The World Bank IMPLEMENTATION COMPLETION AND RESULTS REPORT (IDA-40610) ON A POVERTY REDUCTION SUPPORT CREDIT

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized The World Bank Report No:ICR IMPLEMENTATION COMPLETION AND RESULTS REPORT (IDA-40610) ON A POVERTY REDUCTION SUPPORT CREDIT IN THE AMOUNT OF SDR 13.1 MILLION (US$ 20.0 MILLION EQUIVALENT) TO THE REPUBLIC OF AZERBAIJAN March 30, 2007 POVERTY REDUCTION AND ECONOMIC MANAGEMENT SOUTH CAUCASUS COUNTRY UNIT EUROPE AND CENTRAL ASIA

2 CURRENCY EQUIVALENTS (Exchange Rate Effective March 21, 2007) Currency Unit = New Azeri Manat AZN 1.00 = US$ US$ 1.00 = AZN FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS AAA ACG ADB AIOC ANB APL BEEPS BIS BOT BTC CAS CFAA CIS COM CPAR CPIA CPS EBRD EITI ESMAP EU FDI FIAS FID FSU GATS GBWSP GDP GFS GTZ HIPC IAS IBA IBTA ICR IDA IDPs IFC IFI IFRS IMF INOTIS Analytical Advisory Activities Azerbaijan-Chirag-Guneshi Asian Development Bank Azerbaijan International Operating Company Azerbaijan National Bank Adaptable Program Lending Business Environment and Enterprise Performance Survey Bank of International Settlements Build-Operate-and Transfer Baku-Tbilisi-Ceyhan pipeline Country Assistance Strategy Country Financial Accountability Assessment Commonwealth of Independent States Cabinet of Ministers Country Procurement Assessment Report Country Performance Indicator Assessment Country Partnership Strategy European Bank for Reconstruction and Development Extractive Industries Transparency Initiative Energy Sector Management Assistance Program European Union Foreign Direct Investment Foreign Investment Advisory Services Foreign Investment Department Former Soviet Union General Agreement on Trade and Services Greater Baku Water Supply Rehabilitation Project Gross Domestic Product Government Finance Statistics Gesellschaft furt Technische Zusammenarbeit Heavily Indebted and Poor Countries International Accounting Standards International Bank of Azerbaijan Institution Building Technical Assistance Implementation Completion and Results Report International Development Association Internally Displaced Populations International Finance Corporation International Finance Institutions International Financial Reporting Standards International Monetary Fund Integrated Non-oil Trade and Investment I-PRSP IPSAS ISA LDP LIL LPG LTORMS M&E MDGS MED MEP MIS MoF MOFE MoH MOLSPP MTEF NAS NBA NBS NGO O&M OSCE PAD PAR PES PHC PIP PPF PPIAF PRGF PRSC PRSP PSA QAG REER RFP RTGS SAC SDR SME SOCAR Strategy Interim Poverty Reduction Strategy Paper Investment Public Sector C Standards International Standards on Auditing Letter of Development Policy Leaning and Innovation Liquid Petroleum Gas Long Term Oil Revenue Management Strategy Monitoring and Evaluation Millennium Development Goals Ministry of Economic Development Main Export Pipeline Management Information System Ministry of Finance Ministry of Fuel and Energy Ministry of Health Ministry of Labor and Social Protection Medium-Term Expenditure Framework National Accounting Standards National Bank of Azerbaijan National Budget Survey Non-Governmental Organization Operations and Maintenance Organization for Security and Co-operation in Europe Project Appraisal Document Poverty Assessment Report Public Employment Services Primary Health Care Public Investment Program Project Preparation Facility Public-Private Infrastructure Advisory Facility Poverty Reduction and Growth Facility Poverty Reduction Support Credit Poverty Reduction Strategy Paper Production Sharing Agreement Quality Assurance Group Real Effective Exchange Rate Request for Proposal Real Time Gross Settlement System Structural Adjustment Credit Special Drawing Rights, SDR 1= US$ Small and Medium Enterprise State Oil Company of Azerbaijan Republic

3 SOE SPPRED SSA SSPF TA State-owned Enterprise State Pogramme for Poverty Reduction and Economic Development State Statistical Agency State Social and Pension Fund Technical Assistance UNDP USAID VAT VDS WTO United Nations Development Programme United States Agency for International Development Value-Added Tax Voluntary Departure Schemes World Trade Organization Vice President: Shigeo Katsu Country Director: Donna Dowsett-Coirolo Sector Manager: Carlos Felipe Jaramillio Project Team Leader: Christos Kostopoulos ICR Team Leader: Christos Kostopoulos

4 Azerbaijan Poverty Reduction Support Credit (PRSC) CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring 1. Program Context, Development Objectives and Design Key Factors Affecting Implementation and Outcomes Assessment of Outcomes Assessment of Risk to Development Outcome Assessment of Bank and Borrower Performance Lessons Learned Comments on Issues Raised by Borrower/Implementing Agencies/Partners Annex 1 Bank Lending and Implementation Support/Supervision Processes Annex 2. PRSC Policy Reform and Results Matrix Annex 3. Summary of Borrower's ICR and/or Comments on Draft ICR Annex 4. Comments of Cofinanciers and Other Partners/Stakeholders Annex 5. List of Supporting Documents MAP... 55

5 A. Basic Information Country: Azerbaijan Program Name: Poverty Reduction Support Credit (PRSC) Program ID: P L/C/TF Number(s): IDA ICR Date: 04/02/2007 ICR Type: Core ICR Lending Instrument: PRC Borrower: Original Total Commitment: Implementing Agencies: Ministry of Finance Cofinanciers and Other External Partners: B. Key Dates GOVERNMENT OF AZERBAIJAN XDR 13.1M Disbursed Amount: XDR 13.1M Process Date Process Original Date Revised / Actual Date(s) Concept Review: 02/18/2004 Effectiveness: 01/13/ /13/2006 Appraisal: 06/01/2004 Restructuring(s): Approval: 05/17/2005 Mid-term Review: Closing: 06/30/ /30/2006 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Risk to Development Outcome: Bank Performance: Borrower Performance: Moderately Satisfactory Substantial Moderately Satisfactory Moderately Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Moderately Satisfactory Government: Moderately Satisfactory Quality of Supervision: Moderately Satisfactory Implementing Agency/Agencies: Moderately Satisfactory Overall Bank Overall Borrower Moderately Satisfactory Performance: Performance: Moderately Satisfactory C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments Indicators Performance (if any) Potential Problem Program at any time Yes Quality at Entry (QEA): None Rating: i

6 (Yes/No): Problem Program at any time (Yes/No): DO rating before Closing/Inactive status: No Satisfactory Quality of Supervision (QSA): None D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) General education sector General energy sector General industry and trade sector General public administration sector Health Theme Code (Primary/Secondary) Legal institutions for a market economy Primary Primary Macroeconomic management Secondary Secondary Other financial and private sector development Secondary Secondary Public expenditure, financial management and procurement Primary Primary Regulation and competition policy Primary Primary E. Bank Staff Positions At ICR At Approval Vice President: Shigeo Katsu Shigeo Katsu Country Director: D-M Dowsett-Coirolo D-M Dowsett-Coirolo Sector Manager: Carlos Felipe Jaramillo Samuel K. E. Otoo Program Team Leader: Christos Kostopoulos Christian E. Petersen ICR Team Leader: ICR Primary Author: Christos Kostopoulos Mansour Farsad F. Results Framework Analysis Program Development Objectives (from Project Appraisal Document) The objective of the proposed PRSC is to support the Government#s policies and structural reforms that are consistent with and supportive of the poverty reduction and economic strategy as highlighted in the SPPRED. More specifically, the credit aims to enhance the Government's ability to manage Azerbaijan's natural resource boom ii

7 efficiently, and to stimulate balanced economic growth and job creation, which are fundamental to poverty reduction. Revised Program Development Objectives (if any, as approved by original approving authority) None (a) PDO Indicator(s) Indicator Indicator 1 : Value (quantitative or Qualitative) Baseline Value Contain inflation. 2004: 10.4 Year end inflation Original Target Values (from approval documents) Single digit inflation Formally Revised Target Values Actual Value Achieved at Completion or Target Years 2005: 5.5% Yearend inflation 2006: 11.4% Yearend inflation Date achieved 12/31/ /31/ /23/2007 Comments (incl. % The target was almost achieved in 2004, achieved in 2005, and missed in achievement) Indicator 2 : Diversification of economy and growth of non-oil GDP. Value (quantitative or Qualitative) 2004: 13.5 Non-oil GDP gr. 2004: 18% Non-oil Exp/Tot Exp Diversification of non-oil economy; non-oil exports grow by more than 10% a year. WB estimates that the target is surpassed. 2005: 8% Non-oil GDP gr. 2005: 10% N-O Exp/Tot Exp 2005: 50% Non-oil Exp gr. 2006: 12% N-O GDP gr. 2006: 7% N-O Exp/Tot Exp 2005: 23% Non-oil Exp gr. Date achieved 12/31/ /31/ /23/2007 Comments The target was achieved in all years since the beginning of the operation (N-O (incl. % refers to "non-oil"). achievement) Indicator 3 : Public and publicly guaranteed external debt Value (quantitative or Qualitative) 2004: 18.5% of GDP Range of percent of GDP 2005: 13.1% of GDP 2006: 9.2% of GDP Date achieved 12/31/ /31/ /23/2007 Comments The target was achieved in all years since the beginning of the operation. iii

8 (incl. % achievement) (b) Intermediate Outcome Indicator(s) Indicator Indicator 1 : Value (quantitative or Qualitative) Baseline Value Original Target Values (from approval documents) Formally Revised Target Values Actual Value Achieved at Completion or Target Years Sustainable fiscal deficit (non-oil primary balance rel to non-oil GDP reported) Consistent with Long Term Oil Revenue 2005: -13% 2004: -13% Management 2006: -32% Strategy (LTORMS) Date achieved 12/31/ /31/ /23/2007 Comments (incl. % achievement) The target largely achieved in all years, despite large spending increase in The LTORMS allows for accelerated spending in the early years of the oil boom but contains no specific expenditure targets. Macro concerns raised. Indicator 2 : Strengthening of institutions for non-oil growth, financial services (FS), and accounting standards (AS). Value (quantitative or Qualitative) FS: payment systems strategy prepared AS: Accounting Law prepared FS: payment systems strategy adopted AS: Accounting Law enacted FS: payment systems strategy adopted AS: Accounting Law enacted Date achieved 12/31/ /20/ /27/2005 Comments (incl. % achievement) Achieved fully. G. Ratings of Program Performance in ISRs Actual Date ISR No. DO IP Disbursements Archived (USD millions) 1 06/28/2006 Satisfactory Satisfactory H. Restructuring (if any) Not Applicable iv

9 This Implementation Completion and Results report is being undertaken as part of the Bank s internal requirement for evaluation of competed programmatic development policy loans. Usually, these reports are undertaken after the full series of loans is completed, and the accompanying reform programs have been implemented. In the case Azerbaijan s PRSC, the ICR is being prepared about halfway through the reform program which is currently under implementation, because Azerbaijan has decided that it will not be necessary to borrow for additional PRSCs, given the absence of financing needs. Still, Azerbaijan s reform program is being implemented with the support of the Country Partnership Strategy for FY07-FY10. Accordingly, this ICR reviews the PRSC operation through 2005, and assesses the progress being made towards the achievement of the medium term program objectives. The ICR proposes that additional reviews of the PRSC s contributions to the medium term reform program is conducted alongside the interim and final completion reviews of the Country Partnership Strategy. 1. Program Context, Development Objectives and Design (this section is descriptive, taken from other documents, e.g., Program Document/ISR, not evaluative) 1.1 Context at Appraisal (brief summary of country macroeconomic and structural/sector background, rationale for Bank assistance) 1. The PRSC was part of the World Bank s continuous structural reform dialogue with Azerbaijan which dates to the early years of adjustment in the latter half of the 1990s. The period prior to appraisal, which was initiated in May 2004, was marked by macroeconomic stability and progress in structural reforms. During , the economy grew at an average annual rate of about 12 percent, in contrast to the dramatic output drop the country experienced in the early part of the 1990s (accumulated to 60 percent), after independence. Between 2000 and 2004, output in agriculture and industry doubled, while output in key service sectors (e.g., transport, communications, and the social sectors) more than tripled. Foreign direct investment (FDI), which primarily supported the oil sector but had a trickle-down effect on the rest of the economy, was a large contributor to the economic expansion. FDI flows peaked at 32 percent of GDP in 2003; they supported the oil sector with deep water wells and construction of the Baku- Tbilisi-Ceyhan (BTC) pipeline. Overall, during the period, Azerbaijan succeeded in maintaining macroeconomic stability despite the high FDI inflows by relying on generally sound fiscal and monetary polices, and in achieving low fiscal deficits (2.8 percent of GDP per annum), low inflation (2.6 percent per annum), and high non-oil growth (13.0 percent per annum). 2. Azerbaijan s structural reform program was supported by the second Structural Adjustment Credit (SAC-II) in the period , a two-tranche operation. The first tranche was disbursed in March 2002 (upon effectiveness), and the second tranche was disbursed successfully in May While the preparation of the operation was lengthy, the operation closed successfully in December The SAC-II aimed to enhance the Government's ability to manage the country s forthcoming natural resource boom efficiently, and to stimulate balanced economic growth, job creation and poverty reduction. In particular, the SAC-II (i) improved transparency in public finances, and the 1

10 strategic priority setting of public expenditure to accelerate poverty reduction and economic growth; (ii) enhanced conditions for private enterprise and foreign investment, especially in the non-oil part of the economy; and (iii) supported reforms in the utility sector to improve access to reliable electricity, heating, and clean water for the population. At the strategic level, the SAC-II achieved three important outcomes for Azerbaijan s future: (i) it led to the establishment of the governance framework of the Oil Fund and helped secure more than US$13 billion in FDI for the oil and gas sector; (ii) it led to the amendment of the Budget Systems Law beyond the credit s conditionality, integrating Oil Fund spending into the Consolidated Budget; and (iii) it set in motion the preparation of the country s poverty reduction strategy. 3. In 2003, the Government, in collaboration with civil society, prepared a poverty reduction strategy entitled the State Program for Poverty Reduction and Economic Development (SPPRED, Report No AZ). The SPPRED aimed at maintaining economic stability, improving infrastructure, increasing access to basic social services, and increasing the income-generating opportunities for the poor. The first SPPRED progress report and its joint Bank/Fund assessment was presented to the Board in September 2004, and the second one in August In 2003, Azerbaijan also saw a defining political development which, among other things, had an impact on the preparation of the next adjustment operation (PRSC). The prolonged illness and death of President Heydar Aliyev late in the year; both had a temporary dampening impact on the pace of reform in the country. By November 2003, Ilham Aliyev had been elected President and Presidential Decrees had been issued in November 2003 and in April 2004, aiming to assure continuity in the reform program. Nevertheless, the transition in leadership had an understandable effect on the pace of reforms. While the appraisal of the PRSC was initiated in May 2004, it was completed in February Rationale for Bank Assistance. At the request of the Government, the IDA prepared an SDR 13.1 million (US$20 million equivalent) Poverty Reduction Support Credit (PRSC) as the first operation in a three-year reform program to assist Azerbaijan in implementing the SPPRED (the country s PRSP). The Operations Committee reviewed the PRSC and raised the issue of the appropriateness of adjustment lending to resource rich countries, including Azerbaijan. The Committee concluded that in the case of Azerbaijan adjustment operations in general (or combined with TA operations) were important instruments for supporting reforms and encouraging growth in the non-oil sector. While the lending amounts were relatively small, the operations themselves were thought to contribute to creating a forum for continuous policy dialogue on key issues and had proved effective in Azerbaijan (as in the case of the SAC-II) in advancing the reform agenda. Beyond the financial support, the role of the Bank was considered critical in reducing the non-income dimensions of poverty by improving the quality of education and health services, as well as supporting access to basic infrastructure, clean water and sanitation. 5. The PRSC, discussed by the Board in May 2005, was the first of two single tranche adjustment operations planned for the FY03-05 Country Assistance Strategy (CAS, Report No AZ, dated April 29, 2003). The first PRSC comprised the base case scenario and was planned for FY05. The second PRSC which did not materialize owing to lack of financing need defined the high case scenario of the FY03-05 CAS. 2

11 The PRSC operations were designed to successively support core structural reforms included in SPPRED. They followed on the reforms supported by the SAC-II and were accompanied by the second Institution Building Technical Assistance project (IBTA-II). The PRSC supported reforms, being a continuation of the reforms initiated by the SAC-II, were seen as an umbrella for supporting other Bank operations in Azerbaijan. 1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved) 6. The objective of the three-year PRSC program was to support the Government s SPPRED. The program aimed to enhance the Government's ability to manage the country s natural resource boom efficiently, and to stimulate balanced economic growth and job creation, which were fundamental to poverty reduction. 7. The key indicators for the PDO are broad and are included in strategic goals 1 and 2 of the policy matrix. They include the growth of the non-oil economy, non-oil trade, indebtedness, inflation, institutional milestones in the efficiency and effectiveness of public resource use, and measures of development for the institutional development of the private sector. (Individual statistics are included in the Results Framework Matrix of the ICR.) 1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and Reasons/Justification 8. The PRSC objectives and components remained unchanged throughout the operation s implementation. However, the Government has decided that it would not need to borrow for additional budgetary support after 2006 given dramatic increases in oil prices in the current year, and the projected high prices in the medium term. The PRSC lending program was therefore suspended. However, the PRSC policy reform program continues to be supported by the new Country Partnership Strategy (presented to the Board, December 7, 2006), under a variety of analytical, technical assistance, and investment lending tasks (see Section 7.4, below). Given that the present ICR is being drafted as the ongoing medium term policy reform program continues to develop, it focuses on the actions taken prior to the Board presentation of the first operation and the subsequent progress in the reform agenda. The report assesses the likelihood that the medium term program objectives could be reached within a reasonable time frame. 1.4 Original Policy Areas Supported by the Program (as approved) 9. The components of the PRSC program covered the following policy areas consistent with the overall development objectives described above: 1. Managing the oil boom, with the objective of maintaining macroeconomic stability, avoiding Dutch Disease and facilitating non-oil growth, employment and pro-poor expenditures. 2. Generating jobs and sustainable non-oil growth, with the objectives of improving the business environment and the access to financial services, building SME support infrastructure, and stimulating agriculture. 3

12 3. Improving access to services and infrastructure, with the objective of reversing the decline in social services, social assistance, and infrastructure. 4. Realizing the oil and gas potential, with the objective of addressing issues of transparency in the use of oil resources. This component complemented actions under component Implementing the SPPRED, with the objectives of supporting institutional capacity building to monitor SPPRED outcomes, and ensuring that the sustainability of the reforms remains in the forefront. 1.5 Revised Policy Areas (if applicable) 10. The policy areas under the PRSC were not revised. 1.6 Other significant changes (in design, scope and scale, implementation arrangements and schedule, and funding allocations) 11. No significant changes were made to the operation. 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance (supported by a table derived from a policy matrix) 12. The PRSC was the first operation in a three series program. The planned disbursement date was May 31, 2005, but actual disbursement took place on January 13, 2006 given the lack of financing needs until late 2005, as a result of the unexpectedly high oil prices during that year. Declaration of effectiveness, which requires immediate disbursal, was timed to need financing needs. First Operation in a Programmatic Series List conditions from Legal Agreement/ Program Document Status 1. The Borrower has maintained a satisfactory macroeconomic framework. Met 2. The Law on Investment has been submitted to the Parliament for its Met consideration. 3. The Borrower has adopted a national strategy for the development of Met payment systems for FY The Law on Accounting has been enacted. Met 5. The Borrower has made satisfactory progress in its implementation of an action program for the restructuring of SOCAR, which includes, inter alia: (a) Met adoption of international financial reporting standards; and (b) financial and corporate restructuring of SOCAR. 6. The Borrower has developed for the utility sector: (a) a medium-term tariff policy; and (b) a regulatory framework which envisages, inter alia, the Met establishment of an independent regulatory agency. 7. The Borrower has made satisfactory progress in implementing its Budget Systems Law, including: (a) approval of implementing regulations; (b) implementation of a training program for those involved in budget formulation Met and execution of the budget systems in the Ministry of Finance of the Borrower; and (c) preparation of a budget process manual based on the Budget 4

13 Systems Law 8. The Borrower has: (a) ensured that all the expenditures of SOFAR have been included in the consolidated budget, the MTEF and the PIP for FY 2004; and (b) published the account of SOFAR for FY 2003, which was audited in accordance with international standards of accounting. 9. The Borrower has submitted the MTEF to the Parliament and prepared the PIP for FY The Borrower has: (a) transferred regulatory functions from the Caspian Shipping Company to the Ministry of Transport of the Borrower; and (b) published that a similar process will be undertaken in other transport sectors. 11. The draft law on targeted social assistance has been submitted to the Parliament. 12. The Borrower has adopted a legal framework for public sector accounting in accordance with the international standards. Met Met Met Met Met 2.2 Major Factors Affecting Implementation: 13. The first PRSC was not restructured, nor was it ever at risk. There were also no major changes in its design. However, the second and third PRSCs were cancelled. The MoF and MED provided an effective oversight and coordinated activities of the other implementing agencies. Other major factors that contributed to the successful implementation of the PRSC included the following: Ownership and commitment of the Government to the reform agenda. The Government had committed itself to a comprehensive program through a balanced approach to economic reform as outlined in the SPPRED. The SPPRED presented a credible poverty reduction strategy consistent with the multi-dimensional nature of poverty reduction in Azerbaijan and the need for developing the non-oil sector. The Government initiated the preparation and implementation of this reform agenda with the strong backing of the President and Parliament (see Section 8.1 for details). Soundness of the background analysis was a major contributing factor in the identification and implementation of policy measures under the PRSC program. Key inputs for the preparation of this operation were provided through a variety of economic and sector analytical work. The Bank completed the Integrated Non-Oil Trade and Investment Strategy (INOTIS) in November 2003, the Public Expenditure Review in December 2002, the Poverty Assessment in June 2003, the Country Procurement Assessment Report (CPAR) in July 2003, and the Country Financial Accountability Assessment (CFAA) in September The PRSC also benefited from a PSIA on the impact of increases in electricity tariffs on the poor, completed in December 2004, and a comprehensive Energy Sector Report for Azerbaijan, completed in February Significant analytical work also continued through the implementation of the program and helped shape the course of the reform program. At the level of project lending, operations such as the Second Structural Adjustment Credit (SAC-II, completed in June 2003), and the Second Institution Building and Technical Assistance (IBTA-II) also contributed to the design and implementation of the PRSC, as did several sectoral investment projects (see Section 7.3). 5

14 Intensity of the policy dialogue and focus of the policy measures. A high level policy dialogue has been maintained during the preparation and implementation of the operation. The purpose of the dialogue was to maintain encouragement, cohesion and focus in the sectoral discussions of the entire policy matrix. The policy measures under each component also benefited from extensive consultation with the other donors and feedback from civil society organizations. Relevance of risks identified. The President s Report adequately recognized the risks relevant to the operation. These risks comprised: (i) the risk that nonreformers could delay key program elements; (ii) the financial management risk (the risk of spending pressures from high oil revenues); (iii) an implementation risk (lack of coordination of sectoral ministries of the Government s agenda); (iv) a resource flow risk (risk of delays in oil production); and (v) a political and security risk (stemming from the need to share resources quickly). Unforeseen were the high oil prices of 2005 and 2006, as well as the delays in program implementation that were associated with the gradual process of consolidation of power by the country s new President. Cancellation of PRSCs II and III, and operation under CPS. With the cancellation of the second and third PRSCs, the Policy matrix was adjusted slightly to fit the format of a Results matrix for the CPS. As discusses in section 2.4 below, the team adjusted its mode of operation, from focusing on conditionality, to focusing on advising the Government through investment operations and through AAA tasks. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization: 14. Monitoring and evaluation design arrangements were sound and helped to moderately strengthen the existing system and the capacity for implementation. The PRSC Policy Matrix and the Letter of Development Policy were the main reference documents for monitoring and evaluating the performance of the operation and the country s structural reform program. The Policy Matrix defined the three-year outcomes of the operation and identified indicators for monitoring progress toward the development objectives. 15. The monitoring and evaluation of the PRSC Policy Matrix components was carried out in several ways: The IMF monitored the implementation of macroeconomic policy measures on a regular basis and through the Poverty Reduction and Growth Facility (PRGF). The Bank also used other relevant macro data to monitor and evaluate macroeconomic developments, resource allocation and use. The monitoring and evaluation of the operations of the Oil Fund was done through its annual audited accounts. Monitoring the implementation of the Budget Systems Law and the efforts to improve the public expenditures management process was undertaken through advisory work with both the Ministry of Finance (MoF) and the Ministry of 6

15 Economic Development (MED) on the Medium Term Expenditure Framework (MTEF) and the Public Investment Program (PIP). A related area was Treasury modernization, which was monitored through the IBTA-II Monitoring and evaluating fiduciary responsibilities and progress in building the relevant capacities were carried out through the IBTA-II and other technical assistance (TA) (e.g., E-procurement). Sectoral reforms were monitored through regular Bank operations in Azerbaijan that had policy links to the PRSC program (e.g., Education Reform APL; Health Reform LIL; Pension and Social Assistance Project; and Financial Sector Assistance Program). Separate studies, and an expenditure tracking survey were also carried out to evaluate the trend and efficiency of health and education expenditures. Monitoring of the progress to be achieved toward the overall goals of poverty reduction and the MDG targets was carried out through the Household Budget Survey at the national level. A new Household Survey was carried out in 2004, during project preparation, establishing a new poverty benchmark which provided more reliable poverty figures and helped to identify a more realistic set of poverty indicators. Further evaluation of annual poverty trends was also carried out through a programmatic poverty assessment in Expected Next Phase/Follow-up Operation (if any): 16. Despite the lack of financing need, the Government of Azerbaijan has indicated its desire for and commitment to implementing the medium term reform program supported by the PRSC (Letter of Development Policy [LDP] of April 1, 2005) in the new Country Partnership Strategy (CPS) (ref. Letter from the Prime Minister to the Country Director, dated February 13, 2006). The CPS supports continued implementation of the PRSC policy agenda through a host of complementary investment and capacity building TA projects (see Table 7 of the CPS), as well as programmatic TA and AAA tasks (see Table 6 of the CPS). The CPS will monitor the implementation of the reform agenda with a list of key progress indicators linked to the CPIA (see Table 8 of the CPS) and a results matrix (see Annex 1 of the CPS) which specifies in good detail the intended outcomes and implementation milestones for the CPS, in much the same way as the PRSC Policy Matrix. However, the conduct of policy dialogue under the CPS is qualitatively different that the policy dialogue under the PRSC. While under the PRSC policy dialogue was driven by conditionality, under the CPS, self-standing policy dialogue is undertaken with a two pronged approach: policy changes are embedded in the investment/ta projects, and in non-lending activities such as workshops, AAA. Both require the Bank to prove every day that it can provide top quality and timely knowhow, and neither for the two approaches provide the closure that a fulfilled condition could bring policy-based lending. However reform ownership is expected to be even stronger under the CPS. 17. The CPS will follow up on four broad policy areas, as is discussed below. The policy support under each area mirrors the policy measures envisaged under the planned second and third PRSC operations (albeit with some adjustments in the timing, making 7

16 up for the originally ambitious nature of the operation). The policy areas have been agreed following extensive consultations with the Government. 1. Improving the Quality and Transparency of Public Sector Governance. Continued macroeconomic stability will remain the top priority in this area. Since the IMF-supported PRGF came to its conclusion in 2005, the Bank has become more actively involved in monitoring and supporting the macroeconomic management policies of the Government in the medium term. Indicators on macroeconomic developments are monitored quarterly. 2. Supporting the Sustainable Growth of the Non-oil Economy. There is now expanded access to financial services, and further reduction in the barriers to doing business in Azerbaijan. The next phase of the operation following PRSC1 would support: the development of rural infrastructure and services, an improved transit corridor and transit policy, improved coverage of the water supply system, improved reliability of the electricity and gas supply, and improved financial viability of the utility services. 3. Improving the Quality of and Access to Social Services. In this area the followup operations would aim at: improving the quality and coverage of healthcare services, modernizing the education system, expanding the efficiency and coverage of the social protection system, and improving living conditions and economic opportunities for internally displaced people. 4. Improving Environmental Management. The follow-up operations would support the clean-up of oil spills, as well as the better management of natural resources within the context of rural development and the conservation of ecosystems. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation (to current country and global priorities, and Bank assistance strategy) Relevance of Objectives 18. The PRSC program was prepared at a time when the country had established its credibility for sound macroeconomic management, was anticipating the advent of high oil revenues and had prepared the first line of institutional defenses for foreign currency inflows (the Oil Fund and the Budget Systems Law) under the SAC-II. The next policy objectives, which the PRSC program identified and addressed were: (i) managing the oil boom; (ii) Generating jobs and sustainable non-oil growth; (iii) improving access to services and infrastructure; (iv) improving Realizing the oil and gas potential, and (v) implementing the SPPRED. 8

17 Relevance of Design and Implementation 19. The PRSC design was sound for the following reasons: It supported the poverty reduction strategy: The PRSC included a broad range of policy measures dealing with key structural problems which were of high priority and critical to the success of the SPPRED (e.g., improving social and infrastructure services). It was closely related to the CAS: The PRSC operation (and the dialogue surrounding it) was the pivotal forum around which the policy context for the CAS s investment operations was determined. Its scope was comprehensive: It covered most of the important reform areas of the SPPRED, thus providing maximum support to reform initiatives. It provided additional sound features: Other positive aspects of the design included strong ownership, prior analytical work, a rich policy dialogue, and the identification of risks and their mitigation (see Section 7.2). 20. The PRSC design was optimistic on the timing of the reforms, for the first operation and for subsequent operations. While the first operation took almost a year longer to appraise than originally expected (completed April 2005 compared to a planned date of July 2004), in good part because political consensus had to be built in a new political environment following the illness and passing of Heydar Aliyev, the second year reforms were exceptionally heavy and their timing was unrealistic given the actual reform achievements in April Some examples of reforms that took longer than anticipated in the Policy Matrix are as follows: (i) the MTEF process was not implemented to its full potential, mainly because of weak institutional capacities at the central government level; (ii) the separation of commercial and regulatory functions of state-owned entities in the transportation sub-sector has been delayed; and (iii) auditing capabilities in the Chamber of Accounts are still generally weak. 21. The scope of the operation was broad. The operation aimed to be at the same time both strategic and opportune: on the one hand, substantial structural reforms remained to be achieved at the time of preparation, and still do, and, on the other hand, the advent of new oil was expected to allow only a very small window of opportunity. The three-year PRSC program did have a large number of conditions (a combined 134 conditions, triggers, and benchmarks for the three PRSCs, including 38 conditions for the first PRSC, of which 13 were core). In retrospect, experience with the implementation of the new CPS (that is based on the PRSC) suggests that the Government remains committed to the broad reform program (as discussed below), and thus it may not have been necessary to secure it in the broad PRSC matrix. It may have been more appropriate from the beginning (see discussion in Section 8.2) to have spaced out the reforms over a five-year period, instead of a three-year period, and to be more specific regarding some critical reforms, such as macro and budgeting, and the business environment (especially entry and exit). 3.2 Achievement of Program Development Objectives (including brief discussion of causal linkages between policy actions supported by operations and outcomes) 9

18 22. The Government reform program supported by the PRSC, and its components, are discussed in detail in the Program Document (No AZ). Drawing on that document, the major accomplishments under each of the first year PRSC components, and the extent to which they contributed to the expected output/outcomes, are discussed below. Strategic Goal 1. Managing the Oil Boom 23. The Government s medium term program aims to: (i) avoid Dutch Disease and (ii) improve the efficiency and effectiveness of public resources. The implementation of these policy objectives (goals) is expected to allow the Government to achieve the following outcomes (results) by the end of the three-year PRSC program period: (i) maintain macro stability with low levels of inflation; (ii) continue to manage the oil revenues in a transparent and efficient manner; (iii) formulate the budget based on a medium term public expenditure framework and a PIP, through a more participatory process and through the adoption of program budgeting; (iv) increase transparency and accountability in the management of public resources by achieving greater transparency in financial reporting, accounting, and auditing; and (v) show improvement in the impact of expenditures on the welfare of the population, especially in health care and education. Progress under the First PRSC toward Expected Program Output/Outcomes. 24. Azerbaijan was successful in maintaining macroeconomic stability in 2004 and 2005, a key element of the economic environment conducive to growth and poverty reduction. To a large extent, that has been due to the policy dialogue during the preparation of the PRSC. The country s institutional architecture for managing profits from oil through the Oil Fund, with the assistance of the Budget Systems Law established under SAC-II, was largely successful. The country has also successfully handled largescale FDI which flowed into the oil sector (oil FDI at the unprecedented level of US$ billion in were equivalent to between around 20 and 50 percent of GDP). At the same time, with the increase in oil-related revenues in 2004 (including taxes from oil accruing directly to the budget, not the Oil Fund), public spending on the part of stateowned enterprises and the Government rose. Given the effectively pegged exchange rate, money supply growth accelerated causing double digit inflation in However, concerted actions of the National Bank of Azerbaijan and Government in early 2005, including introducing more flexibility to the exchange rate, brought down the inflation rate back into a single digit (5.4 percent) by end The economic growth in 2004 and 2005 was strong: overall GDP and non-oil GDP growth rates averaged 18.3 percent and 11.0 percent, respectively, for the two-year period. The non-oil growth was broad-based (as discussed in the next section). The real effective exchange rate (REER) depreciated in 2003 and 2004, and appreciated in Overall in 2005, it had not appreciated relative to 2002, and had appreciated 14 percent relative to 2003 (according to NBA estimates). The Manat has appreciated less than other currencies in the region since Azerbaijan s non-oil trade grew at 24 percent a year in both 2004 and 2005, and is expected to have grown at 40 percent in 2006; non oil merchandise exports grew at 50 percent in 2005, and had grown at about 30 percent a year in the third quarter of 2006 (year in year). External debt has remained very low. Azerbaijan s performance under the IMF program (PRGF) ended satisfactorily in May The country successfully ended 10

19 the period with a 20.6 percentage point reduction in the poverty rate, which is representative of the gains made in urban and in rural regions (see Table 3). Table 1: Key Macroeconomic Outcomes Compared to PRSC Projections, PRSC ICR March 2007 PRSC MoP May Real GDP growth Real Non-oil GDP gr Inflation (CPI, eop) Gross Inv., %GDP Resource Bal, %GDP Cons Fiscal Bal, % GDP Cons Fiscal Bal ex OF, %GDP M2, %GDP External Debt, % GDP Oil Price Memo items Cons Gov Expend, %N-O GDP Ext CAB, % GDP M2, gr, rate Exchange rate, REER (NBA) Exchange rate, AzN/USD (eop) Note: Differences between May 2005 and March 2007 for 2003 and 2004 reflect revisions to the data. The years 2005 and 2006 were forecasts in May Source: World Bank (PRSC Program Document); Azerbaijan authorities; Bank staff estimates. 25. In the medium term, the prospects for macroeconomic stability and poverty reduction are good, although the Government needs to recognize increasing risks. In 2006, the Government effectively initiated an aggressive medium term effort to repair and rebuild dilapidated infrastructure that is proving a hindrance to non-oil growth and to poverty reduction, financed by rising oil profits to the Oil Fund, and oil-related taxes to budget. Consolidated government expenditures increased by 81 percent in nominal terms in 2006 compared to 2005; increases in 2007 and beyond are expected to be significant, although less pronounced. The priority in the 2006 budget, as it was in the budgets of the previous two years, has been investments in the energy sector and in human development (absorbing about 50 percent and 25 percent of investments respectively). The priorities are reasonable, given the comparatively low levels of services. However, the rapid pace of the increase in public spending has been responsible for the inflationary pressures building up by late 2006 and in early The concern is that these pressures may cause much higher rates of inflation in the medium term, because of lags in the effects of monetary policy and because inflationary expectations will be built into the economic agents decisions. To date, partially owing to de-dollarization (due to the issuance of the New Manat and the greater confidence in the currency), high rates of inflation have been avoided. The ability of Azerbaijan to control inflation in the short term will depend on the pace of the oil-financed public spending and the rate of nominal exchange rate appreciation which the Government will choose to maintain. The expenditure incidents in 2004 and in 2006 raise questions as to the effectiveness of existing budgetary institutions 11

20 to monitor economic developments and to pace public spending increases in a manner consistent with the absorptive capacity of the economy. The country s ability to ameliorate Dutch Disease also depends on the quality and type of public expenditures and the pace of the entire structural reform program: should public expenditures (and structural reform policies) succeed in raising productivity, to overcome the inevitable appreciation of the real effective exchange rate that comes from increases in aggregated demand which manifest themselves in resource rich economies, then Dutch Disease will be avoided or its impact mitigated. 26. The results of Azerbaijan s growth on poverty reduction have been impressive. Poverty dropped at unprecedented rates (see Table 2) from 2002 (the earliest comparable measures) to Results from the programmatic poverty assessment suggest that poverty dropped by 16 percentage points between 2003 and Table 2: Estimated Number of People Living in Poverty in Azerbaijan, (percent) Total Baku Non-Baku Urban Rural poor very poor poor very poor poor very poor poor very poor Sources: Household Budget Survey and staff estimates. 27. Oil revenue management has been transparent and efficient. Azerbaijan has been managing its oil wealth largely in line with the Long Term Oil Revenue Management Strategy (LTORMS), which states that the oil wealth will be managed to assure constant real spending from oil resources, although, during the early years, spending may be higher in order to establish the foundations for future growth (the LTORMS does not contain discrete expenditure targets). The Government s higher spending levels in the 2005 and 2006 budgets reflect the higher spending indicated in the LTORMS, although, again, the magnitude of the 2006 spending increases may not have been anticipated under the LTORMS. Azerbaijan s Oil Fund has been managed in a highly transparent manner and has received international recognition. The Oil Fund published quarterly reports on the internet ( and its annual financial statements have been audited by a reputable international auditor for 2003 (as part of the PRSC conditionality), and also of 2004 and Azerbaijan is also a leading proponent of the Extractive Industries Transparency Initiative (EITI), being the only country that has already published four EITI reports. The report Eye on EITI published by the NGOs Publish What You Pay and the Revenue Watch Institute showed that, out of the 21 countries endorsing EITI, Azerbaijan is one of only two countries that have taken the most essential EITI steps and have published fully audited and reconciled EITI reports. In Oslo, in October 2006, Azerbaijan became a board member of the multi-stakeholder board established to manage EITI at the international level and to oversee the future operation of EITI. The country s membership on the IAB Board of EITI bodes well for the future sustainability of sound Oil Fund management in Azerbaijan. Azerbaijan could 12

21 next move to establish similar quality in the transparency into the resource flows of SOCAR. 28. Improvements in budget management have been too slow, compared to the accelerated pace of public spending. On the budget management side, the Government made steady progress in 2004 and 2005: in 2004 it included the Oil Fund expenditures as part of the consolidated budget for 2004; in 2005, it submitted an indicative MTEF for the 2005 budget and prepared the PIP for as part of the PRSC conditionality, and also approved the Long Term Strategy for the Management of Oil and Gas Revenues. The Government also adopted a new budget classification system within the framework of GFS Manual and trained the Ministry of Finance staff in the budget formulation and execution. Government also adopted new regulations for the implementation of the Budget Systems Law in In subsequent years (2006 and 2007 budgets) the consolidated budget has been maintained, as has preparation a nominal MTEF, and a PIP, although the PIP lagged in timeliness. In 2006, Ministry of Economic Development took significant steps in restructuring the Ministry and adding a position of Deputy Minister for Macroeconomic Policy, and in strengthening the Ministry s Center for Economic Research. The new structure is aimed at strengthening capacity in macroeconomic management. Notwithstanding these important institutional changes, further steps are needed to improve the preparation of the MTEF, including preparation of the macro framework at the Government level (involving the Ministry of Finance, the Ministry of Economic Development, the Oil Fund, and the National Bank on an advisory basis) -- these have lagged thus far. In 2005, the Government prepared an early draft of the Budget Process Manual, and a draft Public Investment Manual was prepared in 2006; but the manuals need to be finalized during 2007, in preparation for the 2008 budget cycle and to include more advanced steps in program budgeting. 29. The Government has made moderate progress in financial management. Since the financial accountability framework required substantial strengthening to ensure transparency and improved governance, the Government embarked on a program to strengthen the auditing capacities in the Chamber of Accounts. It also adopted a legal framework for the introduction of public sector accounting based on international public sector accounting standards (IPSAS). Despite the recent advances, however, progress has been slower than anticipated in increasing the scope of activities of the Chamber. Procurement practices also need to be strengthened, despite the progess made with e- procurement to date. In the area of budget management, line ministries do not as yet participate fully in the MTEF process. Problems also remain with respect to reporting and expenditure control, which requires developing a strong internal audit function with the enforcement of implementation. Experience in other countries has shown that these reforms usually take time to implement. In Azerbaijan, there is a greater urgency than in most countries, as natural resource flows are expected to increase in the immediate future. Nevertheless, reforming institutions and training human resources cannot be easily leapfrogged. The impact of public spending on the welfare of the population is generally considered to be positive, although, at this stage, it is mostly due to the pro-cyclical nature of public spending, which is responsible for some of the jobs created, and to the targeted social assistance scheme, rather than to expenditures on health and education, where reform dialogue is picking up in early It must be noted, however, that 13