublic opinion andbuild support. 47. Additionally, inthe area o f publicfinancial management,there i s scope for: (i) improving budget murksmunshzjdaccuracyincases o f certain large departments, where excesses havebeen consistent and significant; (ii)including adequate information relating to guarantees, and status o f the investment inPSEs, others inAnnual Financial Statements; (iii) reinforcing responsibility and accountability o f the Head o f the Department (HOD)to ensure more effective utilization o fresources and strengthen internal controls; (iv) enhancing effectiveness ofofJicers responsible for `inspection' inthe spending departments, where formal Internal Audit does not exist; (v) more effective response to audit by co-coordinating timely response from line departments and addressing systemic issues consistently appearing inaudit reports; and (vi) reducing delays in legslative oversight. 48. Public procurementinHPis governed byProcedure & Rules for the Purchaseo f Stores, which is an appendix to GoHP's Financial Rules. These are maintained by Controller o f Stores under Ministry o f Industries, and relate to procurement o f goods. While the Store Purchase Organization i s the nodal agency for negotiation o frate contracts, there i s an increasing effort to decentralize department specific purchase to the respective departments. Procurement takes place amidst a large number o f controllers and overseers. Improvingoversight o fprocurement involves rationalizing control as well as increasingthe ability o f the government and the private sector to monitor performance. The existing rules provide a preference for domestic suppliers with an aim to promote the local industries. Itneeds to be reviewedwhether such preferences actually result inthe desired effect. Simplification o f laws and regulations i s often best accomplished through the adoption o f a modem procurement law that applies to all lunds o fprocurement undertaken usingpublic funds (goods, works and services). 49. Some additional steps could be considered to improve public financial management andprocurement. + Inorder to improvefinancialreporting,GoHP couldincludeinformationrelatingto guarantees, and status o f the investment inPSEs inthe Annual Financial Statement. It could also begin presenting information on revenue due butnot collected, payables, and outstanding commitments. + Inthe area ofinternalcontrols,(i) responsibility and accountability o fthe HODS needto be reinforced inorder to ensure more effectiveutilizationofresources andingeneralstrengtheninternal controls; (ii) the Himachal PradeshFinancial Rules, 1971, which are outdated, difficult to interpret and require 24 reference to numerous circulars, needto be revised; (iii) responsibility to discharge both the Treasury and Subordinate Accounts Service functions could be combined and skills development needs of staff could be assessed; and (iv) an Internal Audit function mightbe createdby setting up a small, shlled team to review areas ofperceived risk. + Treasury computerizationneedsto berolledout to cover the entire state; this will greatly improve public financial management ingeneral and internal controls inparticular. + Inprocurement,the state should adopt amodemprocurement lawthat applies to all hndsof procurement undertaken usingpublic funds (goods, works and services). A public procurement disclosure policy can improve the flow o f information on procurement, and allow for public participation inmonitoring and oversight. A review o fthe FinancialManagementand Procurement Policies o fthe PSEs could be undertaken with a view to modernizingpractices; the government may start with the two largest PSEs. 25 - Chapter 3 Improving the Investment Climate for Private Sector 1. Policy makers inHPrecognize that a vibrant private sector i s centralto promoting growth and expanding employment opportunities. Effective partnerships with the private sector could enhance the efficiency o fthe state's economic performance, reduce the burdenon the public sector, and free public resources for critical investments. However, HP continues to be heavily dependent on the government for its economic development. This chapter looks at the key constraints that affect private sector participationinthe state. A. ChallengesinIndustrialization 2. HPhas achieved significant progress inindustrialization, more so since fiscal incentives were made available to industry. Since the announcement ofthe Special Incentive Package by Go1in2003, the state has receivedinvestment proposals of close to Rs. 200 billion (including new units and expansions o f existing units) withproposed employment o fmore than 280,000 persons (Box 3.1). Actual realizedindustrialinvestment has increasedby about 50 percent since 2003. The key sectors are cement, textiles, food processing, pharmaceuticals, engineering, electricals, andelectronics. Box 3.1: SpecialIncentivesfor W's Industrial Development Himachal Pradeshhas beenthe recipientof agrant o f a specialpackage ofincentives by Go1(2003), as well as an investorfriendly state IndustrialPolicy (2004). These haveattractedsignificant investment proposalsinthe state, which has contributedto growth inthe secondaryandtertiary sectors. Central IncentivePackage InMarch2003, Go1announceda special incentivepackage for industriesin"special category" states. The industries eligible for such incentives were to be `environment fkiendly with apotential for local employment generationanduse o f local resources. The mainfiscal incentives includedthe following. (i) industrialunitsandexistingindustrialunitsontheirsubstantialexpansion,setupinGrowthCentresorIndustrialInhstructure New Development Centres(IIDCs) are entitledto: k > 100percentoutright excise duty exemption for aperiod of 10years fromthe date ofcommencementofcommercialproduction. 100percentincometax exemption for an initialperiod offive years, andthereafter 30 percent for companies and 25 percent for other than companies for a further period o f five years fromthe date of commencement o fcommercialproduction. > Capital investmentsubsidy at the rateof 15 percent of investment inplant andmachinery, subject to a ceiling of Rs. 3 million. (ii) sectorindustriesidentifiedinthep Thrust horticulture, food processing, pharmaproducts are entitledto similar concessions as mentioned abovewithout any Intheoriginal proposal, the excise and incometax concessionswere validfor industrieswhich commence productionuptoMarch2013. On opposition fromneighboringstates, however, the validity period for excise concessionswas initiallyreducedto March2007, buthas now been extendedupto March2010. As per latest reports, the tax incentives maynow be limited only to fresh investment. Since the notification of special package, several major privatecompanies have come into HP. These include cement majors like ACC and Gujarat Ambuja, pharmaceuticalfirms Dabur, Ranbaxy, as well as electronics andtextile companies. StateIncentives With a view to ensure balancedindustrializationinthe state andto generate employment opportunities for localpersons, GoHPhas enactedanew Industrial Policy (2004) where it providesgradedincentives to the industrialists so that industries beingset upinthe interiors o fHP gethigherincentives. The fiscal incentives beingoffered include subsidies, concessionalrateo f electricity duty, and deferment ofthe Value Added Tax. The statehas also introduced a single wmdow clearance andmonitoring authorityto ensure speedy approval fromvarious departments and agencies. A SpecialEconomic Zone is also beingset up inthe Kangra, Una, and other districts o fthe State, with an estimatedcost of over Rs. 50billion. The unitslocated inthis economic zone can avail certain specific concessions and facilities likeexemption from the payment o f central excise duty, levies, specified taxes, relaxationinlabor laws. The new units are however eligible for the state incentives only ifthey employ at least 70 percento f its total manpower, whether on regular/contractual/sub contractual/dailv basis or anv other modefrom amongst the bonafideHimachalis. 26 I80 45 D?.. b inadequately funded. It i s estimated that, given the unit cost for upgradation o f an existing single lane roadto double lane o f Rs. 20 milliodkm., just to upgrade the core network would cost more than Rs. 80 billion. The Public Works Department (PWD) has to contend with highfuced costs, with a salary billthat crowds out critical non-wage O&M. The PWDis saddled with a large gang workforce, and the overall productivity o f this workforce is unclear. About two-thirds ofthe budget provided for maintenance i s usedup inpaying the salary o f these staff, leaving only a small sum for periodic maintenance. This has resulted ina large backlogofperiodic maintenance works and poor condition o f the network. The service levels on existingnetworks are low. Due to the focus on enhancing rural connectivity and inadequate maintenance, the service levels are currently poor with respect to volume/capacity, surface ridingquality, lack o fcross drainagehlopeprotectionworks, weak pavement structure, poor horizontal and vertical geometry, poorjunction layout, periodic closure o froads due to landslides, inadequate snow clearance equipment, limitedroad signage, and absence o ftraffic management inbuiltup areas. The sector i s affected by outdated management and implementation practices. Almost all road works in the State are undertaken through the HP PWD. The organizational structure inHPPWD differs fi-om modem road agencies inseveral important ways including: (i)geographic division of functions, and a absence o f specialization withmthe PWD; (ii) use o f force account to undertake a large amount o f activity; (iii)virtual absence o fresearch or development intechnology and management practices; (iv) low level o f Information Technology (IT) use for planning,monitoring andreporting; (v) continued use o f outdatedprocurement, quality control and financial management practices; (vi) absence o f departmental vision, outcome performance measurement system, or linkbetweenpolicy and customer expectations; and (vii) lack o f an effective humanresource development programme. Strategic Options 8. Although there i s no formal Road Sector Policy inthe state yet, the 2006-07 Budget Speech stated that rural connectivity and better roads are o f the highest priority inaccelerating economic growth. The state has a two-pronged vision for the sector-xtension o fthe ruralnetwork along with simultaneous improvement to the core network o f 2,160 km.o f state highways and 2,240 km. o f major district roads.38 9. Inorder torealizethe vision, the stateneeds to: (i) the policyframework,byformulating aRoad clarify DevelopmentPolicy, and associated monitoring and evaluation, including adequate integrationo f low cost rural access inall areas including forests, and establishing a highlevel standing committee to promote sustainable policies for road development and maintenance, and interagency coordination; (ii) improve maintenance funding,throughmeasures to revise norms for maintenance, provide increasing allocations asper norms on a timely basis, encourage local governments to help fundmaintenance, assess feasibility and implications o f transferring noncore roads to local bodies, create a road maintenance fundthrough existing and new resources along with an empowered committee to manage it, and remove the backlog indeferred maintenance in a phased, time-bound manner;39(iii) revisit the current institutionalstructure,by reviewing the organization and training needs o f P W D staff, and establishing and applyingrevised staffingpatterns, job descriptions, and responsibilities along with a suitable training programme, as required; (iv) upgrade sectoralplanningby establishing and applying simple procedures for data collection on road inventory, surface condition, and traffic, so as to be able to update and generate management reports on completing routine works and prioritizing periodic maintenance works at district level and state level; (v) undertake a thorough assessment o f costs and benefits o fthe ganglaboursystem, which i s ongoing, and look at reformoptions to enhance productivity o f 38A World Bank investment lendingprojectis underpreparationto support improvementsandmanagementof the core network inHP, andis expectedto go to the BoardinFY2006-07. 39The state has alreadyendorseda RoadMaintenanceAction Planand GoHPneedsto focus on steadfastimplementationofthe Plan. 29 11. This suggests that the problem is not so much of supply, as one o f mismatchbetween the shlls being impartedthrough the formal education system and those required by the upcoming industries. There i s thus a case for GoHP to focus onrevamping the education system to better equip Himachalis to take upnewjobs that are becomingavailable. 12. What sort o f slulls does industryrequire? At the workmen level, discussions with industry representatives suggest, and international evidence also backs up, that they are basically looking for workers withthe slulls taught ingeneral secondary education, along with technical skills.41 Support for the proposition that industryvalues secondary education highly also comes from data which shows that the meanwages o f workers with higher secondary education are 44 percent over those earned by highschool graduates. Technical education adds additionalvalue andraises meanwages further by an additional 8 percent.42 Beyond this level, the main source o f employment for workers with tertiary education i s inthe service sector, especially inthe public sector. 13. Accordingly, provision of technical training has the potential o fmeeting industrydemands and raising workers' employability and incomes. The state currently provides vocational and technical education inGrades XI-XI1inthe school system, andthrough 5 engineering colleges, 6polytechnics, 51public andprivate Industrial Training Institutes (ITI), 24 private IndustrialTraining Centres, and 112 Vocational Training Centres. However, this streamhas not found favor with students: the share o f students entering technical education is small inthe state, with most students preferring tojoin the general academic stream. Only 12 percent o f students entering higher education chose technical education in2002-and this share declined to under 8 percent in2003-04, lower than the national average o f almost 11percent. It i s important to keep inmind, however, that ifthe state develops its naturalresources and comparative advantages, for example, intourism and hydropower, it i s likely that shortages o f specific, related s h l l s will emerge inthe future. Without a proactive strategy to develop an appropriately shlled labor force, economic growth o f the state can also be compromised. 14. The state presently lacks hard data to estimate where the s h l l mismatches are or forecast where they may arise inthe future. This i s an area where further analysis i s required. There is, however, anecdotal evidence that, other than the s h l l s gap, there are other "mismatches" which needto be factored in: (i) many o f the newjobs created inthe developingindustrial belt bordering Punjab and Haryanarequirerelatively low level shlls, and the educated youth o f HP are unwillingto take up thesejobs while employers can also fill these positions more cheaply by migrant labor from outside the state; and (ii) poor infrastructure facilities and living conditions inthe industrial belts may be deterring native Himachalis from migrating to these areas insearch of employment. 15. The first is the mismatchbetween industryrequirements and workers' expectations. As noted earlier, industryfinds it easier to hire and train secondary pass-outs, andthe demand for more qualifiednon-technical graduate andpost-graduates i s limited. Discussions indicate that educated youth o f HP are unwillingto take up thesejobs. This i s consistent with the experience elsewhere inIndia, that the "organized" sector-which offers better pay andjob security-is the sector o f choice for better educated Withinthe organized sector, the public sector i s the dominant provider of employment. In2001, 0.3 1million workers, or more than 10 percent o f the workforce were employed inthe organized sector, but only about 48,000 o f these were inthe private sector.44 Inpart, the highdependence on the public sector itselfmay be a response o f a well-educated workforce whose expectation interms o f employment are increasing, but where the current industrialization pattern inthe economy has not been able to generate enough suitable private sectorjobs to meet their aspirations. For many, migration out o f the state i s a better option. As per the 2001 census, about 0.4 million people-r about 6 percent o f the state's population-reported themselves as having moved out o f the state, o f 4'This is basedonfield visits, anddiscussionswithrepresentativesfrom53 industriesinHP. 42MinistryofFinance,GovernmentofIndia2005; Bank StaffEstimates 43Organizedsectorrefersto employmenteither inthe government, or inestablishmentsemployingmorethan 10persons. 44Nationally,7 percentofthe workforce is in organizedsector employment. 31 which more than a quarter had moved due to employment-related reasons.45 Employers too find that they can also fill positions more cheaply through migrant labor from outside the state. 16. The second mismatch i s betweenthe more populateddistricts o f the state (Kangra, Mandi, and Shimla), and those where new industrial unitsare coming up (Una, Bilaspur, Solan, and Sirmaur). Talung advantage o f the employment opportunities being generated here may require some Himachalis to migrate to these districts. However the poor infiastructure facilities and living conditions inthe industrial belts may be deterringnative Himachalis from migrating to these areas.46 Limited evidence for this comes from census data which shows that for inter-district migration o f Himachaliswithinthe state, against an average in-migration rate o f 5.4 percent for all HP districts, the combined in-migrationrate for the more industrializedborder districts was less than 5.1 percent.47 Infact, industryrepresentatives claim that they are unable to fill 70 percent o f theirjobs with local youth as per state policy because they do not find enough applicants for thesejobs. 17 Inorder to addressthe challenges inthis area, the following measures couldbe consideredbyGoKP. + The state proposes to undertake a study on skills mismatches and shortages inHP. This will be an important step, since the extent o f slull gaps and mismatches inthe state is unclear at present. This constrains evidence-based policy reforms. The study would include a skills-mapping exercise, to identify particular sectors which would emerge inthe near future, so that skill requirements could be projected. Based on ths, the state needs to come up with a slulls development strategy to bridge current and future skills shortages and skills mismatches-worked out inconsultation with industry, workers, and educators. + Going forward, a Labor Market Information System (LMIS) needs to be established to provide both the demand and supply side o f the labor market with timely information on slulls that are indemand or available for hire. An L M I S will improve the efficiency o f individuals' decision to invest intheir human capitalby enabling them to make education and training choices that have a more certain and larger pay-off inthe labor market. It will also aid the government innot spreading thinly scarce public resources but undertaking targeted interventions to correct for market failure or equity inthe labor market. + There could be greater public private cooperation inthe planning and operations o f technicalhocational education inthe state. The government has implementedthe IndustryManagement Committee (IMC) concept at the IndustrialTraining Institutes withprivate participation, but these Committees are severely restrained inthe extent o f delegation o f powers on key issues (recruitment, pay scales, and curriculum). GoHP i s cognizant o fthis and has engaged indialogue with the private sector. However speedier movement on key action items, such as updated online employment exchange, empowerment o f IMCs, mapping studies for required skills, etc. i s needed. Since this issue requires coordination amongst various government departments, a single champion must be designated and an inter-departmental coordinationmechanism should be institutedwith regular monitoring o fprogress. 4 The single window clearance system inHP has been ineffect for more than five years. The state proposes to initiate a study to evaluate the effectiveness o f business facilitation measures at the state and district level, including lessons learnt from single window systeminHPand other states. Findingsfrom the study would inform adoption or refinements inbusiness facilitation measures. `'Over halfthe migrantmale Himachalis had moved out o f the state in search o f employment. For women, however, the most important reason-accounting for over half o f female migration over the 1990s-was marriage-related. A field visit to the Baddi and Bilaspur industrial areashighlighted the lack o f suitable housing and sanitation and sewage facilities as major problems faced by workers inthe area. 47The border districts considered here are Solan, Sirmaur, Bilaspur, Una, and Kangra, which are more industrially developed as per Figure 3.1. 32 24. Giventhe state's fiscal situation, increasing localresource mobilization shouldreceive a strongpolicy attention. The first priority inthis regard would be the increase in beneficialy charges for services, especially economic services such as water supply. Alternative organizational and financial arrangements would have to be explored, not only for the services currently provided by local governments-but also by state governments such as roadtransport services, tourist services, etc. Organizational options shouldnot be limitedto public corporations, but include various forms ofpublicprivateparticipation. It could contributeto public financing sources rather than addingto liabilities. Other innovativefinancing measures could include accessing the capital market throughmunicipal bonds, and involvingcommunities inO&M. InstitutionalStrengthening 25. Policy instruments andinfrastructure investments will needto designed and implementedby various state and city level institutionswith adequate capacity. Due to the early stage o f urbanization, the state's urban management institutions are particularly weak. Inmany rapidly industrializing areas inthe lower areas, there i s no urban governance system inplace. Most existingtowns are hardpressed to provide minimal urban services and planning guidance, and their rapid growth i s making the situation increasingly tenuous. Strengthening the capacity o f local governments and service providers, and decentralization mechanisms needto be explored. 35 Figure4. I:E ntapped Potential in HFdropouer. but Good Outcottie\ ia Poncr C`onnecti\itv 4Cp3 estimated that, by the end of the Ele'vcntIa Plan, SOMC 43 percent of the p ~ ~ ~ e ncoutda he in opera~i~n. ~ i l Iowever, h ~ d r o p o ~d~cr e ~ l o ~ n ~ ethc~EIinialayas Involves c ~ ~ n s i ~risks, $and sttftes, ~ n ~ ~EXP~, hatei n ~ v in n ~ ~ ~ ~ e ' d a modest track record in the ~ ~ ~ ~ l eof~h e~ d~ r ~o ~projects~eonrotheir own. ~a~~~ n 2001-02 2302-03 2003-04 2004-05 2005-06 m 0 5 f 3 * ed if 11isntlt to have a as staffstrength of slig costs. 11faces an acute shortage (3 e ~ ~ o f e s s i oandltechnical skills needed to ~ a ~ ~ eof~ ~ n ~ s the sector and the c ~ a n hum ~ c~ ~ ~ ~ ~ ~ Itowill g ~ n ~hc~crrticalnfur the sector's efficient a ~ ~ . performance to carry out a humanresources need and slull assessment, and develophmplement a plan to meet the emergingnew sector structure and evolving business environment. + Itis importantto adopt a clear powertrading strategy, given that revenuesexpected from the sale o f hydroelectricity constitute a significant portion o f the state's plannedrevenue for years to come. As most o f the electricity will be sold outside the state, it will be important to adopt a strategy that will maximize for the state the benefits o fthis trade-based on an analysis o f actual and expected future market conditions, talunginto account expected dynamics o f supply and demand indifferent regions in India, especially inthe Northern Region. A useful first step for identifying the optimal strategy for HP would be to carry out a detailed assessment o fthe market, and the implications o f different trading strategies (e.g., takingan equity exposure inprojects, setting up a separate trading company distinct from HPSEB, going infor short term or long term contracts for sale o f power, meetingthe state's demand duringwinter months when there i s a deficit, etc.). + The biddingprocess for new hydropower projects i s not inconformity with national policy. The current practice i s o f financial loading on hydro projects through up-front biddingcharges, earmarlung a percentage of the project cost for local area development, and assessing an increasing level o frevenue as royalty from free power (for use o f the state's water resources), against the policy mandate o f going infor tariff-based competitivebidding. While this isthe essenceo fthe benefit ofhydropower development to the state, this approachneeds to be carefully evaluated interms o f the risk it could pose to the overall trading plans o f the state-given the large capacity addition beingplannedbypower- surplus states (north-eastem region, Uttaranchal, Orissa, West Bengal) and the ultra megaprojectsbeing plannedby GoI. These charges will inevitably putupwardpressure on tariffs for end-consumers and may make the projects less attractive or difficult to finance. The current practice o f awarding potential hydro projects on the basis o f upfront charges could be revised to tariff-based competitive bidding, in line with the national policy. GoHP has recently set up a new generationcompany,the Himachal Power Corporation, to undertake implementation o fhydropower projects inthe state to operate inthe manner o f the central public sector power corporations. Ithas been proposedthat a number o fnew projects that hadbeen either earlier allocated or are still unallocated be transferred to this new entity. This new approach can have significant implications for the state on account of: (i) possible crowdingout o f funding for priority sectors with the state's resources getting tied up for contributionto equity or raising debt for development o fthe new hydropower projects; (ii) limited resources and capacity o f the state to undertake the new projects, thereby slowing the pace o f hydro development; and (iii) the possible need for GoHP to bear the off-take andpricing risk for the power generated from these projects, especially considering the very competitive tariffs projected from the proposed coal-based ultra megaprojects which are easier to implement. It would be worthwhile for GoHP to strategically evaluate the risks involved under this model, incomparison with the corresponding benefits depending on the different approaches that are possible. 8. Ofparticular importance i s the needto exploit the state's hydropower resources ina sustainable manner. Injudicious exploitation o fthese resources could have implications for the future availability o fhydropower resources, for the societies and communities affected by hydropower development, and for the wider environment. This critical aspect o f hydropower development i s discussed subsequently." B. PromotingHighValue-Added Cultivation inAgriculture andAllied Sectors 9. The agricultural sector faces several challenges. The average holding size i s about 1.2 hectares, which i s about 80 percent o f the national average holding size, with over 92 percent o f holdings classified as small or '*SeeChapter 7. 39 restructured "HP Agncultural and Horticultural Produce Marketing (Development and Regulation) Act 2005" The state has taken several important steps to encourage private participation inpost-harvest a ~ t i v i t i e s . ~ ~ 13. The Department o f AnimalHusbandryhas a policy to support natural breeding for remote areas, and has started providing door-step delivery o f Artificial Inseminationat subsidizedprices from 2003. Inaddition, the department i s providing veterinary services through a network o f 2,070 veterinary institutions, which include 7 polyclinics, 328 veterinary hospitals and dispensaries, 14mobile veterinary dispensaries, and 1,721 veterinary dispensaries. The HP LivestockDevelopment Boardhas been set up to improve the animal husbandry services inthe state, while Hp MILKFEDis operating dairy development activitiesinthe state byproviding remunerative outlet for surplus milk. Strategic OptionstoAchieve the Vision 14. The state needs to take steps to energize this sector, especially given its importance as a source o f livelihood for poor rural communities. This will require close collaborationwith the private sector inpost- harvesting activities, and improving the infrastructural requirements for the sector-especially inthe form o f irrigation and rural access. Government may consider the followingmeasures. + While not enormously important infiscal terms, it i s important to rationalizesubsidiesprovided through the departments o fAgriculture and Horticulture according to the principles of: (i) discontinuing or drastically reducing subsidies on traditional practices to free up funds for proposed new activities such as diversification, value addition, grading, packaging, processing, and marketing;55(ii) malung subsidies sustainable, possibly through one-time support for new activities; (iii) enhancing consistency between strategy and state policy, by, for example, reducing subsidies on fertilizer and pesticides where organic farming i s encouraged, and freeing funds for the use o f bio-fertilizers, bio-pesticides, and Integrated Pest Management; and (iv) improving targeting o f subsidies to poor and marginal farmers by identifying activities generally undertaken by them. Inthe animal husbandry sector, the subsidies on medicines for curative measures should be dispensed with, and finds used more vigorously for protective measures against possible outbreaks and community activities-such as de-worming. + The state shouldre-examine its landpolicyto facilitate cultivation o fland on a lease basis. At present, the owners keep agncultural land fallow instead o f giving it on lease due to fear of losing ownership. + Inorder to modernizeextensionservices,the state could consider stepstowards: (i) malung better use o fNGOs and farmer associations for training; (ii) organizingrefresher courses for staffto orient them to the needs required to implement the state strategy, and utilizing the services o fthe two universities at Nauni and Palampur to effectively train the trainers; (iii) developing slulls inmodem communication, by effectively usingmass media; and (iv) makingthe best use o f available staffthrough a multidisciplinary approach wherein competent andtrained staff services are used exclusively for technological dissemination. Under the present extension system, inagnculture inparticular, there are vacancies at the grass-roots levels, and this makes reorganization o f the systemparticularly i m p ~ r t a n t . ~ ~ The Departmento f Horticulture should also upgrade the capacity and skdls o f its staff under the 54 Recognizedlargeestablishmentslike the Adani Group andothershave establishedControlledAtmosphericStoragesinthe state. Storage capacity of 18,000 tons hasalreadybeenestablishedby theprivateagenciesandhas startedworking fromthe current year. This i s over andabove the efforts of organizations likeHimachalPradeshMarketingCooperation(HPMC) andAgro IndustrialPackaging IndiaLimited (AIPIL). 55 There are nomoresubsidiesby the Departmentof Agricultureon pesticides, and the fertilizer subsidy is reducedto Rs 1O/bag for every farmer. 9o Underthe presentextension system, the grass-rootlevel extensionworkers are Agricultural ExtensionOfficers(AEOs) with eight in eachblock. Sincethere are 50 percentvacanciesthere exists about 4 AEOs ineach block, covering 10to 12 GramPanchayats(30 to 40 villages). Added to this, each AEO has to performseveralother activitiesrelatedto inputsupply andimplementationof other schemes. 41 HorticulturalTechnologicalMission's scheme, through stronger efforts inthis dire~tion.~'For animal husbandry activities, there is one extension representative on average for 1-2 GPs. The number should be reduced, while alternatives like para-vetenarians are trained, and the capacity and quality o f existing staff improvedthrough refi-esher courses, modemtechnologies, and upgrading communication sk~lls.~* + Despite steps to improve post-harvest processing and marketing, results are still not visible for perishable products like vegetables and flowers cultivated by small farmers. There is a clear understandinginthe Department o f Horticulture that only private agencies can effectively take up processing, value addition, andmarketing o fproduce-and this is also the policy o f the state. A detailed critical study could be conducted to identify the constraints inproductiono f highvalue crops (especially medicinal and aromatic plants), and inhibitions o f the private agencies intalung up the processing and marketing should be addressed based on study findings. The Departmento f Agnculture also has a strategy to facilitate marketing, but this i s not adequately reflected inthe 2006-07budget." + The state can invest inresearch to improve productivity. The universities could particularly help in getting the quality planting material-especially exotic patented germplasm-to improve horticultural production. Inanimal husbandry, there is shortage o f quality pedigree bulls for Jersey and Holstein cows, and also for Murrah Buffalorequired for cross breeding. This should be resolvedby acquiring highquality animals tobemaintainedandmultiplied at the University researchfarms, andmodem establishmentsinPalampur and Nalagarh should be effectively utilized for this purpose. + Diversificationo fhorticulture inthe state i s currently largely confinedto apples, even though there is potentialto expand more aggressively into other fruits and vegetables. Hence, it i s important to look effectively beyond fruits-in particular, apples, which may soon be overwhelmedby Chinese production. l l u s requires more effort across the spectrum, from production(identification o f crop, availability o f quality seedplanting material, and packagingpractices) to processing and marketing (through private agencies). + The state already has several thousand farmers who have been certified as organic producers by three agencies. Inorder for more farmers to get an attractive price for organic horticultural produce, the state should extend promotion o f organic certification, and could offset some o f the up-front costs (certification as well as compensation for low yields) normally associated with converting to organic production. . + Sectoral policies should be harmonized across the state, and not be basedon projects/programmes funded by specific agencies. Activities are often uncoordinated across Go1and donor-funded schemes, and attempts could be made to adjust to the need o f the state andthe state policies.60 The recently established, "Natural Resource Management Society" under the chairmanship the ChiefMinister as a part o f the World Bank-financed "Mid-Himalayan Watershed DevelopmentProject" could provide an ''Horticulturegotan importantboostwith the commencement of the Horticultural TechnologicalMission in2003-04, with avision towards privatization,diversification,value addition,marketing, organic farming, technologicalinnovations,andimprovedproductivity. 92The departmentofAnimal Husbandrycontinues to subsidize the cost of artificial insemination(AI). The pricewas raisedfrom Rs 5 to 15per A I incompliance ofthe commitment undertheBank-financedwatershedproject. Lookingto the successful door-stepdelivery which cost an additionalRs35 to 40 per AI, it canbe saidthat the farmers are willing to pay for good andtimely services. This service is presentlyprovidedby the VeterinaryPharmicistsworkingwith the veterinarydoctors. Ifthey are providedwith sufficienttraining they can also providethe healthservices. This makes astrongcase for identifying andtraining the village youth to work as para-vets(not as governmentemployees)under the supervision ofthe veterinarydoctors. A similar approachcan be followed for providing bulls for naturalbreedingto the communityonnominalpricemaintainedby an individual/communityby chargingfor service andunder the supervisiono f the veterinarydoctor. 59The departmentexplainsthat the infrastructuredevelopment for marketingi s largelytaken care ofby, first, marketingboardswhich collect the marketingfees for theproduceand, second, to some extentbythe Governmentof Indiaschemes. However,this doesnot meet thebasic strategic needfor facilitating theprocessinganddevelopingmarketinglinkagesto thevalue-addedproducts. 60Suchflexibility already existsto some extent inthe Horticultural TechnologicalMissionprogrammesbutother examples are rare. 42 4 33 + User charges, which are among the lowest inthe country and cover only about 2.3 percent o frequired O&M expenditures, haveto be increaseddespite expectedpopular resistance, through: (i) accepting in principlethat O&M cost recovery has to be met through service charges; and (ii) gradually increasing costs through advance announced amounts to reach full cost recovery level. + The Department o fIPHis overstaffed, with 30,704 staff (including 3,823 permanent). Most o fthese staff are underutilized; two-thirds o fthe non-regular staff are "key men" who are paidto turn &dung water taps on and off. The state could gradually reduce staff strength, and hand over the responsibility o f O&M to Gram Panchayats or communities. IPHi s consideringadding a maintenance function to the responsibilities o fthe key men, which would increase their cost effectiveness. + The state has already announced a participatorystrategy involvingbeneficiaries and GPs to participate inplanningandexecution ofthe irrigationand drinkingwater schemes. Thiscouldbepracticedfor all new projects wherein the government provides technical and one-time financial support to the GPs or beneficiaries to develop their own water resources. + The IPHDepartment intends to adopt a multidisciplinary approach, to develop and utilize the water resources with representation from other departments like Agriculture, Health, Rural Development, Power, and Forestry. This would help foster coordination, learn from best practices, and avoid unnecessary duplication. C. Developing the State's Tourism Potential 19. Tourism is an important labor-intensive sector where the state has potential due to its environmental, climatic, and naturalheritage. Given that it offers visitors excellent exposure to temperate forests, HP can be an ideal area for activities like treklung, safaris, rock climbing, nature walk, angling, camping, etc.-thus signifyingthe possibilitieso fnature tourism, eco tourism, and adventure tourism. GoHP specifically recognizes that tourism i s a sector that can prove vital to the state's long term growth and employmentprospects-largely on account o ftourism being a labor intensive sector where HP has immense potential on account o fits environmental, climatic, and natural heritage. The sector also has the potential to absorb educated workers- Planning Commission estimates show that an investment o f Rs. 10 lakh intourism creates 47 jobs, making it particularly important inthe context o f HP's stated objective o f creating productive work opportunities for educatedworkers. 20. Inspite o fthese advantages, the sector's performance leavessomething to be desired. Recentgrowth rates calculations show that the sector has been growing at an annual rate o f about 6.3 percent since 1993-94- which is slower than the sector's national growth rate o f almost 8 percent. Even though HP i s one o fthe few Indian statesreceiving tourist inflows per year greater than its total populationo f 6 million, this contributes a small share o f tourists to India (Figure 4.6). Moreover, the state faces challenges interms o f attracting high-end tourists and providing themwith experiences to rival international destinations. Intakes are confined largely to low-end and domestic tourism, while foreign tourists account for only 3.1 percent o f annual intake. This i s better than the national average o f 2.3 percent foreign tourists in2004, but states like Kerala have achieved higher shares o f foreign tourists like 5.6 percent. Domestic tourists tend to spend a lot less than foreign tourists-suggesting that attracting foreign travelers may be one way o f increasing sectoral revenues. According to a 2003 study, the average per capita expenditure by a domestic tourist, in HP, for a 3-day stay i s Rs.4988 while the corresponding figure for a foreign tourist is Rs. 11318. Interms o fcontribution to GSDP, the trade, hotels, and restaurants sub-sector related to tourism contributes about 8.5 percent o f GSDP at present. On a per-arrivalbasis, this contributionworks out to be lower inHPthan nationally, inmore developed states like Kerala and Tamil Nadu, and insmall countries which have worked on developingtheir tourismpotential- lending credence to the theory that tourism inthe state i s largely low-value (Figure 4.6). However, HP is doing better than other hill states like Uttaranchal-where the sub-sector contributes only about 6.6 percent o f GSDP, and about Rs. 1039 per tourist annually, and foreign tourists are only about 0.5 percent o f annual inflows. 44 'S 015 pcrccnr by 20 has some good thinlungand the right statements o f intent. It focuses on developing better inter-sectoral coordination, upgrading infrastructure facilities, marketing HP effectively as an attractive tourist destination, investingintraining for tourism services, and promoting activity-based tourism. Inparticular, the Policy recognizes the needto promote the private sector, and strengthentourism inan environmentally sustainable manner. However, implementationis behind schedule-and the Policy needs to clearly define financial targets, achievement targets, and modes o f financing. 24. GoHP has taken steps to improve eco-tourism. Eco-tourismprojects are located on forest landunder the Department o f Forests, which has already formulated an Eco-tourismPolicy inconsultation with the Department o f Tourism-with a view to developing eco-tourism inan ecologically sustainable way. Eco- tourism societies havebeen established on a Community Based Eco-Tourism (CBET)basis to cover the Greater HimalayanNational Park (Kullu), Himalayan Nature Park (Shimla), Potter's HillVan Vihar (Shimla), Renuka Wildlife Sanctuary (Sirmour). Further development o feco-tourism sites-along with private parties-in an environmentally sustainable manner (including charging fees for maintenance) are part o f GoHP's longer term plans. GoHP already charges a "green fee" from tourists to Manali. It plans to introduce this inother tourist destinations, and use the h d s so collectedfor environmental conservation activities inecologically vulnerable tourist areas. 25. A multi-departmental HP TourismDevelopment Board (HPTDB)hasbeen set upunderthe chairmanship o fthe ChiefMinister, to promote the sector-and it was operationalized in2005 with a view to minimizing bureaucratic hurdles intourism development. The HPTDBi s supposed to formulate policy guidelines for tourism development, and advise GoHP on matters relating to regulation and licensing. The Tourism Policy recognizes that tourism development inHP is under-funded relative to other states, but better coordination and integration among departments including Public Works, Transport, h g a t i o n and Public Health, Power, Forests, Environment, Urban Development, and Town and Country Planning-which can contribute to better infrastructure and civic amenities-will help tourism development. The state hopes to achieve this through the HPTDB, which has representation from various line departments. 26. Intheareaofregulationandclearances,inorder tominimizebureaucraticdelaysfortheprivatesector, GoHP has introduced single window clearance for tourismprojects. However, the system has to be made more efficient to attract more investment. The HP Registration Tourist Trade Act was passed in2002, inorder to allow for checking and inspecting hotels and travel agencies against over-charging or substandard services. GoHP also plans to promote tourism through strengthening the capacity o f Hotel Associations to conduct inspections, classifyingtourist unitsby facilities provided to ensure value for money to tourists, and strengthening Tourist Police by training 500 police and home guards intourism-related matters like safety for tourists. The major development inthe state's tourism sector during2005-06 i s the approval of the largest ForeignDirect Investment project inthe tourism sector inIndia, worth $135 million, to develop the Himalayan Ski Village Project near Manali, with a total project cost $300 million. This project is expected to be implementedduringthe next three years, and once operational in2009, i s projectedto yield GoHP about Rs.1.O- 1.2billion inrevenues over the next 10year period. 27. Recent steps have been taken to improve air connectivity. The airports at Shimla, Dharamshala, Patahankot, and Kulluare not well-connected to other Indiancities, and can take ATR 42 aircraft. There are 56 helipads inthe states, but they are not used for regular commercial services. Moreover, travel time from Delhi to Singapore or Bangkok i s half o f that requiredto reach Shimla by surface transport. Inorder to overcome this constraint, the government i s loolung to improve air connectivity. The Airlines Authority o f India has opened the expanded runway and new terminal o fKangra Alrport at Dharamshala, and Air Deccan (a major domestic airline) has operated its first flight inApril, 2007. The runway o fthe KulluAirport is to be expanded by buildinga bridge on ariver near the terminal, andconnecting it to the runway. An airport is plannedat Mandi. Since expansion o f airports are a mediumterm option requiringfinancial resources, encouraging regular helicopter and chartered flights-especially inconjunction with major private hotel chains-are also part o f GoHP's plan to improve accessibility. 47 I Box 4.1: Kerala's Approach to Tourism Development I Keralahasbeenthe most successfulstate inIndiainpositioningitselfcompetitively inthe internationaltourist market. In2003, it recordedIndia's highest growth ininternationaltourist arrivalsat almost27 percent overthepreviousyear, and an averageinternational traveler staysinthe state about 14daysper visit. It is importantto learn fromthe experience of India's only "tourism super brand" state, which hasbeenlistedbyNationalGeographicTraveleras one ofthe fifty destinationsfor alifetime. The state announceda comprehensiveTourismPolicy in 1995, after which tourismtook off inamajor way inKerala. The state focused onthe "Six S" frameworkofIndia's NationalTourismPolicy: (i) swagat,or hospitality, including facilitation on arrival andmemorable experience;(ii) soochna,or information, includingmarketingandpromotion, tour operators, andinformationdissemination; (iii) suvidha, es, includingaccommodation, amenities,hygiene, andconveniences; (iv) suraksha, or security, includingtourist safety and environmentmanagement; (v) sahyog, or cooperation, includingquality control andassurance; and (vi) sanrachna, or infrastructure, includingtourismproductdevelopment, and coreandlinkageinfrastructure. A recentsurveyoftouristsby CRISIL InfrastructureAdvisory Servicesshowsthat all touristsrateKeralaas "Very Good"or "Excellent" alongthe Six Ss oftourismdevelopment, and 100percentwantedto revisit Keralaandrecommenditto their relativeandfriends as a tourist destination. The keyingredientsin Kerala's successhavebeento buildtourismon core and naturallyavailableresources,createadistinctbrand image, competeinternationallyratherthan locally, providestrongpolitical support andprofessionaladministrationoftourism developmentprogrammes, and givethe privatesector space to grow. The statehasalso investedstrategicallyincore and linkage infrastructure, andhasmade effortsto buildacritical mass oftourismworkersthroughappropriatetrainingand capacitybuilding. Policy OptionstoImproveSectoral Performance 28. Going forward inthe tourism sector, GoHP might consider the following options that would help realize the potential from the sector. + The state needs to activate the HP Tourism DevelopmentBoard (HPTDB)that has recently been establishedunder the chairmanship o f the ChiefMinister as a forum for a more strategic approach to tourism development inthe state. The HPTDBcould go a long way towards improving inter- departmental coordination. The outcome indicatorso f the HPTDBshould be clearly established, with extensive participation o f the non-government entities inthisprocess. + Inpartnership withthe private sector, HPneeds torevampits marketing andbranding strategy of promoting itselfas an up-market tourist destination. The State Tourism Policy, 2005, has identified a number o f thrust areas ineco-tourism, pilgnmtourism, and adventure tourism which holdtremendous promise inHP. The state could be projected as an attractive upscale destination for health tourism (spas, healthresorts, recuperative centres) and business (conferences and retreats). + The state must encourage the private sector to develop upscale resorts across HP. GoHP needs to facilitate the development o f some high-profile projectsby the private sector ineach o fthe thrust areas, to be implemented ina time-bound manner. Foreign and domestic investors could be encouraged to set uphigh-endhealthresorts, spas, ski resorts and entertainment parks-preferably as part o f international chains. Door-to-door tourist packages that handle all logistics, and better standardization and certification regimes for players inthe tourism industrycould also help the sector. + The state could consider disinvesting select properties of HPTDC,especially those where the private sector is interested. It i s importantto work out a strategy for the heavy loss-mahng properties, including closure/sale/lease to the private sector. Resources from privatization could be utilized to upgrade the facilities at the lesser known destinations which are economically viable. A study to assess the profitability and prospects o f HPTDCproperties could be undertaken leadingto the development o f a time bound action plan. 48 + The airports at Bhuntar (Kullu) and Jubbal (Shimla) mustbe developed on a priority basis to address the issue o f air connectivity. Instead o f spreading scarce resources thinly on upgradation of various airports/airstrips inHP, the state must focus on improving the landing and other facilities at these two airports, and set up a time-bound implementationprogramme. This will require creating fiscal resources, but would be a valuable long term investment. A first step towards this would be initiation o f feasibility studies to cover technical and financial aspects, and to identify viability and sustainability. 49 Chapter 5 Promotingthe InstitutionalEnvironmentfor InclusiveGrowth 1. HimachalPradeshhas many achievements to its credit: rapid improvements inhuman development indicators over time, a tradition o f openness ingovernment, and relatively low levels o f corruption. Yet, the state faces major challenges like overstaffing, politicization ofrecruitment and transfers, and a slow pace o f decentralization. Developinga coherent strategy to address these challenges i s an important element in sustainingthe state's positive past record inhuman development. Inaddition, governance reforms could have particularbenefits interms o f assisting the fiscal recovery. 2. Despite objective indicatorsthat are better than national averages, a recent assessment o f user perceptions suggests that public service delivery inHP could be strengthened further. Combining data on access to, reliability of, and satisfaction with public delivery o f drinkingwater, health care, the Public Distribution System (PDS), primary education, and transport services, the survey ranks HP seventh among sixteen states (Figure 5.1). Though this i s a perception survey, it indicates that, inthe eyes o f HP's residents, muchmore couldbe done to improve the quality ofpublic services. Bridgingthis perceptiongap could also help garner public support for any political party seeking to win state elections.64 Figure 5.1: Relative Ranking of Public Service Delivery inIndian States, 2003 14 Statesare ranked based onperceivedquality of delivery,with a lower number indicr ing a bei rank. DrinkingWater Health Transport PDS Education Overall 0 1 - TN TN TN 2 - TN AP 3 - 4 - 8 AP 5 - 0 KR 8AP 8 - 0 KR 7 - Y UP +HP 8 - 0 KR g - In UP 10 - 81 PJ 11 - Y PJ 12 - RJ eRJ 8 BH 8 BH A OR 13 - A OR 14 - 8BH m UP 15 - A OR RJ 16 - 8 W 8 BH BH Key PerceivedCauses of Dissatisfaction withSpecijicServicesin HP Drinking Water Health Transoort PDS Educatwn Only 12% and 18% Almosthalfrespondents About 15%respondentswere Only 6% were satisfiedwith Only 34% ofrespondents respondentswere fully reportedproblemswith happywth thepunctualityof qualityand quantityof grain were satisfied with the satisfied with adequacy accessto public healthcare bus services, and 12% and provided, 11%were satisfied qualityofinfixstructurein and qualityofpiped facilities, andonly about 14% respectively were withreliability,andless than schools, andaccess was water, and20%reported 10%reportedfull satisfied with the frequency of halftheruralrespondents reportedlyan issuefor a access problemsand satisfactionwithbehavior the serviceandthe behaviorof were satisfiedwith accessto quarter ofrural frequent breakdownsin ofdoctors andmedical conductorsand drivers on the PDS supplies. respondents. SUDDlV .. < staff at facilities. buses Notes: Based on Samuel Paul, et. al. (2003). Inany case, surveys based on long-runoutcome indicators tendto reflect a state's past achievements far morethanany current efforts to strengthen public services. ...."........................... ...... Ratio t.73 1.31 I .so I.56 1.04 2.20 2.12 5. Analysis suggests that the growing fiscal burden from overstaffinghas largely been the result of: (i) periodic regularization drives, where regularizedemployees had to be paid as per standardpay scales, while new hiringo fnon-regular staff to replace those regularizedadded to the government's fiscal load and created a new pool o f employees who would inevitably be regularizedindue course; (ii) the historic linking of HP's civil servicepay-scales to those of Punjab, which paid its civil servants more than Go1and other states, such as Haryana. Regardless o fthe reasons behindHP's burgeoning civil service, the fact remains that the state can no longer afford the resultingwage andpensionbill, amountingto 50 percent o fthe state's revenue receipts, thus crowding out muchneeded capital and non-wage O&M expenditures. Trimming the size of the civil service i s thus a key challenge for the state, and experiences from other states could be a useful guide (Box 5.1). Box 5.1: Wage and HiringRestraint to Control the Size ofthe CivilService Wage Bill TargetedretrenchmentinIndiahas failed as a tool to reduce the size ofthe civil service. Some states, such as Orissa and Kamataka, and Go1haveoffered civil servants voluntary retirement packagesbutthere havebeenfew takers. Goa is the only state that has actually succeededinretrenching the civil service. Some 2,000 civil servants inGoa(five percent ofthe civiI service) havetaken advantage ofan early retirement programme. The majority was over 55 years inage andabout40-45 percenthasbeenreplacedbyyounger employees. Sucha scheme is likely to generateonly very limited fiscal savings. Ineffect, statescan only control the size o fthe civil servicethrough attrition andthis necessarilyinvolves enforcinghiring andwage restraint to beeffective. AP's core civil service, for example, is estimatedto havedeclined by anannual average of 2-4 percentbetween2002 and2005 as a result of such restraint. As a percentage of GSDP, salariesinAP are estimated to havefallen from5.5 percent in2000-01 to 5 percent in2002-03, and are expectedto fall further to 4 percentin2006-07. IfHPcanenforceapolicy ofzero net hiring and limit salaryincreasesto the rate ofinflation, then the fiscal costs o f a laree civil servicecanbecontainedsuccessfullv. 6. Inorder torestrainthe growth o fthe civil service, GoHP couldconsider takingthe followingmulti- pronged approach. + Enforce a strict ban on the hiringo fnon-regular staff, especially work-charged and part-time workers inIPH,PWD,andHPSEB, and curbregularizations.66 + Develop a humanresource database to track all GoHP employees more systematically, audit muster rolls, and weed out ghost-workers. + Identify redundant postsby conducting functional reviews inmajor departments: (i) assessing whether current staffingpatterns exceed establishednorms; (ii) revise existing norms to take into account technological improvements andrevise staffing norms accordingly; and (iii) identify posts that could be outsourced to the private sector. + Identify vacant posts across government and abolish all posts that are both vacant and surplus. + Develop an outsourcing policy for government and allow outsourcing inseveral areas, such as the provision o f security, gardening, cleaning, and driving. + Examine avenues for redeployment by: (i) creating a surplus pool ingovernment; (ii) surplus training staff for redeployment inother departments or employment inthe private sector; and (iii) amending cadre rules to allow greater flexibility inredeployment across cadres. + Implement a Voluntary Retirement Scheme for government employees who wish to leave government service, especially inPSEs, and enforce compulsoryretirement provisions inthe All India Service Rules to remove inefficient staff from service. + Accelerate the process o f hiringcontract staff-in education and health-under the supervision o f Panchayati Raj Institutions(PRIs) to reduce the fiscal burden on the state. 66 In2005-06 alone, some 22,597 work-charged posts were regularized inPWD and 16,127 inIPH. 52 7. Itwill alsobe importantto take measures to decouplepay-scales inHPfrom those o fPunjab, given the fact that Punjab has historically paid its civil servants more than GoI. Pay increases routinely approved in Punjab are automatically translated into pay increases for GoHP civil servants. The issue o f decouplingHP's pay-scales from Punjab i s a sensitive issue, but a start inthe right direction could be made by creating an HP Pay Commissionthat would, over time, chart an independent course for determining the state's salary structure. Rationalizing Government 8. The state needs to look at measures for administrative rationalization to facilitate effective policy- malung and coordinationina complex bureaucracy, and improving the workingo fthe secretariat. 9. First,there is anissueo firrational clustering of responsibilities. GoHPhas 11Ministers, 25 hncipal Secretaries and Secretaries, and 45 departments. This relatively small number o fMinisters, but large number o f departments, offers an opportunity to cluster departments along fimctional lines. While some portfolios have beenrationally assigned-for example, one Minister handles Revenue, Rural Development, and Panchayati Raj, all linked inone way or another to rural questions-other portfolios do not seem to have been assigned with a view to encouraging functional specialization or linkage.67 Thisjumble o f responsibilities i s repeated at the level o f Secretaries: one Principal Secretary, for example, handles both Revenue and Public Works; another handles Horticulture, Environment, Hydropower, and Biotechnology; another handles Information Technology and Labor. This confusion o fresponsibilities also occurs lower down the bureaucratic hierarchy. Reporting relationships also become more complex with some Secretaries reportingto several Ministers at one time. Accordingly, the state could consider clustering related departments at the level o fMinisters as well as Secretaries to provide for greater coordinationand linkage across related areas, more efficiency inpolicy- malung, and clearer reporting relationships. 10. Second, secretariat reforminthe area o f file movement i s an important priority. While GoHP has introduceda computerized file monitoring systemin2004, very few Secretaries and their officers are actually usingthe system to reduce delays and cut pendency. Section officers inparticular are not well trained inthe use o f computers. The use o fthe single-file system across government i s limited, with only RuralDevelopment and Panchayati Raj malung use o f that at present. GoHP could focus on the use o f change management tools to better equip staff for the wider use o f e-governance inthe Secretariat. GoHP could consider extending the use o f the single-file system across government. CurbingIrregular Recruitment and Improving Stability of Tenurefor CivilServants 11. Given the intense pressures on government to recruit, it i s not surprisingthat the process o f transfers and recruitmentappear to have become politicized, and irregularrecruitmentinPSEs and other avenues o f government employment has become an issue. This also affects the tenure o f civil servants intheir current positions. While GoHP has taken steps to improve the recruitment process-the Subordinate Selection Services Board, for example, can no longer destroy records after three months, as was the practice inthe past, and the Boardi s begmning to use Information Technology (IT) to enhance the transparency o f its functioning-it will be important to follow procedures to curb irregularrecruitment. Inthe small state, it i s relatively easy for constituents to contact their representativesto pushtheir case for transfers. The imposition o f a ban on transfers (lifted duringthe transfer season) has had a paradoxical effect: transfers are routinely routed through the ChiefMinister's office, thus undermining the authority o f Secretaries and HODS formally vested with the authority to transfer staff. At the mass level, politically-motivated transfers can leadto slull mismatches, shortages o f key staff in schools and PHCs, and fuel the growth o f corruption inthe state. While data on `mass' transfers was hardto come by, estimates indicate that some 14percent o f all Health Department staff were 67For example, one Minister handlesbothAnimalHusbandryand Housing,two departmentswhich bear little relationto one another. Another handlesExciseandTaxationas well as Town andCountryPlanning, while thePowerMinisteris alsoresponsiblefor Pollution Control, which clearlyraisesconflict-of-interestissues. 53 transferred inthe last year; Karnataka, incontrast, imposed a quantitative limit o f five percent on transfers across the board. There is no evidence to indicate that the three year minimumtenures establishedby HP's transfer policy for most posts are being followed.68 Nor are tenures for senior Indian Administrative Service (IAS) officers sufficiently stable to promote effective stewardship o f a department's reformprogramme. The average tenure (intheir current posts) o f Principal Secretaries and Secretaries inHP i s currently a mere 14 months; tenures for Deputy Commissioners are marginally better, at 17 months, but still well below the three- year minimumtenure set by HP's transfer policy.69 12. GoHP can improve tenurial stability for I A S officers by creating statutory committees to authorize transfers and postings for senior officers, including exceptions to the three year minimumtenure on the basis o f clearly definedreasons. Transfers o f senior I A S officers shouldbe closely monitoredthrough the creation o f a stability index to ensure that the average tenure o fthe I A S cadre as a whole inthe state does not fall below three years. These steps will also help prepare GoHP for the implementation o fnew All-India Service Rules establishing minimumlegal tenures for senior officers. At the level o f general transfers instaff-intensive departments, GoHP could consider the adoption o f a system o f formal counseling to allocate transfers and postings ina rational and objective fashion, while enforcing quantitative limits on the total numbers o ftransfers across the state (e.g., limitingaggregate transfers to only five percent o f civil service size). B. StrengtheningInstitutionsfor Transparency andAccountability 13. It is important to note that, while HP residents do not rank the state's services near the top relative to other states, they do not appear to view cormption as a major problem (Figure 5.3). HP i s one o fthe few states inIndiato have enactedlegislationto address corruptioninpublic service delivery providingjail terms and fines for officials and non-officials for a series o f offenses such as corruption inthe award and execution o f contracts, including contract splitting; manipulatingmuster rolls or measurement books; supplyingsub-standard goods to government; adulterating medicines or manipulating their purchase; charging illegal fees; lending to fictitious persons; maintaining false records; and absenting oneself from public duty." However, it i s important to maintainthis impressive performance inrestraining corruption, and further strengthen institutions o fpublic accountability. 14. The Right to Information(RTI)Act needs to be aggressively implemented. It has been inforce for almost a year, but usage o f the Act has been low and the State Information Commission has receivedonly 15 appeals since the Act came into effect, which is far lower than the appeals receivedinKarnataka, for example. All government departments arenowrequiredto release a large cache o finformationto the public, inorder to reduce the need for explicit requisitions. A recent study o f Education Department websites in27 states and 7 Union Territories along 37 dimensions ranked states on a "Duty to Publish"index, where HP was ranked only eighteenth (Figure 5.3)." Though several other states also perform poorly intheir publication requirements under the RTI, HP i s rankedbelow national averages inthis regard, and i s far behind other hillstates like Uttaranchal. This suggests that there i s considerable room to improve compliance. 15. L o w usage may reflect HP's tradition o f openness ingovernment resulting inmore information being available inthe public domain inthe first place, as well as the lack o f strong NGOs capable o f demanding the release o f sensitive information from the government. There are several ways to expand access to information inthe state. First,GoHP shouldstrictly implement the suo-motu provisionso fthe RTIAct releasingpro- actively informationrelating to development works to facilitate social audits by local institutions, for example. Employeesoftenwant transfers for avariety of reasons: some wish to bepostedto their homedistricts; otherswant to movefrom a rural district to an urbancentre; and still otherswant postingsto `coveted' positionsofferingopportunitiesfor rent-seeking, particularly indepartmentsthat dealwith taxationorpublic works (e.g., PWD andIPH). 69A senior IAS officer inHP is likely to enjoyabout the same truncatedtenure as one inPunjabor Jharkhand. 'OSee The HimachalPradeshPreventiono f Specific CorruptPracticesAct, 1983 for more on this. 71See 2006 ReportCard on RTIComplianceby State, conductedby the Centre for Civil Society, New Delhi, which constructsa37-point indexbasedon Section4 of the RTI, for the EducationDepartments. 54 strengthening, and GoHP should ensure that it has the last word on issues relating to the definition o f inter-operability standards, the use o fparticular software packages across government, and the right to monitor the quality and progress of initiatives undertaken by departments. + Second, priorities could be clarified further for the ITDepartment. There are currently 40-odd e- governance projects underway inthe state, and these could be sequencedbased on departmental capacity and need. Projects that could constitute the backbone o f a powerful e-governance pushfor the state could include the development o f a state wide area network, the development o f Integrated Citizen Services Kiosks, the computerization o f landrecords together with property registration, andthe application o f information technology to local government functions and augment its capacity to implement projects. + Third, there isneedto builddepartmentalownership, as the ITDepartment isnot ina positionto drive from the outside e-governance projects that belong inparticular departments. While departmental capacity for IT has been augmented by the appointment o fnodal officers under the Project E-Mission Team (PEMT) initiative, these officers are too junior to drive projects, and can only monitor them and offer technical solutions as necessary. Projects needto be drivenby senior officials with the support from the Secretary, and adequate political backing. + Fourth, e-governance cannot succeed without process re-engineering where necessary. Computerizing existingprocesses without simplifyingor restructuringthem yields few benefits for either the government or citizen^.'^ The focus should be on process re-engineering, rather thanjust information technology. + Fifth,public privatepartnerships (PPPs) are lackinginthis area, largely becauseprivate players are reluctant to invest as they see low volumes inIT initiatives given the state's low population density, althoughthis logic clearly does not hold true for the state's major urban centers at present. Wherever possible, PPPs should be the preferred mode o f implementingprojects, as it is a useful way o f mobilizing additional financial resources for a project, as well as new technical and managerial slulls. Privateparties can also be held to account more easily than public sector actors through service-level agreements (SLAs). C. PromotingDecentralizationto Improve Local Provision of Services 20. GoHP i s committed to the process o f decentralization. The latest Budget speech stresses the importance o f strengthening local-level accountability mechanisms by enhancing PRIcontrol over staff, such as teachers and para-medics, as well as strengthening PRIcapacity. It is likely that decentralization will help improve the quality o f service provision inHP, throughbetter community participation, as it has inother states (Box 5.3). Despite the government's stated commitment to decentralization, however, progress inthis area has been relatively slow. 21. Activating local government control over local providers is likely to result inimprovedperformance and spark more pressure on government to fill vacancies inschools and PHCs inremote areas. Strengthening PRIs can also help improve the capacity to monitor the execution o fprogrammes and schemes at the local-level. These are issues-along with improvingrevenuemobilization at the local level-that deserve serious policy attention as HP seeks to move towards second-generation reforms that focus less on access to public services and muchmore on their quality. 73Computerizing land records without verifying their accuracy, suppressing the use o f manual records, or effecting links to property registration is not likely to yield major benefits inthe long-run; nor will the computerization o f the RegistrationDepartment in the absence o f additional steps, such as the abolition o f the use of stamp paper, the creation o f a central valuation committee to hold district valuation committees accountable for their decisions, and possibly lower registration rates. 57 Box 5.3: CommunityParticipationinHospitalManagement M P ' s Rogi KalyanSamiti(RKS) representsacreativeadaptationto theproblemof excessivespendingon salaries. UnderRKS, district hospitalsare turnedover to the independentsocieties, which not only managehospitals, but havethe powerto levy user fees, solicit privatedonations, use vacant hospitallandto generatemorerevenue, andoutsource cleaningandother functions. RKS societiesconsist of importantplayers locally includingthe collector, MLAs, andNGOs. User fees collectedby RKS societiesare directedtowards funding maintenanceandthe cost ofpurchasingnew equipmentfor the state's oftendilapidatedhospitals. The first RKS society was introducedinIndoreby the collectorin 1995 to sustainimprovements after the massiveclean-upofthe city's MaharajYeshwant Rao Hospital launchedinthe wake ofthe outbreakofplague innearby Swat in 1994. M P ' s ChiefMinisterwas so impressedwiththe results that hedecidedto roll-out RKSto all healthfacilities inthe staterangingfrom district hospitalsto communityhealthcentersto primary healthcenters at one stroke. The RKSmodelispopularwith doctorsandst& becauseitmakesavailableequipmentthatmight not otherwisebeaffordablegiventhe high proportionofthebudget spent on salaries. By earmarkinguser fees for maintenanceand equipment, RKS societieshelpedimprovetheproductivity ofsalaryexpendituresbytoppingthemoffwith necessarynon-salary spending. Thepoor are exempted frompayinguserfees on the basisof self-identification, ratherthanany formal criteria. The central government's NationalHealthMissi the RKSmodelfor replicationacrossthe country. RKSs were introducedinHP inJune 20 chargeswere depositedinthetreasury. But withthe constitutionofRKSs, not only were the RKSs freeto set their own chargesbutthe amount so collectedwas put at their disposal. RKSs hadarepresentationfrombothgovernmentandthe civil society. However, in2003, the RKS was reconstitutedas the AspatalKalyan Committee, which hadonly officials as its members. Following recentrulingby the HighCourt, it is expectedthat the RKS will be revived. Inorder to developsuccessfulRKSs, thekey ingredientswould be: (i) civil societyrepresentationinthe Samities; (ii) reasonableuserchargesifdecidedbythe state government, or bythe Samities as perthe guidelinesofthe state government; (iii) autonomyto Samitieswith respecttouse ofthe amount collectedby way ofthese charges; and(iv) exemptionofthepoor from these charges, with this powerbevestedwiththe RKS. 58 looks 120% 86% 40% 0% Quality of Education 5. While learningoutcomes inthe state i s muchbetter than the average Indian state, the state still has some way to go to achieve good quality education. Inthe lower age-groups, for example, a 2005-06 survey finds that 19.5 percent o f students inthe age-group 6-14 years cannot read a small paragraph o f short sentences o f Grade 1 difficulty, and 36.6 percent o f the same age-group cannot read a story text with some long sentences o f Grade 2 diffi~ulty.~~ Inmathematics, 22percentofthe age-group cannot solve writtennumericalsumsthat requiretwo digit subtractions withborrowing, and44.9 percent cannot divide three digts by one digit. Quality o f secondary education inthe state i s also cause for concern. Evidence of this comes from the pass rates o f students sitting for secondary and higher secondary final examinations. In2002, pass rates were only 46 percent and 40 percent among students who took the secondary and higher secondary examinations respectively. Student preparedness inlower grades isparticularlypoor, andthis, inalllikelihood, affects overall learningachievements. 6. The quality o f education inbasic schoolingneeds to be improved. This requires paying more attention to student learninginthe lower grades, inparticular. Inorder to improve quality o f education, GoHP could look at two dimensions. ImprovingTeacher Training 7. An aspect that plausibly contributes to low learninglevels inlower grades is the quantity and quality o f teacher training. Educationexperts make the distinction between pre-service and in-service training, considering the latter to be more effective inhaving an impact on learning outcomes. InHP, about 98 percent o f all regular government school teachers and 81.1percent o fpara-teachers hadbasic qualifications in2005. However, 71.7 percent teachers inprimary schools and 56.9 percent o f teachers inupper primary schools received any in-service training inthe previous year.75 Accordingly, it i s important for the state to complete relevant in-service training, especially o fteachers inprimary grades. CurbingTeacher Absenteeism 8. Teacher absence is relatively highinthe state. A recent survey, infact, finds it to be only marginally lower than national averages, and only about halfthe teachers present were actually found to be involved in teaching-which i s a disturbingfinding (Figure 6.2). Figure6.2: Teacher Absenteeism inHP and Other States loo% 1I :-TeacherPresent I JH BH PJ AS UC CH UP AP AI WB RJ OR KN HR T N h KR MP GJ MH Notes: Kremer et al,. 2005,based on schools surveyed on a working day during working hours. ''Annual 74 Status of EducationReport, 2006, PRATHAM. Elementary EducationStateReportCards, 2005, NIEPA. 60 9. The state needs to consider measures to curb teacher absenteeism through a mixture o fmonitoring and incentive mechanisms (Box 6.1). Enhancing decentralization could be particularly valuable inthis context. GoHP should consider vesting PRIs with the power to hire and remove all new teachers, as well as halt salary disbursements for teachers who fail to teach, as a first step towards strengthening the quality o fpublic services at the local level. Box 6.1: Measuresto CurbTeacherAbsenteeisminOther States Various interventions, especially experimental, havebeenputinto placeto improve attendance o fteachers inschools. GoHP couldpilot similar measuresto improve teacher attendance. Insome schoolsinRajasthan,teacherswere gi tamper proof cameraand modestmonetary incentives to provide pictures ofthemselves and childrenat opening feachschoolday. Thisexperiment inimpersonalmonitoring reducedabsence ratesbyhalfand increasedthenu teachers with highattendancerecords intreatment schoolsvis-&-vis comparisonschools (Duflo andHanna,2005). ons are underway ina few statesin Indiawhereby teacher attendance is expectedto improve through greater ver serviceprovidersvia an educationinformation campaignintreatment villagesvis-&-vis no campaignincontrol villages (Pandey, forthcoming). Eventhough local communities andparentsthrough the PRIs and other local bodies suchas village educationcommittees(VEC) andparent teacher associations (PTA) havecontrol over school functioning inprinciple, inpractice such control is either weak and ineffectualor non-existent due also to lack of any information regardingentitlements and controls. Non-experimental initiatives are also being implemented insome Indianstates. For example, Orissa is considering acareer path for contractteachers similar to the tenuretrack systeminUS universities. The basis for teachers' promotionwill betheirperformance evaluation along anumber ofdimensions, including attendanceand students' learningachievement. The state has also authorized the VECs to certify teachers' attendancefor their salaryrelease. Partnership with the Private Sector 10. Partnership with the private sector can improve quality as well as free up fiscal resources. The government i s the key provider o f education, especially at lower levels. In2005,91.1 percent (compared to the all-India average o f 75.1 percent) o f children inthe age-group 6-14 years inthe rural areas o f HP went to government schools, and only 7.1 percent (compared to the all-India average o f 16.4 percent) went to private schools. The state realizes the importance o f the private sector inproviding higher and technical education in particular, and i s talung steps to partner with private parties. For example, the Pnvate Universities Act was passed in2006 to allow establishment and regulation o fhigher education institutions inthe private sector. GoHP i s loolung for private sector partners who can use the state's existing educational facilities to conduct technical and vocational courses that can improve employability o f the youth-with the private party to guarantee some minimumpercentage o fplacements for students who take the offered courses. Such innovative measures can reduce the burden on the government, and help improve marketability and employability o f educated youth. Basic Infrastructure 11. The state has done well indevelopingsome dimensions o f school infrastructure, but lags along other dimensions. Except for the thinly populated districts o f Kinnaur and Lahaul & Spiti, all other districts inHP have attained the norm o f a primary school located within a lulometer o f a habitation. About 86.4 percent o f all schools have a drinlungwater facility, and 5.2 percent o f primary schools and 11.7 percent o f upper primary schools are single classroom schools. At the same time, ina recent survey, only 3 percent o fpeople surveyed in the state expressed satisfaction withthe quality o f toilets ingovernment primary Inthe same survey, only 4 percent o f the respondents expressed satisfaction with the quality o f school buildings. About 35 percent schools inthe state have a common toilet and only 23 percent have a grls' toilet.77 Only 55 percent o fprimary 76 See Paul, et al. (2006). 77 ElementaryEducation, State Report Cards 2005, NIEPA. 61 school and 50 percent o f upper primary school classrooms are ingood condition. Accordingly, it i s important to upgrade infrastructure quality in schools, and this requires fiscal resources. B. Health 12. HPhas better healthindicators than many other states o f India, as discussed above.78 InHIV/AIDS, which is one o f the MDGs, the state falls inthe low prevalence category, since HNprevalence rate is less than five percent inhighrisk groups and less than one percent among antenatal women. The life expectancy o f 65.9 years inPi s higher than the national average o f 62.5 years." Public health spending inthe state i s higher than inmostother stateso fIndia. 13. However, there are some areas where the state needs to improve performance. Indicators such as IMR-which has actually risen slightly as per the latest National Family Health Survey figures-and MMR continue to be matters o f concern.80 Furthermore, inthe border belts adjoining Punjab and Haryana, the state has experienced adverse sex ratios. The hilly terrain o f HPposes special challenges. Diseases specific to the hilly region-such as chronic obstructive pulmonary disease (COPD), and other unintentional injuriedaccidents account for a relatively highshare o f the burden o f disease. 14. There are policy issues inthis sector around the composition o f manpower, infrastructure, and access to services for remote districts. Privateparticipationinthis sector i s low, as inother aspects o f service delivery. Accordingly, GoHP could look at the following areas inthe health sector. Human ResourcePlanning 15. A key issue for the HealthDepartment is humanresource planning. While there are nomajor issues at the lower slull end o fpersonnel, there i s a shortage o f specialists and qualified workers. InSeptember 2006, for example, over 10percent o f doctor's positions were lyingvacant. Retaining andposting qualified staff inrural remote areas i s also a challenge confionting the state. 16. There i s a needto ensure that adequate number o f sufficiently motivated and well-trained staff exists at the facility level. There may actuallybe a case for filling sanctioned specialist posts that are currently vacant in rural andremote areas, based on analysis o fneeds and availability. It i s also important to provide good training to the existing staff. While it may be difficult to post specialists at lower health facilities, general duty doctors can be impartedtraining inspecial skills. For example, Go1has short training modules for doctors inareas such as anesthesia. Health Infrastructure 17. The Health Department perceives infrastructure shortages inthe state. PHCs are currently not equipped to handle complicateddelivery cases, and the state sees an unmet need for labor rooms at PHCs, along with residential accommodation for trained personnel. There are some 800 PHC and sub-center facilities still to be constructed, currently functioning on rented premises or on space providedby Panchayats/Trusts, malung renovations difficult and impactingthe quality o f care. 18. HPis one o fthe focus states under the National RuralHealthMission (NRHM),which, among other things, providesfor upgradation andrenovationo fpublic healthinfrastructure upto Community HealthCenter (CHC) / First ReferralUnit(FRU) level. Although NRHMis evolving, the HealthDepartmentperceives some gaps which cannot be funded even under NRHM-like residential accommodations for medical officers and ''''Life See Chapter 1. expectancy figures pertain to the period 1998-2002. `OAlthough IMR inHP i s lower than the national average, pen-natal mortality, early neo-natal mortality and still birthrates inHP are almost as high as the national average. 62 6, Social Frutection 23. Thespen -poverty progrnmmesfrom the stable at low levels tn recent years, atjust over 0.5 percent of GSDP, The most ~ i s ~ ~f ~n a~~~~ isociale ~ r o t e ~ ~ ~ o ~ of r ~e spending in the state ts the highshare of ~ ~ p e n ~on~social r e ~ ~ ipensions for d e s ~ i ~elderly, ~ t e W ~ ~ O U ' S , and d ~ s a ~ l e d - ~ ha~i:c?untsfor a ~ ~ ~halfsof totat state s ~ e ~ i d i ningreccrit years, with spend in^ on p u ~ worksc a ~ o t ~ ~ a c ~ ~ s ~ ~for tano~her30 percent. n i n ~ 24. ~ r Q ~ r n m ~Q~~e 'ineHPi s~generally good, with a few cxeepttons. Basedon new survey data ~ ~ ~ e ~ # ~ ' earr~en~~r e ~ e ~section~of~heo ~ s ~ h o92dpercent of ~ o ~ ~ s earc r~ ~o el de ~~somenbenefit ~ n dat~ r t a ~ ~ ~ , ~ ~ i ~ least one of the ~ a i gn o ~ e ~soeiat ~c rn c~~ ~p ~~~ot ~~ ~o comparedmtoethe~a ~~ ~ - ~ average of about ~ ~ na ~ ~ n d ~ a ~ ~ ~ r e c ~ ~ uThe~coverage~of i n d i ~ ~ ad ~n a~~ i ~ ppr ~o ~~ r~aappears to be ~oiosc to the national a e ~ s . ` e~ ~~ ~ ~ e average for most p r o g r a ~ ~with e ~ ,the notable e ~ ~ ~ofpsocialipensions where coverage 1s s ~ c ~ ~ ~ ~ ~ ~ i ~ htgher (Table 6.1)$ The ~ ~of life ~~n s ~ r a~andetheeKtssanrcard in HP is higher than~in the rest o f fiidia, n ~ ~ ~ buthealthinsuran~ecoverage is very tow (Figure 6.4). the PRIsystemwhere hnctions will lie? As the trend inprogrammes i s towards greater roles for PRIs, HP, like other states, will needto develop its implementationstrategy withthis inmind. + There are concerns about the targeting of anti-povertyprograms, especially with respect to the large disparities between the distribution o f BPL households across the state betweenthe 1997 and 2002 BPL lists-the latter as yet to be officially approved. Reconciling these estimates ina way that is consistent with bothlocalpolitical economy demands andthe needto keep the aggregate number o fBPL households roughly constant (for the purposes o f fiscal allocations from the centre) will be challenging. + Poor record-keeping and the lack o f effective monitoring and evaluation make it difficult to assess the overall workmg and impact o f the various programmes. Despite apparently reasonable outcomes, basic record-keeping remains well below the level one would expect in a state o f HP's income level and low beneficiarynumbers.86 Inaddition, and incommon with many states o f India, there is no robust impact evaluation o fprogrammes which proceeds from a reliablepre-programme baseline or use o fbasic controYtreatment approaches to evaluation. HP can strengthen record-keeping and basic administration o fmajor social protectionprogrammes, identifying and introducinglessons from other states on simple administrative improvements (Box 6.2). For all major programmes, HP could initiate periodic impact evaluations which go beyond the concurrent ex-post evaluations presently undertaken. A first step in thiswouldbe ensuringreliablepre-programme baselineswhenever new interventionsare launched. Box 6.2: Findings from an Evaluationof SocialPensionSchemesinKarnataka The GovernmentofKarnataka(GoK) providesmonthly financial assistanceto the destitutethrough the Old Age Pension( O M )and DestituteWidow Pension(DWP) schemes. In2002-03, GoK paidout over Rs. 1billionto about amillion beneficiaries, each entitledto receiveastipend ofRs. 100permonth. At GoK's request, the Bankconductedan evaluationofthe scheme inorder to: (i) quantifythe extent ofleakages inpublic funds, inaggregate, andat variousstages ofimplementation; (ii) examinethe extent ofover- andunder- coverage, andeffectivenessoftargeting; and(iii) distortionsthat impedethe service delivery process. The assessment finds that identify socialpensionschemes inKarnatakahaveboth strengths andweaknesses. On leakages ofpublicfunds, the study finds that state-wideleakageis low. Ofevery Rs. 100that is spent onbeneficiarypayments(not includingthe costs of administeringthe programme), Rs 13 doesnot reachthe beneficiary. However, there are wide variationsacross taluks, with about 20percentofpublic resourcesnot reachingbeneficiariesinthe problemtaluks. To reduce leakage, aone time effort to deletefictitious pensionersis needed, backedby afew improvementsinthe TreasuryDepartment's databasemanagementsystemand monitoringsystemsto ensure that leakages do not creepback into the systemat alaterdate. On targeting,the study shows evidenceof "pro-poor'' targeting, with coverageratesunder socialpensionsfalling sharply as wealth and assetsincrease. However, the lack ofperfect targetingmeansthat coverageamongthe poorest ismuchless thanpossible. To improve targeting, eligibility criteriashouldberevisedandenforced. On the deliveryprocess,the studyfindsthat althoughawareness ofthe programsis high, transaction costsof applyingfor apensionare a deterrentto potentialbeneficiaries. Incontrast, oncepensionshavebeen sanctioned, the deliveryof benefitsworks smoothlywith minimal costs imposedon thebeneficiaries. There i s a lack of linkages between specific programmes and the broader rural livelihoods agenda o f the government. Challenges o f inter-departmental and public/private coordination make this difficult at times, but leveraging the resources o f the social protectioninterventions to enhance the impact o f other livelihoods interventions could have significant dividends. Facilitatingmarket linkages is particularly important inHP due to its mountainousterrain. 27. Inaddition, HP's incomeanddevelopment levelsalso suggest that itwill increasinglyface some new and important second generation issues insocial protectioninthe coming years. *'Thelatter concernarises due to the smallaverage GP size, with only about 1700to 3000 populationand inherentlylow capacity. 86This i s an importantweakness highlightedin boththe CAG andPEO reports on SGSY, IAY and PDS, which note the lack o f records ofhouses constructedor repairedunder IAY as well as the projectsunder SGSY. 66 + First, coverage o fsociul insurance remains very limited to date, with the notable exceptiono f life in~urance.~'The most pressingsocial needs appear to be for some form o f healtwdisability insurance, and old age security. Inaddition, improved crop and/or weather-based insurance may be increasingly important as HPexpands into higher value but higher riskproduction. Inboththe government and non- governmental sectors, HP, to date, lags other states inthe level of support and experimentation inefforts to expand social insurance coverage to the unorganized sector. While HP's fiscal situation suggests considerable caution on new commitments to insurance subsidization, the experiences o f other states with different forms o fnon-subsidized or low subsidy social insurance products (e.g. UnitTrust o f India's old age pensionplan, which operates without subsidy insettings as poor as Bihar;Maharashtra's Mathadi Worker's Fundwhich i s contribution-driven; West Bengal's Provident Fundfor Unorganized Workers, which has achieved significant coverage with a modest contribution subsidy), and o f the non- government sector offer useful models which may be worth piloting inHP." HP can initiate pilots on a scale and with models that control fiscal exposure on subsidies, while exploiting the conveningpower o f the government to bringpublic and private partners together. + A second area where HPis already expanding services butwhere a strategic vision isto date laclungis social cure servicesfor specific vulnerable groups. Initiatives which are already underway include old- age homes, houses for victims of domestic abuse, and orphans. These are areas where one would expect expansion in service provision as the population grows richer, demographic and lifestyle patterns change, and expectations from the populationevolve. To date, coverage is small scale, but one concern i s that responsibilities are being added ina somewhat piecemeal manner without a clear vision o f the state's expected future role-in particularthe optimal model o fpublidprivate mix infinancing and service provision-nor withamore immediateeye onthe staffingandresource demands implied. This can continue inthe short run,but, inthe medium term, would benefit from a policy-hven approach to expansion o f services which draws on the experiences o fthe non-governmental and private sectors. Accordingly, GoHP could consider development o f a social care service strategy for the state. Strategy development would be a useful process to develop consensus on the priority services for HP inthe medium term, and a sustainable financing and delivery strategy. A critical element on the delivery side will continue to be playedbythe private andNGO sectors, and they should be close partners in developingsuch a strategy. "AnalysisfromvariouspartsofIndia-including several which are muchpoorer than HP-suggests that demand for different forms o f social insurance i s significant among those inthe unorganized sector who presently have no coverage. ''Other states have taken group insurance policies with commercial insurers for specific groups for specified risks (e.g. Rajasthan with a group life insurance policy for all BPL; Assam with a group health and accident policy for all BPL). 67 Chapter 7 PromotingEnvironmentally SustainableDevelopment 1. Sustainability o f economic growth inHPi s contingent upon sustainability o f its environmental heritage. HP's key growth andrevenue drivers inthe medium term are critically dependent on the state's naturalresource base. While some environmental degradation inevitably accompanies growth, inaction or failure to balance the environmental costs o f development with the benefits will have particularly serious consequences for the state- whose opportunities lie insectors like horticulture, tourism, and hydropower which depend on the environment. Given HP's unique geographic situation and small resource base, protectingrichnatural resources assume greater importance than inother states. Inaddition, increasedpollution can have implications for the entire Indo-Gangetic plains. 2. HP's recent development pattern and trendhave had some worrying impacts on the environment. While forest cover has increasedinrecent years, the quality and density o fthe cover has diminished-as has the economic productivity, water holding capacity, and the ability to sustain species richness (Figure 7.1). Recent years have also witnessed risingpollution levels (Figure 7.l), withincrease inhumanandlivestockpopulation, pressures o f urbanizationand industrialization, and increasedhealthhazards. These disturbingtrends needto be addressed by GoHP. Figure7.1: RecentEnvironmentalDegradationinHP 232 - - 4.5 2o 1 g" !a SPMIO Concentration,uglm3(LHS) 16 4 22%- iG -A - 4.0 _m Y 9 224 - - 3.5 P- 0 g g 220- e - 3.0 E8 U .c CL Total ForestCover - 2.5 -+-DenseForests (CrownDensity> 40%) 2.0 1991 1993 1995 1997 1999 2001 2003 Notes: Forest data from DeoartmentofForests. GoHP. Pollutiondata from Central Pollution ControlBoard. 3. HPhas introduceda number o fcommendable new initiatives to address the growing threats to its fragile ecology, though there remain issues around implementation. These initiatives include: (i) broadeningthe State Pollution Control Board's (SPCB) regulatory role to include environmental auditing, micro/macro level environmental planningby which zoning atlases have been completed for five districts, the preparation o f district level industrial siting guidelines, and industrial estate planning studies; 89 (ii) establishment of a Special Area Development Authority to implement the approved notified development plans; (iii) implementation o f a ban on polythenebags o f certain dimensions with effect from June, 2004; and (iv) segregation o f non- biodegradable waste." The major concernremains the weak implementationo fregulations. There is an over- reliance on command and control regulations which are cumbersome and costly to enforce. A. Improvingthe InstitutionalApproach for EnvironmentManagement 4. Environmental management is an interdisciplinary field requiring cross-sectoral decisions and coordinationfor effective management, inthe absence o f which most development activities can induce significant and irreversible changes with adverse environment implications. Inhydropower, landuse change, catchment area degradation, landslide hazards, aquatic life patterns and hydrological changes, and poor muck 89The five districts are Shimla, Kullu, Kangra, Kinnaur and Chamba 90Draft "State ofthe EnvironmentReport", HimachalPradesh, Coordinatedandpreparedby State Council for Science, Technology& Environment,Sponsoredby the MoEF. 68 disposal affect eco-sensitive areas withhightourist potential. In industry, there i s a neglect o f environment planning, such as clustering o f like industries for effective environment management solutions for industrial (also hazardous) waste. Further, small scale industries are primary violators as they generally do not have enough resources to invest inenvironment protectionmeasures. Inmining, slope degradation due to weak implementationo frehabilitationplans, and pressures caused by the influx o fworkers affect the environment, with more violations from small scale miningunits. Inforestry, the current banon green felling has hadan adverse impact on forest quality due to constraints on maintenance works, inaddition to unsustainable extraction o f forest resources, excessive grazing due to a growing livestockpopulation, conversion o f forest lands to apcultural, and diversion o fbiodiversity rich forest lands due to hydropower and mining. '*Inagriculture and horticulture, there i s danger to the environment from shortage o f groundwater sources, pollution from chemical pesticides, and inadvertent introduction o f new weeds which may be harmful to human and animal health. In irrigation andpublic health, there are environmental threats from degradation o f sub and surface water quality, source protectionand contamination due to unhygienic ways o f handling water and poor sanitation, neglect o f traditional water sources, and conflicts between upstream and downstream water users which are exacerbated due to weak community ownership o fwater resource management and monitoring. In health, weak hospital waste management could leadto other health hazards. There is a trend towards urbanization, with the urban population growth at an annual rate o f about 3 percent over the last decade. However, much o f this growth has been without a coherent strategy, poor solid waste disposal mechanisms, weak enforcement o f zoning and buildingstandards, unreliable water supply, and congestion which has contributedto ecological andcultural decay and poor quality o f life inurban centres. In the transport and roads sector, opening access to eco- sensitive areas, poor construction practices and debris disposal mechanisms, landuse change, slope destabilization, pressure on resources caused by influxo f large construction crews, congestion and air pollution due to poorly managed transport systems, improper fuel mix, and inefficient combustion o f vehicles causes overall environment degradation. Intourism, weak planning and management, unplannedexpansion, and burdening o f existingtourist areas are contributing to ecological damage and a negative perception o fHP as a tourist destination. 5. Given that the natural environment heritage i s critical to HP's development plans, it i s important to consider it as a key planning criterion. Institutional aspects o fenvironmentmanagement typically involve interagency coordination, andinvolvement o f affected groups, communities and NGOs." Better Intersectoral Coordination and Mainstreamingof EnvironmentalActivities Key Challenges 6. Despite such externalities, the current institutional approach to environmentmanagement is fragmented, with environment considerations not consistently internalizedwithin sectoral departments, given limited priority, and perceived more as a "clearance" requirement rather thanplanning criteria. Moreover, the Environment Department i s at a very nascent stage of establishment, currently housed as a small, one-member wing within the Science and Technology Department, andnot geared to influence development decisions from an environmental perspective. Further, the SPCB i s a separate entity, mandated, as per the Environment Protection Act and Rules, to monitor environmental norms for typical industrial activities (including housing). The Forest Department i s mandated, per the Forest Conservation Act, to monitor green cover. The state relies mainly on clearances from these departments for environment preservation. 7. Weak intersectoral coordination and decision-maktng between departments leads to unsustainable outcomes which then adversely affect the natural and social environment, even though some coordination mechanisms are inplace. There are examples o f inter-departmental disagreements inHP-such as between the Departments o fPower and PWD on the construction o f roads (timing, alignment, and debris disposal), and the For example, it is estimatedthat while 1.9million cubic meterso ffuelwood is consumedeachyear, regrowthis amere 0.7 million cubic meters,implying considerabledepletionof forest stocks. 92World BankTechnicalPaperNo. 139, EnvironmentAssessment Sourcebook. 69 Departments o f Power and Forests on the definition o f catchment area; and weak linkage between the Departments o f Mining, Industry, Forest, and Revenue inthe context o f licensing and implementatiodmonitoringo f quarry rehabilitationplans. The urban scenario also reflectsdisconnects in implementationand enforcement of urban area development plans, given the involvement ofmultiple agencies (Town and Country Planning, IPH,Art and Heritage) with minimal participation from the people. There are frequent violations ofbuildingstandards-with regularizationevery three years which encourages further violations. Issues such as safe, commuter-fkendly road designs, public transport, air quality due to congestion, parking places, wayside amenities, and bus shelters are not effectively addressed due to Transport and PWD (for roads) being two separate Departments, without enough coordinationbetween the two. 93 Although tourism i s highon the state's growth agenda, there i s no systematic method to address overall tourism needs inspite o f the interdependence o f the sector on line agencies such as Forests for access to eco-sensitive areas with high tourismpotential, PWD for roads and connectivity, and Power andIPHfor reliable electricity and water supply. Strategic Options 8. Accordingly, there should be better intersectoral coordination to improve the fragmented institutional approach to environment management. The state can consider a number o fmechanisms inthis regard. + Itwould be useful to look at measures to strengthen theEnvironment Department and develop capabilities which would help to systematically assesshow the state can maximize its natural advantage, and to ensure applicationo f environment norms across sectors. The state can consider redeploymento f surplus staff from other departments for administrative functions to minimize fiscal costs, although limitedspecialist staffmay needto be hired. + Informed and strategic policy making i s not possible without information on critical issues, so improving the information database inat least the key sectors which have wide rangingenvironmental consequences, and enhancing the dissemination o fthis information, should be a highpolicy priority. In this area, HPcanbuilduponrecommendations from the State o fthe Environment Report. + The state i s considering the preparation o f an "Environment Plan" and anEnvironmentPolicy which may help bringconvergence o f sectoral targets and development goals, and provide a holistic view with respect to implications on naturalresources and environment-carrying capacity. + Specific coordination agencies-like the Tourism Development Board that has been constituted headed by the ChiefMinister to ensure convergence and avoid intersectoral conflicts-should be established and strengthened. 9. Furthermore, it i s important to better mainstream environment considerations invarious sectoral activities, instead o fregarding it as a "clearance" function to be obtained from various departments and boards. Inorder to strengthenthis aspect, the following actions couldbeconsideredinvarious sectors. Inhydropower, it would beusefulto follow an integratedriver-basin wide approachtowards preparation and expeditious implementationo f activities such as project allocation, Catchment Area Treatment Plans, Compensatory Afforestation, Net Present Value (NPV)money for use o f forest land and biodiversity offset^.'^ Inindustry, environment planning, such as clustering o f similar industries, would ease environment management solutions. Intourism, itis important to develop mechanismsto detect environment conflictsresulting from cross purpose implementationo f development policies and projects, through strategic planningto demarcate areas that have 93 However, the PublicWorks Department(under the World Bank financed State RoadsProject)is inthe processof adoptingI S 0 9000 on quality controland I S 0 14001 on EnvironmentManagement-thus internalizingenvironment managementwithin the department, considerablyreducingthe reliance onmonitoringby the State Pollution ControlBoard, which is notmandatedto monitorpoor construction practices,materialmanagement, anddebrisdisposaletc. The Departmentalso plans to experimentwith bio-engineeringas an alternativetechnology to address slope slips and failures. 94 See SectionB below for further details. 70 tourismpotential vis-$-vis those for purely development needs. Promotion of eco-tourism, inparticular, is closely linked with environmental resources, and can provide important economic returns as indiverse countries like Australia, New Zealand, South Africa, Kenya, and Tanzania. Inforestry, an independent environment regulator could ensure that development activities are camed out according to the original Memorandum of Understanding (MoU) with various line agencies, and environment assessmentsare carried out for multi- development works. 10. The state could also experiment with an area based environment management approach, which could be a potentially valuable tool for a fragile hill state. This provides a way o f clustering industrialpollution sources and so: (i) restricts the pollution footprint to a predefinedarea andprovides a cost effective way to mitigate andrestrict the damage to the area; (ii) allows for a scientific assessmentto prioritize among multiple pollution sources, a consensus-based stakeholder process to establish environmental and community goals, and the integrationo f diverse management options to address the cumulative impact on the ecosystem. Inpractice, thisapproachhashadmixed success across the world.95 Itis importantto learnfromthese experiences, emulate good practices, and improve the effectiveness o f this tool within the institutional framework for environmental management-likely bylinkingit with the decentralization process andlocal government agenda, strengthening the authority o f municipalities and regional development authorities, and enabling them to facilitate integration o f multiple sectoral strategies and stakeholders. ImprovingEnvironmentally ResponsiblePublic Participation 11. Public participation inenvironmental decision-making i s low inHP and the state needs to improve this. The recently concluded India Country Environment Analysis reveals that effective enforcement requires and i s strengthened by informed consensus on environmental management objectives andpolicies, based on a good understanding o fthe shared roles and responsibilities o f all players, including the regulator, the regulated community (developers and polluters), and the affected community (general p~blic).'~ 12. Moreover, environmental management i s not only an issue o f fvring regulatory institutions-but intricately linked to the behavior and responses o f the private sector. An incentive-based mechanismto protect the environment can be adopted, whereby the private sector i s motivatedto behave responsiblythrough a "carrot-and-stick approach". Internationalexamples also suggest the importance o f community participation, throughincentives andrewards for environmentallyresponsiblebehavior (Box 7.1). Penalizingpolluters on one hand and rewarding those that meet international environmental standards intheir private sector operations on the other may be necessary, as the state cannot enforce all environment-related activities. 13. Public participation could be effectively usedby improving communication and trust among stakeholders; maximizing the effectiveness ofthe Rightto Information Act (RTI); providing credible and easily accessible information; developing public participation strategies inthe context o f a specific development project and with sensitivity to the local situation; buildinggovernment agency capacity for more effective public consultation and participatory decision malung; broadeningthe understanding and strengtheningthe capacity o f local governments inenvironmental decision-making; sensitizing sectoral agencies and developers to the need for meaningful public participation; buildingcivil society institutionsand capacity to understand; and exercising a participatory action planningprocess. '' 95A review o f Indianexperience highlights severallessons, includingthe needto: (i) awider range ofstakeholders insuch involve programmes, and particularly better define the role of affected communities inthe monitoring process; (ii)establish adequate performance indicators, linkedto environmental quality improvements inthe area, and not simply implementation ofmeasures by individualpolluters; (iii)strengthen oversight of implementationand incentives for polluters to complete the actions speedily; and (iv) better integrate area-wise sources inthe programme, includingboth non-point and point sources. Some of the most successful international examples include those where an appropriate coordinating "area-based" authority was established with adequate powers, such as rivedlakebasin or coastal zone management agency (e.g. Laguna Lake Development Authority inPhilippines), or city-level air quality councils (e.g. Mexico). ''WorldBank2006, 96 Bank2006, IndiaCountry EnvironmentAnalysis. World India Country Environment Analysis. 71 Box 7.1: WorldBankInvolvementinEnvironmentManagement HimachalPradeshisknown for its wealthofnaturalresourcesandrichculturalheritage. What this popularperceptionoverlooksis the ecologicalfragility ofthe Himalayas. The economyis largelyagrarian, andmajority of arablelandinthe stateisrainfed. After the success of $135 million IDMIBRDfundedIntegratedWatershedDevelopmentProjectwhich closedon September 30,2005, the World BankhasworkedwithGoHP to prepare arepeaterprojectcalledthe Mid-Himalayan WatershedDevelopmentProjectwhich becameeffectiveinMarch2006. The keyobjectiveofthe project isto reversethe processofdegradationofthe naturalresourcesbase andimprovethe productivepotentialofnaturalresourcesandincomesofthe ruralhouseholdsinthe project area. The secondary icy and institutionaldevelopmentto harmonizewatersheddevelopmentprojectsandpoliciesacrossthe statein accordancewith b of socio-economican Le. land, water, andbiomass; and(v) developinginfrastructureto improveconnectivityand accessibilityto markets, andpromotingagri- business. The project i s implementedthrough an independentsociety calledthe "Mid Himalay WatershedDevelopmentSociety". The partnershipbetweentheprojectandthe ForestDepartmenthashelpedinpromotingamajor shift towards amoredecentralizedand community- orientedforestryapproach, ratherthan aconventionalconservationstrategy. Community-centered, sustainable, and equitable management systems havebeenput inplacethroughlocal governingbodiescalledtheGramPanchayats(GPs). Around 600 GPs are likely to beincludedunderthis project. Another importantguidingprinciple usedunderthis project is the multi-stakeholder approachwith activepartnership&omthe DepartmentsofAgriculture, Horticulture,RuralDevelopment, andForest. Inorder to facilitate differentwatershedactivities, aNaturalResourceManagementSociety(NRMS) was establishedas partofthe projectpreparation process. The primaryobjectiveofthe NRMS is to providepolicy guidelinesfor effectivecoordinationamongdifferentline departments responsiblefor thewatersheddevelopmentactivitiesinthe state. The projecthas completedits first year, during which community mobilization,micro-plans, capacity building for PRIanduser groups, andbase line surveys are some ofthe key interventionundertaken as partofthe implementationprocess. To facilitate the afforestationinthe HimachalPradeshMid-Himalayan region, the projecthasrecentlyintroducedan additional componentcalledthe Bio-Carbon Conservationsub-project. Underthis component, around 12,000 hectaresofnon-arable land, degraded forest land, anddegraded commonpropertylandwill beusedfor plantation. Farmerswill not only receivecash incentivesfor afforestationwork bysellingcarboncredits, but also get directbenefitoffuelwoodandNonTimber ForestProducts. The main objectivesofthis component areto: (i) sequester or conserve greenhouse gasesinforests; (ii) restoredegradedlandby afforestation; (iii) establishviablebiological connectivityamong severalcurrentlyisolatedforests andprotectedareas; and (iv) improvethe livelihoods of the farmers. B. Sustainable Hydropower Development 14. Hydropower is a key resource o f the state, and can be a major source o fnon-tax revenue, as described above. It i s particularly important that hydropower be developed inan environmentally sustainable manner. Injudicious exploitation o fthe state's hydropower resources can pose a threat to the state's natural resources. As the development o fthe significant hydropowerpotential o f HP advances to a mature stage, concerns pertaining to optimal planning for the development o f the state's river water resources and the long-term sustainability o f this development will come to the fore. 15. The project-based approach currently inuse by the state (and throughout India) will be inadequate to address these concerns. With the entry o f the private sector as well as a number o f relatively new public sector agencies into hydropower generation, HP is increasingly experiencing the situation where projects in the same river basin are assigned to a number o f different public and private operators. This approach to allocating projects could eventually give rise to controversy or conflict, as the differing owners/operators could have different priorities for the quantum of exploitation o f the water resource available to them, and there may be differing views on the actual use o f the water heldby local communities, environmentalists, and other interest groups. Eventually, as the revenues from power sales become significant, it i s normal to expect the emergence o f competingviews on the use o f these revenues inthe context o fthe public discourse on the budget. 72 16. Inorder to manage these processes, GoHP, asthe steward o fthese significantresources, mayfindit useful to move beyond the presentplanningparadigmbased on the individual project to a more holistic approach to development based on river basinmanagement as a whole, that incorporates the environmental and social aspects as integral to the process o f development. There are many aspects o f management on the level o f the river basinwhich are crucial for sustaining revenues and the long-term operability o fprojects, but which are not adequately reflectedwhen development i s viewed from the perspective o f individual projects. Examples o f this includemanagement o fthe rivercatchment area; management o f sediment inthe river bed; management o f social and environmental impacts; and the implications for the entire river basin of the long-termevolution o f basinhydrology andriver geomorphology, including the possible impact o f climate change. 17. A potentially positive development is the recent establishment o f aForum ofHydropower Producers of Satluj Basin inorder to achieve common goals and objectives for harnessing the hydroelectricpotential o fthe Satluj basin inan eco-friendly manner, and to ensure the development o f the area including welfare o fpeople.98 The state could facilitate a river basin study for the Satluj basinas a startingpoint, and prepare an implementable Action Planthat could promote sustainable development o f the hydropower resources along the dimensions outlined below. InstitutionalArrangementsfor River Basin Management 18. Inordertopromoteeffective institutionalarrangements forriverbasinmanagement, the statecould consider creating a specialized agency with a broad mandate for overseeing the development o fthe major river basins. Another important benefit o f a river basinagency with a mandate for coordinationi s the positive role the agency can play infacilitating the work o f investors with other governmental agencies in specific areas o f relevance to project development, e.g. land acquisition, implementation o f environment management plans, resettlement andrehabilitation aspects, etc. Ina well-functioning agency, this would facilitate the overall project implementationprocess and give assurancesto investors, contributing to the mitigation o fthe significant risks generally perceivedto be associated with development o fhydro projects. The followingpoints must be considered withrespect to a river basinmanagement agency. + Common institutional models follow a two-tiered management and governance structure, whereby political support and policy decision-malung are separated from technical and managerial functions. The design o f a river basin agency model for HP would need to assess and address the specific issues o f operations across departmental and administrative jurisdictions and include mechanisms o f conflict resolution. Given the highlytechnical nature o f the expertise requiredto operate such an agency, it will be particularly important to ensure the insulation o fthe technically-based decisions from political pressures. + Basin institutions can be advisory innature but they may also include planning, construction or management intheir mandate. The mission o f the agency must define thefields of activity, which may include flood management, social and environmental management, disaster planning, etc., inaddition to hydro development. + Basin institutions can also help facilitate puttinginplace mechanisms for cost-benefit sharing between projects within the same basin, for example, ina scenario where an upstream storage project could complement several downstream projects with increasedgeneration duringlean season + Identification and incorporationo fstakeholders i s crucial for ensuring that all interests are represented, that the adequate legal authority i s vested, and that adequate financial resources are made available. It i s 98The members of the forum are - BhakraBeasManagementBoard(BBMB), NTPC Ltd, HimachalPradeshElectricityBoard(HPSEB), Satluj Jal VidyutNigamLtd.(SJVN), Jai PrakashHydropowerLimited(JPH), HimachalSarongPower Ltd., andNuziveduSeedsLtd. 73 also important to realisticallyassess the requirements o f dnvingthe change agenda, and to include the institutional actors accordingly. 19. A practical startingpoint couldbethe creation ofa worlung-level forum for the coordinationof existing projects on a given river basinand to finance its growth over time through earmarlung a small portion o f the revenues fromprojects as they enter commercialproduction. Where such forums already exist, they shouldbe institutionalizedand given a formal role. Hydropower Planning 20. One o f the key issues inthe planning for the development o f the Himalayan rivers for hydropower generation has been the relative dearth o f storage projects, with preference given to small and medium-sized run-of-river projects. Under certain circumstances, storage projects could be the economically preferable alternative, as long as adequate provision can be made for mitigating the generally greater environmental and social impacts o f the project. The storage projects can provide significant benefits interms o f drinkingwater availability, peakmgpower generation and silt management. 21. Incurrent practice inIndia, the decisions regardingthe sitingandcapacity for the hydro project allocations are generally not supportedby river systems analysis. This can leadto sub-optimal planning whereby benefits are foregone due to under-realization o fhydro potential. A strong river basinmanagement agency with good analytical capacity could help rectify this shortcoming o f the planning process. 22. Better hydropower planning could be adopted, with decisions regardingthe siting and capacity for hydro project allocations supportedby river systems analysis. There i s an important role for the state in identifying and encouraging storage projects for possible future development, and this hnction could be assigned to a river basinmanagement agency. The state could investigate opportunities for economically viable storage projects and, where identified, facilitate their development while ensuring adequate risk mitigation towards environmental and social impacts. Environmental Management of Hydropower Development 23. One o fthe most challenging and controversial dimensions o fthe development o f the Himalayanrivers, including the rivers o f HP, i s the environmental impact o f the development projects. Given that this i s a major sector that GoHP wishes to expand inthe medium term, particular attention needs to be paid to ensure that hydro projects are developed inan environmentally sustainable manner. Injudicious exploitation o fthe state's hydropower resources can pose a threat to the state's natural resources. Delay inor improper implementation o f environmental management activities falling within state's domain i s a threat to the larger environment. InHP, this is important notjust for assuring stewardship, but also because o fthe negative external impacts on the growth prospects o f other economic sectors. 24. The track record o f GoHP's agencies, notably the Forest Department, inimplementing Environment Management activities-like the Catchment Area Treatment (CAT) plan, Compensatory Afforestation, development o f fisheries, conservation o f wildlife, etc.- related to hydropower projects inthe state i s modest. Inorder to promote sustainable development ofthe sector, itis importantto take steps to improve these activities, as discussed below. 25. CatchmentArea Treatment(CAT) is critical, but insteadofusingariver-basin approach, the current approach o fpreparation and implementationo f CAT plans i s piece-meal. A uniform approach to the preparation and implementationo f the CAT plan, rather than the current piece-meal approach that divides responsibility for the CAT plan among the individual projects, would have direct technical benefits, as removal o f sedimentation i s one o fthe major operational problems faced by hydropower generation plants onrivers in the Himalayas. Inorder to improve the framework for environmental management with regardto hydro 74 development, the state could reform o f the practice ofpreparation and implementation o f CAT plans using a river-basinapproach, consider alternative methods o f implementation(e.g. through outsourcing, through project developer, etc.), and ensure the activities are completed in synchronization with project completion. 26. Any delay inthe implementationofthe environmentalmanagement activities (such as CATplans, compensatory afforestation) falling within state's domain i s a threat to the sustainability o f the environment. It is critical to ensure that these activities are implementedinsynchronization with the project implementation schedule so that maximum benefits are available to the stakeholders. Given the limited capacity o f local government institutions and agencies (e.g. Forest Department) to implement environmentalmanagement activities, it may be worthwhile to consider such innovationsas outsourcing this responsibility or malung the project implementing agency responsible for carrying out the activities under the CAT plan andother important tasks inthe area o f environmental management. Inparallel, it would be advisable for the state to putina place a plan for buildingup capacity o f state regulatory agencies for implementingand supervising such activities- such as the SPCB and the Forest Department. 27. The current approach o f applying a uniformminimumecologicalwater flow requirement irrespective o f the project site and other considerations i s inefficient to the extent that the actual requirement (i.e. what i s needed to achieve the stated objective o f the minimumflow) at any given location may be higher or lower than the arbitrarily determined uniformnorm. Ifthe uniformnorm i s higher than the actual requirement, then there would be a loss inthe benefits o f electricity generation. Onthe other hand, ifthe uniformnorm i s lower than the actual requirement, then there would be a failure to achieve the stated objective o f the minimum ecological flow. Flexible norms that are determined on the basis o f site-specific analysis would lead to outcomes that are preferable from both a technical and an environmental perspective. The role o fthe government, then, shouldbe not to determine uniformnorms, but to specify the nature and quality o f the environmental analysis to be carried out at specific sites inorder to come to the determination o fthe minimum ecological flow requirement for the concerned section o f the river. Accordingly, the state could introduce flexible, site-specific norms for minimumecological flow-where GoHP determines the nature and quality o f the studies requiredto make the site-specific determination 28. Given the increased global focus on "low carbon"technologiesfor generating power and the significant role hydro power can play towards that end, the state may also wish to consider measures to encourage use o f carbon finance as a potential source o frevenue towards mitigating the costs o f the risks associated with development o fhydropower. While the likelihood o f future projectsbeing commissioned and becoming eligble to receive carbon revenue before the end o f the first commitment period under the Kyoto Protocol, in2012, i s low, negotiations are on-going for the second commitment period, which may provide important opportunities for HP. Social Inclusion and Benefit Sharing 29. Local communities are the most directly affected by the development of hydropower projects. The disruptionto community social and economic life duringthe construction phase i s often considerable and can take a variety o f forms; duringthe operation phase the impacts are typically less severe. Inthe case of the main rivers o f HP, the development activity that will impact on specific communities is likely to continue for many years, as many projects are slated for future implementationon the small number o fmajor rivers inthe state. 30. Itisbecause ofthe disproportionalimpact onlocal communities, sometimes including the permanent loss of the use o f the water for other purposes (at specific locations), that benefit-sharing mechanisms have been developed as a means of ensuring sustainable and equitable development, and o f amelioratingpotential oppositionto development that could emerge inthe absence o f any benefit-sharing mechanisms. 31. Initseffortstoensure sustainable, equitableandsocially acceptable development ofthestate's rivers, one alternative for GoHP to consider would be to give local communities (which wouldhave to be explicitly 75 definedat the outset) a share inthe specific project benefit streams over time (i.e. a part o f the power royalty collected by GoHP). The financial cost o fthis will be very small compared to the revenue streams o f the project, as overall project returns are generally high, and the communities concerned generally small interms o f population. The positive impacts for local social and economic development should also help buildpublic support for Government's hydropower development program. There are various models that GoHP could consider to help buildlocal communities' and local administration agencies' limitedcapacity to manage revenue streams and decide on development priorities. Inone such model, local area development activities would be implementedthrough the project implementing agencies themselves, with the selection o f schemes and their monitoring the responsibility o f a body withrepresentatives o fthe project authority, affected villages/panchayats and the local district administration. 32. Contemporary river basin agencies engage their communities through active and managedprocesses o f involvement to generate a sense o f ownership and to ensure that the development processes and outcomes meet the needs o fthe communities. Community participationmechanisms will needto be carefully selectedbased on the nature and level o f community participationthat i s deemed desirable and feasible. 76 - Chapter 8 ImplementingandSequencingthe ReformAgenda 1. Itis clear fkom the preceding discussionthat, inspite o f commendable recent achievements, HPfaces several challenges to achieving its development priorities o f sustainable and inclusive growth. T h s Report has analyzed some o f the key challenges inrestoringfiscal sustainability, promoting private sector participation, exploiting opportunities inthe emerging sectors, improving public administrationand service delivery, protectingthe environmental and ecological heritage, and further improving human development and social protection strategies. 2. The Report has suggested various reformoptions for GoHP to consider inaddressingthese challenges. The menu o freform options i s based on the Bank team's understanding o f constraints and reformpriorities that i s mostly already under consideration by GoHP. While these are all considered vital policy measures, the assessmentrecognizes that they may not all be implementableimmediately from the view o f political feasibility, and that actions internal to GoHP could be undertakenmore easily than reforms involving changes innational policies or those requiring wider consultations. 3. The broad elements o f a possible development strategy for the state are summarized inFigure 8.1. The agenda is large, and will need to be executed over a substantial term time span. However, it will be to HP's advantage to begm the process soon-identifying some o f the priority areas. Several reforms proposed inthe Report are administrative innature, and, where sufficient backgroundmaterial andmodels already exist, can be implemented without delay. Others require a cross-cutting approach, and prioritization and sequencing should be guided by the exigencies o fthe situation and the complexity o f the requirements. Ifproposed policy measures require more preparation and internal consultations within the state, involving various stakeholders, GoHP should begin the process. 4. Given the complexity o f the task, a flexible approach i s suggested by which GoHP identifies those reforms which are the most pressing, implementable, and likely to yield significant returns, inorder to develop a cohesive programme that i s reflective o f and consistent with the state's vision. GoHP could also guide the proposed sequencing o freformactions. As a first step, this assessment suggests that GoHP address the fiscal constraints on a priority basis-backed bygovernancereformmeasures to curb the salary bill. The state should take steps to promote sectors with untapped potential-and could consider measures for hydropower and tourism development as priorities. Simultaneously, measures to conserve and protect the environmental heritage-both inthe context ofhydropower development, and interms beginningthe process ofdevelopingan Environment Policy-should also receive priority attention. At the same time, it would be important for GoHP to take steps towards making the transition fkom a state-led to a private sector oriented economy, and it i s important to signal clear intentinthis area. Inorder to address employment issues, GoHP shouldbegin the process o f assessing and projecting skills and education requirements. 5. While the Report assesses that certain reforms could precede others, this i s not to suggest that other measures are unimportant. Inparticular, since social and human development outcomes are superior to most other states, reforms inthis area could follow more pressing policy needs-but measures to improve quality and access should not be ignored. The critical issue i s to develop a credible overarching and coherent medium-term strategy for the state to guide reforms along various inter-related dimensions, so as to meet the stated development objectives o f sustainable growth and inclusive development. Reforms should ultimately be adoptedby GoHP with the medium terms agenda inview. A. ProposedReformOptions 6. The following reforms are proposed for implementationover the short to mediumterm. 77 Sustainingthe Fiscal Recoveryfor Growth 7. The Report identifies the fiscal situation as a major constraint that the state must address, inorder to realize its development priorities. The assessmenthas accordingly identified a number o f areas where GoHP could introduce policy reforms. + As a first step, the state mustrefine its mediumterm fiscal projections,incorporating a clear policy basis, demonstrating, for instance, expenditure reallocationto capital outlay and non-wage O&M in critical areas, and to reflect stronger reform outcomes consistent with TFC recommendations. + Inorderto strengthen thebudgetformulationprocesstobetterlinkpolicygoalsandresource allocationto embed the medium-term perspective inbudgeting, a fiscal strategy paper could be presentedto the Cabinet preceding the budget preparation process-which will result inthe communication o f departmental expenditure ceilings and fiscal projections as part o f the budget call circular. + Inorder to enhance own-taxrevenues,the state could: (i) from a specific to anadvalorem switch excise duty structure, as inMaharashtra; (ii) the licensefee structure for alcohol vending; (iii) simplify initiate a review o f the motor vehicle tax andfees regime with a view to raising specific rates o f the motor vehicles tax, revamping fees for permits, registration, licenses, and fitness certificates, and introducinga `green tax'; (iv) re-introduce the Professions Tax;(v) begin evaluation o f VAT implementation with a view to streamlining and strengthening VAT administration; and (vi) initiate an analysis o fstamp duty evasion schemes and their revenue impact to prepare for a more fundamental reform o f the stamp duty system, and reduce registration fees on par with other states + Inorder to enhance non-taxrevenuesfromuser charges, GoHPcouldestablish aPublic Tariff Commission for various services like transport, education, health, water, and irrigation inorder to depoliticize the determination o f user charges. + Inordertoimproveprovisioning, control, andcompositionofexpenditure,GoHPcould: (i) first completepension projections for government and public sector agencies, and begin annual budgeting on an actuarial basis; (ii) implement an effective wage and hiring policy consistent with fiscal sustainability; (iii)introduce a contributory pension schemeat par with government employees for new employees, withpensionable pay, inPublic Sector Boards, Corporations, Universities and Local Bodies; (iv) appoint a Committeeto examine containment o fexpenditure under subsidies, a gradual phase out o f non-merit subsidies as announced, and present a roadmap for subsidy containment, and implement recommendations; (v) reduce power subsidies, and delink it from the power tariff; (vi) initiate the process o f identifying schemes that have lost relevance, andrestructure and rationalize them by constitutingan Expenditure Review Committee to critique ongoing schemes; and (vii)reallocate expenditure towards non wage O&M expenditure incritical sectors, and capital outlay. + Inthe area ofmanagementofdebt and contingentliabilities,GoHP could: (i) ofS-budget merge borrowings withbudgetedborrowings, and eliminate future off-budget borrowings; (ii) riskweight guarantees and beginreporting; (iii) the targetfor risk-weighted guarantees under the FRBM revise after eliminating off-budget borrowings; (iv) establish a set o fformal rules to govern eligibility o f PSEs, cooperatives, and statutory boards for government guarantees, tahng into account financial statements, record o fprofitability, performance on past guarantees, priorities o f government, etc.; and (v) make progress towards the implementationo fthe reform strategy for state-owned PSEs outlined by the government inits order dated October 20, 2000, including initiation o f the preparationo f a turnaround plan for HRTC. 79 + GoHP could initiate measures to modernize tax administrationby considering, for example: (i) creation o f the necessary organizational basis for separating and strengthening the key tax administration functions o fregstration, audit, collection, and taxpayer services; (ii) introductiono f multiyear strategic planningprocesses underlying annual business plans, defining the mission and vision o fthe revenue administration, identifying the challenges and reformpriorities for the planning period; (iii) improvement o f the accountability mechanismto move from collection-based accountability to wider reforms like better quality o f services andinformation provided to taxpayers, increased integrity,broader tax net, or reducedtime requiredfor registrationo fa business for tax purposes; (iv) strengthening o f the human resources inthe Excise and Taxation Department; and (v) making the Excise and Taxation Department the basis for a unzped tax collection system so that other revenue- collecting agencies could then concentrate on their core, non-collection functions. + Inthe areaofpublicfinancialmanagementandprocurement,GoHPcould: (i) modernize the HimachalPradeshFinancial Rules, 1971,which needto be updated and simplified, (ii) replace the existingProcedure & Rules for the Purchase o f Stores with apublicprocurement law that can apply to all procurement undertaken usingpublic funds (goods, works and services), andwhich can be piloted in 2-3 departments and PSEs to ascertain the benefits; and (iii) out treasury computerization to cover roll the entire state. Improving theInvestment Climatefor the Private Sector 8. Inorder to promoteprivate sector participationsothat investments inthe state continue beyondthe phase out o f special incentives in2010 and the burden on the state as a provider o femployment i s reduced, efforts need to focus on the key constraints as identified inthe short survey undertaken for this Report: improvingroad infrastructure, addressing slulls mismatches, and strengthening the urban infia~tructure.~~ 9. Inthe area ofskills mismatches,the first step would be a study, since the extent ofslull gaps and mismatches inthe state i s unclear at present. The study would include a skills-mapping exercise, to identify particular sectors which would emerge inthe near future, so that slull requirements could be projected. This could subsequently be the basis o f a slulls development strategy to bridge current and future slulls shortages and skills mismatches-worked out inconsultation with industry, workers, and educators. Exploiting the Potential in Emerging Sectors 10. Inthe ApproachPaperto the EleventhPlan, the statehas itselfidentifiedseveral sectors itwishes to focus on, where it has natural advantages. These include highvalue added agnculture (especially horticulture), tourism, and hydropower. 11. With a view to realizationofthe fullpotential from the state's hydropowerresources, initial reforms could focus on the following dimensions. + Inorder topromotesustainable hydropower development,itiscriticalthat the state setupan institutional mechanism (including its structure and functions) for monitoring and implementing environment management activities-such as CATplans, NPV, Compensatory Afforestation, lease value o f forest land, development o f fisheries, conservation o f wildlife, etc.-related to hydropower projects inthe state, to ensure that these activities are completed before the projects are commissioned (and are then subject to ongoing monitoring), and that HP's precious natural resources are managed well. 99Policy changes inthe roads sector are being addressedthrough an investment project supported by the Bank. Urban infrastructure is an area where further analysis i s proposed. 80 + Inordertobettermanagehydrorevenues,thestatecouldinitiateastrategystudyfor: (i) modelHP the should follow inbuildingup hydropower projects (through state/central/private/Joint Venture routes or a combination o f these); (ii) analyzingthe possible impact on bulkpower tariffs from the proposed coal- basedultra mega projects, andthe capacity o f HP to manage the development risks associated with the hydro power projects, ifthey are fully or majority owned by GoHP; and (iii) best utilization o fthe revenues flowing to GoHP from the hydropower projects to ensure the maximumbenefit for the state and for those most affected by the development o fprojects. + Inorder to encourage integratedriverbasinplanning, the state could facilitateariver basin study onthe Satluj river, and prepare an action plan for time bound implementation, basedon the agreed recommendations. + With a view to implementingtheElectricity Act of2003, GoHP could facilitate implementationo f open access, separation o f the power trading function, and appropriate restructuringo f the HPSEB. 12. Inordertoimprovetheperformanceandsustainability ofagriculture, GoHPcouldtakethe following steps over the next few months. + GoHP could review and rationalize the subsidy regime. Where the state i s proposingto focus on organic farming, there i s an element o f inconsistency in subsidizing consumption o f chemical fertilizers and pesticides, and support should insteadbe aimed at offsetting costs o f organic practices, particularly for horticulture and h i t production. + User charges inirrigation cover less than 2.5 percent o frequired O&M expenditures, and needto be rationalized. Inaddition, many irrigation schemes could well be better managedbyproducers themselves, following successful practices inthe state and elsewhere. The state could prepare a strategy with animplementationtime table andprogress indicators, aimedat increasing costs to reachfull cost recovery within a designatedtime period, as well as an action plan for devolving suitable irrigation schemes to beneficiary farmers. 13. The key constraint intourism appears to be that o f connectivity-and addressingthis would require investment resources over the medium term. Inthe policy arena, the state should activate and empower the Tourism Development Board that has beenrecently established under the chairmanship o fthe ChiefMinister as a forum for better inter-sectoral coordinationand strategic approach for tourism development inthe state. Improving theInstitutional Environmentfor Growth 14. Inordertopromoteaninstitutionalenvironment for development, GoHPmustenhancetheeffectiveness o f civil services, strengthen institutions for transparency and accountability, and promote decentralization to improve public service delivery. Short term measures could focus on some o f the following areas. + Inorder to tackle the keyproblemofoverstaffing andthewagebill, GoHP could: (i) enforce a strict ban on recruitment,especially for non-regular employees as well as Class IV employees inthe regular civil service, and work-charged and part-time workers inIPH,PWD, and HPSEB, and curb regularization; (ii)identify redundant posts by conductingfunctional reviews inmajor departments, assessing whether current staffing patterns exceed established norms, revising existing norms to take into account technological improvements, and preparinga plan to abolishredundant posts inphases, starting with posts that are both surplus and vacant; (iii) identify posts that could be outsourced to the private sector such as the provision o f security, gardening, cleaning, and drivingservices; (iv) establish an HP Pay Commission to decouple salary structures from those inPunjab, that would over time chart an independent course for determiningthe state's salary structure inview of political sensitivities; and (v) implement a Voluntaly Retirement Scheme(VRS) for government employees who wishto retire, 81 and compulsory retirementprovisions inthe All-India Service Rulesto remove inefficient staff from service, especially inorganizations like the HRTC and HPSEB. + Inorder to improve administrative efficiency, GoHPcould: (i) enforce the minimumthree-year strictly tenure as per HP's transfer policy by establishing statutory committees to authorize transfers and postings for senior officers and creating a stability index to ensure that the average tenure o f the I A S cadre as a whole does not fall below three years; (ii) currentfunctional clustering at the level o f review Ministers as well as Secretaries with a view to clustering `like' Departments; and (iii) at the level o f general transfers instaff-intensive departments, GoHP could consider the adoption o f a system o f formal counseling to allocate transfers and postings ina rational and objective fashion, while enforcing quantitative limitson the total numbers o ftransfers across the state. + Ine-governance, prioritiesfortheITDepartment-from among the 40-odd projects underway-should be clarified, by focusing on a few flagship projects, and implementation should be sequenced. The focus should be on process re-engineering, rather thanjust information technology. + To enhance transparency and accountability, the following measures are important: (i) the suo-motu provisions o f the RTI should be aggressively implemented, especially through posting o f suo-motu information on the web, and providing departmental websites to those still lacking the same; (ii) efforts should be made to strengthen the Lok Ayukta by amending the L o k Ayukta Act to allow for suo-motu powers to take action incases without a formal complaint, byproviding qualified legal and other staff to assist him, andby widening the definition o f corruption to include grievances arising out o f maladministration; and (iii) the weakening ofpolice capacity to provide effective law and order services, as reflectedinthe declining overall conviction rate, should be reversed, by implementing the recent Supreme Court directive to create a State Security Commission to insulate the force from political pressures, and enforcing a minimumtenure o f three years for the Director General o f Police and senior officers Strengthening Human Development and SocialProtection Strategies 15. The Education Department could take the lead on the skills mismatch study mentioned above. Other measures under consideration to partner with the private sector inthe provision o f technical education-like usingprivateparties to providetechnical and vocational education usingthe state's existingeducational infrastructure-should be speeded up and implemented. The state should also identify specific steps to improve teacher attendance and accountability-through involvement o f communities inthe monitoring process. 16. The Health Department could benefit from thefunctional review o f staffingdescribed above-with a view to rationalizing postings o f specialists inremote areas. A study proposedby GoHP on assessing the efficacy o f mobile vs. static units could also contribute towards eventually addressing the problem o fhealth service delivery inremote areas. 17. Inthe area o fsocial protection,the state currently faces issues aroundrecord-keepingandtechnical impact evaluation. GoHP could consider the following measures inthis area. + Carry out rapid review o f administration and record-keeping inkey social protectionprogrammes, in order to develop options for improvedperformance. Going forward, based on this review, GoHP could develop and approve an Action Plan for improvingadministration and record-keepingof major social protectionprogrammes (particularly with respect to reporting o f outcome indicators) + Initiate a thirdparty impact evaluation o f social pensions-the single largest interventionfor the poor in the state. This could leadto better design and implementation o f the programme inthe future. 82 PromotingEnvironmentally Sustainable Development 18. Itwould be useful for GoHPto look at measures to strengthenthe EnvironmentDepartment and develop capabilities which would help to systematically assess how the state can maximize its natural advantage, and to ensure applicationo f environment norms across sectors. 19. GoHP could initiate an institutionaland "gap" analysis of the environment sector, which could then feed into institutional strengthening o f environment management inthe state, and help indrawing up the proposed EnvironmentalPolicy.'oo This could include: + Assessment o fkey environmental pressures, with a particular focus on emergingpollution hotspots, environmentallyfragile areas (including those with highpreservation values, such as endangered biodiversity, and highecosystem functions, such as watersheds), and areas with hightourismpotential. + Identification o fregulatory, institutional, and policy gaps leading to these pressures. This will include assessmento f mandates, gaps and overlaps, and also incentives for compliance and enforcement o f functions. + Assessment o f workload and implementation capacity for the Environment Department, Forest Department, and SPCB, including staffinghkill mix, equipment, and knowledge resource requirements (including contract appointments). + Strengthening o f compliance and efjciency by assessing alternative ways o f implementation (such as separating the regulatoryvs. management vs. implementationroles o f the Forest Department), greater use o f economic instruments (as recommended by the National Environmental Policy, 2006), allowing contracts with private parties, or line public agencies, recasting the management and implementation functions, and buildingupon newer initiatives such as the Natural Resource Management Society (with systems for clear physical, financial targets and monitoring). + Assessment o f the effectiveness and ways of improving Compensatory Afforestation Schemes and use o f Net Present Value revenues; strengthening o fmanagement practices and guidelines usingprinciples o f restoration biology and the global experience with biodiversity offset schemes; establishment o f firm timelines for implementationand monitoringprogress inbothplanting and ecosystem restoration. + Assessment o f the adequacy of the existing range o fpolicy instruments and feasibility o f usingnew ones that target the systemic androot causes ofpolicy failure. 20. Based on this analysis,. GoHP could develop an Action Planwith an implementation timetable, inorder - to: (i)restructure the Environment Sector as indicatedby the analysis; (ii) prepare an overarching Environment Policy as a guidingprinciple; and (iii) develop a set o f key performance indicators to monitor and evaluate progress inimplementation. B. PoliticalEconomyConsiderations 21. Policy suggestions can only be a first step-it i s critical to implement the policies that can help the state realize its development goals. GoHP needs to craft an overarching programme for the state to guide reform, identifying the policies--from or beyond those suggested here-that itwould like to implement. There isneed to builda consensus for change within the state through an effective communications strategy, and get the looThe Bank's EnvironmentUnit ishappyto assist GoHPwiththis throughtechnical support underthe IndiaCountryEnvironmental Analysis. 83 political leadership to demonstrate their commitment to the proposedprogramme, motivate agents for reform within the bureaucracy, and gamer public support. 22. Itisparticularly important to pay close attention to the sequencing andprioritization o freforms, andto move more rapidly on policies which are likely to yield quicker and visible results. The Report has proposed a menu o f measures that can be initiatedwithin the next few months, and GoHP could, based on internal discussions, move forward on those that are considered appropriate and feasible. However, this shouldnot detract focus from other substantive measures recommended inthe Report which shouldbe implemented over the longer term to deepen reform. 23. Additionally, successful reforms have to be context-specific and grounded inlocal knowledge. The general economic principles behind accelerating growth and improving service delivery-such as a healthy investment climate, sustainable fiscal policy, responsive and transparent institutions, and private sector participation-apply to HP as they do to most other states. However, economic reformprinciples needto be creatively packaged by policy-makers inorder to be sensitive to local constraints and take advantage o f local opportunities. Inthis context, it becomes particularly important to focus on sectors where HP has a comparative advantage, and keep inmindthe importance o f conserving the environmental resources which can provide further opportunities to the state. 24. Inclosing, itshouldbeemphasizedthatactionnowislikelytobelesscostlythanactionlater. Politico- administrative and topographical peculiarities o f HP demand a continuingrole for the state. However, ifthe state does not take specific steps towards self-sufficiency, the recent achievements may not be sustainable. In particular, any reduction o fprivileges as a "special category" state and announcement o f Sixth Pay Commission awards could hurt the state's fiscal situation further; the absence o f suitable private sector employment opportunities for the educated population could lead to unfulfilled expectations and add to the fiscal burden for the state as an employer o f last resort; and failure to take action against environmental degradation could threaten future growth prospects. It i s critical to address these challenges before they start to impact on the state's successful socio-economic performance. 84 1. The ~ c o n o ~~i ee ~~ roe ste n~t ein~the earlicr ~ ~ ~was~~reparcdbyctherWorld Bank at.es ~ ~ s ~ matron a ~ a i l a at ~t'rce ttrrtc ~ ted to GoHP on Fchruary 19,2007. Thc govern A, CreatingFiscalSpace and ImprovingPublicFinaneia 85 5. The targeted debt reductioni s achievable ifthe state stays on the projected fiscal path under the MTFP. However, the debt trajectory i s sensitive to fiscal shocks, and will require the state to maintain a strong fiscal correctionpath over the medium term to achieve debt sustainability (Figure A1-2). Stress tests demonstrate that future uncertainty or shocks like decline incentral transfers or lower growth rates than those assumed under the MTFPcould derailthe projected debt reductiontrajectory. This shows the need for continuedmaintenance o f fiscally sustainable policies over the medium term, as well as the importance o frobust and sustained fiscal correctionto counter future uncertainties that can upset the trajectory o f debt reduction.'" Inorder to maintain the projected fiscal correction path, GoHP has announced various measures which are described below. 75% - Shockto Growthin2010and 2011of 2.5% 65% - 55% - 3iz 5iz m m 2R zd, c g r 2 0 28 w r N K Source:SeeAnnex 5for details. Reforms to Enhance TaxRevenues 6. To improve tax revenues, GoHP has announced several encouraging measures inits 2007-08 budget to raise its own tax revenue from 5.9 percent o f GSDP in2005-06 to 6.5 percent by 2011-12. Ifsuccessful, the state's dependence on central government grant transfers will decline fiom 15.2 percent o f GSDP in2005-06 to 11.8 percent by 2011-12. The measures will correspondingly leadto improvement inown revenue effort from 8.6 percent o f GSDP in2005-06 to 9.1 percent o f GSDP by 2011-12. P For the motor vehicle tax regime, GoHP proposes to increaseMotor Vehicles token tax ratesto target an additionalgrowth o f at least 6 percent inmotor vehicles tax take over 2006/07 (RE). To avoid congestion and pollution, a higher token tax has been proposed for vehicles over 15 years. These measures should yield an Additonal Resource Mobilization o f about Rs. 6 crores, over and above natural buoyancy. Additionally, the Transport Department shall initiate studies to examine how to improve motor vehicle taxes, including the use o f ad valorem taxes for all new vehicles.Io2 GoHP has also liberalized the licensingrules for private bus operators effective financial year 2007-08, and that should see an increase inpermit and registration fees, the annual token tax, and the special road tax. > To plugleakages inthe collection o f luxury tax by hotel owners, it has beenproposed that the luxurytax should be based the number o f beds as opposed to the presentregime o f a flat 10percent o f hotel roomrent. lo'See Annex 5 for details. IO2Non-transport vehicles are subject to one time tax, while transport vehicles are subject to an annual tax. Inaddition, HP levies a special road tax on transport vehicles. The current level of the one time tax is 2 percent on the price ofpersonal vehicles such as cars and 1.5-3 percent on the price of two wheelers. The one time tax is considerably lower than inother states where it could range between 6 percent and 8 percent o fthe price of the vehicle. Transport vehicles are charged an annual specific tax depending on the nature o f the vehicle. 86 9 GoHPhasintroducedanewlicensefee system to vendliquorbasedonminimumguaranteed off-take for different kinds o f liquor. The system, as presently structured, has specific excise duties on liquor and licensing to vend liquor classified ineight categories, with sub-categories. P The introductiono f VATin2005 raisedgrowthinsalestax revenue by34percent in2005-06-but this is projectedto grow by a slower rate o f 7 percent in2006-07 (RE). Although VAT is the main own tax source, gains from this may dry out following two years o f implementation ifits administration i s not strengthened. The yield from this tax has to be raised at least to the national average o f 3.7 percent o f GDP. As a first step, GoHP i s undertaking computerization of VAT administration. Furthermore, GoHP i s considering an evaluation that could include value chain analysis, VAT assessment, system o f refunds, use o fnationally harmonizeddefinition o f goods, fraud risk analysis, VAT threshold limit, etc. The results o f the evaluation will be usedto further strengthenVAT administration. P Studies shall alsobe initiatedto explore further areas for increasing tax buoyancies, includingfolding the electricity duty into the VAT. GoHP currently has an electricity duty at the flat rate o f 6 paise per unit consumed inbulkuse and 33 paise per unit on consumption by industries, as last revisedinthe 2005-06 budget. The tax take from this source has been uneven over the years and constituted below 4 percent o f tax revenue in 2005-06. 9 Thestampduty rate for regstrationoflandsaletransactionsisproposedtobereducedfrom 8percentto 5 percent, so as to check evasion and the undervaluingo fproperty transactions. GoHP has already reduced stamp duty from 12percentto 8 percent inApril 2005. As a further measure to strengthen administration, GoHP will introduce franlung machines to plugleakages instamp duty revenue. InHP, at present rates, stamp and registrationduties amount to a potential tenth o f property value, higher than inmost other states.'03 Stamp duty reformis, therefore, a significant measure, and i s expected to increase registeredproperty transactions, create a more active landmarket, and make the state more attractive for investment. Reforms to Enhance Non-Tax Revenues 7. Since HP i s a small state, its tax base i s limited. Accordingly, non-tax revenue needs to be expanded, with the major source identifiedas the state's natural hydropowerpotential that will make the state a net exporter o f electricity. It is estimated that revenues from the sale o froyalty power and/or a share o f the power generated proportional to equity invested by GoHP inhydro projects with other partners+.g., Go1inthe case o f Satluj Jal Vidyut NigamLimited (SJVNttogether with dividends, could be more than 37 percent o fHP's current level o f own revenue receipts and more than double the current level o f own non-tax revenues by 2012- 13. However, efforts needto be broadbased beyond hydropower resources to raise non-tax revenues inorder to help make critical services provided by GoHP self sustaining. There i s scope for raisingroyalty from user charges periodically, inparticular. However, rationalizationo fuser charges i s politically challenging which makes the pace and magnitude o frevision more difficult, and this has to be calibrated. A rational institutional mechanism that can periodically decide on appropriate user charges i s required. 8. As a first step to improving cost recovery, GoHP has indicatedthat an administrative review ofuser charges will form the basis for rationalizing user charges. Eventually, an institutional mechanismwill be set up-to regularly review user charges, reduce implicit subsidies, and improve sustainable financing o f O&M o f public investment. GoHP also plans to reconstitute Rogi Kalyan Samitis-which were abolished in2003- and provide them autonomy indeciding on user charges. 9. GoHP is workmg to address the fiscal burden arising from the gap between O Mexpenses in Irrigation and Public Health and the user charges collected. As discussed inChapter 4, use charges fund about 2.5 '03 Inadditionto the 8 percentstamp duty, registrationfee under the IndianRegistrationAct, 1908, as applicableto HP, at the rateof2 percent on thevalue of consideration, subject to amaximumofRs.25, 000 is also levied. Most stateslevy only 1 percent registrationfee. 87 percent o f O&M expenses incurredby the government. GoHP has already developed guidelines for devolving schemes to beneficiary groups. GoHP has initiatedpilots that will be scaled up over time. As o f March 31, 2007, operations o f 292 Water Supply Schemes and 17 Minor h g a t i o n Schemes hadbeen transferred to GPs and users respectively, on a pilot basis. Inaddition, the state has already announced a participatory strategy involvingWater User Associations and GramPanchayats (GPs) to participate inplanning and execution o f irrigation and drinlungwater schemes respectively. This will be practicedfor all new projects wherein the government provides technical and one-time financial support to the GPs or beneficiaries to develop their own water resources. TargetedImprovements in Expenditure Composition 10. Simultaneously, the government appreciates the need to improve expenditure composition towards capital outlay and critical non-wage O&M. As a first step, the MTFPhas committed that GoHP will: (i) contain share o f salary expenditure to total expenditure to 30 percent by 2011-12; (ii) reduce interest expenditure to revenue receipts to 17 percent by 2011-12; and (iii) and increase non-wage O&M and capital outlay by at least 4 percentage points and 8 percentage points o f total expenditure by 2011-12 (Figure Al.3). Achievement o f these targets will be critically dependent on the reforms implemented. GoHP has announced several reformmeasures to create fiscal space and improve expenditure effectiveness. These actions are projected to result ina decline in the expenditure to GSDP ratio from 28.2 percent in2006-07 (RE) to 26.6 percent in2009-10. FigureA13: ImprovingExpenditureCompositionunder GoHP MTFP 2004-05 2011-12 *.Salaries 9.5% Pensionsand Retirement Benefits 1SubsidiesandTransfers ~7Interest Payments 3.0% Other RevenueExpenditure J, NonWage O&M aCapitalOutlayand Net Lending Source: Finance Department, GoHP. All numbers aspercentage ofprojected expenditures under MlFP. > Subsidies and transfers account for about 7 percent o ftotal expenditure, up from 5 percent in2003-04. GoHP's subsidy to the Himachal PradeshElectricity Board (HPSEB) was Rs. 2.45 billion in2006-07 (RE)- which i s relatively small compared to other states.lo4 GoHP has reduced the power subsidy to Rs. 1.5 billion in the 2007-08 budget, and will strive to containthe level o fthe subsidy. > Pensions are an increasing fiscal burden, having risen from about 8 percent o f expenditure in2002-03 to over 9 percent at present. InAugust 2006, the state introduceda Contributory Pension scheme for new employeesjoining service after M a y 15,2003, and it follows the Go1pattern o f contribution^.'^^ However, the impact o fthe new pensionscheme will be felt over the longer term, and, till then, the state will have to contend with pension expenditure under the Defined Benefit scheme for employees hiredprior to May 15,2003. GoHP IO4The power subsidy essentially finances the revenue loss to the HP State Electricity Board on account o f the difference inthe tariff recommended by the HimachalPradesh Electricity Regulatory Commission and the implemented tariff. The scale of the subsidy is small inHP as compared to other states (e.g. Andhra Pradesh andTamilNadu) andthere areno issues offree power to contend with. The employee contributes 10percent o f Basic Pay and Dearness Allowance towards his pension benefits and the state matches the contribution. 88 has announcedthe creation o f a fund for financing Defined Benefit pension scheme with an initial corpus o f Rs. 0.5 billionthat will be enhanced over time. GoHP also plans to undertake pensionliability and cash flow projections with respect to civil service with a view to medium term reforms.'06 > In2006-07, the statehadinitiateda systemofperformance-based budgeting, whichwillbe activelypursued and implemented. > GoHP plans to expand performance budgetingby initiating departmental Medium Term Expenditure Frameworks ina few key departments, such as Education, Health, Public Works, and h g a t i o n and Public Health. > GoHP proposes to develop maintenanceplans for fixed assets such as roads, buildings, and equipment for fundingpurposes. P GoHP is considering apermanent internalinstitutional mechanismto undertake rollingannualreviews to identify unproductiveprogrammes, and rationalize and improve efficiency o f existing programmes. Management of Debt and Contingent Liabilities 11. GoHP has been classified as a debt stressed state by GoI."' Over the period 2007-08 to 2011-12, GoHP proposes to replace Rs. 15.5 billion o fhighcost debt with couponrates o f 10percent and above. Debt that carries coupon rates 10percent and above constituted about 18 percent o f outstanding debt stock at the end of March 31,2007. Approximately 40 percent o f the debt will be repaidbetween2007-08 and 2011-12. As GoHP's fiscal situation improves, its interest expenditure to revenue receipts ratio will also decrease from 24 percent in2005-06 to 17 percent in2011-12. 12. HPhas 23 Public Sector Enterprises (PSEs) that employ close to 50,000 people. Importantly from a resource flow perspective, however, the annual support to PSEs by way o f direct subsidies i s not too high. GoHP has kept annual subsidies to these enterprises at a relatively low level o f Rs. 0.4 billion in2006-07, down from Rs.0.48 billion in2005-06. Much o fthis i s given to Himachal RoadTransport Corporation (HRTC) on account o f the state's social responsibility o f providing public transport services on unviable routes. Onthe other hand, contingent liabilities inthe form o f outstanding guaranteedborrowings by state-owned PSEs i s high-at about Rs. 35.5 billion or about 14percent o f GSDP as on March 31,2006. The government also carries significant fiscal risks from the accumulated losses incurredby PSEs. As o f March 2006, the total past accumulated losses o f these enterprises was about Rs. 9 billion or 3.5 percent o f GSDP. The HPSEB and HRTC and are the largest, accounting for nearly 80 percent o fthe employees and 70 percent o f the accumulated losses. 13. GoHP has proposed several reforms to lower off-budget borrowings and contingent liabilities. The 2007-08 budget has announced that risk-weighted state guarantees for loans will be capped at existing levels. GoHP will cap guarantees at 40 percent o f the previous year's revenuereceipts by the next financial year. This will help minimize exposure to poorly performing state owned enterprises andboards, while malung the award o f guarantees strategic infurtherance o f development objectives. Off-budget borrowing i s to be contained, and the state has already consolidated Rs. 27.6 billion o f its off-budget borrowings inits books. Moreover, GoHP presently reports guarantees on an equal weightedbasis-but will beginreportingrisk-weighted guarantees as required under the FRBM. While these PSEs as o f today are not imposing a huge annual cash subsidy burden on GoHP, the loans extended to some corporations and guarantees given to others may result ina future fiscal liability. Inthe medium term, GoHP plans to put inplace a set o f formal rules to govern eligibility o f PSEs, cooperatives, and statutory boards for government guarantee. 106 Projections will be initiated for Statutory Boards, Corporations, Universities and Aided Institutions, and LocalBodies andthe DC scheme i s proposed to be extended to cover new pensionable staff inthese agencies. 107A state is classified as "debt stressed" by Go1ifits interest payment to revenue receipt ratio is equal to or greater than20 percent 89 ImprovingPublic Financial Management 14. Despite several achievements described briefly above, some key areas need strengthening for the state's publicfinancialmanagementsystemto assist expenditure effectiveness, and support GoHP's mediumterm fiscal and governance program. The need for reformi s particularly evident inthe area o fbudget execution procedures, includingweaknesses ininternal controls. It i s necessary to complete the ongoing computerization o f treasury systems, create an internal audit system, and have more effective legdative oversight and timely follow up on audit observations. GoHP has outlined an agenda for further strengthening financial management and procurement and prioritizedthe following actions from the year 2007-08 onwards: (i) modernize the Himachal Prudesh Financial Rules, 1971, inline withthe General Financial Rules (GFR), 2005, o f GoI, to strengthen internal controls; (ii) reinforcethe responsibility and accountability of Heads of Department (HOD) to ensure more effective utilization o fresources and strengthen internal controls; (iii) a Public Financial conduct Management andAccountability Assessment to review PFMarrangements including inthe PSEs, startingwith two largest PSEs; (iv) complete treasuly computerization and roll out coverage to the sub-district level; (v) constitute a worlung group to work out an internal auditfunction interms o f scope, coverage, and focus, with a view to movingtowards a `risk based' audit approach as opposed to a transactions based audit approach, and streamline the audit function inUrban Local Bodies (ULBs); and (vi) reduce backlog o fUtilization Certificates and audit o f ULBs, and (viii)create a database o f serious audit observations, to monitor and improve the responsiveness. 15. As regards modernizationo fpublicprocurementsystems,the challenge is to integrate procurement into a well defined PFMsystem. GoHP proposes to follow such an approach that will focus on integrating procurement with planning, budgeting, accounting, and auditing. The reformwill be overseenby the Finance Department, and will work towards institutinga modem procurement law to guide procurement activities in government and conducting an assessment for e-procurement. B. PromotingKey Sectorsfor Growth, Employment,andRevenueMobilization TappingHydropower ResourcesEfficiently and Sustainably 16. GoHP appreciates that the development o f hydropower should be inconsonance with environmental safeguards. Implementation o f most o fthe environment management activities falls within the domain o f the state and, HP i s taking steps to strengthen its institutional structures for the planning, implementation, and monitoring o f environmental management activities. The state i s designing an accountabilitymechanismfor preparation and implementation o f CAT Plans. It i s also talung steps to accelerate the implementation o f the CATplans for the ongoing hydropowerprojects-in the short term, the focus will be on identifying 3-4 critical items from the CATplans o f ongoing large hydropower projects and demonstrating implementation o f the same. Inthe mediumto longterm, the focus would beon scaling upthe full implementationo fCATplans across ongoing hydropower projects and ensuring their implementation at the earliest, and for the new projects, in parallel with the project implementationschedule. One o f the approaches that the state i s considering i s outsourcing implementation o f some ofthe activities under the CAT plan to either the project implementing agency or other contractors. Inparallel, the state i s planning to undertake an assessment o f the slull and capacity gaps existing inthe different state agencies for undertaking the environmental management activities, and will then prepare a plan for buildingup capacity for implementation and supervision. Inaddition, HP i s beginning to focus on incorporating the river-basin approachwhile preparing such plans. For a start, GoHP has facilitated the initiation o f a study for the Satluj Basin for the optimal and integrated development o f power. 17. As described inChapter 4, HP has been following a mixedmodelo f development o f the hydropower resources. Recently, however, following the establishment o f the Himachal Power Corporation, it has been proposed that a number o fnew projects that hadbeen either earlier allocated or are still unallocatedbe transferred to this new entity for development. This new approach can have significant challenges for the state. GoHP proposes to strategically evaluate the risks and benefits involved infollowing this model, incomparison 90 with the corresponding risks andbenefits from the alternative models. Inaddition, GoHP also plansto analyze best management o frevenues flowing to state from the hydropower projects, to ensure the maximumbenefit for the state and for those most affected by the development-including suggesting alternative ways for benefit sharing with the communities. 18. The internal efficiency of HPSEB-which hadbeen suffering financial losses untilFY06, but has now started to show a cash surplus driven mainly by the significant increase inrevenue from inter-state sales- remains an issue. Under the Electricity Act (2003), states were to restructure their state electricity boards by segregating the transmission function from the power trading function. With a view towards implementingthe Electricity Act o f 2003, GoHPMPSEB proposes to prepare an implementationplan for enhancing the effectiveness o f operations o f HPSEB under the Electricity Act 2003-and begin implementationo f the plan. Unlocking thePotential in theHigh Value TourismSector 19. Despite GoHP's stated commitment to tourism development, an inter-departmental consensus on its importance appears to be absent. The state's current Tourism Policy lacks clear fundingprovisions, and i s behind targets interms o f implementationdeadlines, as discussed inChapter 4. Accordingly, GoHP will support the update o f the existing Tourism Policy. This will include: (i)view o f the future within the context a o f Indiantourism, recognizingthat tourism and economic development are inseparable and mutually supportive; (ii)macro-levelperspectiveplanfortourismdevelopmentofHP,soastoguidefuturedevelopmentina a strategic, scientific, sustainable, and professional manner, while keepingwithin the defined vision; (iii) a micro- level destination development master plan, with a 1-5 year perspective, for the focused development o f the specific areas/sites/sub-regiondthemes identified for tourism development; (iv) well defined mechanisms for financing this vision throughpublic, private andjoint sectors; and (v) clear responsibilities and accountability for implementation. 20. GoHP seeks to strengthen institutions for tourism development. Inorder to develop and implement this vision, the institutionalmechanism-including inter-departmental coordination-has to be improved. The HPTDBis an apex bodythat couldtake the institutional lead-but it mustbe activated, with clear mandates and regularizedmeetings. The HPTDBmust lead infacilitating a political consensus amongst all constituencies about the importance o ftourism, and clearly communicate to all the stakeholders that tourism i s a priority industry. The ExecutiveBody o fthe HPTDBis supposed to haveover 100members, which makes itunwieldy. The organization, composition, and mandate o fthe HPTDBwill be evaluatedby GoHP, and changes introduced as appropriate in subsequent years ifrequired. GoHP also plans to create an empowered Single Window mechanism under the TDB for facilitating approvals for tourism projects, requiring inter-departmental coordination. Ifnecessary, GoHP will hire professionals to work with the government on a longer term basis. GoHP also plans to involve and consult with civil society groups indeveloping tourism-especially inits plan to certify and classify tourist facilities, andorganize specialized tourist events like annual fairs, etc. 21. The state proposes direct measures to involvethe private sector. The state runs the HP Tourism Development Corporation (HPTDC)-and while lack o f funds prevent upgradation o f HPTDC facilities, the private sector also cannot operate these state-owned properties ina more profitable and professionalmanner. Properties that belongto HPTDC, ifprivatized, could send the right signals to investors. It i s likely that good tourism properties owned by the government could earn much more revenues for GoHP, apart from attracting the highend traveler, ifrunprofessionally by a good hotel chain. GoHP has already tendered for Expressions o f Interest for the development o f seven properties, broadly suggesting usage-like golf courses, health facilities, hotels, etc-in conformity with GoHP's priorities. Short listing i s inprocess, andbidsare likely to be approved this calendaryear. 22. Inorder to promoteconnectivity, GoHP is alsoplanningto involve the private sector inthe construction o fthree ropeways: Dharamshala-Triund, Manali-Rohtag-Solan, and Kullu-BijliMahadev. The bid 91 process for this will be initiated shortly. Over the medium term, the state plans to upgrade Kangra and Buntur airports to allow for larger aircraft carriers, as well as develop helipads and helicopter connectivity. C. PromotingtheInstitutionalFrameworkfor EnvironmentallySustainableDevelopment 23. GoHP recognizes the needto improveinstitutionsto manageenvironmentalassets, as described in Chapter 7. GoHP has committedto improving environmental management, particularly by: (i) promoting inter- departmental coordination to ensure convergence o f environmentalobjectives and minimize intersectoral conflicts; (ii) strengthening the Environment Department, which currently has insufficient capacity and powers, inorder to capitalize onthe state's comparative advantages anduse environmentalresourcesas growth dnvers; and (iii)preparing anEnvironment Master Plan supporting development goals, and providing a holistic view o f the growth-generating potential o fnaturalresources, as well as the limits and carrying capacity o f key resources. 24. Recognizingthe importance o f environment, GoHP, inits Budget announcement, has proposed to form a DepartmentofEnvironmentandPollutionControl, as per terms o freference issuedby the Ministry o f Environment o fForestry inGoI. A comprehensive Government Order has already been notified by GoHP on April 13,2007, providingdetails for the formationo fthe department itself, its staff andequipment composition, and functions for each o f the subset departments: Science and Technology, Biotechnology, and Environment and Pollution Control. 25. An urgent needhas beennotedfor conductinga capacity assessmentfor the new Department o f Environment and Pollution Control. The assessment would review staffing/skill mix, equipment, knowledge andresourcerequirements, as well as identify functions to be performed by the Departmentand those to be outsourced. Ithas been krther emphasizedby GoHP that the state's extremely fragile Himalayan eco-systems warrant a strong researchand development capacity inpriority areas such as adaptation strategies for glacial melts due to global warming; preservation o fpasture lands and wetlands (Ramsar sites); river basin issues impactingenvironment flows, aquatic life and impacts on livelihoods. GoHP plans to mainstream environment management within sectoral agencies by preparing sectoral guidelines to strengthen environmentmanagement in sectors with highvulnerabilities. This will be initiatedwith a particular focus on the needs o f the hydropower sector. 26. With a longterm perspective inmind, GoHP has indicatedits intentionto prepare an Environment MasterPlanfor the state to foster inter-departmental coordinationand include environmentalconsiderations as key planningtools. This includes identifying execution, accountability, monitoring, and enforcement procedures, and roles for other departments such as Transport, Forestry, Tourism, Hydropower, Industry,Urban Development, Town and Country Planning, and Public Works-to be coordinated by the Environment Department. The components o f the Environment Master Plan would include detailed resource inventory covering all environment parameters; trend analysis o f environment degradation; vulnerability assessment to establish zones and appropriate development criteria to guide development and optimize resource utilization. Once prepared, its implementationwould be piloted, beginning with fragile areas and gradually scaling up to state level. 27. Inorder to builduptowards the EnvironmentMasterPlan, GoHP will first initiate a "gap analysis"of the sector. This would include: (i) assessment o f environmental pressures invarious areas inthe state; (ii) identification ofregulatory, institutional, and policy gaps leadingto these pressures; (iii) assessment o f workload and implementationcapacity for the Environment Department, Forest Department, and the State Pollution Control Board; (iv) strengthening of compliance and efficiency by assessing alternative ways o f implementation o f development projects; and (v) assessment o f adequacy o f the existing range o fpolicy instruments and feasibility o f usingnew ones that target the systemic and root causes o fpolicy failure. 28. Inaddition, GoHP iskeenon strengthening communityinvolvementmechanisms,to enhance environment performance and accountability, and improve regulatory compliance. Since GoHP has already 92 establishedLocal Area Development Committees ineach district, it has been proposed that pilot "community environment monitoringmechanisms'' would be initiated through these Committees. Inaddition, gnevance redressalmechanisms will be establishedby project proponents to increase their environment responsibility and public accountability. 29. Inthe context ofGoHP's specific needs ofbalancinggreencover andmaintainingthe "health" of forests, the need for further researchinthe area o f environmentalrestoration and regenerationhas been recognized by GoHF'. GoHP will work on preparation o f guidelines to strengthenthe Compensatory Afforestation programs using scientific criteria (e.g. biodiversity offsets, restoration biology) inthe short term. D. Improvingthe GeneralBusinessEnvironmentfor PrivateSector Participation 30. Given that one o fthe key constraints to private sector development as well as productive employment for educated youth i s the skills mismatchdiscussed inChapter 3, GoHP i s seelung to assess and project the slull needs o fthe secondary and tertiary sectors; better match the provision of technical and vocational training opportunities to market opportunities; and improve the general quality o f education with a view to increasing employability. The state proposes to undertake a study on skills mismatches and shortages inHP. This will be an important step, since the extent o f slull gaps and mismatches inthe state i s unclear at present. This constrains evidence-based policy reforms. The study would include a slulls-mapping exercise, to identify particular sectors which would emerge inthe near future, so that skill requirements could be projected. Basedon this, the state plans to come up with a slulls development strategy to bridge current and future slulls shortages and slulls mismatches-worked out inconsultation with industry,workers, and educators. It should be noted that it i s not proposed that GoHP take the lead on skill development-but that the study provides grounding for policy-based reform, including on private sector involvement. 31. GoHPi s also worlung towards improvingtransport facilities to raise connectivity-which i s another major bottleneck faced by the private sector. As part o f a strategy to make available public transport to rural areas, GoHP has announced an automatic licensing scheme for all investment applications, where at least 60 percent o fthe bus route i s for rural roads. To make full use o f the highinvestment made inroads construction, the licensingregime will be liberalisedto grant more permits to the private sector for plyingo f buses. This new policy i s a "win-win" on many accounts. There shall be more direct and indirect employment avenues for the unemployedyouth. Through better transport opportunities, the state economy shall benefit substantially, especially insectors such as agriculture, horticulture, and tourism. The state's tax revenues will also gain in terms o f enhanced consumption o f diesel, spare parts usage and higher collection o f road tax. The role of HRTC will continue to remain important, especially for the interior andfar flungareas o fHP. 32. GoHP also plans to step up infrastructuredevelopment inindustrial areas. Though the Baddi- Barotiwala-NalagarhDevelopment Authority (BBNDA) has been set us to oversee infrastructure development inthe area, there are issues offundingand coordination. The operation will support measures to synergize efforts under the BBNDA, the Industries Department, and other relevant agencies-to avoid duplication in planning and implementation o f industrial area development o f BBNarea. A proposal for development o f worker housing inthe BBNarea, basedon public private partnerships, will also be supported. Duringthe first tranche, a proposal to enact the IndustrialArea Development (IADA) Act to facilitate planned industrial infrastructure development through the creation of industrial area authorities inpriority locations i s expected to be enacted. It was also agreed that measures would be taken to strengthen the BBNDA and other IADAs through additional fundingduringthe operation. 33. Effectofbusinessfacilitationmeasures. GoHP will also undertake a study to evaluate the effectiveness o fbusiness facilitation measures at the state and district level duringthe first tranche. Measures like the single window facility have been inoperation in the state for several years-and GoHP would like to assess its effectiveness and identify remainingbottlenecks. Recommendations from the study could inform subsequent tranches. 93 E. StrengtheningGovernanceandPublicAdministration 34. Transfers are an importantissue, and GoHP supports increasing tenurialstability. As described in Chapter 5, the average tenure (intheir current posts) o f Principal Secretaries and Secretaries inHP i s currently a mere 14 months; tenures for Deputy Commissioners are marginally better, at 17months, but still well below the three-year minimumtenure set by HP's transfer policy. Given the highturnover among senior staff, GoHP i s seekmg to improve the tenure and stability o f civil servants to promote effective implementation o fprogrammes by enforcingthe average tenure o fa minimumo fthree years, consistent withHP's transfer policy, while discouraging politicizationo f transfers and recruitment. GoHP also plans to contain transfers across government at 3 percent o fthe actual worlung strength o f cadres per year. A Committee on MinimumTenures i s to be establishedand GoI's proposal on minimumtenures for Indian Administrative Service posts i s to be accepted. Furthermore, mid-year transfers inEducation are to be banned. 35. Improving administrative efficiency through better file management is a policy priority. While GoHP has introduceda computerized file monitoring system in2004, very few Departments are actually using the system to reduce delays and cut pendency. Section officers inparticular are not well trained inthe use o f computers. The use o fthe single-file system across government i s limited, with only RuralDevelopment and Panchayati Raj making use o f that at present. GoHP will focus on the use o f change management tools to better equip staff for the wider use o f e-governance inthe Secretariat. The single-file system will be extended to selected major departments. GoHP will also issue a Government Order requiring use o f REFNIC-which i s a file tracking software-by departments for all file management and tracking functions inSecretariat. 36. GoHP needs to strengthen policecapacity. Despite a good law and order situation, the overall conviction rate for all crimes (including, but not limitedto, corruption cases) under the Indian Penal Code (IPC) and Special Local Laws (SLL)has fallen inthe last decade. Measures proposed to reverse the weakening o f police capacity to provide effective law and order services, reflected inthe declining overall conviction rate, will include: (i) implementing the recent Supreme Court directive to create a State Security Commission to insulate the force from political pressures; and (ii)enforcing a certain minimumtenure for the Director General o f Police (DGP) and senior officers. 37. E-governancehas enormous potential inHP as a tool for simplifyingtransactions andmaking it easier for citizens to access government services. GoHP plans to implement landrecords computerizationin 88 Tehsils and Integrated Service Center luosks inall Tehsils in Shimla District, with at least seven services during the coming year. This will be scaledup to other districts during subsequent years, along with business process re-engineering initiatives as necessary. 38. Among other measuresto improvepublic administration,the Right to Information Act will be more aggressively implemented. All state Departments are being encouragedto post all the required information under the RTIAct on their respective websites, so that the common citizen can access all relevant information pertaining to departmental schemes. GoHP plans to experiment with an outsourcingpolicy insome key departments-including functions like sanitation work o f hospitals and urban local bodies. Furthermore, GoHP proposes to undertakefunctional reviews o f departments with a view to improve government efficiency. 94 Annex 2: Some HumanDevelopmentOutcomeandAccess Indicators,HP and Other States 120 100 +IN yGJ 80 60 40 20 0 120% 100% pJ t 80% 60% MH + PJ 40% MH @GJ t HR HR $IN 20% 0% KR Note: All data from National Sample Survey (1999-00) or National Family Health Survey (1998-99). States represented are MH= Maharashtra; KR= Kerala, GJ= Gujarat; HR = Haryana; PJ= Punjab; HP = Himachal Pradesh, and IN= India Average. 95 Annex 3: TechnicalNoteon Estimationof Vulnerability Defining Vulnerability 1. Poverty and vulnerability are closely relatedbut distinct concepts. Poverty i s the actual observed state of the household falling below a specified threshold with respect to a specified welfare measure. Vulnerability, on the other hand, i s the priorprobability o f the household beingpoor. Inother words, poverty i s the expost realizationof a statewhile the latter i s the ex ante probability o f a household being inthat state. Households vary intheir exposureto shocks and intheir ability to cope with these shocks. Consequently, some households may be more vulnerable than others. Thus, it i s important to examine vulnerability arising due to household characteristics andor shocks that make households more likely to remain inpoverty or to fall into poverty inthe future. 2. InthisNote, we adopt the approachthat vulnerability is "the likelihoodthat at agiventime inthe future, an individual will have a level of welfare below some norm or benchmark". This approach develops a model to predictrealizedwelfare, measuredas consumption inthis specific case, at apoint inthe future usingcross- sectional data, and the probability of an individual household falling below the predictedwelfare level (see Chaudhuri 2000). Two attractions of this approach are: (i) the measures o f aggregate vulnerability are analogousto poverty incidence and are thus easy to interpret and apply to policy; and (ii) data availability. 3. The basic intuitionbehindthismethodologyis essentially to understand the household's random consumption generating process and hence, the probability o f household consumption falling below a specified threshold. Inthe absence ofpanel data with observed consumptiondistributions over time, a consumption model i s estimated usingcross-sectional data and the predictions fiom this model are usedto generatethe distributiono f expected consumption and the predictedprobability of beingpoor inthe future. Households with probability o f future poverty below an arbitrarily chosen vulnerability threshold, analogous to the poverty line, are classified as vulnerable to expectedpoverty. While it is acknowledged that vulnerability i s essentially a forward-looking concept so that cross-sectional data can provide some insightonly at the cost of stringent assumptions, it i s equally important to make an attempt, inthe absence ofpanel data, to highlight the need to focus on the volatility o f consumption and the movement o fhouseholds into and out o fpoverty. Key Steps in Estimation of Vulnerability 4. Empirically, the first step i s to estimate areduced form consumption model as follows: InCh =X;l@ eh + (1) where ch i s the per capita household consumption expenditure, xh i s a (kxl) vector o fhousehold characteristics (including household demographics, main economic activity, endowments of labor and land, etc.),fl i s a (kxl) vector of unknownparameters that describe the state of the economy and eh i s the normally distributederror term N(0,o:,~). error term capturesthe idiosyncratic shocks that result indifferent This levels ofper capita consumption for otherwise observationally identical households. The model allows for the cross-sectional variance ofthe error (and hence of log consumption) to vary with household characteristics as follows: oe,h =xk8 uh + (2) where 8 i s a (kxl) vector ofunknownparameters to be estimated and u,, i s the normally distributederror term 96 5. The parameters /3 and 8 are estimated using a three-step feasible generalized least squares (FGLS). This procedure generates consistent estimates o f e,allowing equation (1) to be transformed so that the error term is homoscedastic. The consumption regression model can then be estimated usingordinary least squares (OLS) to obtain consistent estimates o f s.Usingthese estimated parameters, we can obtain household-level expected log consumption: &In C, IX, 1=X$ (3) and household-level variance o f expected log consumption: +[InC, X, 3 = I a:,,& (4) 6. Assuminga normal distribution for log consumption, vulnerability canbe estimatedas follows: where z i s the specified poverty line and @(.)i s the standard cumulative normal density function. 7. Overall vulnerability incidence is then defined as the total number o f vulnerable households, i.e., those households where the estimated vulnerability falls below a specified threshold ina given time horizon. Clearly, the measure o f vulnerability incidence i s sensitive to the choice o f the vulnerability threshold (v,) and the time horizon (n). 8. Following standard practice inthe literature, we focus on the most commonly usedthreshold for vulnerability incidence,^, = 0.5 ,defined over a three-year time horizon, i.e., the probability o f falling into consumption poverty at least once inthe next three years.'" 9. The advantage o f this approach i s that it does not require panel datasets that are rare indeveloping countries and can be used to assess vulnerability based on cross-sectional data. Additionally, the methodology yields an overall incidence o f vulnerability measure that is analogous to the commonly usedpoverty headcount ratio and i s familiar to policy-makers. Note that the measure of vulnerability already incorporates the use o f copingmechanisms (as it i s defined interms o f observed consumption expenditure) and thus, reflects both income risk and the use o f smoothing (Pritchett, Suryahadi and Sumarto 2000). On the flipside, the shortcomings o f this approach relate to the strong assumptions that are required to assess vulnerability from a single cross-section (see Chaudhuri 2000 for details) - one, inter-temporal variance can be proxied by cross- sectional variance across households at a sufficient level o f disaggregation; two, the structure o fthe economy i s stable so only idiosyncratic shocks enter the model through the error term. Data and Variables Usedin Estimation 10. We estimate separate consumption regression models for rural and urban areas o f Himachal Pradesh usingthe 1999-2000 large-scale National Sample Survey consumption schedules, as per the methodology outlined above. The variables usedto explain log consumption includehousehold head characteristics (including age, gender, marital status, educational attainment), household demographics (such as household size, number o f children and elderly inthe household), main economic activity o f the household (i.e., whether the household is primarily self-employed inagricultural or non-agricultural activities, primarily engaged inregular wage or casual wage-agricultural andnon-agriculturalinrural areas-mployment or other activities), land owned and facilities (whether the house i s electrified), other household characteristics (including caste and 'OsNote that, bydefinition,providedthe sample is largeandnormally distributed,the estimatedmeanvulnerabilityshould tend towards the observedpovertyrate. 97 religionbackground) as well as controls for seasonality. The impacts on householdlog per capita consumption o f the majority o f these variables are broadly plausible. Results are reportedbelow. 1 RURAL URBAN HHheadage 0.0205*** 0.0016 (0.0041) (0.0064) HHheadage, squared -0.0001*** 0.0000 (0.0000) (0.0001) HHheadmale -0.1369." -0.0992 (0.0307) (0.0639) HHheadmanied -0.1571" 0.0745 (0.0694) (0.0520) HHheadwidowed -0.1909" 0.1086 (0.0792) (0.1019) FemaleHHheadwidowed -0.1310** -0.1787 (0.0546) (0.1133) HHheadcompletedprimaryschool 0.1150*** -0.0035 (0.0250) (0.0452) IHHheadcompletedmiddleschool 1 o.iai7*** I 0.1615*** I (0.0313) (0.0490) HHheadcompletedsecondaryschool 0.3035*** 0.3202*** (0.0240) (0.0350) HHheadcompletedgraduate school 0.4979*** 0.5327"' (0.0565) (0.0394) HHsue -0.1536"' -0.1918"' (0.0110) (0.0202) HHsue, squared 0.0073'** 0.0115*** (o.ooos) [ (0.0021) No. ofchildrenaged0-6 years inHH I1 -00403*** I -0 1023*** (0.0102) (0.0212) Muslim 0.2386." -0.1558" (0.0563) (0.0733) Scheduledcaste -0.0967*** -0.1495*** (0.0217) (0.0309) Scheduledmie -0.0029 -0.0259 (0.0385) (0.2272) Self-employed o . o m * In nAlA\ Self-employedinagriculture -0.1052*** (0.0253) Self-employedinnon-agriculture -o.oai4*** Casuallabour I -0.1051* Casualagriculturallabour I1 -0.2367"' (0.0501) II II , \ - I , Other casuallabour 11 -0.1982*** (0.0336) Regularwagdsalaryearnings 0.1401*** (0.0403) Landowned(logs) -0.0254 -0.0369 (0.0308) (0.0305) Prop.ofcultivatedlandimgated 0.0243 (0.0281) HHis electrified 0.1737*** 0.2020*** (0.0388) (0.0692) HHinterviewedinApr-Jun 0.0163 0.0256 (0.0232) (0.0326) HHinterviewedinJul-Sep I1 0.0348 0.0512 (0.0237) II (0.0330) HHinterviewedinOct-Dec -0.0083 -0.0486 (0.0239) (0.0309) Constant 6.5818*** 7.0278*** (0.1194) (0.1431) Standarderrorsinparentheses * significantat 10%; ** significantat 5 % *** significantat 1% 98 \nine of rotni)an? Yrotir I os\" Protir I015 Paid up ('apitai HP Statc Itandicraftr;and itandfoam ICorporationLtd I 414.161 99 Annex 5: FiscalProjectionsandDebt SustainabilityAnalysis FiscalProjections 1. The Government o fHimachal Pradeshhadproducedmedium term fiscal projections that were tabled along with the Budget for 2007-08. The projectionswere subsequently revised to reflect stronger improvement inexpenditure compositionand fiscal correction. Therevisedframework isoutlinedbelow. The MTFPis broadly consistent withthe Himachal PradeshFRBM, 2005 and alignedwith TFC's recommendations. The MTFPtargets elimination o f GoHP's current deficit in2008-09 andreducingthe ratio of gross fiscal deficit to GSDP from 4.3 percent in2006-07 to 2.2 percent by 2011-12. Going forward, GoHP plans to execute its budget to meet the 2007-08 MTFPtargets, and prepare the 2008-09 budget inalignment with the MTFPtargets for that year. GSDP i s expected to grow at a nominal rate o f 14percent, which is broadly consistent with a realrate o f growth o f 8 percent. 2. Revenue. The projections indicate an annual growth rate of roughly 16percent inown tax revenues (and a buoyancy o f around 1.1). This seems achievable, given that the state has announced several encouraging measures inits 2007-08 budget to raise its own tax revenue. These include raising the motor vehicle tax on personal vehicles from 2 percent to 5 percent, and to prevailing national levels by 2011-12, levying a green tax on vehicles over 15 years old, and a hotel tax based on notional minimumoccupancy. The state excise regime has beenrevisedto a vendor-wise auction regime, with annual license fee linkedto minimumguaranteed quota that i s based on past trend insales. As a percent o f GSDP, the state's own tax effort i s forecast to increase from 5.2 percent in2006-07 (RE) to 6.5 percent by 2011-12. Non-tax revenues show a growth o f a little over 10 percent annually. These are fairly conservative, given that non-tax revenue has grown rapidly from 2002-03 onwards at an average o f45 percent year on year, largely on account o frevenue from sale o f hydropower. Centraltaxes and grants are projectedto decline from 15.7 percent o f GSDP in2006-07 (RE) to 14.9 percent by 2011-12. The revenue effort is projected at an almost even 24 percent o f GSDP through the MTFPperiod, in part because o f a conservative forecast o f share o fnon-tax revenue. Table A5.1: Revenues under the MTFP (Percentage of GSDP) 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Actual Actual R.E Proj Proj Proj Proj Proj Total Revenue 20.1 25.8 24.0 23.5 23.5 23.6 23.8 24.0 State'sOwn Revenues 8.0 8.6 8.3 8.8 8.9 8.9 8.9 9.1 Tax 5.4 5.9 5.2 6.1 6.2 6.3 6.4 6.5 Non- Tax 2.6 2.7 3.0 2.7 2.7 2.7 2.6 2.6 Central Taxes and Grants 12.1 17.2 15.7 14.7 14.7 14.7 14.9 14.9 Shared Taxes 2.3 1.9 2.0 2.4 2.5 2.7 2.9 3.1 Grants 9.8 15.2 13.6 12.3 12.1 12.0 12.0 11.8 3. Expenditure. The projections indicate that GoHP recognizes the needto improve expenditure composition towards capital outlay and critical non-wage O&M. The MTFPattempts to: (i) reduce share o f salary expenditure to total expenditure to 30 percent by 2011-12, from 35 percent in2005-06; (ii) decrease interest expenditure to revenue receipts to 17 percent by 2011-12 (i.e. by 5 percentage points o frevenue expenditure from 21percent in2005-06); and (iii) increase non-wage O&M and capital outlay to 18 percent and 20 percent o f total expenditure respectively by 2011-12 (Table A4.2). The underlyingbasis o fthe forecast has been strengthened to reflect hiringplans, attrition, inflation indexationo f wages, likely impact o f the next Pay Commission, and wage creep inthe salary projections. Subsidies and transfers remain fairly constant in absolute terms. 100 TableA 5 2 ExpenditureCompositionas apercentof TotalExpenditure 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Actual Actual R.E Proj Proj Proj Proj Proj Salaries 36% 35% 33% 34% 34% 33% 31% 30% Pensions and Retirement Benefits 9% 10% 10% 10% 10% 10% 10% 9% N o nWage O&M 10% 11% 13% 13% 14% 15% 17% 18% Subsidies and TTanSfeIS 7% 7% 8% 9% 8% 7% 6% 5% Interest Payments 25% 21% 20% 20% 18% 17% 16% 15% Capital Outlay &Net Lending 10% 11% 13% 12% 14% 16% 18% 20% 4. While the projections may not meet Twelfth Finance Commission's guidelines on salaries (35 percent o f revenue expenditure net of interest payments and pension) and interest expenditure (15 percent by 2009-lo), they do meet the Twelfth Finance Commission targets o f elimination o frevenue deficit and a fiscal deficit ratio o f 3 percent o f GSDP. Moreover, what is important i s that the projections do show a story o f consistent fiscal improvement. The proposed fiscal trajectory i s shown inFigure A5.1. FigureA5.1: ProjectedFiscalTrajectory 5% 1 m FwalDeficit -+ - &venue Deficit -t-RimaryDeficit (D co 0 b JI h,0 gg 0 g& gg 2o& ; g: 0 v- 0 0 7 2 7: 0 N 0 0 N N 0 hl 0 N 0 N 0 (v I Debt Sustainability Analysis 5. The state, inits mediumterm fiscal projections, predicts that debt will reach around 47 percent o f GSDP by2011-12. While the state, inthe past, has not beenreportingoff-budget liabilities, andthereby underestimating the actual level o f debt, it i s now making an effort to consolidate the outstanding o f f and on budget debt for fiscal management purposes. Figure A5.2 below gives the debt projections as per the government's projections, after including off-budget liabilities from 2005-06 onwards. The debt stock i s expected to decrease by over 20 percent over the next six years. 101 growth starts at 8.5 percent, arid 11iovcs~ a d ~ atowards a tong term growth rate of aro~nd7 percent by 2016. l ~ y Table A5.3: Debt ~ r ~ j eunder~~i a~ n~scenariosn(percent GSDP) ~ ~~ i ~ 7. Ifnder steady state c o n d i ~of the~MTFP, ifprojected ~ 1 ~ ~ ~to 2020, debt~to GSDPratiodshould ~ r decrease to about 35 percent in 15 years time. ~ ~ ~ ~ ~a shockr to GSDP grot\ith of 2.5 ~ e r ~ in,201~1-62. e ~ e r , e n could slow the r e d ~ofdcbt~to GSDP~lo 38 ~ ~ c ~ ~ ~by 2020. Inca second test,~a decline in central transfers r ~ ~ ~ ofan order of 5 perccnr a n n ~ from 2010-13 o n ~ ~ ~wiffr raise~the end~ e rdebt ~to GSDP ratto to 46 a ~ ~ ~ ~ d s i ~ percent. ~ ~ n decline 111central bansfcrs of lfic order of5 p e r ~a~nnn~~ afrom~2010-11 onwards, combined a ~ ~ y ~ ~ f ziithan interest rate shock of3 ~ ~ r c e n tpoints in2010-IIand 2011-12, wi13 raise the ~ ~ ~ ~ edebtt todGSDP a ~ e c e xatto over the baseline by nearly 13 percent ofGSDP til 2020 to 49 ~ e r ~ e n2'0. n ~ a i ~ ~onginatidebt t the ~ ~ I ~ r at n the face of~shocks the state would have to generate higher ~ j ~ ~ ~ ~ ~ r i ~ ~ ~ ~aClearly,~the state~ ~ ~ ~ needs to stay on a strong fiscal c ~ ~ ~path overi the ~~ ~ ~term.e c ~ o d ~ ~ ~ ~ ~ Annex 6: Fiscal Data for HP Himachal Pradesh:FiscalSummarv 2006-07 Rs Crore 1990-91 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 (R.E) Revenue 806.5 2992.6 3045.6 3715.8 3658.8 3980.9 4634.5 6558.6 6946.0 State'sOwn Revenues 209.8 904.6 863.2 1089.0 1052.0 1259.3 1851.9 2186.6 2398.0 Tax 160.9 620.3 728.4 915.6 887.5 984.3 1251.9 1497.0 1516.6 Non- Tax 48.9 284.4 134.8 173.5 164.5 275.0 600.0 689.7 881.4 CentralTaxes andGrants 596.7 2088.0 2182.3 2626.8 2606.7 2721.6 2782.6 4372.0 4548.0 SharedTaxes 188.0 552.0 330.3 325.1 347.6 449.6 537.3 493.3 592.9 Grants 408.7 1536.0 1852.0 2301.7 2259.1 2272.1 2245.3 3878.7 3955.1 Non- Interest Expenditures 974.8 3639.4 3911.2 4030.2 4541.2 4810.0 4803.8 5715.6 6519.5 Salaries (incl GIA for education) 470.7 1644.2 1758.6 1956.7 2147.3 2251.3 2301.6 2583.5 2728.1 Pensions& RetirementBenefits 50.8 474.4 421.6 440.3 488.6 532.6 590.7 714.8 800.0 Non- Wage 0 & M 164.2 604.8 623.5 516.0 455.9 613.0 613.2 780.8 1057.8 Other RevenueExpenditures 8.9 34.0 99.3 109.4 93.1 254.5 197.5 310.8 263.9 Subsidies andTransfers 96.3 327.3 446.6 357.0 497.2 382.1 448.8 512.8 615.3 CapitalOutlay 149.2 553.9 548.7 649.8 859.7 784.8 654.0 820.8 1065.9 NetLending 34.6 0.8 12.9 1.1 -0.6 -8.4 -2.0 -7.8 -11.4 IF' PrimarySurplus (+)/Deficit (-) -168.3 -646.8 -865.6 -314.4 -882.4 -829.0 -169.3 843.0 426.5 InterestPayments 109.2 736.8 979.2 1196.9 1459.2 1554.6 1641.1 1563.5 1665.3 Go HPRevenueSurplus (+)/Deficit(-) -93.8 -828.9 -1283.2 -860.5 -1482.4 -1607.2 -1158.4 92.5 -184.3 Go Hp FiscalSurplus (+)/Deficit(-) -277.5 -1383.6 -1844.8 -15113 -2341.6 -2383.6 -1810.4 -720.5 -1238.8 Debt Stock 1294.0 7330.4 8728.8 10359.3 12149.7 14293.0 15571.4 18850.7 19942.8 Guarantees 403.3 1874.7 3061.0 4285.0 4428.3 4809.8 4315.5 3553.3 GSDP 2815.2 14112.5 15661.2 17148.2 18904.7 20721.0 23024.0 25435.0 28995.9 2006-07 % GSDP 1990-91 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 (R.E) ~ ~ ~ Revenue 28.6 21.2 19.4 ^.- L1.1 19.4 19.2 20.1 25.8 24.0 State's Own Revenues 7.5 6.4 5.5 6.4 5.6 6.1 8.0 8.6 8.3 Tax 5.7 4.4 4.7 5.3 4.7 4.8 5.4 5.9 5.2 Non- Tax 1.7 2.0 0.9 1.o 0.9 1.3 2.6 2.7 3.0 CentralTaxes and Grants 21.2 14.8 13.9 15.3 13.8 13.1 12.1 17.2 15.7 SharedTaxes 6.7 3.9 2.1 1.9 1.8 2.2 2.3 1.9 2.0 Grants 14.5 10.9 11.8 13.4 11.9 11.0 9.8 15.2 13.6 Non- Interest Expenditures 34.6 25.8 25.0 23.5 24.0 23.2 20.9 10.2 9.4 Salaries (incl GIA for education) 16.7 11.7 11.2 11.4 11.4 10.9 10.0 2.8 2.8 Pensions& RetirementBenefits 1.8 3.4 2.7 2.6 2.6 2.6 2.6 3.1 3.6 Non- Wage 0 & M 5.8 4.3 4.0 3.0 2.4 3.0 2.7 1.2 0.9 Other RevenueExpenditures 0.3 0.2 0.6 0.6 0.5 1.2 0.9 2.0 2.1 Subsidies and Transfers 3.4 2.3 2.9 2.1 2.6 1.8 1.9 2.0 2.1 CapitalOutlay 5.3 3.9 3.5 3.8 4.5 3.8 2.8 3.2 3.7 Net Lending 1.2 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 HP PrimarySurplus (+)/deficit (-) -6.0 -4.6 -5.5 -1.8 -4.7 -4.0 -0.7 3.3 1.5 InterestPayments 3.9 5.2 6.3 7.0 7.7 7.5 7.1 6.1 5.7 GoHP RevenueSurplus (+)/Deficit(-) -3.3 -5.9 -8.2 -5.0 -7.8 -7.8 -5.0 0.4 -0.6 GoHP FiscalSurplus (+)/Deficit(-) -9.9 -9.8 -11.8 -8.8 -12.4 -11.5 -7.9 -2.8 -4.3 Debt Stock 46.0 51.9 55.7 60.4 64.3 69.0 67.6 74.1 68.8 Guarantees 14.3 13.3 19.5 25.0 23.4 23.2 18.7 14.0 103 HimachalPradesh:FiscalProiectionsunder RevisedMTFP 2007-08 2008-09 2009-10 2010-11 2011-12 (Proj) (Proj) (Proj) (Proj) (Proj) Rs Crore Revenue 7760.0 8861.7 10156.9 11658.6 13379.7 State's Own Revenues 2900.0 3340.0 3831.2 4375.8 5063.4 Tax 2000.0 2330.0 2691.2 3121.8 3621.3 Non- Tax 900.0 1010.0 1140.0 1254.0 1442.1 Central Taxes and Grants 4860.0 5521.7 6325.7 7282.8 8316.4 SharedTaxes 785.0 957.7 1168.4 1425.4 1739.0 Grants 4075.0 4564.0 5157.3 5857.3 6577.3 Non- InterestExpenditures 7149.4 8213.6 9499.7 10861.4 12409.3 Salaries (incl GIA for education) 3014.4 3414.4 3777.9 4023.2 4385.4 Pensions& Retirement Benefits 915.0 974.1 1087.6 1229.0 1388.7 Non- Wage 0 & M 1111.5 1385.8 1717.2 2161.7 2587.4 Other RevenueExpenditures 244.0 261.1 295.4 323.4 356.7 Subsidiesand Transfers 777.7 778.3 778.5 782.7 782.1 CapitalOutlay 1093.2 1409.9 1854.6 2354.4 2923.6 Net Lending -6.3 -10.0 -11.4 -12.9 -14.6 Interest Payments-withDPL 1737.0 1829.1 1948.0 2074.7 2209.5 HP PrimarySurplus(+)/Deficit (-) 610.6 648.1 657.2 797.1 970.4 Go HP Revenue Surplus(+)/Deficit(-) -39.6 218.9 552.4 1064.0 1669.9 Go HP FiscalSurplus(+)/Deficit(-) -1126.4 -1181.0 -1290.8 -1277.5 -1239.1 Debt Stock 21069.3 22250.3 23541.1 24818.6 26057.7 GSDP 33055.3 37683.1 42958.7 48972.9 55829.1 2007-08 2008-09 2009-10 2010-11 2011-12 % GSDP (Proj) (Proj) (Proj) (Proj) (Proj) Revenue 23.5 23.5 23.6 23.8 24.0 State'sOwn Revenues 8.8 8.9 8.9 8.9 9.1 Tax 6.1 6.2 6.3 6.4 6.5 Non- Tax 2.7 2.7 2.7 2.6 2.6 Central Taxes and Grants 14.7 14.7 14.1 14.9 14.9 SharedTaxes 2.4 2.5 2.7 2.9 3.1 Grants 12.3 12.1 12.0 12.0 11.8 Non- InterestExpenditures 21.6 21.8 22.1 22.2 22.2 Salaries (incl GIA for education) 9.1 9.1 8.8 8.2 7.9 Pensions& Retirement Benefits 2.8 2.6 2.5 2.5 2.5 Non- Wage 0 & M 3.4 3.7 4.0 4.4 4.6 Other RevenueExpenditures 0.7 0.7 0.7 0.7 0.6 Subsidiesand Transfers 2.4 2.1 1.8 1.6 1.4 CapitalOutlay 3.3 3.7 4.3 4.8 5.2 Net Lending 0.0 0.0 0.0 0.0 0.0 Interest Payments-withDPL 5.3 4.9 4.5 4.2 4.0 HP Primary Surplus(+)/ Deficit (-) 1.8 1.7 1.5 1.6 1.7 Go HP Revenue Surplus(+)/Deficit(-) -0.1 0.6 1.3 2.2 3.0 Go HP FiscalSurplus(+)/Deficit(-) -3.4 -3.1 -3.0 -2.6 -2.2 ConsolidatedSurplus(+)/Deficit(-) -5.8 -5.4 -5.1 -2.9 -2.1 Debt Stock 63.7 59.0 54.8 50.7 46.7 104 Annex 7: PreliminaryAssessment of PublicFinancialManagementand Procurement A. INTRODUCTION 1. The purpose o f this Annex i s to provide a preliminary assessment o f the Public FinancialManagement System inGovernment o f Himachal Pradesh (GoHP). 2. This note has been preparedbased on findings o f a World Bank team which visited Himachal Pradesh (HP) duringOctober 16- 19andthen duringOctober 26 -November 3,2006. The Bankteam met with Officials o f GoHP, Public Accounts Committee, Auditor General (AG), Controller o f Stores inShimla and reviewedrelevant documents (Finance Accounts, Appropriation Accounts, C&AG Audit Reports, Procedures & Rules for the Purchase o f Stores, IndustrialPolicy Rules, and various Acts and Rules etc.) duringthe course o f its work. B. BUDGETFORMULATION AND EXECUTION 3. BudgetaryFramework:The framework for BudgetingandAccounting inGoHP is divided inthe following three parts; this i s similar to the structure for any other Indian state. Part I- Consolidated Fund:Most o fthe transactions o f the state flow through the Consolidated Fund.lo9 These include taxation and other receipts, capital receipts andproceeds from loans raised by the State Government on the receipt side. On the expenditure side these include revenue expenditure, expenditure on creation o f assets and repayment o f loans. Part I1-Contingency Fund: This fund i s established to meet transactions o f an unforeseen or urgent nature; currently balance inthe fund is Rs. 5 crores. Part I11- Public Account: This includes transactions relating to deposits, advances, remittances and suspense; in cases where the government acts as a banker or trustee. This may include Provident/ Pension Funds, various reserve and development funds, deposits relating to various departments, and suspense/ temporary accounts which are expected to be closed through offsetting transactions. The Public Account also holds the cash reserves o f the state government. 4. Chart ofAccounts:A budgetdocument provides details o fbudget-estimates for the coming financial year. The budget estimates are prepared for different heads o f accounts which are based on a uniform classification system as adoptedby most states. As stated above, at the broadest level all transactions are classified into one o f the funds. Consolidated Fundi s divided into Revenue and Capital sections, which are further broken down into sectors and sub-sectors. The sub-sectors are further divided into a six-tier hierarchical structure, classified as follows: +++++ Major Head-a major function o f the Government Sub-Major Head- a sub-function Minor Head - a programme Detailed Head - a sub-scheme Sub-Head - a scheme + Object Head - standardobject o f expenditure 109 Funds which are received directlyby the implementing agencies(e.g. State Societies incase of Health or Primary Education or DRDAs in case of Rural Development Schemes) under Centrally SponsoredSchemes would normally not be reflected in the StateBudgetor Annual Financial Statements 105 This classification implies that the budget i s very detailed and consequently the implementing departments have limited flexibility duringthe year to be able to shift resources from one scheme to another. This shift may be warranted incase there i s slow progress on one scheme and fast progress on another; bothbeing implementedby the same Department. Insuch instances, the shift may be made only with approval o f the Finance Department; which tends to delay optimum utilization o fresources' lo. 5. BudgetPreparation:Frameworkfor preparation o fthe budget is as per the Budget Manual, 1972. Though there has beenno major review o fthis document till date, circulars/ directions are issued by the GoHP from time to time to meet any new developments/ requirements. The budget i s prepared on a cash basis and is divided into two parts i.e. Planpart which i s the responsibility o fthe Planning Department"', while the non- Planpart which mainly consists o f salaries, establishment and other recurrent expenditure which i s preparedby the Finance Department based on detailed information"* provided by other departments. 6. The Planning/BudgetingProcess: InHP, the Plansize ismuchsmaller thanthe NonPlanoutlay, salaries, pension and interest account for 70 percent o f expenditure; moreover focus o f departments duringthe course o fbudgetingfor Plan Fundstends to be on schemes, rather than needs. Though there i s a conscious effort interms o fscheme prioritization, still steps shouldbetaken tobringmore ofanoutcome focus inthe Budget. An outcome budget would clearly articulate objectives, financial outlays, deliverablesl physical outputs and desired outcomes o f a prograd scheme; it i s intended to bringina higher level o f accountability for results. Go1 has recently moved inthis direction by presenting its first outcome budget for FY 2005-06; other Indian states are also moving int h s direction. Towards garnering maximumresources for development, the state also needs to ensure that it gets the best possible allocations out o f the Centrally Sponsored Schemes114with high rates o futilization o f these allocations. 7. The Budgetdocument: The Annual Budgethas the following features: + The Budget i s a very detailed document with information on receipts and payments; it i s supported by a detailed book for each o f the 31grants. The budget document i s not easily understood by readers, in terms o flevel o f detail as well as description o f the heads and sub-heads. Though an attempt has been made to summarize/ explain the same through an ExplanatoryMemorandum; much more needs to be + done interms o f presentation to enable the public to understand and analyze it. The Budget becomes a public document after it i s tabled inthe state legislature. It i s also available on the GoHP website; however as explained above, it i s not easy to comprehend. 8. LegislativeApproval: The State Legislature i s requiredto approve the budget as part o fan annual Appropriations Act; this is mandated as per the Constitution o f India. Incase supplementary or additional grants are required duringthe year, the same also need a similar approval. Ifthe Budget i s not passedbefore commencement o f a year, a Vote OnAccount i s requiredto enable expenditure inthe initial months ofthe financial year. Timings o f approval o f the budget inGoHP are reasonable; the last two budgets i.e. for 2005-06 and 2006-07 have been approved before March31,2005 and 2006 respectively"'. 9. Itismandatory for all state governments to obtainlegislative approval for any excess over a grant/ appropriation by the state legislature. InHP a total o f Rs 13,871.86 crores o f excess spending since FY 2001-02 requires approval o f the legislature. Inthe past, this process o fregularizationi s understood to be talung a period 'lo See Paragraph10of this Annex, on BudgetaryControl. Planningdepartmentprepares an overall Planoutlayfor the year; this depends uponanumberof factors including the Annual PlanApproach Paperand the Five Year Plan. For determination of department-wise outlay, it normally considerspast outlays, any guidelines for growth the Approach Paper has identified, and specific schemes launchedby GoI. 'I2Departmentsprepare salary and other recumng part of the budget with full details, including list of employees, etc. The information is collected and compiledat the Directorate level in each department. 'I3 E.g. Kamatakahasmovedtowards OutcomebasedProgrammeBudgeting. 'I4 Incaseofthe Sarva ShikshaAbhiyaan, the state spent 69% and 83% ofitsAnnual Work PlanandBudgetfor FY 2004-05,200546 respectively. 'I5 Howeverearlier budgetswere passedas per the following timelines; 2004-05by June 30,2004 and 2003-04by July 16,2003. I06 o f4 - 5 years; thisprocess needs to be reviewedboth incontext o f minimizingthe excess as well as inreducing the time taken for regularization. GoHP: Excess over provisionrequiringregularization Year 2001-02 2002-03 2003-04 2004-05 Total Rs.Crores 2,965.36 3,295.74 4,515.58 3,095.12 13,871.80 10. BudgetaryControl:GoHP exercises control over budgeted expenditure, through a number o f processes. + At the transaction level, the Finance Officer at the spending department scrutinizes the payment request for various checks, including availability o f the budget. Further, the Treasury ensures that only those + payments are processed, for which budget is available116. At the Departmental level any request for additionalbudget has to be made to the Finance Department, which if convincedo f the requirement, would normally sanction an `additionality' (specific approval/ additionalallocation) to the department with copies to Treasury and AG (A&E). The `additionalities' are a way o freducing the number of supplementary budgetprovisions which i s done only once117 towards the end of the financial year. Around September/October, the Finance Department instructs all departments to submit budget proposals for the next year along with revisedbudget estimates for the current year. Thus providing opportunity to the departments to not only identify additional budget requirement but also surrender any likely excess budget provisions. 11. BudgetMarksmanship/ Accuracy: CAGhas pointedout anumber o fexcess/ savings inthe grants providedinthe budget. However a significant part of the variations relatedto repayment o f overdrafts/ ways and means advances118inFY 2003-04,2004-05. 12. However, an analysis of excesses incase o f select departments/ grants indicates significant variations over the years; reasons for the same need to be analyzed and furthermore there i s a need to improve the process o f monitoring. GoHP: Excess utilization o f Grants (%) Financial Year Grant 2004-05 2003-04 Public Works 56.2% 76.9% Road& Water Transport 61.5% 80.9% WSS, Housing & Urban 79.1% 173.9% C. RULESFORACCOUNTING, PROCUREMENTAND FINANCIAL REPORTING 13. FinancialRules:Accounting andFinancialControl includingProcurement inHPis guided by `The Himachal PradeshFinancial Rules, 1971'.These rules cover areas such as General Principles, Budget, Revenue Receipts, Pay, Allowances & Pensions, Stores, Works etc. Pnma Facie, the Rules seem difficult to interpret and require reference to circulars releasedsince issue of the Rules; these need to be updated and significantly simplified. In practice, since the sub-treasuries are not computerized and therefore not able to get real time information on budget availability (for a particular DDOunder a specific head), there are possibilities where the actual expenditure may exceedthe budget allocated. I" While the total number o f additionalities during the year may be as large as 200, in the past only one supplementary budget provision was made encompassingall the additionalities `I8 For this purpose, the CAG considers eachrepayment of overdraft as an expenditure 107 14. The General Financial Rules (GFR) o f Government o f India (GoI) have been revisedin2005. This was done through a task force setup with the objective o freviewing and revising the rules. The Report o fthe Task Force states "The GFRS, 1963were issued as a compendium of instructions for guidance of government officers dealing with matters of afinancial nature, have been inforce for overfour decades.A large number of the original rules havefallen into disuse due to changes in the environment in which government departments operate. Rapid growth of alternativeservice delivery systems, developments in information technology and the expectations of thepublic that Government should render timely, efficient and quality service has necessitated a comprehensive review of the governmentfinancial management systems, so as to ensure transparency, accountability and effectiveness ....."These facts are equally relevant for any Indian state. A revision o f the Rules (possibly usingthe Go1GFRs as a base) would ensure that the framework guiding financial management i s precise, easy to understand and contemporary. 15. Procurement inthe HP i s governedby Procedure & Rules for the Purchase o f Stores, which i s an appendix to GoHP Financial Rules. These are maintainedby Controller o f Stores under Ministryo f Industries, and relate to procurement o f goods. While the Store Purchase Organizationi s the nodal agency for negotiation o frate contracts, there i s an increasing effort to decentralize department specific purchase to the respective departments. The existingrules provide a preference for domestic suppliers with an aim to promote the local industries. Itneeds to be reviewedwhether such preferences actually result inthe desired effect. Moreover, when procurement i s decentralized, multiple rules & departmental regulations/ instructions develop over time with little ifany effort made to ensure consistency inthe regulatorybasis or clarity inregardto which rule applies when. 16. Simplification o f laws and regulations i s often best accomplished through the adoption o f a modem procurement law that applies to all kinds o fprocurement undertaken usingpublic funds (goods, works and services). States like Tamil Naduand Karnatakahave adoptedmodemprocurement laws. 17. AnnualAccounts:Annual Accounts o fGoHP arepreparedon a regular anda timely basis andprovide considerable information. These consist o f the Finance Accounts and the Appropriation Accounts. + The Finance Accounts provide information (inform o f 19 Statements and various appendices) on receipt and expenditure, borrowing and liabilities, loans and investments made, and cashbalances. The + formats are fairly consistent from year-to-year; incertain cases `balances till date' are also provided. The Appropriation Accounts contain details o f expenditure vis-a-vis the voted charged appropriations for the year. 18. Timeliness:The Annual Accounts are usuallyready withinsix months o fclose o fthe financial year; e.g. accounts for FY 2004-05 were approved by the C&AG on September 19,2005. This i s considered quiet reasonable incomparison with many other Indian states. Interms o f m~nthly"~ accounts, GoHP fares much better than most Indian states e.g. GoHP accounts for the month o fJuly 2006 were available on the C&AG website inOctober 2006. This i s an indicator o f timeliness o f accounting as well as a culture o f openness in terms o freadinessto share/ disclose information. 19. Responsibilityfor preparationof AnnualAccounts:The following points are o fnote. + GoHP's Annual Accounts are prepared by the C&AG (Accounts and Entitlement Wing). The various spending departments send one set o f original paid documents to the AG for compilation/ consolidation o f information for the entire state; this i s done through the Voucher Level Consolidation (VLC) software. `I9 The'CAG publishes monthly accounts of Indian states on its website. This is published with the following qualification "Comptroller and Auditor General o f India is entrusted with maintainingthe accounts of the state governments, in all the states except Goa. The position of summarised monthly accounts incase of states who have agreed to display on the web site is available here.. ..". 108 + The accounts are certified by the C&AG o f India; the certificate states that "Points o f interest arising out ofthe study o fthese accounts as well as test audit conducted duringthe year or earlier years are contained inmy Reports being presented separately for the year to the Government o f Himachal + Pradesh". Thus the C&AG clarifies that a report on audit o fthe accounts would be issued separately. Due to the process explained above, GoHP has only part ownership o fthe Annual Accounts. While on the one handthis ensures uniformity across the country, it also implies that accounting i s seen by state governments merely as a compliance function and the state government may not view it as a tool for management control. 20. Completenessof financial information:The following issues are ofnote. + GoHP issues guarantees to assist state/public sector undertakings inborrowing funds andor reducing the cost o ftheir borrowings. As on March 31,2005 the total amount of guarantees issuedby the state government stood at Rs 6409 crores. Guarantees are capped under the HPFRBMat 80 percent o ftotal revenue receipt inthe preceding financial year for which actuals are available as per Finance Accounts. Also there i s no system o f assessing risk involved with each Guarantee and malung provision to fund + payments incase these are likely to be invoked. Since a cash basis o f accounting is followed, the accounts do not present any information on revenue + due but not collected, payables and outstanding commitments. Onlythe state share o fthe Centrally SponsoredSchemes (CSS) is reflectedinthe FinancialStatements since usually Go1directly transfers funds'20to the implementingentities for these programs. Since allocationto CSS is significant, the overall expenditure on the Schemes could be reflected as additional + information inthe Financial Statements. As explained ina subsequent section, though investments inPublic Sector Enterprises (PSE) are disclosed at face value, the fact that the accumulated losses inthe PSEs are greater than the investments, i s not disclosed. 21. Publicaccess to Procurement & FinancialInformation:Withpassingo fthe Rightto Information Act, 2005 every public authority has the responsibility to provide specific information on its functions and activities. The act (Section 4 (2)) further states that "it shall be the constant endeavor of everypublic authority to take steps toprovide as much information suo mot0 to thepublic at regular intervals through various means of communications, including internet so that thepublic have minimum resort to use this Act to obtain information ". 22. A disclosure policy couldbe help establish informationthat needs to be disclosedsuo moto. Firstly, the formats for provision o f information needto be simplified to ensure that information i s easily understood by the general reader. Secondly, though the Annual Financial Statements are tabled inthe state legislature, these are not widely debated so as to increase awareness amongst the general public. Thirdly, in context o fnon-financial information, Annual Performance Reports o f departments could also be more widely disseminated including availability on the GoHP website. 23. Drawingand DisbursalOfficers @DO):There are approximately 3600DDOsinthe state; more than 2000 o fthese are School Headmasterswhose role as a DDO i s primarily for payment o f salaries and miscellaneous expenses at schools. Each DDOposition implies the entire cycle o f accounting& book-keeping, reporting for consolidation, reconciliation and audit. The number o f DDOs needs to be rationalizedby introducinghigher levels o f automation/ use o fbanlung facilities or both. Inthe state o f UttarPradesh for example, DDOpositions were rationalizedby following the principle o f `one DDOper department per district'. Also to note that Tamil Naduhas moved to ECS salary payments for approx. 14lakh employees (including school teachers) and proposes to extend the functionality for all payments including suppliers. 120Few exceptions do exist where funds are initiallyreceived in the Consolidated Fundso f the State, e.g. some schemes inthe RuralWater Supply Sector 109 D. INTERNAL CONTROL AND INTERNAL AUDITING 24. Reinforcingresponsibilityand accountabilityofthe Headofthe Department(HOD):Though HOD i s responsible for effective financial management for the department this needs to be more clearly stated inthe relevant Rules/ Codes. Sometimes it i s a perception that these matters are responsibility o fthe Finance Department. This results insub-optimal utilization o fresources, weaknesses ininternal controls, delay in response to audit reports etc. The GoI, inits revised GFRs, has included Rule 64 to more clearly articulate responsibility o f the HOD.The Rule reads as follows; "Rule 64. Duties and Responsibility of the Chief AccountingAuthority. - TheSecretary of a Ministry/ Department who is the Chief Accounting Authority of the Ministry/ Department shall-.... and clearly lists down 9 areas o fresponsibility includingresponsibility for " financial management, ensuring that funds are used for the purposes intended, responsible for full and proper maintenance o f accounting records etc. The state can draw lessons from this to ensure that Accountability of the HODis clearly established. 25. TreasuryComputerization: HPhas aTreasury Systemwhich is computerized at the state and district levels; the On-line Treasury Information System (OLTIS) inuse has been developed by the National Informatics Centre (NIC). The state i s inthe process o f installing a state-wide Wide Area Network (WAN) and the Treasury system is expected to be rolled out to a further 30 sub-treasuries'21 inthe short term usingthe WAN. An additionalbutrelated aspect i s a plan to develop a Personnel Management Information System (PMIS); this will have an impact on the Treasury since it i s expected to automate payroll preparation and therefore improve controls related to this task. 26. StaffCapacities:The GoHP has two types o fstaff discharging the responsibilities incontext o fthe financial management function. + Accounting: Finance Department inthe GoHP has a dedicated cadre o f (Subordinate Accounts Service) staff which are selected through the HP Public Services Commission. Staff with at least five years o f experience are eligble for selection, and undergo around six months o f training before they begin work. They are posted at various levels inall major departments and provide a level o f independence in + context o f the financial matters o f the department. Treasury:Similar to the above, the Treasury has a cadre o f staff selected through the HPAdministrative Service/ others. This staff is responsible for checlung documents/ recording transactions inthe treasury software; this processing includes ensuring availability o fbudget, checking signatures, adequacy o f documentation etc. 27. The following points are o fnote. Firstly, this staff bringsinan element o f independence and thus strengthens internal control. Secondly, the s h l l development needs o f staff needto be assessed; while training at entry i s provided, there i s no system o f ongoing training. Thirdly, since bothtypes o f staff are under the same department and essentially workmg to strengtheninternal control, it is most logical that staff have opportunities to discharge both the functions'22; this would provide them with a wider range o f experience andbetter opportunities for career progression; thus rendering them more effective and improving morale. 28. InternalAudit @A):Incontext o fthe spending departments IA does not exist, however officers in various departments like Rural Development or h g a t i o n and Public Health are responsible for `in~pection'~~'. Inspections are not very regular and do not exist incertain departments like Health & Family Welfare'24, moreover information on results o f inspections i s available neither at the department nor at the state level. HP 12' The state has atotal of 85 sub-treasuries. 122 Instates likeTamil Nadu, asinglecadreofstaff work inTreasuries/are deputedto variousdepartments 123 Inspection covered a number of issues including budget monitoring, status of Works, stores registers, status on double entry book-keeping, review of expenditure transactions,service recordsetc. 124Para3.1.59 :CAG Civil report 31-3-2004 - 110 needs to establish an IA function by a strategic allocation o fresources. A small, centralized, skdled internal audit team should be setup to conduct systemic reviews inareas o fperceivedrisks. 29. ExaminerLocalFundAudit (ELFA): Mandate o fthe ELFAis mainlyto undertake audit o flocal funds generated out of local incomes/ fees or donations. Ithas approximately 125 staff including 73 auditors who are requiredto cover over 600 School Boards, Himachal Urban Development Authority, Universities, Colleges, Market Committees, Temple Trusts etc. GoHP is reviewing the possibility o f transferringthe responsibility o f audit o f ULBsto the ELFA. 30. UtilizationCertificates:Ininstances where funds are releasedinform of Grants to an Institution or Organization, the relevant agency i s required to submit a Utilization Certificate (UC) confirming that the Grant has been spent for the intended purposes; this needs to be submitted within 12 months o f the closure o f the Financial Year. As on March 31,2005 a total o f 2859 UCs aggregating to Rs. 355.27 crores were due; this i s an indicator o f weakness ininternal controls. 31. OversightofProcurement:Procurement presently takes place amidst a large number o fcontrollers and overseers. Improving oversight o fprocurement involves rationalizing control as well as increasing the ability o f the government and the private sector to monitor performance. Actions may include: introducing performance monitoring o fprocurement; developing effective mechanisms to conduct internal and external auditing o fprocurement; creating trusted mechanisms for receiving and responding to complaints; developing forums for receiving input from business groups and beneficiaries; and enhancing the disclosure o f information on procurement. 32. Improvingcommercialpractices:These canbe accomplished through improvedcontracting, better inventory and asset management (e.g. IPHdepartment is already undertakinginventory management initiatives), improved contract management and enforcement, effective dispute resolutionprocedures, and attention to interactionwith the supplier community. E-procurement can help reduce transactional cost o fprocurementas well as result incost savings for the government. E. EXTERNAL AUDIT 33. Independenceand Scopeof ExternalAudit:The Externalauditor for the State Governmentis the Comptroller and Auditor General o f India (CAG, India's Supreme Audit Institution) through its field office in HP (the Auditor General or AG); this is similar to the arrangements inall Indian states. Independence o fthe CAG i s well established; drawing its functions and powers from the Constitution o f India. The audit covers all expenditure departments, revenue receipts and select state public sector undertakings. Audit i s broadly o f the following types: (a) regularity or compliance audit covering aspects such as overpayments, failure to collect revenue, infructuous expenditure, inventory control, internal control etc, and (b) performance reviews which try to provide a picture o f the performance o f a particular department inthe year. Inthe last two years the AG has conducted performance review each year covering key/ major spending departments like Irrigation and Public Health, Revenue (2004-05), Health & Family Welfare and Public Works (2003-04). 34. Audit ProcessandCoverage:Audit is conducted on a "test basis". Thts implies that frequency and coverage o f audit are determined incontext o fthe perceivedrisk and the amount o f money involved. The initial process after completion o f the audit i s issue o f an InspectionReport which i s provided to the office auditedand with an opportunity to respondto or `settle' the observation. Only those audit paras/ observations which are significant innature and have not receiveda satisfactory reply from the office/ department audited are included inthe final Audit Report. This reportisissuedunder the signatures ofthe (State) AG as well asthe CAG. 111 35. Timeliness:Receipt ofaudit report has usually beenwithin 11- 12monthslZ5o f close o fthe financial year. This compares very well with other Indian states. 36. Audit Management:Response to inspection reports andpreliminary audit paras is providedbythe concerned departments; the Finance Department plays a coordinatingrole when the final audit report i s received from the CAG. Overall the audit process will be strengthened ifa centralized `Audit Committee' i s made responsible for a gamut o f issues relating to audit. These would include monitoring timeliness/ quality o f responses o fdepartments, assessment o f systemic issues and timely action for the future and communication o f the States' priorities to the AG to ensure best value out of the audit. F. LEGISLATIVE OVERSIGHT 37. PublicAccounts Committee(PAC)/ CommitteeonPublicUndertakings(COPU): As per convention, the PAC inHP i s headedby a member o fthe party inopposition; it has 11members. Regular hearings o fthe PAC are held; an officer o fthe Finance Department i s invited to participate. Once the Audit report issuedby the CAG isreceivedby the PAC, departments are asked to respond to different paragraphs; this i s first done through an interview process and subsequently the department may be requested to submit an Action Taken Report (ATR). The response i s examined by the committee and ifnot satisfied it may again ask for further examination. 38. While the PAC reviews areas o f mainstream government as reportedinthe Civil/ Revenue Audit Reports, the COPU examines aspects relating to the State Public Sector Undertakingsas reportedinthe Commercial Audit Report. The COPUholds around 4 meetings ina month, and usually it review observations higher than Rs 10 lakh invalue. 39. While the framework o f PAC & COPU i s an important instrument o f enforcingpublic accountability, however inpractice the process'26i s such that there i s significant delay between the event and its resolution at these committees; e.g. the PAC submitted its report on Health and Family Welfare Department relating to Audit for FY 2000-01 inMarch06. At present the PACi s examiningaudit report for FY2002-03; traditionally the PAC has examined reports ina chronological order though there is nothing to prevent it from examining the latest available audit report i.e. for FY2004-05 and then gradually going back intime to cover the backlog. G. OTHERAREAS: 40. While the main focus o f the team's work was on State Government Departments through which bulk of public funds currently flow; funds also flow throughUrban Local Bodies (ULBs),Public Sector Enterprises (PSEs), and Rural Local Bodies (PRIs). Some o f the aspects relating to these are discussedbelow. 41. UrbanLocalBodies. HPhas a total o f49 UrbanLocal Bodies (ULB)consisting o f 1Municipal Corporation (Shimla), 20 Municipal Councils and 28 Town Panchayats. Total revenues o fULBsfor FY 2004- 05 amounted to Rs 69 crores, consisting of own income o f Rs 33 crores (48%) and Grants from GoHP o f Rs. 35.6 crores (51%). Accounting Records inULBsare maintainedusingsingle entry accounting system. Audit o f the ULBs i s undertaken by staff (deputed from Local Audit Department) worlung under The Director, Urban Development. 42. The following issues are o fnote: 125For FY 2004-05, the RevenueAudit Reportwas finalized inNovember05 and the Civil and CommercialAudit Report in February06. For FY 2003-04 the Civil Audit Reportwas finalized in February05 and the CommercialAudit Reportby March 05 The accountability cycle i s completed when the audit is conducted, reportissued, PAC hearingsheld, responsesreceived from the Government, and the PAC tablesits reportsin the StateLegislature. 112 + The Directorate o fUrbanDevelopmenti s planning to undertake reforms inULBsby shiftingto double- entry system o f accounting. These reforms are likely to be ina phasedmanner startingwith the Shimla Municipal Corporation. GoHP may draw on experience o fthe ULBsinKarnatakawhich have made significant strides inthe areas o f double entry accounting and better disclosure o f financial information + including a higher level o f involvement o f its citizens. The Audit process has not been very regular and frequently audits undertaken have covered a period of 7 - 8 years at one stretch impactingeffectiveness o f audit. Status o fthe audits pendingi s summarized as follows: Audit pending < 1year 1-3 years 4-5 years 6-8 years 8 years > for number o f years No. ofULBs 8 14 9 9 8 % 16.5% 29% 19% 19% 16.5% + Above may be attributed to inadequacy o f audit staff. Moreover utility/response to audit i s limited; a + large number o f audit paras i.e. 16,853lZ7for different ULBsare required to be settled. GoHP i s reviewing transfer o f the Audit function o fULBsunder the ELFA, this will have a positive impact on the quality and timeliness o f audit. 43. Public Sector Enterprises. On date there are 21 Government PSEs inthe state with a total investment o f Rs 4920.30 crores including Equity730.32 cr and Loans etc. Rs. 4189.98 CrlZ8.GoHP receiveda dividend o f Rs70.30 lakhs onthis investment; the policy of a minimumdividendlZgo f 3% was complied with, by only one company. 44. Many o f these PSEs have been incurring financial losses over the years and the cumulative position o f losses i s Rs. 894.88 crores. Thus total investment o f GoHP inthese PSEs has been completely eroded. While the total investment o f GoHP inthe PSEs i s presentedinthe Finance Accounts (Statement 14) the position o f accumulated losses i s not provided, thus providing an inaccurate picture of the status o f investment. 45. Audit o fHPSEB andHRTC are undertaken bythe AG, while audit o fmost o fthe other Government Companies i s undertaken by a firm o f chartered accountants appointed by CAGunder the Companies Act, 1956. Ofthe 17worlung companies, audit o f six companies were delayed by one-two year while the delay was five years for the HP Electricity Regulatory Commission. 46. A preliminary readingo fthe AuditedAnnual FinancialStatements o fHP State Electricity Boardand Himachal RoadTransport Corporationreveals that the reports provide useful information on operation o f the entities for the given period and the audit reports provide an overall opinion on true & fair status o f the financial statements; however quality o fpresentation couldbe improved including a clearer statement o f the Accounting Policies. 47. Monitoring o f financial managementpolicies/ practices o f the PSEs at the state level i s negligible. This needs to be strengthened. This could be started with review o f the two largest PSEs, looking at their existing Financial Management and Procurement Policies to identify performance improvement areas. 48. Rural local Bodies. HP has 3243 Gram Panchayatsl30 (GP) (Village level), 75 Panchayat Samitis (PS) (Block level) and 12 Zilla Parishads (ZP) (District level). The Panchayati Raj Department assumes overall 127Source: Audit Wing of Urban DevelopmentDepartment. lz8CAGCivil& CommercialReport2005. Para 6.1.8 of CAG Civil & CommercialReport2005. Source: Annual Plan2006-07. 113 responsibility for the Rural Local Bodies (RLBs) and ensuring implementation o fthe HPPanchayati Raj Act, 1994. GoHP annually allocates about Rs.5 million to RLBs.RLBs also receive a significant amount o f funds under Centrally Sponsored Schemes for poverty alleviation and other developmental works. While GPs have power to levy and collect taxes on various accounts, PSs and ZPs do not have such powers and are allocated funds by State Finance Commission. 49. The following are o fnote. + Audit-This is conducted through an audit wingworkmgunder the Director, PanchayatiRaj. The HP Panchayati Raj Act, 1994requires that annual audits be conducted o f all PRIs; during2005-06, 50% + ZPs, 39% PSs & 55% GPswere audited. The shortfall is reportedto be due to elections o fthe PRIs'~*. Inspectionprovides internalaudit function o f PRIs. EachPRIshould be inspected at least once duringa + year. DuringFY2005-06 around42% o f the GPs were subjected to inspections. Like most other Indian States, HPtoo faces issues relating to shortage of Panchayat Secretaries as well + as low levels o f education/ training among the existing Panchayat Secretaries. Given the geographical nature o f the state, buildingprocurement & financial management capacity at this level can help enhance outcomes. H. CONCLUSION:Areas requiringpriority attention (a) Rulesrelating to financial management i.e. `The Himachal PradeshFinancialRules, 1971' needto be revisedto ensure that the framework guidingprocurement & financial management are precise, easy to understand and contemporary. (b) The state can initiate efforts to ensure that the public procurement systempromotescompetitiveness through steps that mightinclude application o f e-government procurement, and improving the commercial practices o fthe government. (c) Formats/ presentation o f Budgets and Annual Financial Statements need to be rationalized. These need to be shorter and more easily understandable. (d) Regardingdisclosureincontext o fthe Rights to Information Act, 2005 GoHPmay articulate a `Policy on disclosure o f Information' to ensure that relevant and critical information is consistently available for public scrutiny. (e) The benefits o f the effectively functioning treasury at the district level needto be rolled-out to cover the entire state; this will be an important step to strengthen internal controls as well as to maintain efficiency o f operation incontext o f the geographical/ climatic factors. (f) Accountability o fthe HODneeds tobemore clearly establishedto ensure more effective and efficient utilization o fresources provided to departments. (8) The LocalFundAudit function needs to be consolidated; staffunder the ELFAand audit wings o fthe Urban/ Rural DevelopmentDepartments needto be viewed as a single resource andutilized across the state usinga riskbasedapproach. (h) InternalAudit -a small, centralized, skilledinternalaudit team maybe setup to conduct systemic reviews inareas o fperceived risks. The process o f inspection needs to be systematized. 13'AnnualAdministrative Report, PRD 114 (i)Responsetoauditneedstobestreamlined;thisshouldbesupportedbyasystemtotrackallauditparas, PAC/ COPUobservations. This would ensure that the state gets the best value out o f the audit process rather than seeing it merely as a compliance function. (i) Towardstheobjectiveofsafeguardingitsinvestments/ annualgrantsandensuringgoodgovernancea one time review o fthe Financial Management and Procurement Policies of the PSEsmay be undertaken; the government may start with the two largest PSEs. 115 Listof References Ajwad, M.I. Statistics on the Safety Net Programs in India, Manuscript, World Bank. 2006. CAG. 2003. Pe$ormance Audit: Ministry of Rural Development: Rural Housing, Chapter 3, Comptroller and Auditor-General of India. + CAG. 2003. Pe$ormance Audit: Ministry of Rural Development: Swarnajayanti Gram Swarozgar Yojana, Chapter 2, Comptroller and Auditor-General of India. + Chaudhuri, S. 2000. Empirical methods for assessing household vulnerability to poverty. School o f Internationaland Public Affairs, Columbia University,New York. Manuscript. + Dev, S. Mahendra, C. Ravi, B.Viswanathan, A. Gulati and S. Ramachander.2004. Economic Liberalisation, TargetedProgammes and Household Food Security: A CaseStudy of India, MTID Discussion PaperNo. 68, IFPRI. Rajan, S. I.2001. Social Assistance for Poor Elderly:How Effective?,Economic and Political Weekly, February 24,200 1. PEO. 2005. Pe$ormance Evaluation of TargetedPublic Distribution System, Programme Evaluation Organisation, Planning Commission. + PlanningCommission. 2005. Himachal Pradesh Development Report. Government of India. Academic Foundation, New Delhi. World Bank Technical PaperNo. 139, Environment Assessment Sourcebook. World Bank. 2004. ResumingPunjab's Prosperity: The Opportunities and Challenges Ahead. Poverty Reductionand Economic Management Sector Unit, South Asia Region. + World Bank. 2006. India Country Environment Analysis. 116