JUDICIAL SERVICES AND SMART INFRASTRUCTURE PROJECT OF THE REPUBLIC OF AZERBAIJAN LOAN NUMBER 8407 AZ

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1 Public Disclosure Authorized Public Disclosure Authorized JUDICIAL SERVICES AND SMART INFRASTRUCTURE PROJECT OF LOAN NUMBER 8407 AZ Special-Purpose Financial Statements and Independent Auditors' Report For the Year Ended December 31, 2016 Public Disclosure Authorized Public Disclosure Authorized

2 TABLE OF CONTENTS Page INDEPENDENT AUDITORS' REPORT 1-2 SPECIAL-PURPOSE FINANCIAL STATEMENTS : Special-purpose balance sheet 3 Statement of cash receipts and payments 4-5 Statement of project activities 6-9 Statement of designated and project accounts 10 Statement of expenditure and summary sheet withdrawal schedule 11 Notes to the special-purpose financial statements 12-17

3 -'WBAKER TILLY 19- YEARS AZERBAIJAN Audit, Tax and Consulting Demirchi Tower, 16th floor Khojaly Avenue, 37 AZ1025, Baku Azerbaijan T:+ 994 (12) F:+ 994 (12) office@bakertilly.az OFEXCELLENCE INDEPENDENT AUDITORS' REPORT To the Management of the Judicial Services and Smart Infrastructure Project of the Republic of Azerbaijan: Opinion We have audited the Special-Purpose Financial Statements of the Judicial Services and Smart Infrastructure Project of the Republic of Azerbaijan (the "Project"), which comprise the Special-Purpose Balance Sheet as at December 31, 2016, and the Statement of Cash Receipts and Payments, the Statement of Project Activities, the Statement of Designated and Project Accounts and the Statement of Expenditure and Summary Sheet Withdrawal Schedule ("SOE and SSWS") for the year ended December 31, 2016, and a summary of basis of accounting and other explanatory notes (collectively referred to as the "Special-Purpose Financial Statements") financed under the International Bank for Reconstruction and Development (the "IBRD") through loan agreement 8407 AZ (the "Loan Agreement"). In our opinion, the accompanying Special-Purpose Financial Statements present fairly, in all material respects, the financial position of the Project as at December 31, 2016, the cash receipts and disbursements on behalf of the Project and transactions passed through the Project's special accounts for the year ended December 31, 2016 in accordance with IPSAS "Financial Reporting under the Cash Basis of Accounting" and relevant provisions of the Loan Agreement as described in Note 2 of the Special-Purpose Financial Statements. In addition, with respect to the SOE and SSWS, all payments reported are eligible for financing under the respective Loan Agreement and adequate documentation have been maintained to support the claims for withdrawal. Basis for Opinion We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditors' Responsibilities for the Audit of the Special- Purpose Financial Statements section of our report. We are independent of the Project in accordance with the International Ethics Standards Board for Accountants' Code of Ethics for Professional Accountants (IESBA Code), and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. An independent member of Baker Tilly International

4 BAKERTILLY AZERBAIJAN Emphasis of Matter-Basis ofaccounting and Restriction on Distribution and Use We draw attention to Note 2 to the Special-Purpose Financial Statements, which describes the basis of accounting. The Special-Purpose Financial Statements are prepared to assist the Project's Implementation Unit in complying with the financial reporting provisions of the Loan Agreement referred to above. As a result, the Special-Purpose Financial Statements may not be suitable for any other purpose. Our report is intended solely for the Project Management Team, the Government of the Republic of Azerbaijan and the IBRD and should not be distributed to or used by parties other than Project's Implementation Unit and the IBRD. Our opinion is not modified in respect of this matter. Responsibilities of Management for the Special-Purpose Financial Statements Management is responsible for the preparation and fair presentation of the Special-Purpose Financial Statements in accordance with IPSAS and relevant provisions of the Loan Agreements as described in Note 2 to the Special- Purpose Financial Statements, and for such internal control as management determines is necessary to enable the preparation of Special-Purpose Financial Statements that are free form material misstatement, whether due to fraud or error. Auditor's Responsibilities for the Audit of the Special-Purpose Financial Statements Our objectives are to obtain reasonable assurance about whether the Special-Purpose Financial Statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these Special-Purpose Financial Statements. As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: * Identify and assess the risks of material misstatement of the Special-Purpose Financial Statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control; * Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Project's internal control; * Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. A 2,, June 14, 2017

5 SPECIAL-PURPOSE BALANCE SHEET AS AT DECEMBER 31, 2016 ASSETS AND CUMULATIVE USES OF FUNDS Note December 31, December 31, Cash and cash equivalents 3 108,693 3,496,236 Project expenditure 66,339,692 27,975,778 Accumulated foreign exchange rate differences 26,395 47,108 TOTAL ASSETS AND CUMULATIVE USES OF FUNDS 66,474,780 31,519,122 SOURCES OF FUNDS Cumulative IBRD Funds 34,408,469 20,854,141 Cumulative Government Funds 32,064,638 10,664,749 Other Funds 1, TOTAL SOURCES OF FUNDS 66,474,780 31,519,122 Approved and signed on behalf of the Judicial Services and Smart Infrastructure Team: Azer Jafarov Project Director Zaur NasrullayJ Finance Manager June 14, 2017 June 17, 2017 The notes on pages form an integral part of these Special-Purpose Financial Statements. 3

6 STATEMENT OF CASH RECEIPTS AND PAYMENTS Year ended Year ended Cumulative December 31, December 31, December 31, OPENING BALANCE IBRD Designated Account 3,496,236 1,829,033 TOTAL OPENING BALANCE 3,496,236 1,829,033 ADD: FUNDS RECEIVED IBRD Loan Number 8407 AZ Initial deposit to the IBRD Designated Account - 3,000,000 5,000,000 Direct funding 1,012,014 6,677,275 7,689,289 SOE replenishment 12,542,315 8,926,866 21,469,180 Front-end fee ,000 Subtotal IBRD Loan funds 13,554,329 18,604,141 34,408,469 Government funding for Loan Number 8407 AZ Advances to the Project Account 21,399,889 4,290,450 32,064,638 Subtotal Government of Azerbaijan funds 21,399,889 4,290,450 32,064,638 Other funds Tender fees accumulated in the IBRD Designated Account 1, ,673 Subtotal other funds 1, ,673 TOTAL FUNDS RECEIVED 34,955,659 22,894,823 66,474,780 Cash withdrawals/ibrd Loan Number 8407 AZ Cash withdrawn from the IBRD Designated Account (535,455) (955,530) (1,507,985) Total cash withdrawals (535,455) (955,530) (1,507,985) LESS: EXPENDITURE IBRD Loan Number 8407 AZ (bank payments) Civil works (4,288,090) (7,599,793) (11,887,883) Goods (5,213,075) (1,668,858) (6,881,933) Consultants' services (6,130,589) (6,124,868) (12,351,060) Training (120,202) (56,073) (176,274) Incremental operating costs (656,253) (532,013) (1,246,624) Front-end fee - - (250,000) Subtotal IBRD Loan expenditure (bank payments) (16,408,209) (15,981,605) (32,793,774) IBRD Loan Number 8407 AZ (cash payments) Consultants' services (131,784) (101,084) (232,868) Training (8,090) (4,088) (12,178) Incremental operating costs (415,942) (831,853) (1,264,795) Subtotal IBRD Loan expenditure (cash payments) (555,816) (937,025) (1,509,841) Total IBRD Loan expenditure (16,964,025) (16,918,630) (34,303,615) 4

7 STATEMENT OF CASH RECEIPTS AND PAYMENTS (Continued) Government of Azerbaijan expenditure for IBRD Loan Number 8407 AZ (bank payments) Year ended Year ended Cumulative December 31, December 31, December 31, Civil works (13,241,734) (1,359,458) (20,975,491) Goods (6,440,642) (2,071,601) (8,512,243) Consultants' services (1,138,835) (534,979) (1,673,814) Training (110,001) (2,100) (112,101) Incremental operating costs (16,050) (40,985) (57,035) Other costs financed fully by the Government (452,627) (252,766) (705,393) Total Government of Azerbaijan expenditure (21,399,889) (4,261,889) (32,036,077) TOTAL EXPENDITURE (38,363,914) (21,180,519) (66,339,692) FOREIGN EXCHANGE DIFFERENCE Cash on hand 20,733 (18,505) 2,230 Project Account - (28,561) (28,561) IBRD Designated Account (21) (35) (64) TOTAL FOREIGN EXCHANGE DIFFERENCE 20,712 (47,101) (26,395) CLOSING BALANCE IBRD Designated Account 108,321 3,496,236 Cash on hand TOTAL CLOSING BALANCE 108,693 3,496,236 Approved and signed on behalf of the Judicial Services and Smart Infrastructure Team: Azer Jafarov Project Director Zaur Nasrullayev Finance Manager June 14, 2017 June 14, 2017 The notes on pages form an integral part of these Special-Purpose Financial Statements. 5

8 STATEMENT OF PROJECT ACTIVITIES PROJECT COMPONENTS/ACTIVITIES Year ended Year ended Cumulative December 31, December 31, December 31, Judicial Service Delivery Improvements 1.1 Expanding Access to Justice for All Consultants' services Barriers to access to justice for internally displaced persons, women, juveniles, minorities and other vulnerable groups - policy and operational analysis and recommendations for improvement 67, , ,253 Legal aid: needs analysis, review of policy options and technical support for improving policy and institutional framework and policy capacity 146, , ,798 Removing barriers to expansion of alternative dispute resolution: (a) needs analysis, (b) review of policy options and (c) technical support for improving policy and operational framework and institutional capacity 26, , ,839 Analysis of the extent and causes of gender based violence and preparation of a national strategy and action plan for improving support for victims of such violence 66, , ,884 Juvenile justice: introducing a legal and institutional framework: (a) needs analysis, (b) review of policy options, (c) preparation of national strategy for prevention of offences by juveniles - 40,000 40,000 Subtotal 306, ,888 1,026, Expanding e-justice services across the Republic of Azerbaijan Goods Accelerating electronic filing in selected high-volume courts and court complexes through digitization 377,790 1,048,378 1,426,168 Subtotal 377,790 1,048,378 1,426,168 Consultants' services Upgrading and modernizing court web portal 136,641 45, ,308 Electronic Document Management System (DMS) and Case Management System (CMS) software in selected Phase 1,057,859-1,057,859 Consultancy services for location-specific site surveys of judicial infrastructure in Baku city Bine 35,812-35,812 E-library services - design and implementation of a pilot e- library under the Supreme Court 23, , ,476 Consultancy services for location-specific site surveys of judicial infrastructure 101, , ,900 Subtotal 1,354,858 1,022,497 2,377,355 Total Judicial Service Delivery Improvements 2,039,534 2,790,763 4,830,297 6

9 STATEMENT OF PROJECT ACTIVITIES (Continued) PROJECT COMPONENTS/ACTIVITIES Year ended Year ended Cumulative December 31, December 31, December 31, Strengthening Institutional Capacity, Efficiency and Monitoring and Evaluation ("M&E") 2.1 Improving Sector Efficiency, Performance and M&E Consultants' services Development of the key performance indicators and pilot management dashboard for e-court system 173,956 43, ,460 Design and conduct of user surveys 105, ,428 Senior judicial information systems advisor 138,832 64, ,263 Subtotal 418, , , Strengthening IT Management and Operational Capacity Goods Procurement of Information Technology Service Management (ITSM) software solutions for MOJ IT Helpdesk 93,080-93,080 Subtotal 93,080-93,080 Consultants' services Policy analysis and options for sourcing and employment of skilled IT professionals as Ministry of Justice ("MOJ") personnel 50, , ,388 ICT* Development and capacity building manager 16,633-16,633 ICT Infrastructure specialist 14,415-14,415 ICT Operation Head 11,867-11,867 Project Controller (Deputy Project Manager) 16,670-16,670 IT Trainer and support specialist 8,274-8,274 ICT support specialists 20,041-20,041 Interim chief information officer for MOJ 268, , ,254 Subtotal 406, , , Communications, Outreach and Change Management Consultants' services Audio-Visual Media Preparation 45,353-45,353 Subtotal 45,353-45, Strengthening Professionalization and Knowledge Consultants' services ICT training for judges, court staff and staff of other justice institutions, Phase 3 700, ,672 Subtotal 700, ,672 Total Strengthening Institutional Capacity, Efficiency and Monitoring and Evaluation 1,663, ,930 2,255,798 7

10 STATEMENT OF PROJECT ACTIVITIES (Continued) PROJECT COMPONENTS/ACTIVITIES Year ended Year ended Cumulative December 31, December 31, December 31, Expansion and Modernization of Justice Infrastructure Civil Works Construction of Sumgait Court Complex 6,852,202 5,247,087 12,099,289 Construction of Baku City Narimanov District Court 2,854,096 2,153,817 5,007,913 Construction of Surakhani District Court 2,231,159 1,108,653 3,339,812 Construction of Masalli District Court 2,075,053-2,075,053 Construction of annex in Sheki Court Complex and capital repair of current Sheki District Court building for further location of the Sheki City Bailiff department 3,517, ,694 10,341,308 Subtotal 17,529,824 8,959,251 32,863,375 Goods ICT and other technical equipment for Sumgait Court Complex 2,280,145-2,280,145 Office equipment and furniture for Baku City Narimanov 1,377,826-1,377,826 Office equipment and furniture for Baku City Surakhani District Courts 1,249,281-1,249,281 ICT and other technical equipment for Imishli District Court 105, ,193 ICT and other technical equipment for Zagatala District Court 106, ,425 Office equipment and furniture for Baku City Binagadi District Court 796, ,037 Office equipment and furniture for Imishli District Court 120, ,361 Office equipment and furniture for Zagatala District Court 163, ,665 Office equipment and furniture for Gabala District Court 140, ,103 ICT and other technical equipment for Masalli District Court 188, ,570 ICT and other technical equipment for Baku City Narimanov 946, ,373 ICT and other technical equipment for Baku Surakhani District Courts 860, ,194 Office equipment and furniture for Sumgait Court Complex 2,278,830-2,278,830 Information computer technologies and other technical equipments for annexes in Sheki Court Complex - 885, ,658 Office equipment and furniture for Masalli District Court 569,844 1,771,412 2,341,255 Subtotal 11,182,847 2,657,070 13,839,916 Consultants' services Updating and refinement of courthouse and justice institution buildings designs 1,102,360 3,133,159 4,235,519 Author supervision of courts to be constructed 291, , ,978 Independent technical review of technical designs for selected courts 1,573, ,123 1,913,285 Independent Technical Review (ITR) of JSSIP civil works for Baku Grave Crimes Courts 452, ,821 Technical supervision of courthouse construction 106, , ,411 Subtotal 3,526,403 3,894,124 7,443,014 Total Expansion and Modernization of Justice Infrastructure 32,239,074 15,510,445 54,146,305 8

11 STATEMENT OF PROJECT ACTIVITIES (Continued) PROJECT COMPONENTS/ACTIVITIES Year ended Year ended Cumulative December 31, December 31, December 31, Project Management and Coordination Goods Vehicle for Project Implementation Unit ("PIU") - 35,011 35,011 Subtotal - 35,011 35,011 Consultants' services Remunerations 748, ,492 1,354,537 Subtotal 748, ,492 1,354,537 Training Training for PIU and MOJ staff and relevant government officials 131,637 62, ,898 Subtotal 131,637 62, ,898 Incremental operating costs Operating costs 1,066,417 1,380,163 2,516,690 Salaries of the employees 21,828 24,688 51,763 Subtotal 1,088,245 1,404,851 2,568,453 Other costs financed fully by the Government 452, , ,393 Total Project Management and Coordination 2,421,438 2,287,381 4,857,292 5 Front-end-fee ,000 TOTAL PROJECT ACTIVITIES 38,363,914 21,180,519 66,339,692 * ICT- Information and Communications Technology. Approved and signed on behalf of the Judcial Services and Smart Infrastructure Team: Azer Jafarov Project Director Zaur Nasrullayev Finance Manager June 14, 2017 June 14, 2017 The notes on pages form an integral part of these Special-Purpose Financial Statements. 9

12 STATEMENT OF DESIGNATED AND PROJECT ACCOUNTS Project Account, Designated Account Cash on Main State IBRD USD- Hand Treasury Account AZ491BAZ International Bank of Azerbaijan OJSC, Nagliyyat branch Opening balance as at January 1, ,829,033 - Add: Project funds received 4,290,450 11,926,866 Other funds received Cash received ,530 Total receipts 4,290,450 11,927, ,530 Deduct: Project eligible expenditure (4,261,889) (9,304,330) - Cash withdrawn (955,530) Cash expenditure - - (937,025) Total deductions (4,261,889) (10,259,860) (937,025) Effect of foreign exchange rate IBRD share (35) Government share (28,561) - Cash on hand - - (18,505) Total effect of foreign exchange rate (28,561) (35) (18,505) Closing balance as at December 31, ,496,236 - Add: Project funds received 21,399,889 12,542,315 Other funds received - 1,441 Cash received from the IBRD Designated Account 8407 AZ ,455 Total receipts 21,399,889 12,543, ,455 Deduct: Project eligible expenditure (21,399,889) (15,396,195) - Cash withdrawn from the IBRD Designated Account (535,455) Cash expenditure - - (555,816) Total deductions (21,399,889) (15,931,650) (555,816) Effect of foreign exchange rate IBRD share - (21) Government share - - Cash on hand ,733 Total effect of foreign exchange rate - (21) 20,733 Closing balance as at December 31, , Approved and signed on behalf of the Judicial Services and Smart Infrastructure Team: Azer Jafarov Project Director Zaur Nasrullayev Finance Manager June 14, 2017 June 14, 2017 The notes on pages form an integral part of these Special-Purpose Financial Statements. 10

13 STATEMENT OF EXPENDITURE AND SUMMARY SHEET WITHDRAWAL SCHEDULE Category 1 Category 2 Category 3 Category 4 Category 5 Total Total Advance Required Replenished Application No. pame Civil Consultants' Training R lc payment wrs Goods sevcs Training IOC works Gosservices Total applications reimbursed as at the inception date* ,000,000 2,000,000 2,000,000 Total applications reimbursed during the year ended December 31, ,000,000 2,000,000 2,000, ,000, ,000,000 3,000, , , , , , , ,941 1,579,699 1,579, , ,141 2,338,565 30, ,536 3,687,566 3,687, , ,204 1,749,031 16, ,209 3,470,750 3,453,857 Total applications reimbursed during the year ended December 31, ,000,000 1,242,773 1,544,263 4,873,039 46,857 1,236,826 11,943,758 11,926,865 Total applications reimbursed as at December 31, ,000,000 1,242,773 1,544,263 4,873,039 46,857 1,236,826 13,943,758 13,926, ,104-2,438,675 30, ,058 3,484,642 3,484, ,564 1,868,465 1,816,190 15, ,252 4,277,927 4,277, ,175,728 2,135,964 1,238,920 23, ,147 4,779,746 4,779,746 Total applications reimbursed during the year ended December 31, ,845,396 4,004,429 5,493,785 70,248 1,128,457 12,542,315 12,542,315 Total applications reimbursed as at December 31, ,000,000 3,088,169 5,548,692 10,366, ,105 2, ,486,073 26,469,180 * The inception date of the Project is October 22, Approved and signed on behalf of the Judicial Services and Smart Infrastructure Team: Azer Jafarov Project Director Zaur Nasrullayev Finance Manager June 14, 2017 June 14, 2017 The notes on pages form an integral part of these special-purpose financial statements. 11

14 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS 1. DESCRIPTION OF THE PROJECT On October 22, 2014 the Republic of Azerbaijan (the "Recipient") has concluded loan agreement with the International Bank for Reconstruction and Development (the "IBRD") in the amount of USD 100,000,000 (the "Loan") to assist in improvement of the access, transparency and efficiency of delivery of selected justice services (the "Project"). The maturity date of the loan agreement is December 31, The Project consists of the following components: Component 1: Judicial Service Delivery Improvements - Improving access to justice through: (a) piloting innovative, participatory and more efficient ways to provide legal aid services to the vulnerable and marginalized through the provision of goods, consultant services and training to the Ministry of Justice; and (b) analytic and diagnostic studies focusing on: (i) the legal aid system, in particular for vulnerable groups; (ii) the development of alternative dispute resolution systems; (iii) the policies and institutional arrangements on access to justice particularly for vulnerable groups and on gender issues related to justice; and (iv) the development of specific interventions to support access to justice for the Internally Displaced Persons, refugees and other vulnerable groups through the provision of consultant services and training. - Expanding the provision of electronic access to selected justice services through: (a) the development and rollout of selected justice e-services; (b) the improvement of the infrastructure for the justice sector information and communications technology; and (c) the construction of a data center and the rehabilitation and upgrading of a facility for disaster recovery center, through the provision of goods, consultant services and training and the carrying out of works. Component 2: Strengthening Institutional Capacity, Efficiency and Monitoring and Evaluation - Improving justice sector performance through, interalia: (a) a sector efficiency and expenditure review including analyses of court case backlogs, efficiency, justice system revenues; (b) strengthening justice sector monitoring and evaluation capacity and quality including through the development of a justice sector performance monitoring framework and performance indicators and the preparation of a strategy and action plan to improve such capacity; (c) strengthening sector capacity to undertake and apply poverty and social impact analysis to improve service delivery to economically and socially vulnerable groups such as Internally Displaced Persons; and (d) the carrying out of periodic surveys of, inter alia, court users, lawyers, judges, court staff, notaries, and other justice sector service providers all through the provision of goods, consultant services and training. - Strengthening the information systems management and operational capability of the Ministry of Justice to support the provision of selected justice services through the provision of goods, consultant services and training. - Carrying out communications, outreach and change management activities aimed at facilitating stakeholder engagement in the justice sector reforms, including but not limited to: (a) the development and implementation of a communications, outreach and change management strategy; and (b) the conduct of stakeholder workshops, roundtables, public awareness campaigns, radio, television and print media/internet programs, all through the provision of consultant services and training. 12

15 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS (Continued) - Strengthening the professional capacity of judges, staff of courts and the Ministry of Justice and the Justice Academy through, inter alia: (a) the preparation of a justice sector gender strategy and action plan based on an assessment of gender-based barriers to employment for judges, lawyers and other justice professionals and an analysis of training and sensitization needs on gender issues for justice professionals; (b) the development of training courses and curricula and the delivery of training for judges and other justice professionals aimed at, but not limited, to improving the quality ofjudicial decisions in economic and commercial disputes and in first-instance courts; and (c) the carrying out of knowledge-sharing activities between judges and other justice sector professionals in Azerbaijan and between Azerbaijan and other judiciaries, justice training institutions and professional networks, through the provision of goods, consultant services and training. Component 3: Expansion and Modernization of Justice Infrastructure - Construction and rehabilitation of about six courthouses and court complexes at the locations selected in accordance with criteria set forth in the Operational Manual through the carrying out of works and the provision of goods, consultant services and training. Component 4: Project Management and Coordination - Strengthening the capacity of the Ministry of Justice in Project management, monitoring and coordination including audits of: (1) Project financial statements, (2) environmental and social safeguard compliance; and (3) implementation of infonnation and communications technology activities under the Project, all through the provision of goods, consultants' services, and training, and financing of incremental operating costs. The Loan agreement 8407 AZ was intended to finance building of about six modem court buildings area (Sumgait Court Complex, Baku City Narimanov Court, Surakhani District Court, Baku Grave Crime Courts Complex, Masalli District Court, Annexes in Sheki Court Complex). 2. BASIS OF ACCOUNTING Statement of compliance The Special-Purpose Financial Statements have been prepared on the cash basis of accounting in conformity with the International Public Sector Accounting Standards ("IPSAS") "Financial Reporting under the Cash Basis of Accounting" issued by the Public Sector Committee of the International Federation of Accountants ("IFAC-PSC") and incorporate the principal accounting policies from the "Guidelines: Annual Financial Reporting and Auditing for World Bank Financed Activities". Other basis of preparation criteria The Special-Purpose Financial Statements are prepared under the historical cost basis of accounting. Source funding and government contributions are recognized when the related cash is received or paid out on the Project's behalf. Expenditure is accounted for on the basis of actual disbursement of funds from the Project accounts. 13

16 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS (Continued) Foreign currency transactions and translation The Project uses the United States Dollar ("USD") as its functional currency for the following reasons: a) The IBRD's funding is received in USD; b) A substantial share of the Project's expenditure is denominated in USD; and c) Budgets and financial reports for the Project are prepared in USD. Balance sheet monetary items denominated in currencies other than USD have been translated into USD using the exchange rate of the Central Bank of the Republic of Azerbaijan ("CBRA") effective as at appropriate date. All income and expense transactions denominated in currencies other than USD are converted into USD using the exchange rate of the CBRA prevailing on the date of transaction. 3. CASH AND CASH EQUIVALENTS Cash and cash equivalents included in the Special-Purpose Financial Statements comprise balance with resident financial institution. December 31, December 31, IBRD Loan Number 8407 AZ Cash on hand IBRD Designated Account USD 108,321 3,496,236 Total cash and cash equivalents 108,693 3,496, DESIGNATED ACCOUNT The Recipient has established Designated Account at a commercial bank acceptable to the IBRD in accordance with the Loan Agreement. Designated Account is established, managed, replenished and liquidated in accordance with the World Bank's "Disbursement Guidelines for Projects" dated September 2006 and detailed arrangements agreed upon between the Recipient and the IBRD. The Project maintains its Designated Account in USD with the International Bank of Azerbaijan OJSC (located in the Republic of Azerbaijan). 5. CONTRACTUAL COMMITMENTS As at December 31, 2016 total contractual commitments amounted to USD 14,496,769 (2015: USD 26,535,493). The contractual commitments per expenditure categories were as follows: Category December 31, December 31, (1) Civil Works 10,814,542 24,086,502 (2) Consultants' services 3,483,515 2,146,102 (3) Goods 198, ,889 Total contractual commitments 14,496,769 26,535,493 14

17 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS (Continued) 6. BASIS OF FUNDING AND ELIGIBLE EXPENDITURE The following table specifies the categories of eligible expenditure that may be financed out of the allocations of the amounts indicated in the Loan to each category, and the percentage of expenditure to be financed for eligible expenditure in each category: Category December 31, 2015 Amount of the Percentage of expenditure Loan allocated to be financed (Net of VAT) (expressed in USD) (1) Goods, works and non-consulting services for the Project 65,734,738 49% (2) Consultants' services including audits, training and incremental operating costs for the Project 31,340, % (3) Unallocated 2,674,903 (4) Front-end fee 250, % of the Loan amount (5) Interest Rate Cap or Interest Rate Collar Premium to be paid out of the premium - proceeds of the Loan Total eligible expenditure 100,000,000 During the year ended December 31, 2016 other costs in the amount of USD 265,572, USD 125,465 and USD 61,590 were financed fully by the Government of the Republic of Azerbaijan regarding "purchase of firefighting equipment", "cleaning of ecological wastage and establishment of technical water drainage" and "safety gates for front doors of courts", respectively. During the year ended December 31, 2015 other costs in the amount of USD 133,682, USD 53,627 and USD 65,457 were financed fully by the Govermtnent of the Republic of Azerbaijan regarding "billboard and fencing for courts under construction", "blind lanes" and "program software for implementation of e-court", respectively. On November 25, 2014, the IBRD responded by "no objection" to request of government to finance the construction of Annexes in Sheki Court Complex using 100% funding from the Government of the Republic of Azerbaijan. The procurement plan was revised accordingly. 7. METHODS OF DISBURSEMENT The methods of disbursement used from the inception of the financing up to and including December 31, 2016 were as follows: Advance - the IBRD may advance loan proceeds into the Designated Account of the Recipient to finance eligible expenditure as they are incurred and for which supporting documents will be provided at a later date. Direct Funding - the IBRD may make payments, at the Recipient's request, directly to a third party for eligible expenditure. Reimbursement procedure - the IBRD may reimburse the Recipient for expenditure eligible for financing pursuant to the Loan Agreement ("eligible expenditure") that the Recipient has pre-financed from its own resources. 15

18 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS (Continued) Commitment procedure - the IBRD may pay amounts to a third party for eligible expenditure under special commitments entered into, in writing, at the Recipient's request and on terms and conditions agreed between the EBRD and the Recipient. 8. METHOD OF WITHDRAWAL IBRD Designated Account Designated Account is designated disbursement account of the Project to effect the payment of eligible expenditure, within defined limits, which do not require individual authorization from the IBRD. Available amounts were drawn down within the limits determined by the relevant loan agreement for the payment of eligible expenditure for sub-contractors from the Designated Account. Direct payments from the IBRD Designated Account Under this method, the Project management prepares applications based on supporting documents which are submitted to the IBRD. Payments are made from the Loan Account directly to the contractors. Project Account The Project maintains a separate account in the State Treasury Agency where the Govermnent funds are accumulated. The funds are further disbursed to sub-contractors based on the shares of expenditure to be incurred by each funding source. Statement of expenditure ("SOE") Under the SOE method, the Project forwards to the IBRD an application for reimbursement of payments already made using an application for withdrawal with SOE forms as the only documentation. Cash on hand For the year ended December 31, 2016, the Project management has withdrawn cash in the amount of USD 555,816 from IBRD Loan Number 8407 AZ (2015: USD 937,025) to cover miscellaneous expenditures. The withdrawn amounts have been converted into AZN and disbursed further to fund the Project expenditures. The mentioned transactions were segregated from the other transactions. The cash balance was USD 372 as at December 31, 2016 and nil as at OPERATING ENVIRONMENT The Project's operations are conducted in the Republic of Azerbaijan. As an emerging market, at the present time the Republic of Azerbaijan is developing business and regulatory infrastructure that would generally exist in a more mature market economy. Major indicators of the Azerbaijan economy were influenced by a number of negative factors. Considering significant drop in crude oil prices starting from the second half of 2014, there continues to be uncertainty regarding the economic growth, access to capital and cost of capital in the Republic of Azerbaijan, because Azerbaijan produces and exports large volumes of oil and gas, its economy is particularly dependent on the price of oil and gas. Economic growth slowed down in 2014 and 2015 approximately 2% and 1.1%, respectively and turned negative 3% in These factors resulted in the economic slowdown to shift from prosperity to recession economy with high inflation and unemployment and decreasing GDP. 16

19 NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS (Continued) The future economic direction of the Republic of Azerbaijan is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory and political developments. The Management is unable to predict, all developments in the economic environment which would have an impact on the Project's operations and consequently what effect, if any, they could have on the financial position of the Project. Decreasing revenues from oil exports made the Central Bank of the Republic of Azerbaijan abandon its peg policy to the basket of US dollars and Euros. In addition, CBRA devalued the Azerbaijani Manat by approximately 34% on February 21, 2015 and further on December 21, 2015 introduced a floating exchange rate that resulted in one-time devaluation of the AZN against US dollars and other major currencies by approximately 48%. The devaluation of Azerbaijani Manat continued in 2016 and resulted in 14% fall against US dollars and 9% fall against Euro by December 31, In January 2016, Standard & Poor's, international credit agency, downgraded long-term and short-term foreign and national currency sovereign rating to the speculative level. Starting from February, 2016 the Central Bank of the Republic of Azerbaijan has gradually increased refinancing rate from 3 to 15% and the minimum capital adequacy ratio was lowered from 12% to 10%. In addition, CBRA prevented speculations in the currency market by setting a limit on the currency exchange rate corridor within 4% of the official rate which was revoked in 2017 and introduced limits on the amount of foreign currency exchange. The Azerbaijani economy is vulnerable to market downturns and economic slowdowns elsewhere in the world. While the Government has introduced a range of stabilization measures and plans to expedite reforms and support to banking system in response to current economic challenges. Amidst the ongoing crisis, the government of Azerbaijan shifted its oil-oriented economic policy, dominated for two decades, to the diversification of the economy. For that purpose, a "national strategic roadmap" was adopted to formulate a correct development strategy. The implementation of the "national strategic roadmap" was assigned to the newly formed "Center for Analysis of Economic Reforms and Communications," the aim of which is analyzing the effectiveness of conducted reforms and making new proposals. It is expected that recession to be short-lived, recovering to economic growth in 2017, partly due to positive effects of investments in gas projects. It is expected the GDP will growth 1.4% and the nonoil sector about 2.4%. Over the long term, Azerbaijan will benefit from production from the new gas fields, which is expected to come online in