FOR OFFICIAL, USE ONLY

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL, USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED CREDIT IN THE AMOUNT OF SDR 3.5 MILLION (US$5.0 MILLION EQUIVALENT) TO SERBIA AND MONTENEGRO FOR A Report No: W MONTENEGRO PENSIONS SYSTEM ADMINISTRATION INVESTMENT PROJECT Human Development Sector Unit South East Europe Country Unit Europe and Central Asia Region May 12,2004 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization

2 CURRENCY EQUIVALENTS (Exchange Rate Effective April 30,2004) Currency Unit = Euro Euro 1.00 = US$1.194 USS = SDR 1.00 FISCAL YEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS CAS CFAA csw CTIS DPR ECA ERTP FRY GDP GOM HSIP IBRD IDA IFC IS IT LCR MOF MOLSA MOU NGO ODPM PAYGO PI0 PRSP PSAIP SAC SFD SAM SOE TA TAXIS TOR TPRA TPRC TSS TSU UNICEF USAID Country Assistance Strategy Country Financial Accountability Assessment Centers for Social Work Central Tax Information System Directorate of Public Revenues Europe and Central Asia Region Economic Reconstruction and Transition Program Federal Republic of Yugoslavia Gross Domestic Product Government of Montenegro Health System Improvement Project International Bank for Reconstruction and Development International Development Association International Finance Corporation Information Systems Information Technology Law on Consolidated Contribution Reporting and Control Ministry of Finance Ministry of Labor and Social Affairs Memorandum of Understanding Non-Governmental Organization Office of the Deputy Prime Minister for Financial Systems and Public Expenditures Pay-As-You-Go Pension and Disability Fund Poverty Reduction Strategy Paper Pensions System Administration Investment Project Structural Adjustment Credit Secretariat for Development Serbia and Montenegro Statement of Expenses Technical Assistance Tax Information System Terms of Reference Taxpayer s Revenue Accounts Component Taxpayer s Registration Component Transitional Support Strategy Technical Services Unit United Nations Children s Fund United States Agency for International Development Vice President: Country Director: Sector Manager: Task Team Leader: Shigeo Katsu Orsalia Kalantzopoulos Hermann von Gersdorff Arshad M. Sayed

3 FOR OFFICIAL, USE ONLY SERBIA AND MONTENEGRO Montenegro Pensions System Administration Investment Project CONTENTS A. Page STRATEGIC CONTEXT AND RATIONALE Country and sector issues Rationale for Bank involvement Higher level objectives to which the project contributes... 6 B. PROJECT DESCRIPTION Lending Instrument Project Development Objectives and Key Indicators Project Components Lessons learned and reflected in the project design Alternatives considered and reasons for rejection C. IMPLEMENTATION Partnership arrangements (if applicable) Institutional and implementation arrangements Monitoring and evaluation of outcomeshesults Sustainability Critical risks and possible controversial aspects Credit conditions and covenants D. APPRAISAL SUMMARY Economic and financial analyses Technical Fiduciary Social This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

4 5. Environment Safeguard policies Policy Exceptions and Readiness Annex 1: Country and Sector Background Annex 2: Major Related Projects Financed by the Bank and/or other Agencies Annex 3 : Results Framework and Monitoring Annex 4: Detailed Project Description Annex 5 : Project Costs Annex 6: Implementation Arrangements Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Annex 9: Economic and Financial Analysis Annex 10: Safeguard Policy Issues Annex 12: Documents in the Project File Annex 13: Statement of Loans and Credits Annex 14: Country at a Glance Map: IBRD 31506R1

5 SERBIA AND MONTENEGRO MONTENEGRO PENSIONS SYSTEM ADMINISTRATION INVESTMENT PROJECT PROJECT APPRAISAL DOCUMENT EUROPE AND CENTRAL ASIA ECSHD Date: May 12,2004 Country Director: Orsalia Kalantzopoulos Sector Manager: Hermann A. von Gersdorff Project ID: PO87470 Lending Instrument: Specific Investment Loan Team Leader: Arshad M. Sayed Sectors: Compulsory pension and unemployment insurance (95%); Non-compulsory pensions, insurance and contractual savings (5%) Themes: Social risk mitigation (P); Tax policy and administration (S); Administrative and civil service reform ((S) Environmental screening category: Not Required Safeguard screening category: Not Required [ ] Loan [XI Credit [ ] Grant [ ] Guarantee [ ] Other: For LoansICreditslOthers: Total Bank financing (US$m.): US$5.0 million Proposed terms: Standard Credit Modified Terms: 20 years to maturity, inclusive of 10 years grace period, with no acceleration clause. Borrower: Government of Serbia and Montenegro Implementing Agencies: Ministry of Finance Stanka Dragojevica Podgorica Republic of Montenegro Ministry of Labor and Social Affairs Cetinjski put bb, PC Vektra Podgorica Republic of Montenegro Directorate of Public Revenues Put Radomira Ivanovica street 2, put prema Tuzima Podgorica Republic of Montenegro Pension and Disability Fund

6 Jola Piletica Podgorica Republic of Montenegro Proiect Coordinator: Office of the Deputy Prime Minister for Financial Systems and Public Expenditures Government Building Jovana Tomasevica BB Podgorica Republic of Montenegro Serbia and Montenegro Contact: Ivan Bojanovic (same address as above) Telephone: (381-81) , (381-81) Fax: (381-81) I Project implementation period: Start: October 1,2004 End: March 31,2008 Expected effectiveness date: September 30,2004 Expected closing date: September 30,2008 Does the project depart fiom the CAS in content or other significant respects? Re$ PAD A.3 Does the project require any exceptions from Bank policies? Re$ PAD 0.7 Have these been approved by Bank management? NIA Is approval for any policy exception sought from the Board? NIA Does the project include any critical risks rated substantial or high? Re$ PAD C.5 [ ]Yes [XINO [ ]Yes [XINO [ ]Yes [ IN0 [ ]Yes [ IN0 [XIYes []No Does the project meet the Regional criteria for readiness for implementation? Re$ PAD D. 7 Project development obiective Re$ PAD B.2, Technical Annex 3 [XIYes [ ]No The project development objectives are to improve the financial sustainability, effectiveness, and efficiency of the pension system through: a. Developing a unified contribution collection and reporting system and establishing central registries that are based on modem information technology and processes. b. Modernization and restructuring, as needed, of the organization, processes, and technology in the key institutions of the Pension system: the DPR and Fund PIO. c. Developing capacity for better policy analysis and evaluation of the pension system and improving readiness for future pension reforms. Proiect description Re$ PAD B.3.a, Technical Annex 4 1. Increase Tax and Contribution Compliance (US$3.5 million of which $2.8million is IDA-financed)

7 This component will serve to improve compliance by strengthening the DPR capacity to: (i) assume the role of social contribution collection in addition to income tax collection; and (ii) take on the role of integrated data collection for income tax and social contributions, in the agreed time period. 2. Restructure and modernize the Fund PI0 (US$2.0 million of which $1.5 million is IDA-financed) This component is aimed at modernizing the fund PI0 to: (i) improve services to clients, both contributors and beneficiaries; and (ii) focus the Fund PI0 on it s core capabilities and processes. 3. Develop and Strengthen Capacity for Pension Policy (US%0.60 million of which US%0.5 million is IDA financed) This component is designed to address capacity constraints in designing pension policy, supervision of private pension finds, and developing a public education campaign. 4. Project Coordination (US%0.3 million of which US$O.Zmillion is IDA financed) This component would support the coordination of project activities and would involve the hiring of a local consultant to serve as a Project Coordinator who will be supervised by the Office of the Deputy Prime Minister for Financial Systems and Public Expenditures (ODPM). As the need arises, an Administrative Assistant may also be hired to assist the Project Coordinator. The beneficiary agencies (Le. the DPR for Component 1, the PI0 for Component 2 and the MOLSA and MOF for Component 3) would be responsible for the implementation of the project and for providing substantive input. Which safeguard policies are triggered, if any? Re$ PAD 0.6, Technical Annex 10 Environmental Assessment (OP/BP/GP 4.0 l), Category C Significant, non-standard conditions, if any, for: Re$ PAD C. 7 Board presentation: None Credit effectiveness: 1. The Development Credit Agreement (DCA) has been executed and ratified, and a satisfactory legal opinion has been presented by SAM to IDA, confirming the validity and binding nature of the DCA The Sub-credit Agreement, satisfactory to IDA, has been executed by SAM and the Republic of Montenegro, and satisfactory legal opinions have been provided by SAM and the Republic of Montenegro that the Sub-credit Agreement is valid and legally binding upon the parties. IDA shall have received satisfactory evidence that the Fund PI0 budget for the year 2004 is balanced. Covenants applicable to proiect implementation: Project Coordination, Implementation and Management 0 The Borrower shall ensure that the Republic of Montenegro provides adequate resources and staffing required for Project Implementation and Coordination, including a Project Coordinator and Focal Points within the Implementation Agencies, during the term of the Project, satisfactory to IDA.

8

9 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues (a) Introduction The Federal Republic of Yugoslavia (FRY) -- now the union State of Serbia and Montenegro (SAM) succeeded to the membership of the former Socialist Federal Republic of Yugoslavia in the World Bank in May Initial Bank Group support to SAM was provided in two stages: first, a pre-membership phase funded through a US$30 million Trust Fund for FRY. The second phase, outlined in a Transitional Support Strategy (TSS - Report YU, June 26, 2001), provided a three year program of support for the Economic Reconstruction and Transition Program (ERTP), to be financed with a US$540 million temporary and exceptional IDA envelope. A TSS Update (Report YU, July 18,2002), described progress in the first year of implementation (FY02) and laid out plans for the FY03 program. A further TSS Update for FY04, presented to the Board on March 16, 2004, describes progress during FY03, including FRY S constitutional transition to Serbia and Montenegro, and provides the strategic framework for the final year (FY04) of the three year Bank Group assistance program. A full three year participatory CAS covering FY05-07 will be developed jointly with the IFC and presented to the Board for consideration in late (b) Political and Socioeconomic Context Political Outlook. The past eighteen months have seen the introduction of the new constitutional union State of Serbia and Montenegro in February The new union is now fully established and functioning. Both Serbian and Montenegrin leaders have placed high priority on seeking early accession to the European Union. Montenegro s ruling coalition garnered a strong majority in the 2002 republican elections. The economic reform program has been somewhat hesitant, although positive progress continues to be made. Economic Developments. SAM s leadership is still grappling with the legacy of a decade of adverse external and internal factors. The centralization of political power at the federal level during the 1990s weakened economic institutions, exacerbated poor public accountability, and led to more government intervention in markets (e.g., with price and exchange controls). The effects of poor economic management were compounded by international sanctions ( and ) which severely inhibited trade and investment in the country. By 2000, recorded per capita GDP had fallen to about one half of its 1989 level. Foreign trade volumes also declined sharply while inflation (including hyperinflation in 1993) was chronic. SAM had accumulated large domestic and external debt. The external debt was around 13 1 percent of GDP in 2000 (figures exclude Kosovo). Although cash deficits of the consolidated government were kept low, this was achieved largely through unsustainable expenditure compression, the accumulation of budgetary arrears, non-servicing of public debt, and the toleration of quasi-fiscal deficits. The real sector became largely inefficient due to the lack of market-oriented ownership structures, the loss of markets, lack of access to working capital, delayed investment and maintenance, and repressive and complicated taxation and regulation. This resulted in a decrease in real earnings, with absolute poverty roughly doubling since 1990, 1

10 and a deterioration in social protection and health services, as available financing fell below existing entitlement levels. Progress in stabilizing the macroeconomic situation and structural reform has remained positive. However, implementation remains the key challenge. Montenegro s consolidated fiscal deficit was cut from about 8 percent of republican GDP in 2000 to 5.3 percent in The renewal of transfers to cover federal union expenditures has placed new pressure on fiscal accounts in Excluding this transfer, the underlying fiscal deficit for 2003 is expected to decrease further to about 3 percent of GDP. Montenegro enacted a new law on pension and disability insurance, a new labor law to increase the flexibility of the labor market, and a number of reforms focused on creating a more favorable business environment. In Montenegro s financial sector, priority areas of focus include: completing the restructuring and privatization of the remaining state bank; resolving bad assets carved-out of privatized banks; and withdrawing Government deposits from the commercial banks. Despite four years of growth, living standards remain low relative to historical standards and popular expectations. In 2003, recorded GDP was less than 60 percent of its 1990 level. Absolute poverty remains a problem in both republics. In Montenegro, most estimates indicate that GDP growth has been modest at less than 2 percent per annum since 2000, while the official unemployment rate has remained high at over 20 percent (among the highest in the region). Not only is open unemployment a problem, households without working members make up one quarter of ail poor, but a large share of the working age population are also inactive or occupying themselves with low productivity andlor occasional work. From an economy-wide perspective, this represents output foregone and income lost. Moreover, the important goal of sharing the benefits of growth more equitably among groups and regions proves increasingly elusive when many citizens are trapped in long-term unemployment. A sustainable supply response does not yet appear to have taken root. Given these conditions, a viable social security system can play an important role in smoothing these volatilities for the vulnerable. However, both the policy and administrative environment for developing a robust and viable social security system have been in disarray and carry a heavy legacy of the socialist systems. The Bank s recent Poverty Assessment found that by mid-2002, material poverty affected every tenth person in both Serbia and Montenegro (defined as population with consumption below the country-specific absolute poverty line). The report found that poorly educated individuals make up the majority of SAM s poor and have the highest poverty risk. Those with elementary education constitute about two-thirds of all poor and are twice as likely to be poor as secondary school graduates. Lower education attainment is the key background factor explaining the higher incidence of poverty of some vulnerable groups, such as rural or jobless households. The report also found that jobless households (i.e., families with working-age members in which no one works) have more than twice the average poverty incidence, but households with gainfully employed members make up 75 percent of the poor. 2

11 (c) Sector Issues The government s strategy in the area of pension administration is to have a more effective and efficient pension system through changes in legislation, regulation, management practices, operational procedures and better use of information technology. This strategy is aimed at: 0 Stabilizing the pension system through policy reforms and administrative strengthening; 0 Improving the collection of social insurance contributions, taking better advantage of scale economies supported by effective IT solutions; and 0 Creating data linkages to monitor and evaluate operations and outcomes across social programs. The current situation, which motivates this strategy is described below. Within the sector, there are serious economic and political constraints to reform including the fragile situation of the public finances, large competing expenditure needs, lack of developed financial markets and regulation, and the need to provide minimum protection to pensioners who may not live to enjoy the eventual benefits from the transition but still expect the government to honor their social contract. Nonetheless, efforts to embark on systemic reform have gained new urgency as it becomes even more obvious that fiscal sustainability of the pension system is at best, precarious. The pension system is under severe fiscal stress, due, in the short run, to an ineffective administrative system, characterized by a loose and fragmented collection and compliance system, and economic and demographic factors that affect its sustainability over the medium term. An aging population and the erosion of the contribution base triggered by economic stagnation and a growing shadow economy, have contributed to a decline in the system dependency ratio to 1.3 workers per pensioner. The age dependency ratio (the ratio of the over- 65 year old population to the year old population) grew to exceed 20 percent. Both indicators are similar to those found in neighboring countries. However, with a replacement rate of 69 percent, a low retirement age of 55 for women and 60 for men, wage indexation of benefits, loose standards for disability eligibility, and overly generous benefits, the pension system became unsustainable. By 2002, pension expenditure reached 13 percent of GDP. Pension contributions and Budget transfers to the Pension Fund (PIO) were insufficient and the pension deficit reached 3.9 percent of GDP in The administrative and institutional arrangements for managing the pension system remain weak, with a host of issues that need to be urgently dealt with, including; (i) fragmented collection and reporting systems, with several agencies doing the same functions; (ii) weak collection and compliance processes and procedures; (iii) a lack of accurate data and weak data management systems; (iv) very little coordination between the key agencies involved, including the Health Fund, Pension Fund (PIO), Directorate for Public Revenues (DPR), and Ministry of Labor and Social Affairs (MOLSA); and (v) lack of capacity to assess and analyze data, and Please see Annex 1 for a more detailed discussion on the pension deficits. The pension contribution rate is 24 of gross salaries, split equally between employees and employers. 3

12 draw policy implications. Underlying these issues, is the politics of the reform process - a shift in power between agencies, a downsizing/increasing of importance of certain posts and positions, and the related unwillingness to share informatioddata among the different agencies. The PIO s databases are outdated, lack proper integration and contain many errors. Recent analysis has shown that 71 percent of employer records are missing their Tax (FIN) number as the primary key, 13 percent of employee records are missing their JMB number (a code to register people) and over 30 percent of self-employed records are missing their JMB number. There are almost 30,000 cases where no return of work and contribution data has been made since Almost 50 percent of these cases are 10 years old. The number of noncompliant cases is rising since 1999, and 5,000 (M4)3 cases remained outstanding during It is possible to set up a pension payment record for a person who does not have a contribution record - as the contribution record database does not interface with the payments processing database. This is a serious control weakness and highlights the general lack of adequate controls - both electronic and manual - in the current system. To address these issues, a new law on pension and disability insurance was introduced in September This law adjusts key parameters of the pay-as-you-go (PAYGO) pension system to better align entitlements to available resources, announces the introduction of the funded pension pillars, outlines administrative reform and a time table for shifting responsibilities among key agencies involved in collection and compliance. These reforms have improved the near-term fiscal balance and provide the possibility for introduction of a multipillar system in the future. These changes (effective in January 2004) included: (i) increased retirement age by five years for men and women (65 and 60 respectively) over a ten-year period; (ii) widened calculation period from ten best years to full career over a 15 year period; (iii) changed indexation pattern from wage to a combination of wages and prices; (iv) introduction of a point formula and lowered accrual rates from more than two percent to one percent per year of service; (v) tightened disability conditions; and (vi) elimination of most social-related benefits, such as rehabilitation and recreation, etc. These changes should lower the pension deficit to less than one percent of GDP in 2006 and are likely to eliminate the pension deficit by 2O0ga4 The declining path of pension to GDP ratio will eventually create the fiscal space for the next round of reform in which the financial management procedures of the pension system will be strengthened and funded pillars possibly introduced. Summary data on contributors wagehalary, employment and social insurance contributions are transmitted to the PI0 annually. This information on the M4 form, must be submitted to the PI0 by 30 April for the prior calendar year, Employers send their M4 forms to the PI0-99 percent are paper based. It is to be noted that these projections assume transfers from the budget to the Fund PI0 equal to 1.8 percent of GDP. The budget is required to finance pensions for war veterans and the police. In addition, the budget is obligated to finance the gap between the calculated pension and the minimum pension. These projections also do not take into account more recent changes being contemplated, including a reduction of contributions from employers from the current 12 percent to 7.2 percent which are likely to push further the path of declining deficits, unless offsetting measures are proposed. 4

13 The Pension Insurance Law and other recently enacted legislation on tax and social contribution collection also envisage a full transfer of collection and control responsibility to the Agency for Public Revenues (DPR) in 2005 and full transfer of reporting procedures and requirements to the DPR in However, these statutory changes address only the policy environment and leave unattended the needed complementary administrative and institutional capacity which are critical to the implementation of the reforms. These capacity constraints, especially in skills for stricter compliance and collections, processing, policy analysis, and the required investments in software and hardware for better data management, registration, and payment processing, both of which are critical to improved efficiency and effectiveness of the system are likely to jeopardize the gains achieved through improvement of the policy environment. The importance of these administrative reforms is critical, in the short run, both on the potential for increased contributions and in tightening illegitimate payments. Some estimates put the level of evasion at 50 percent for the total prospective population of contrib~tors.~ On the payments side, according to one survey, 52 percent of disability pensioners were below 50 years of age, and in 3 1 percent of disability pensions, fiaud may be possible.6 The extent of arrears in 2002, just for the central budget, stood at 37 percent of contributions. Arrears on receivables from other contributors needs to be fully determined. This makes it is impossible to accurately reconcile contributor records with taxpayer records in the DPR. Such reconciliation is required in the fbture, when DPR will take over responsibility for contribution collection and compliance. These problems can be resolved by a unijied PIO/DPR registration and collection system. These weaknesses in the pension system, coupled with an unlikely steep decline in the deficit as has been projected under the parametric reforms (due to any of the assumptions underlying the projections, not holding true) would mean that administrative tightening would provide a strong lever in the short run, both for increasing contributions and preventing hemorrhaging on the payments side. 2. Rationale for Bank involvement In order to ensure that the government has the capacity and the needed investment in place for proper implementation of the legislative framework, a Pensions System Administration Investment Project (PSAIP) had been requested by the Government, through the Minister of Finance, in a letter to the Bank dated November 10,2003. Preparatory work for these reforms has been built up through the Structural Adjustment Credit (SAC) missions and policy measures set out under SAC I and the proposed SAC 11. The project Report by PriceWaterhouseCoopers, August 2 1, Survey on revenues and households no. 6 ISSP Summary data on contributors wagekalary, employment and social insurance contributions are transmitted to the PI0 annually. This information on the M4 form, must be submitted to the PI0 by 30 April for the prior calendar year. Employers send their M4 forms to the PI0-99 percent are paper based. 5

14 will also benefit from the extensive diagnostic work USAID has done in this sector. However, USAID, the largest donor in Montenegro, sees a complementary and supportive role for the Bank as it begins to wind down its efforts and withdraw its involvement in this sector in Given this situation, there appears to be a window of opportunity to: 0 build on the improved policy environment and strengthen the reforms under the Bank s SAC I1 through needed investments at the institutional level; 0 seize a window of opportunity in the sector where government readiness appears to have crystallized around the need for improved administrative capacity and modernization of the pension system; and 0 ensure that the hard-won reforms at the policy level are not derailed due to lack of support in implementation of the reforms. 3. Higher level objectives to which the project contributes The project supports implementation of the new law and reform of the pension and tax administrative system being undertaken by the government. These reforms are intended to: 0 Improve revenue performance of all social contributions and personal income tax; 0 Improve service to pensioners and taxpayers; 0 Reduce the administrative burden for businesses and individuals; 0 Reduce compliance costs for taxpayers and pensioners; and 0 Increase transparency and integrity in administration of the pension and tax system. These efforts would, in the long run, lead to the financial sustainability of the system - a key goal of the pension reforms undertaken by the government. B. PROJECT DESCRIPTION 1. Lending Instrument The project will be a Specific Investment Loan, of US$5 million equivalent. A sector investment operation has been judged the best approach to provide the necessary technical assistance and investment needed for modernization of the system. While there is extensive technical assistance (TA), training, and capacity building to develop the systems and staff, the bulk of the costs will be for information technology - both hardware, software and subsystems. So far, no cofinancing arrangements have been identified, but once capacity is in place for second or third pillar reforms, donor support will be actively sought. 2. Project Development Objectives and Key Indicators The project development objectives are to improve the financial sustainability, effectiveness, and efficiency of the pension system through: a. Developing a unified contribution collection and reporting system and establishing central registries that are based on modern information technology and processes. 6

15 b. Modemization and restructuring, as needed, of the organization, processes, and technology in the key institutions of the Pension system: the DPR and Fund PIO. c. Developing capacity for better policy design and analysis of the pension system and improving readiness for future pension reforms. The key performance indicators would include: 0 Modernization and restructuring implementation plans prepared and implemented in DPR and Fund PIO, with milestones to measure progress. 0 Compliance improved as measured by revenue/(average wage* employment).8 Effectiveness of administration improved, measured by stock of arrearshevenues, 0 Efficiency of administration improved, comparing Montenegro costshevenues to similar sized republics average costs/revenues in neighboring countries. 0 Client services improved, measured by increases in numbers of enquiries received and answered. 0 Lowering of the burden for employers as measured by fewer requirements and forms for processing. 3. Project Components Given the government s strategy in this sector as mentioned under A. 1 (c) above, implementation of recently enacted legislation and policies to improve the pension system will require investments and capacity to be built in the following three areas: (i) tax and contribution collection and information management; (ii) Fund PI0 modemization; and (iii) strengthening capacity for policy analysis and developing a public education and outreach program. The proposed project will provide financing for hardware and software, study tours, foreign and local training, expert advisory services, public education materials, and incremental recurrent costs. The estimated total cost of the project is US$6.5 million. The project aims to benefit from existing work done by USAID. This includes both diagnostic assessments and in the case of the Directorate of Public Revenues (DPR), investments for the first stage of the modemization process. As such, the project draws heavily on the analysis of USAID and builds on the current infrastructure for reform already put in place, especially technology investments in the DPR. The project will be implemented over a period of four years and will consist of the following components and activities: * Employment to be measured by labor force survey; wages are those reported by statistical office. Any changes in payroll tax rates to be normalized in computation; that is changes in payroll taxes alone do not change compliance. 7

16 Component 1. Increase Tax and Contribution Compliance (US$3.5 million of which US$2.8million is IDA-financed). This component will serve to improve compliance by strengthening the DPR capacity to: (i) assume the role of social contribution collections in addition to income tax collection; and (ii) take on the role of integrated data collection for income tax and social contributions, in the agreed time period. Key activities under this component include: Consolidation of contribution collection, control and enforcement functions in DPR. Creation of central registries on tax and contribution payers including central registration of new companies, self employed and fanners, with data dissemination to all involved institutions. Establishment of expanded DPR organizational structure that would perform additional business processes to eliminate the duplicative functions of other agencies. Development of a baseline for benchmarking of progress and measuring of results throughout the life of the project Component 2. Restructure and Modernize the Fund PI0 (US$2.0 million of which US$1.5 million is IDA-financed) This component is aimed at modernizing the fund PI0 to: (i) improve services to clients, both contributors and beneficiaries; and (ii) focus the Fund PI0 on its core capabilities and processes. Key activities under this component include: Reviewing the core functions of the Fund PI0 in light of the new law and establishing core processes and procedures that underlie these functions. Eliminating duplicative functions and streamlining the processes to improve services to pensioners. Investment in equipment, both hardware and software to modernize core functions of the PI0 of statistical and policy analysis, processing of claims, awarding of benefits, appeal processing, and better servicing its clients. Delivering training programs, technical assistance, to support the new role of the PIO. Component 3. Develop and Strengthen Capacity for Pension Policy (US$0.6 million of which US$0.5 million is IDA-financed) This component is designed to address capacity constraints in designing pension policy, supervision of private pension funds, and developing a public education campaign. The subcomponents include: 0 Developing capacity for policy analysis and supervision. This sub-component would include provision of training, equipment, technical assistance and staffing, in: (a) creating capacity and analytical tools such as a pension model to analyze and forecast pension policy 8

17 in the Ministry of Labor and Social Affairs (MOLSA),9 and (b) preparing the groundwork for capacity building for supervision of pension funds by the Ministry of Finance (MOF), and for third pillar reforms, over time." 0 Public education campaign. Key activities under this sub-component would include a phased education campaign aimed, with due sensitivity to the messages and their timing, to promote the goals of the pension reform, and explain the need for the changes. This campaign would be staged over the life of the project and would include, at a later stage, building public support for a three pillar reform and widen public awareness for the need to voluntarily save for retirement. Component 4. Project Coordination (US$0.3 million of which US$0.2million is IDAfinanced) This component would support the coordination of project activities and would involve the hiring of a local consultant to serve as a Project Coordinator who will be supervised by the Office of the Deputy Prime Minister for Financial Systems and Public Expenditures (ODPM). As the need arises, an Administrative Assistant may also be hired to assist the Project Coordinator. The beneficiary agencies (Le. the DPR for Component 1, the PI0 for Component 2, and the MOLSA and MOF for Component 3) would be responsible for the implementation of the project and for providing substantive input. To facilitate the implementation and monitoring of the project by the implementing agencies, focal points would be drawn from each of the named agencies, and will be appointed as members of an expert working group. They will work with the Project Coordinator and the central Technical Services Unit (TSU) under the Office of the Prime Minister which is responsible for providing core procurement and financial management services for this project and all other Bank-financed projects. The costs of the TSU are being financed under the Health System Improvement Project (HSIP). 4. Lessons learned and reflected in the project design The implementation of pension reform and administration projects in the Europe and Central Asia region has shown that success depends on: (i) support from the authorities at the highest level in the implementing agencies; (ii) the willingness to accept technical assistance; (iii) clear linkages between policy reforms and the investment in information systems; (iv) the development of appropriate technology; (v) the development of information architecture prior to the purchase of hardware; (vi) the development of a committed and well-trained Project Implementation Unit (PIU) to implement the project; (vii) adequate training of staff to use the new procedures; and (viii) coordinated policy objectives across Government and the agencies involved in the project. And as evidenced throughout the region, successful pension reform depends on successful administrative reform. There is a serious shortage of qualified staff in the Ministry. In addition to investment needs of the Department, the project would also finance consultants. lo The current Insurance Supervision in the Ministry of Finance consists of a staff of three and is in great need of training, education and equipment. 9

18 In designing the PSAIP, to build commitment and ensure high level support, the team has worked with the government to establish a Steering Committee with the Deputy Prime Minister for Financial Systems and Public Expenditures as its Chair, described as follows: 0 The working group would meet at least once a month to monitor progress and resolve contentious issues. 0 The working group includes the Ministers of Labor, Finance, and all of the Directors of the relevant agencies, such as Health, Unemployment Bureau, and Fund-PIO. 0 The working group has nominated an expert team drawn from the relevant agencies to assist in the implementation of the project. The project s support for consolidated revenue collection and reporting reflects lessons learned and good practice reforms being implemented in South Eastern Europe, and Central and Eastern Europe. The move towards consolidated revenue collection and reporting is supported by both the Bank and IMF as increasing efficiency, accountability and transparency in the revenue system. Examples of Bank-supported efforts in this direction are Bulgaria, Slovakia, and Croatia. However, there is mixed experience as we look specifically at collection, record-keeping and transferring contributions to individual accounts. This is due to a variety of reasons. Contribution rates, including levies on employer and employee, frequently exceed a quarter of gross wages in many countries. Moreover, high contribution rates, coupled with weak links between contributions paid and benefits received, can result in poor incentives to comply or even for people to take jobs or firms to hire them. With contribution rates on average with neighboring countries and benefits more than generous, this particular aspect does not appear to be an issue in Montenegro. On the other hand, complying with contribution requirements can impose a large administrative burden on employers, which appears to be the case in Montenegro. Poor rates of collections can also result from institutional weaknesses in collection systems. For example, employees of collection agencies are poorly paid. This can result in recruitment and retention problems, poor qualifications and motivation. It also increases the potential for corruption. This is very much a live issue in Montenegro. As such, a major focus oftheproject is on institutional strengthening. Other common problems identified are that often more than one agency collects levies on earnings, with social security, personal income taxation, and health insurance administered separately. Different agencies often fail to share information, and duplication adds to public sector s administrative costs and to employers compliance costs. Some countries lack a unique system of identification numbers for workers and fail to take full advantage of information technology, These issues become even more acute for countries with limited capacity and a paucity of trained officials. The above issues are predominant in Montenegro. Given such a situation, care is being taken to address these issues by: (i) approaching the process in a cross-cutting manner, by involving all of the key stakeholders in the reform process; (ii) giving due attention to the political economy and incentives for change, by creating champions, developing a coalition, and explicitly recognizing issues that would need to be dealt with for those who will lose from the reforms; (iii) creating a shared platform with other donors, 10

19 such as USAID, for pushing the reforms forward; and (iv) creating awareness of the reforms in the public and media through a public information campaign. 5. Alternatives considered and reasons for rejection (a) Centralized versus Decentralized Collection. Under a decentralized system, collection is the responsibility of each agency or pension fund, eliminating the intermediate clearing house. However, for Montenegro, the consideration ought to be based on the relative size of its population (roughly 650,000), scarce institutional capacity, processes for control and management, and efficiency, security and costs of both running the system and the indirect cost of compliance borne by employers. The case for a centralized scheme in a pay-as-you go system, as it exists in Montenegro, is clear. This choice is based on the following key factors: l1 Control mechanisms - regular reporting and auditing of contribution records, which is necessary, can best be managed centrally, especially given the lack of technical skills and good data and information systems. Cross controls - Centralizing collection allows for cross-checks of pensions with other information, such as health insurance and personal income taxation. A single agency, responsible for collection, can develop a single reporting system. With separate agencies, there are many pitfalls in sharing of information, as is currently the case in Montenegro. Cost of collecting - This is likely to be cheaper in a centralized system because of the economies of scale, given that it is possible to centralize the collection of pension contributions with other social security contributions and taxes. A centralized system of collection also simplifies the payment processes. Corruption - Centralized collection can reduce the risk of corruption since the central set of information is shared by a number of actors in the pension system. The risk of corruption can be reduced further when centralized collection is simply a set of information signals between financial institutions and the recipient of revenues. The role of the collecting agency is then merely as guarantor of the process. This also avoids the spurious use of funds by the state. One go unification versus phasing-in of agencies, beginning with the Pension Fund. In considering whether it would be more prudent to unify contributions first with just the Pension Fund and then with the Health Fund and other agencies, a key factor is the momentum for reforms and the duplication of efforts that will continue while the other agencies maintain their current systems and processes. (c) Project Not Financed. The most obvious alternative to the project would be not to finance a project at all. The justification for this alternative would be the incomplete progress in Drawn from collecting and transferring pension contributions Rafael Rofinan, and Gustavo Demarco, 1999, 11

20 the area of policy reform. However, the new laws require, irrespective of whether the current system is continued or a new one instituted, the collection of earnings records within DPR instead of the Fund PIO. This collection would be impossible without a new information system. And given that the USAID is pulling out altogether from this sector, it makes it very difficult to find new donors who would step in at this stage, (d) Letting the parametric reforms take their course to improve the system without any administrative strengthening. To illustrate the need in one area of administrative improvement: Client data are provided to the Fund PI0 at the end of the year and not on current basis. Under current procedures, each employer provides aggregate data on its wage bill and information on total numbers of employees to document contributions for pension and employment programs. This system worked for a planned economy. But as contributions are now likely to be paid by multiple employers for any one individual, data losses will be multiplied. Individual records are required. With or without pension reform, individual client records need to be reported on a current basis for the PAYGO system, if future entitlements are to be correct. When pension reform starts without an adequate administrative structure, it is inevitably less effective as some contributions are misdirected (Kazakhstan) or are never made (Poland). C. IMPLEMENTATION 1. Partnership arrangements (if applicable) The project is building on and using the extensive analytical work done by USAID in this sector. Beyond that, no partnerships are envisaged currently, though during implementation of the project, other partners will be actively sought. 2. Institutional and implementation arrangements Beneficiary agencies (Le. the DPR for Component 1, the PI0 for Component 2, and the MOLSA and MOF for Component 3) will manage, implement and monitor the implementation of their respective components. Project coordination and support will be conducted through the ODPM, who will hire a local consultant to serve as a Project Coordinator. If needed at a later stage, an Administrative Assistant will also be hired. To ensure smooth implementation of the Project, a high-level Steering Committee has been established by Government Resolution and made responsible for strategic decisions on project implementation, coordination and monitoring. The Steering Committee is chaired by the Deputy Prime Minister for Financial Systems and Public Expenditures and is composed of the Minister of Finance, the Minister of Labor and Social Affairs, Heads of the DPR and PI0 and other agencies involved in the Project (Health Fund, Unemployment Fund, Statistics Agency, and Secretariat for Development), plus the Head of the TSU. The Steering Committee will meet regularly at least on a monthly basis, or more frequently as the need arises. To facilitate the implementation and monitoring of the project by the implementing agencies, focal points would be drawn from each of the named agencies, and will be appointed as members of an expert working group. 12

21 The central TSU, recently established by the GOM in the General Secretariat (Prime Minister s Department), will be responsible for carrying out core procurement and financial management functions for all fkture Bank-financed projects, and potentially for other donor-supported projects. This TSU has been established with Terms of References (TORS) that define clear boundaries of responsibility between the line Ministries and the TSU, giving the respective line Ministries clear overall responsibility and decision-making authority, and making the TSU accountable to line Ministries for providing prompt, professional services. The costs of operating the TSU are being financed under the Health System Improvement Project (HSIP). The TSU has prepared an operational manual for the TSU, covering financial management and procurement arrangements, and relationships with line Ministries. The Operations Manual for the TSU is generic, covering core arrangements for all future Bank projects which will be served by the TSU. A project-specific annex or operational manual for PSAIP (POM) has been prepared by the Project Coordinator in collaboration with the Implementing Agencies and submitted to IDA for review. The PSAIP POM will ensure that it is consistent with the guidelines and procedures under the TSU operational manual. The TSU has employed a full time procurement officer and accountant. The head of the TSU will be a part-time role for the first year, taken by a senior staff member of the Department of the Deputy Prime Minister. 3. Monitoring and evaluation of outcomes/results The Implementing Agencies will be responsible for monitoring and evaluation. Proposed monitoring indicators are listed in Annex 3 below. The Project Coordinator will work with the expert working group to coordinate the monitoring and evaluation process. 4. Sustainability The Government has already launched the parametric reforms to its PAYGO system. It has also passed a new law on pension and disability insurance in September Under this law, new collection and control responsibilities are envisaged. These cannot be undertaken without the requisite restructuring and investments which the project supports. This cross-coordination is at the core of the project s success. Previous attempts by other donors did not yield results as the dialogue and process for reform proceeded in silos, i.e. within the different agencies, without an attempt to link their efforts or develop cross agency relationships so crucial to sharing of information and getting agreement for implementation. For the first time, all of the key agencies, i.e. the Health Fund, the Unemployment Bureau, DPR, Fund PIO, and other agencies have agreed to an implementation plan. This implementation plan is supported both at the senior management levels, i.e. Directors and the respective Ministers as well as at the working level, by an expert group, again drawn from the relevant agencies. Moreover, the project is being shepherded by the Office of the Deputy Prime Minister in charge of Financial Systems and Public Expenditure. This office is responsible for coordinating the functioning of these agencies as well. 13

22 5. Critical risks and possible controversial aspects Fiscal developments and risks. At the beginning of March 2004, the Government of Montenegro announced its intention to cut contribution and personal income tax rates, effective from May 2004, and fwther cuts in early Such cuts, unless accompanied by countermeasures would in all likelihood increase the budget deficit in 2004 and beyond. Without fiscal countermeasures or withdrawal of the rate reduction package, the fiscal risk to the PSAIP as well as for other Bank operations would be high and increasing, imposing a significant obstacle in the development of a proper policy environment in which the administrative reforms can make a difference. Legislative activities and risks. Development of the central registries with a central registration system, new centralized collection of tax and contribution data, single payment order, and other elements of the new data collection and control system have been indicated in the recently adopted Action Plan of the Working Group. Certain elements of the Action Plan are scattered over other legislations. For example, the laws on tax procedures have already assigned the sole responsibility for control and enforcement to the DPR, while the Pension Insurance Law envisages that DPR will assume pension contribution collection from 2005 and report M 4 data to the PI0 from The DPR's future role is not synchronized over the mentioned legislations and requires a new and separate law that would clearly specify and regulate the DPR's roles and responsibilities as well as those of other institutions, and the central registries and more frequent monthly OPD3 reporting. With the adoption of the Action Plan by the Government, and outlining within the plan the GovernmentS intention to develop and pass such a law, this risk appears to have been minimized. Passage of this law is also part of the reforms being proposed under SAC2. In case the Government fails to draft and pass such a law, these issues might still be regulated in the tax laws. However, the central registry and reporting issues would ultimately have to be regulated by a separate law. If these remain unregulated, these could cause considerable delay in project implementation and/or prevent the achievement of development objectives in component 1. The other risks that may prevent the project development objectives from being met appear to be political and institutional. Cooperation across the agencies, especially Fund PI0 and DPR, continues to be an issue. Capacity within the government agencies to implement the reforms remains weak. To ensure that the different agencies begin to see the overall process and their respective roles, the Bank organized a multi-donor workshop that brought all principal actors in the pension reform process together in February Based on the outcomes of the workshop, two sets of cross agency relationships for implementation have been established - one at the Ministerial level and the other at a more day-to-day working level. 14

23 ~~ To support government capacity during the initial phase of the reform, preliminary diagnosis and evaluation of system requirements are being jointly prepared, with the help of other donors (such as USAID) who have a long relationship in Montenegro. A key step in managing risks in implementation would be to leverage the existing work and relationships of other donors. Risks ~~ To project development objective The Government makes statutory changes that affect the parametric reforms Cooperation between the agencies for unified collection is not forthcoming To Component results (i) DPR is unable to gain credibility and develop capacity to undertake social contributions and compliance in addition to revenue collections (ii) Fund PI0 fails to restructure due to political pressures (iii) Capacity in Ministries of Labor and Finance for policy analysis is not sustained Risk Mitigation Measures 0 Use policy dialogue under the SAC to correct 0 Establish steering committee with the key agencies responsible for implementation 0 Develop transition plan between DPR and Fund PI0 to transfer data and information 0 Ensure milestones for progress on building capacity in compliance are met is built at the highest levels and the need for change is understood within Fund PI0 by providing data and analysis to support arguments for restructuring 0 Ensure careful planning of technical assistance, with due regard for language, culture and regionally relevant training Risk Rating with Mitigation H M N (a) Public education campaign backfires Overall risk rating Risk Rating - H (High Risk), S (Substantial F 0 Stage the campaign with due care to timing of messages and recognition of key constituencies ~~ k), M (Modest Risk), N(Negligib1e or Low Risk) N S No safeguard policies are expected to apply to the proposed project. 6. Credit conditions and covenants Conditions of Effectiveness: 0 The Development Credit Agreement (DCA) has been executed and ratified, and a satisfactory legal opinion has been presented by SaM to IDA confirming the validity and binding nature of the DCA. 0 The Sub-credit Agreement, satisfactory to IDA has been executed by SaM and the Republic of Montenegro, and satisfactory legal opinions have been provided by SaM and 15

24 0 the Republic of Montenegro that the Sub-credit Agreement is valid and legally binding upon the parties. IDA shall have received satisfactory evidence that the Fund PI0 budget for the year 2004 is balanced. Other Project Coordination and Implementation 0 The Borrower shall ensure that the Republic of Montenegro provides adequate resources and staffing required for Project Implementation and Coordination, including a Project Coordinator and Focal Points within the Implementation Agencies, during the term of the Project, satisfactory to IDA. Financial Covenants 0 A bank satisfactory to IDA will be selected for holding the Special Account for the Credit. 0 The Borrower will maintain a satisfactory Project Financial Management System, including records and accounts, for ensuring that financial statements are prepared in accordance with accounting standards satisfactory to the Bank. 0 The Borrower will ensure that annual project accounts and audit reports are provided to the Bank within five months of each fiscal year, with the audit to be carried out by independent 0 auditors in accordance with International Standards on Auditing, and TORS satisfactory to the Bank. The Borrower will ensure that quarterly Financial Monitoring Reports (FMRs) are prepared, which will include, at a minimum: - Project Sources and Uses of Funds - Uses of Funds by Project Activity - Special Account Statement - Procurement report D. APPRAISAL SUMMARY 1. Economic and financial analyses The proposed project would support the improvements in the administration and sustainability of the existing pension system, as well as activities related to the building of the framework for possible third pillar reforms for the future. Please see Annex 9 for an integrated analysis. The introduction of better collections and reporting processes for social insurance, based on individual monthly reporting, should result in an increase in collections and help stabilize the fiscal position of the pension system. Reform of the PIO, could lead to reduced expenditures through more efficient administration of pension benefits. The system would also allow the DPR to maintain information regarding contributions and liabilities of all employers and to match this information with similar information from related systems. This facility will allow the DPR to detect potential non-payments or underpayments and take corrective actions. 16

25 These interventions are also expected to reduce the timekost of clients through more efficient delivery of pension services. The introduction of the new system for collection of pension contributions will increase the overall rate of collection and enable the creation of individual accounts with records of the contributions paid, thus resulting in increased transparency and improved fiscal sustainability of the system. Although it is difficult to estimate the net fiscal impact that can be expected as a result of the new system on the collection rate increase, the experience of other countries that have implemented such systems is largely positive. Drawing on the experience of other countries, gains may be significant: in Croatia, the introduction of individual monthly reporting requirements increased collections from 78 percent to over 90 percent. However, it should be noted that causality between the project investment and economic outcomes cannot easily be established. The most common benefit is the assumed improved compliance as mentioned above but quantifying the net effect and estimating the period of impact would not be useful, particularly, given the government s announced intention to cut contribution rates, with the size of the cuts as yet undetermined. Even if causality could be established, there is much uncertainty about a range of other economic effects to include them in the economic analysis. These include a net savings improvement (which is disputable), policies on closure and bankruptcies of firms, etc. 2. Technical The policy development technical assistance reflects current practice in pension policy design and program evaluation used in OECD and ECA countries. Further, both pension reform and the reform of cash-benefit programs have a long history of policy analytic and evaluative studies by highly respected researchers, so that efforts in this area have a firm intellectual foundation. Organizational changes to be implemented in this project will reflect best practice in pension administration agencies in OECD and ECA countries. The client-service principles followed in this design will lead to more flexible and efficient organizations, saving time of both clients and staff. The computer system solutions (computer equipment and software necessary to upgrade capacity for contribution collections, systems and sub-systems architecture for networking, voice and data management capabilities, statistical analysis, actuarial modeling, evaluation of performance of social programs) represents a good balance between function and cost. It will use a combination of object-oriented and traditional approaches to data management. All software will be fully tested before implementation. 3. Fiduciary Procurement: An experienced procurement specialist has been engaged to work in the central TSU. A procurement capacity assessment has been completed and action plan agreed for developing adequate procurement capacity in the central TSU. A procurement plan for the first 18 months of implementation has been prepared and agreed. 17

26 Financial management: A financial management review was undertaken in March 2004, to determine whether the financial management arrangements for the Project are acceptable to the Bank. It has been concluded that the Project satisfies the Bank s financial management requirements. The SAM CFAA report notes that there are a number of risks on the management of public funds in SAM. The risks to the public funds include: (a) poor public sector financial management in the past; (b) unfinished reforms - the new governments that were elected have commenced a process of major reform, which looks good as designed, but it is still too early to say if the reforms will be totally successful; (c) capacity constraints in both the Federal and Republic governments; (d) weak banking sectors; (e) weak audit capacity; (f) poor implementation capacity in line ministries; and (g) the lack of recent Bank implementation experiences within SAM. Since re-joining the membership of the World Bank, SAM has been using individual implementation units for each investment project (traditional PIU model), located within the relevant line ministries or project beneficiaries, to mitigate some of these risks. During the period since the CFAA was published, the number of commercial banks in SAM assessed as acceptable to hold Special Accounts has increased from three to five and the number of firms assessed as acceptable to audit Bank-financed projects has increased from two to four, indicating an improvement in the fiduciary environment. Experience in implementing Bankfinanced projects is increasing but the lending portfolio is still too young to be able to conclude that the Borrower has a thorough understanding of Bank operations. Disbursements from the IDA credit will initially follow the transaction-based method, i.e., direct payment, reimbursement and special commitments using SOEs and full documentation as appropriate. It is anticipated that the project will migrate to report-based disbursement during 2005, following demonstration for at least two quarters of satisfactory preparation of reports. Retroactive Financing. Retroactive financing of up to US$0.28 million would be applied to expenditures made after June 1, 2004 for (a) consultant services for extending the functionality of tax and pension system; and (b) fees for a Project Coordinator, and as necessary, an Administrative Assistant. 4. Social A Montenegro Social Protection Note preparation has been financed, under this project. This note will provide an overview of social insurance and social assistance programs in Montenegro. It will look at the coverage, effectiveness and efficiency of programs to assess areas for reform. It would also include an assessment of the functioning of the present pension benefits and payments. Given that the MOLSA is working on a new Law on Social Welfare, this will be timely. The Note would also be used for discussions with other donors involved in the sector (e.g. UNICEF, Save the Children). The work will be done between April 1 and May 30, A draft report has been submitted on May 7 and a final report is expected by May

27 ~~ The output would be a report including the following: i. Overview of social protection expenditures and institutional arrangements. ii. Social assistance cash benefits and child allowances: review of programs, eligibility criteria, data by program on expenditures and beneficiaries. iii. Social services: inventory of public services, expenditures, beneficiaries, number of facilities. Institutional issues to be addressed include: (i) who is responsible to whom - administration, and monitoring linkages between the municipalities, CS Ws, social protection institutions, Ministry of Labor and Social Protection, management boards, etc.; (ii) reporting structure between these bodies; (iii) financing flows; and (iv) major roles and responsibilities of key institutional actors (e.g. MOLSA, employment fund, PIO, NGOs, Ministry of Justice, Ministry of Interior). Analysis of the decentralized offices of the MOLSA, the Centers for Social Work, will cover: (i) relations between CSWs and local governments; (ii) organizational structure of the 10 CSWs, division services and cash, professional profile in the CSWs; (iii) services provided (on paper and in practice; and (iv) capacity (staffing, equipment). 5. Environment Civil works or land acquisition are not envisaged. 6. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.0 1) [XI [I Natural Habitats (OP/BP 4.04) 11 [XI Pest Management (OP 4.09) [I [XI Cultural Property (OPN 11.03, being revised as OP 4.1 1) [I [XI Involuntary Resettlement (OP/BP 4.12) [I [XI Indigenous Peoples (OD 4.20, being revised as OP 4.10) [XI 11 Forests (OP/BP 4.36) [I [XI Safety of Dams (OP/BP 4.37) 11 [XI Projects in Disputed Areas (OP/BP/GP 7.60f [I [XI Projects on International Waterways (OP/BP/GP 7.50) [I [XI 7. Policy Exceptions and Readiness Not applicable. The project is building on the work done in this sector by USAID. However, despite USAID involvement in this sector for some three years, progress in administrative reform, has been very minimal. Inter-agency relationships have been cumbersome. Many of the tasks required under the administrative reforms are cross cutting. This puts a premium on ensuring closer cooperation among the agencies involved and in providing high level support to shepherd the process. It also * By supporting the proposedproject, the Bank does not intend to prejudice thejinal determination of the parties claims on the disputed areas 19

28 means a more careful managing of relationships and broader and fuller involvement of counterparts in the project preparation process. As such, a workshop was held jointly by the Bank and the USAID, where all the key stakeholders in the reform process were brought together. A common plan for restructuring and a modality for working resulted from this workshop. This was the first workshop of this kind held in Montenegro. 20

29 Annex 1: Country and Sector Background SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project (a) Country background The Government of Montenegro implemented a program supported by SAC I, covering reforms in (i) public expenditure management; (ii) pensions; (iii) the energy sector; (iv) labor markets; and (v) the business environment. One key feature of the program was the enactment of a law on pension and disability insurance which adjusts key parameters of the pension system to better align entitlements to available resources. The new labor law significantly increases labor market flexibility. The enactment of new enterprise, bankruptcy, and secured transaction laws create a more favorable business environment. The enactment of a new energy law provides a basis for the development of a regulatory framework, together with energy industry restructuring and liberalization. In Montenegro, the consolidated budget deficit was cut from about 8 percent of republican GDP in 2000 to about 5.5 percent in The renewal of transfers to cover federal (union) expenditures placed new pressure on fiscal accounts in Excluding this transfer, the underlying budget deficit for 2003 fell to about 3 percent of republican GDP. Montenegro's 2004 budget envisages a consolidated deficit of 4.4 percent of republican GDP, or 1.6 percent of GDP excluding the transfer to the union government. Both republics have yet to fully overcome the daunting legacy of the past. This legacy includes years of economy-wide decapitalization, a banking sector driven to severe insolvency, and a corrupt and ineffective public sector. Even after efforts of recent years, a critical mass of reforms may not have been reached in either republic. While transition reforms have progressed in both republics, they are incomplete, were not always planned in an integrated fashion and were introduced with inadequate attention to implementation capacity. In Montengro, the massive presence of the public sector in the economy continues with 40 percent of the economy still in State hands. The size and scope of Government intervention in the economy remains large and the capacity of public sector institutions to implement reforms remains weak. The reform effort of recent years has improved governance, public sector transparency and financial discipline, but more needs to be done in each of these areas. One of the key challenges the Government of Montenegro now faces is building strong institutions with the capacity and incentives to carry out the recently adopted formal elements of reform. (b) Sector background Montenegro launched a reform of the pension system in 2003 with the support of SAC I. Prior to this reform, the pension system experienced serious fiscal difficulties due in the short run to an ineffective administrative system, characterized by a loose and fragmented collection and compliance system, and economic and demographic factors that affect it's sustainability over the medium term. An aging population and the erosion of the contribution base triggered by economic stagnation and a growing shadow economy, both contributed to a decline in the system dependency ratio to 1.3 workers per pensioner. The age dependency ratio (the ratio of the over-65 year old population to the year old population) grew to exceed 20

30 percent. Both indicators are similar to those found in neighboring countries. By 2002, pension expenditure reached 13 percent of GDP. Pension contributions (the rate is 24 of gross salaries, split equally between employees and employers), accounted for 50 percent to 60 percent of pension revenues on average. The remaining revenues consisted of required mandatory transfer from the budget for state employees' contributions and citizens eligible for privileged categories' benefits (military personnel, police officers, World War I1 veterans, and public servants retired under special rules). The system had difficulties in covering some of these obligations and thus the pension deficit widened to almost 3.9 percent of GDP in During this first phase of reform, the focus was on restructuring pension finance and on reducing arrears. The initial restructuring effort culminated with the enactment of the new Pension Insurance Law in September Reform of the existing pay-as-you-go (PAYGO) system sets the stage for the future introduction of a multi-pillar system. The law tightens key parameters of the existing PAYGO system in an effort to improve the near-term fiscal balance. These changes effective in January 2004: (i) increased the retirement age by five years for men and women (65 and 60 respectively) over a ten-year period; (ii) widened the calculation period from ten best years to full career over a 15 year period; (iii) changed the indexation pattern from wage to a combination of wages and prices; (iv) introduced a point formula and lowered the accrual rates from more than 2 percent to 1 percent per year of service; (v) tightened disability conditions; and (vi) eliminated most social-related benefits from the pension system. Reforms supported by SAC I1 will ensure the effective implementation of some of the reforms introduced in 2003 aimed at improving the transparency and management of the pension component of public finances. Further SAC I1 support is intended to lay the ground work for the next stage of pension reform envisaged in the Law on Pension Insurance, through the drafting of new legislation to regulate voluntary pension funds. Some elements of budget execution continue to lack adequate transparency. These will be addressed in 2004 by ensuring that no new intergovemental arrears on pension contributions are incurred. Also, by itemizing all required transfers from the budget for all privileged and special categories of beneficiaries, regular reporting to the PI0 on public sector employees' wages and contributions paid will be made possible. (c) Proposed legal and regulatorv changes in the pension system The full transfer of tax and social security contribution collection to DPR in 2005 is a process that goes well beyond centralizing the flows of contributions in the Treasury, envisaged by the tax procedures laws. Effective control of social security contributions requires a prompt and effective flow of information of social security contributions to all relevant institutions. Such an information flow would require a frequent, i.e. monthly or quarterly, personified reporting and a central database of insured individuals and contribution payers. To enable this process, an action plan has been adopted for the unification of registration and reporting of tax and social security contribution collection. The action plan establishes a 22

31 working group led by the Deputy Prime Minister of Financial Systems. This group will draft a new law to ensure the effective implementation of these plans. This new law on consolidated reporting and control on social security contributions, personal income tax and surtax will be enacted by end of By 2005, DPR will have to be fully equipped to collect, control and enforce pension and other social contributions as well as forward contributions paid to the social security funds in a timely manner. By 2006, DPR will prepare corresponding reports on personified contribution payment. In the interim period, the proposed legislation will require that DPR establish: (i) central databases of insured individuals and contribution payers; (ii) procedures for updating individual data; (iii) data dissemination requirements to extra-budgetary funds; (iv) procedures for one-stop registration of newly insured individuals and contribution payers; and (v) other procedures required for the smooth operation of the consolidated administrative system. Also, measures to harmonize provisions on social security contribution control in this proposed law will be undertaken. Currently, such measures are scattered throughout several other relevant laws. The proposed new law would supercede the old laws and eliminate the conflicting discrepancies. As mentioned above, the Pension Insurance Law envisages the eventual introduction of mandatory second and voluntary third funded pension pillars in Montenegro. The law stipulates that the funded pillars will be regulated by separate legislation to be adopted in the future. A decision to have a voluntary pension pillar would be introduced and regulated well in advance of the mandatory second pillar in order to allow the pension fund industry (including regulatory institutions) to develop in Montenegro. Drafting of the law on voluntary pension funds is expected to take place in The Government will adopt the draft legislation by year-end. (d) Information technolow architecture and environment (9 Current system being developed by the USAID. USAID has been working with the DPR to develop and implement a scalable Integrated Distributed Information System. This system will be in compliance with the new legislative framework. The system will be: 0 Multi level distributed client server application. 0 Supporting a Central Taxpayer Registry. 0 Providing Customer services and automated tax return processing. 0 Providing management information at branches and central level. 0 Controlling an authorized access to the data. The system will be connected to the other Government Information Systems (IS) such as: Customs IS, Commercial Court IS, Budget IS, etc. The final product of the USAID project is a Distributed Client - Server Application made up of two basic software packages: 0 A software package that will be implemented in DPR branches, called Tax Information System (TAXIS). 23

32 0 A central package that incorporates a Taxpayer s Registry and warehouse database and will be implemented in the Central DPR office. This package is called (Central Tax Information System - CTIS). The following chart depicts the deployment of the system s packages: I Central TAX Information System I SubBranch 1 Sub-Branch 2 Sub-Branch 3 *.. Each branch system (TAXIS) will be connected to the Central System (CTIS) through a WAN supported by Secretariat for Development (SfD). This connection will be used for data exchange between Central and branch systems. There will be two way flow of data. Package implemented in DPR branches (TAXIS). component and several subcomponents. The entire package will have a core The core of the system consists of: 0 taxpayer s registration component (TPRC), with main functionality to create a registry of the taxpayers, identifying them and their tax obligations; and 0 taxpayer s revenue accounts component (TPRA), that will track information about taxpayer s behavior (filling return forms, payments, reassessment of liabilities, imposed fines, etc.). Constraints in the present system. The following functionalities are not in the scope of the existing ongoing work: 0 audit selection 0 audit tracking 0 document tracking 0 collection activities tracking 0 appeal procedures and legal activities 0 web site information for DPR forms and procedures 24

33 (ii) New system to be developed under PSAIP. The PSAIP would build on this architecture and introduce several new interfaces to ensure compatibility with registration and database systems from the Fund PIO, Health Fund, Unemployment Agency, Banks, Central Bank, and other relevant institutions. The following core application modules have already been developed and deployed under the current project: 0 Registration of natural and legal persons 0 Return Processing for all taxes 0 Payment Processing (both payment system and cash payments) e Taxpayer Accounting supporting tax type sub-accounts The following core application modules are still under development with deployment planned for no later than May 2005: 0 VATRefund 0 Audit selection, assignment, and tracking 0 It is also possible, though not yet firm, that a module for the management of appeals to be delivered. The application system is based on the TAXIS and CTIS packages and methodology from Barrents/KPMG/BearingPoint. It is expected that, under the project, the delivered modules would be extended in many areas to support an integrated revenue collection environment and provide for data sharing with participating agencies. On the payment side, the system is interconnected with the Montenegro Treasury system, which is SAP based. This is an open standard connectivity, which should be able to be continued with no problems under the project. The Project would extend the scope of the TIS in key dimensions so that it can support the implementation in the country of a sophisticated multi-tier pension system. The extension would follow the following principles: The project team believes that the policy environment will continue to evolve over the life of the project, similarly to what is being experimented in other countries in the region undergoing similar reforms. As a result, we will attempt to keep the revenue collection system strategy and architecture deliberately as open as possible - i.e. allowing for future interconnections, interfaces, and policy options. The direction is to build a system not just to process transactions based on current policies, but one that can accommodate future policies with reasonable ease. In particular, the extension should be planned to accommodate more centralized or distributed registration and collection processes which would be defined through the impending legislation for consolidated revenue collection. We believe there is a reasonable chance that this specific legislation will have to be amended a few times over the life of the project as Montenegro gains experience with an integrated collection system and the need to enforce collection 25

34 Finally, the extension must be flexible enough to support the introduction of the second and third pillar of the pension reform, and their administration, especially the corresponding financial and data flows, and reporting. (e) The Fund PIO: the need to modernize and restructure The Fund PI0 faces a number of challenges. There are almost 30,000 cases where no return of work and contribution data has been made since Almost 50 percent of these cases are 10 years old. The number of non-compliant cases is rising since 1999, and 5000 (M4)12 cases are outstanding from the period It is possible to set up a pension payment record for a person who does not have a contribution record - as the contribution record database does not interface with the payments processing database. This is a serious control weakness and highlights the general lack of adequate controls -both electronic and manual - in the current system. The PI0 does not have accurate information about contributors and cannot properly identify those who are failing to register and/or pay contributions. Aside from errors that result from such gaps in information, controls, and management, the possibility of fraud cannot be discounted either. Two areas stand out as requiring urgent attention. (4 Database Accuracy. The PIO s databases are outdated, lack proper integration and contain many errors. Recent analysis has shown that 71 percent of employer records are missing their Tax (FIN) number as the primary key, 13 percent of employee records are missing their JMB number (a code to register people) and over 30 percent of self-employed records are missing their JMB number. This means it is impossible to accurately reconcile contributor records with tax-payer records in DPR. Such reconciliation is required in the future, when DPR will take over responsibility for contribution collection and compliance. These problems can be resolved by a unified PIO/DPR registration and collection system. The PI0 databases show a significant number of persons aged over 60 with an open insurance record but no payment of contributions recorded since 1997 and no pension in payment. This indicates their records have not been updated with vital information and/or their pension payment record is not linked to their workkontribution record. (io IT System. The IT system is struggling to cope with the PIO s business requirements. Much of equipment is outdated and unsuitable for a modern public service with a critical mission. The communications network with Regional Offices - used to access information, record registrations and decisions - is slow and unreliable. Most offices don t have basic word processing or printing facilities. Development of new applications is minimal and many existing skills are seriously outdated. Specialized training is almost non-existent and budgets for development are under-funded. l2 Summary data on contributors wagelsalary, employment and social insurance contributions are transmitted to the PI0 annually. This information on the M4 form, must be submitted to the PI0 by 30 April for the prior calendar year. Employers send their M4 forms to the PI0-99% are paper based. 26

35 Despite having large teams of in-house technical specialists (software engineers etc), the PI0 contracts an external IT company to amend its application programmes, such as was necessary to implement the recent Pensions Law. This indicates the IT Department lacks skills and capacity to properly support the PIO s business. A thorough overhaul of the IT Department and the IT systems is required. Reform Strategy The USAID advisors have deeply analyzed the PIO. Taking into account their findings, including the above issues, they have proposed a reform strategy that re-focuses the PI0 on its core business: pensiodbenefit processing and payment. They have advised that key business functions be transferred from PI0 Regional Offices and centralized in PI0 headquarters. This strategy incorporates a new PI0 business model and a new PI0 organization structure. To illustrate how modernization and restructuring might help the Fund PIO, improve services to contributors and reduce duplication with other agencies, take the area of contribution data processing. Here Employers send their summary data on contributors wages/salary to the Fund PIO. These returns are 99 percent paper based. In the year 2000, some 162,000 such forms were submitted to the PIO. In addition some 60,000 forms (on cessation of employment or commencement) were sent as well. These forms were processed manually and scanned for electronic archiving. The data on these forms is maintained in three locations: the form itself, the PIO s IT system, and the electronic archiving system. The DPR will also collect the same information under the new integrated tax and social insurance collection system. It would be much more efficient to be able to access this information from a central database, as is being planned under the project. And the same applies to other agencies like the Health Fund and the Unemployment Bureau, which maintain their separate databases as well. The main components of modernization and restructuring in the Fund PI0 include: 0 Centralization of pensiodbenefit claim processing in PI0 headquarters 0 Centralization of registration of Contributors and Participants in PI0 headquarters, in preparation for transfer to DPR 0 Transfer of collection of contributions (cash and data) to DPR 0 Transfer of compliance and control of Contributors and Participants to DPR 0 Modernization and restructuring of PI0 organization to focus on core business 0 Restructuring of PI0 regional offices -to focus on service to pensioners The PI0 is responsible for the administration of the social insurance system in respect of the following insurable contingencies: old agehetirement, disability and widow(er) hood. The system is based on the principles of mutuality, solidarity and past labor (accumulated rights relating to years of active attachment to the labor force). It is funded on a Pay-As-You-Go basis. The range of benefits that are covered by the PI0 include: 0 Retirement Pension 0 Disability Pension 0 Family Pension (survivors pension) Cash benefit for bodily injuries (occupational injuries benefiudisablement pension) 27

36 Annex 2: Major Related Projects Financed by the Bank and/or other Agencies SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Support the Government of the Republic of Montenegro in the implementation of a structural reform agenda to enhance medium-term fiscal sustainability, and improve the prospects for economic growth as a basis for sustained poverty reduction. The project supported specific reforms in the areas of pubic expenditure management, pensions, the energy sector, labor markets, and the business environment. Support development of health reform strategy with the aim of supporting the Ministry of Health (MOH) and Health Insurance Fund (HIF) to develop priority areas of policy and regulation and build their capacity; improving quality, efficiency and access in primary health care; and taking measurable steps towards financial sustainability of the health care system. Structural Adjustment Credit 1 (US15 million) Status: closed Republic of Montenegro Health System Improvement Project (US$7 million) Status: under negotiations [mplementation Progress (IP) S N.A. Development Objective (DO S N.A. Legislative and regulatory framework for Republic of Montenegro N.A. health insurance, healthcare delivery, and Structural Adiustment Credit 2 pharmaceuticals; pharmaceuticals expenditure control; public administration reform; unification and strengthening of (us$ls million)" Status: under preparation contributions collection systems. N.A. the Pension system: the DPR and Fund IPDO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory 28

37 Annex 3: Results Framework and Monitoring SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Results Framework Project Development Objectives U 1. Reduce pension deficits as projected under the model Predictability improved measured by budgeted/actual revenues Increases in #of participating contributors Annual actuarial reports to see when and how to introduce the next pillars Information used as basis for developing basis for future reform 2. Improve effectiveness and efficiency in administration of social contributions Effectiveness of administration improved measured by stock of arrearshevenues Track non-payments and ensure timeliness of payments. 3. Efficiency of administration improved comparing Montenegrin administration measured by costslrevenues to republics of similar size in the region 0 Modernization and restructuring of Fund PI0 and DPR proceeds as planned Duplicative functions, such as data archiving and enforcement, across agencies are removed To streamline agency functions and reduce burdens on contributors 4. Develop capacity for improved quality of pension reforms and design of policies Actuarial projections and policy actions taken for future reforms do not require foreign consultants To build capacity for analysis and reduce dependence on foreign consultants 5. Improved services for clients Number of formshequirements is reduced from 20 to 3 To determine HR policies and incentives for better service standards Client services improved as measured by increases in number, of enquiries received and time taken to answer these Intermediate Results One per Component Component One: (i) Increased contributions and compliance Component One: Detection of early signs of noncompliance - non-filing, stop-filing and misfiling, increases... Frequency of audits is reduced...through automated audit selection Electronic filing introduced. Increase in % of contributors filing electronically. Amount of arrears at year end compared with previous year Use of Results Monitoring Component One: Rate of development of central register to identify bottleneck in processes, procedures, training. 29

38 (ii) improved services to clients, both contributors and beneficiaries (iii) Unified collection and registration established Component Two: (i) Fund PI0 focused on core functions as envisaged under new law (ii) improved services to clients, both contributors and beneficiaries Component Three: (i) Future pension reform design, including actuarial projection done by key government agencies Other agencies and funds are able to access the information easily and readily Public perceptions of service and integrity as measured by surveys, media, and pensioners association Central registry on insured individuals established Central registration of individuals All other agencies use central database Unique identification number established for all individuals Individual contribution records maintained Component Two : Core processes and functions for Fund PI0 adopted and implemented through restructuring All duplicative functions phased out Transfer of database of individual contributions to DPR Public perceptions of service and integrity as measured by surveys, media, and pensioners association Time taken to handle enquiries Component Three: Actuarial model is handed over fiom USAID to MOL Government is able to evaluate current balances of the pension system to ensure it remains financially viable in the long term Actuarial projections from government are used as basis for future reforms Capacity for supervising private pension funds operative Public awareness on pension reform Improve client satisfaction Ensure consistency in data to prevent illegitimate payments and fiaud and track contributors better. Component Two: Measure progress on restructuring and cost savings to reduce public expenditure Component Three: Determine basis and prepare for 3rd pillar reforms 30

39

40

41 Annex 4: Detailed Project Description SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Within the government there has emerged a consensus on the needed improvements of the data reporting system for social contributions that would complement the system of consolidated collection in DPR and provide a basis for stronger collection and better compliance. These improvements include: creation of central registries of insured individuals and contribution payers (in DPR), establishing a single-point registration system for insured individuals and contribution payers, monthly reporting on taxes and contributions paid for each insured individual (monthly OPD3 form) to the DPR, and central control function in the DPR. In addition to creating a framework for improvement in compliance, the central registration and data collection institution would have to provide timely reports to other systems in accordance with their data needs.13 Procedures and responsibilities for a more frequent unified reporting, collection and control of tax and social contributions, reporting responsibilities, central registries transactions and update would best be regulated through a separate Law on Consolidated Reporting and Control on Contributions, Personal Income Tax and Surtax that would be drafted by the Government in the first half of 2004 and enacted by the Parliament by end By the end of 2004, DPR would have to be fully equipped to collect, control and enforce pension and other social contributions, forward contributions paid to PI0 in a timely manner, and other extra budgetary funds, and by 2006, to prepare corresponding reports on individualized contribution payment. In the interim period, the DPR would, following the new law, establish central databases of insured individuals and contribution payers, procedures for updating individual data, data dissemination requirements to extra budgetary funds, procedures for onestop registration of new insured individuals and contribution payers and other procedures required for smooth operations of the consolidated administrative system. In this Law, the Government may also consider to harmonize provisions on contribution control scattered throughout other material laws and override the conflicting discrepancies. l5 In order to respond fully to these Government objectives and the laws being proposed, the project envisages three components: Component 1: Increasing Tax and Contribution Compliance (US$3.6 million of which US$2.4million is IDA financed) Under this component there are two major areas of strengthening: l3 For example, health laws link the benefit provision to an information on contribution payment for the insured individual in the period of preceding three month. Similar provisions are considered in the employment and social assistance systems. Finally, a participant in the pension system is not eligible for accruing a year of service unless the contribution has been paid. l4 In addition to laws on tax procedures, reporting requirements have been regulated in domicile laws separately for each social contribution. Such a separate legislation would unify the procedures across taxes and contributions and override the redundant procedures without amending the domicile laws. l5 For example, recent labor legislation had allowed labor inspectors to perform control of contributions paid, despite existing tax laws that recognize only the DPR as the institution responsible for control. 33

42 Establishment of Unified Contribution Collection System. This sub-component would put in place a modern infrastructure to process the flow of data and contributions from the Fund PIO, Health Fund, and the Unemployment Bureau to the DPR. The component would simplify the procedures for payment filing and declarations, introduce electronic filing for large taxpayers, and institute targeted audits (audits for cause) and random audits in lieu of periodic audits. It would improve filing procedures to include information for the client database. Development of a Client Data Base and other Information Systems. This sub-component would create the client database of individualized records necessary for a modern pension system in a market economy and for the fkture reform of the pension system. It would also finance the development and implementation of automation systems and infrastructure for the DPR necessary to ensure efficient and effective delivery of services. It would improve client services in the DPR as well make inquiries easier and service faster. In addition, it would facilitate working out potential problems in assigning individual records, supplementing current procedures to appeal benefit determinations. It would also support database infrastructure development for employment programs for the MOLSAF, and for social assistance, social welfare, and workplace safety for the MOLSAF for program monitoring and analysis. The key activities under this component would include: 0 Consolidation of contribution collection, control and enforcement hnctions in DPR. Project would provide TA, equipment and training for creating additional capacity in DPR and establishing procedures for integration. Creating central registry on tax and contribution payers including central registration of new companies, self employed and farmers with data dissemination to all involved institutions. Creating a central registry on insured individuals and individual taxpayers with a central registration feature and data dissemination to all involved institutions. Implementing integrated and more frequent reporting on personal income tax and social contributions. 0 Installation of new accounting and control procedures, and new management information systems. 0 Development of individual accounts, and collection and dissemination of individual earnings information. Support under the project would include Technical assistance for developing a model for unifying registration and collections; and investments in hardware and software for information system implementation. Component 2: Restructure and Modernize the Fund PI0 (US$2.0 million of which $1.5million is IDA financed) This component which envisages the modernization and restructuring of the Fund PIO, will build on the existing work done by the USAID which has been involved in diagnosis of the agency and has prepared plans for its restructuring for over two years now. Restructuring the Fund PI0 is designed to: 34

43 0 Improve the service to contributors by reducing the points of contact for transacting business through the introduction of Unified Registration, Unified Data and Contribution Collection, Unified Control and Enforcement, all transferred to DPR. 0 Improve the service to insured individuals and beneficiaries by accurately maintaining a registry of insured individuals and beneficiaries with reconciled individual earnings history and benefit payments history. 0 Reduce the cost of public administration and eliminate duplicate processes and instead focus the agency on its core business processes i.e. data and contribution collection (actually outsourced to DPR), eligibility of insured individuals, and payment of granted benefits. 0 Implement recently enacted Law of pension and disability insurance. This component would require: Reviewing the core functions of the Fund PI0 in light of the new law and establishing core processes and procedures that underlie these core functions. Eliminating duplicative functions and streamlining the processes to improve services to pensioners would be part of this. 0 Developing systems to accurately maintain registries of contributors and beneficiaries and database of individual earnings history. 0 Developing information system to regularly inform system participants on contributions paid. 0 OrganizatiodApplication software implementation, i.e. technical assistance for improving basic functions of the Fund, PIO. 0 Investment in equipment required to modernize core functions of the PI0 and develop new organizational structure of PIO. 0 Training programs to support the new role of PIO. Key Activities under this component would include: Mapping core business processes needed to implement recently enacted16 Law of Pension and Disability Insurance. Designing new PI0 organi~ation'~ compliant to mapped core business processes eliminating duplicative functions, reducing complexity of reporting and collection system and improving services to contributors, insured individuals and beneficiaries. Identifying staff positions needed to populate the new organizational structure and writing job descriptions for all staff positions (EC). Assessing IT needs required to implement mapped core business processes and to support redesigned PI0 organization. Develop IT Strategy and Implementation Plan. Mapping Unified Data and Contribution Collection in DPR compliant to generally accepted Revenue module'*. Mapping Data and Contribution Exchange between DPR and PI0 presented in Extended Revenue Model i.e. Unified Data and Contribution Collection Model (Unified Collection Model). Strengthening Analytical Capacity of the PI0 i.e. actuarial and budgetary analysis, administrative statistics etc. l6 Provisions of the Law implemented fiom 1. January l7 Eimar Coleman. l8 Extended Revenue Model were presented on a Workshop held at Friday, 13 February 2004 organized by World Bank and USAID. 35

44 Developing and implementing improved and new Integrated Information System required to support mapped core business processes and restructured PI0 organization. Developing training programs to support new business processes and changed organizational structure. Technical Assistance for improvement of core functions, implementation of structural reform, design of new IT system, improvement of analytical capacity etc. Component 3: Develop and Strengthen Institutional Capacity for Pension Policy (US$0.6 million of which US$0.5 million is IDA financed) This component has two sub-components: (Q Develop capacity to supervise private pension funds. This sub-component has two areas where strengthening is most needed. (a) strengthening supervision capacity in the Ministry of Finance. The team was informed that the issue of financial non-bank supervision has been intensively discussed in Montenegro. While the NBM remains in charge of bank supervision, and the Securities and Exchange Commission in charge of privatization (and future investment) fund supervision, the new draft Law on Insurance designates an independent Agency for insurance supervi~ion.'~ The current Insurance supervision Department in the Ministry of Finance consists of a staff on three and is in high demand of training, education and equipment. Until establishment of the Agency, expected in 2005, this Department will be responsible for legal and supervision work of insurance and pension systems. Finally, it can be expected that the Agency would emerge from this seed Department in the Ministry. Following that assumption, this component should start by focusing on strengthening supervision and legislative capacity of the Department for Insurance Supervision. The key activities under this subcomponent would include: Proposed investment in equipment, TA and training over the project cycle. 0 Investment in equipment is proposed to provide computer hardware (server and three work stations) and specialized supervision software. (b) strengthening pension policy capacity in the Ministry of Labor and Social Affairs. TA proposed by the team includes foreign consultants on legal, actuarial and pension system issues, and local consultants on legal, demographic and actuarial issues. TA is expected to be engaged in producing legal and supplementary acts needed to regulate and supervise private pension funds. This component would be executed by the Pension Policy Department at the Ministry of Labor and Social Affairs and should result in creating capacity and analytical tools such as a pension model to analyze and forecast pension policy in the Ministry. In addition to investment needs in the Department, the team identified a serious shortage of staff and thus proposed that the project would also support staffing of consultants in the Department via participating in the recurrent costs. The activities covered would include: 0 Proposed investment costs for hiring of consultants. l9 Legal status of the Agency has not been fully identified yet, which depends of the Agency's fmancing sources. If the Agency is to be predominantly fee-financed, it might be decided that it becomes fully independent. If, however, it is financed from the Budget, the Agency could get the status of an extemal department of the Ministry of Finance. 36

45 0 Investment in equipment, training, and TA. TA proposed by the team includes foreign consultants on actuarial modeling, and local consultants on modeling macroeconomic, demographic and actuarial processes. TA is expected to result in a pension model that will be used by the Department, manuals for its operation and trained staff to run it. Training budget is proposed to include two study tours to countries with model PAYGO and funded systems, and individual courses on actuarial modeling, macroeconomic/pension policy and programming and computer skills. ii. 0 0 Public education campaign. Key activities under this sub-component would include: Broad PR and education campaign would aim to promote the goals of the pension reform in Montenegro, to strengthen public support for the pension reform process, including expected additional pillars in the future, and to widen public awareness of a need to voluntarily save for the retirement. This component is to be executed by the Pension Policy Department at the Ministry of Labor and Social Affairs. This component is envisaged to be outsourced to a specialized PR company and include PR and education consultancy, opinion polls, development of PR and education materials and publications, analyzing focus groups and campaign outreach, TV and radio time, workshops, lectures, and developing tools for individual assessment of the pension reform outcomes. Component 4: Project Coordination (US$0.3 million of which US$0.2 million is IDA financed) This component would support the coordination of project activities and would involve the hiring of a local consultant to serve as a Project Coordinator who will be supervised by the Office of the Deputy Prime Minister for Financial Systems and Public Expenditures (ODPM)., As the need arises, an Administrative Assistant may also be hired to assist the Project Coordinator. The beneficiary agencies (Le. the DPR for Component 1, the PI0 for Component 2 and the MOLSA and MOF for Component 3) would be responsible for the implementation of the project and for providing substantive input in. To facilitate the implementation and monitoring of the project by the implementing agencies, focal points would be drawn from each of the named agencies, and will be appointed as members of an expert working group. They will work with the Project Coordinator and the central Technical Services Unit (TSU) under the Office of the Prime Minister and who will responsible for providing core procurement and financial management services for this project and all other Bank-financed projects. The costs of the TSU are being financed under the Health System Improvement Project (HSIP). 37

46 Annex 5: Project Costs SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Table 1: Project Cost Summary by Component Project Cost By Component and/or Activity Local Foreign Total US $million US $million US $million 1. Increasing Tax and Contribution Compliance O 2. Restructuring and Modernization of Fund PI Developing & Strengthening Capacity for Pension Policy 3.1 Developing Capacity for policy analysis and supervision 3.2 Public Education Campaign Project Management Total Baseline Cost Physical Contingencies Price contingencies Total Project Costs' Interest during construction n.a. n.a. Front-end Fee n.a. n.a. Total Financing Required 'Identifiable taxes and duties are US$1.4 million, and the total project cost, net of taxes, is US$5.1 million. Therefore, the share of project cost net o f taxes is 78.5%. Table 2: Project Cost Summary by Category Project Cost By Category Local Foreign Total US $million US $million US $million Goods Technical Assistance Training Incremental Recurrent Costs Total Baseline Cost Physical Contingencies Price Contingencies Total Project Costs'

47 Table 3: Financing of Investmentmecurrent Costs by Year Montenegro Pensions System Administration Investment Project Financing of InvestmentlRecurrent Costs and Financial Charges by Year (US$) 1. Investment Costs IDA The Government Total Investment Costs Financing Total , , , , , , , ,067.9 II. Recurrent Costs IDA The Government Total Recurrent Costs Financial Charges Total Financing of Costs , , , ,

48 Annex 6: Implementation Arrangements SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project The ODPM would be responsible for coordination of the project activities. To support the coordination tasks, a full-time Project Coordinator and, as needed, an Administrative Assistant, will be hired The beneficiary agencies (i.e. the DPR for Component 1, the PI0 for Component 2 and the MOLSA and MOF for Component 3) would be responsible for the implementation and management of the project. To ensure smooth implementation of the Project, a high-level Steering Committee has been established by Government Resolution and made responsible for strategic decisions on project implementation, coordination and monitoring. The Steering Committee is chaired by the Deputy Prime Minister for Financial Systems and Public Expenditures and is composed of the Minister of Finance, the Minister of Labor and Social Affairs, Heads of the DPR and PI0 and other agencies involved in the Project (Health Fund, Unemployment Fund, Statistics Agency, and Secretariat for Development), plus the Head of the TSU. The Steering Committee will meet regularly at least on a monthly basis, or more frequently as the need arises. In addition, focal points would be drawn from each of the named Implementing Agencies, and will be appointed as members of an expert working group to further facilitate the implementation and monitoring of the project by the implementing agencies. The focal points will work with the Project Coordinator and the central Technical Services Unit (TSU) which was recently established by the GOM under the Office of the Prime Minister and who will responsible for providing core procurement and financial management services for this project and all other Bank-financed projects. This TSU has been established with Terms o f References (TORS) that define clear boundaries of responsibility between the line Ministries and the TSU, giving the respective line Ministries clear overall responsibility and decision-making authority, and making the TSU accountable to line Ministries for providing prompt, professional services. 40

49 Annex 7: Financial Management and Disbursement Arrangements SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Country Issues The SAM CFAA report notes that there are a number of risks on the management of public funds in SAM. The risks to the public finds include: (a) poor public sector financial management in the past, (b) unfinished reforms - the new governments that were elected have commenced a process of major reform, which looks good as designed, but it is still too early to say if the reforms will be totally successful, (c) capacity constraints in both the Federal and Republic governments, (d) weak banking sectors, (e) weak audit capacity, (f) poor implementation capacity in line ministries, and (g) the lack of recent Bank implementation experiences within SAM. Since re-joining the membership of the World Bank, SAM has been using individual implementation units for each investment project (traditional PIU model), located within the relevant line ministries or project beneficiaries, to mitigate some of these risks. During the period since the CFAA was published, the number of commercial banks assessed as acceptable to hold Special Accounts has increased from 3 to 5 and the number of firms assessed as acceptable to audit Bank-financed projects has increased from 2 to 4, indicating an improvement in the fiduciary environment. Experience in implementing Bank-financed projects is increasing but the lending portfolio is still too young to be able to conclude that the Borrower has a thorough understanding of Bank operations. Implementing Entity Beneficiary agencies (i.e. the DPR for Component 1, the PI0 for Component 2, and the MOLSA and MOF for Component 3) will manage, implement and monitor the implementation of their respective components. Project coordination and support will be conducted through the ODPM, who will hire a local consultant to serve as a Project Coordinator. If needed at a later stage, an Administrative Assistant will also be hired. To ensure smooth implementation of the Project, a high-level Steering Committee has been established by Government Resolution and made responsible for strategic decisions on project implementation, coordination and monitoring. The Steering Committee is chaired by the Deputy Prime Minister for Financial Systems and Public Expenditures and is composed of the Minister of Finance, the Minister of Labor and Social Affairs, Heads of the DPR and PI0 and other agencies involved in the Project (Health Fund, Unemployment Fund, Statistics Agency, and Secretariat for Development), plus the Head of the TSU. The Steering Committee will meet regularly at least on a monthly basis, or more frequently as the need arises. To facilitate the implementation and monitoring of the project by the implementing agencies, focal points would be drawn from each of the named agencies, and will be appointed as members of an expert working group. They will work with the Project Coordinator and the central Technical Services Unit (TSU). 41

50 The central TSU, recently established by the GOM in the General Secretariat (Prime Minister s Department), will be responsible for carrying out core procurement and financial management functions for all future Bank-financed projects, and potentially for other donor-supported projects. This TSU has been established with Terms of References (TORS) that define clear boundaries of responsibility between the line Ministries and the TSU, giving the respective line Ministries clear overall responsibility and decision-making authority, and making the TSU accountable to line Ministries for providing prompt, professional services. The costs of operating the TSU are being financed under the Health System Improvement Project (HSIP). Strengths and Weaknesses The staff of the TSU have only limited experience of WB procedures, however they do have considerable experience of working with other donors and are technically competent. The recent appointment of a TSU Director has substantially strengthened the unit and the general control environment. Funds Flow The International Development Association (IDA) would make funds available to the Government of Serbia and Montenegro (SAM) under a Credit Agreement, governing the terms and conditions of the IDA credit and specifying the project. The Government of SAM would onlend the funds on IDA terms to the Republic of Montenegro based on a Subsidiary Credit Agreement with terms and conditions satisfactory to IDA. The following legal agreements will confirm the flow of funds and the respective parties roles and responsibilities: 0 0 The Development Credit Agreement, between IDA and Serbia and Montenegro (SAM); The Sub-credit Agreement, between SAM and GoM; The Sub-credit Agreement between SAM and GoM will be a condition of effectiveness of the Development Credit Agreement A special account (SA) will be opened by the MOF on behalf of the Project in a bank acceptable to the Association. Project expenditures have not been fully budgeted by the General Secretariat (Prime Minister s Office) for the first year of operations and therefore funds cannot be disbursed directly through the Treasury system. Hence, the MOF will also open a project account in the same bank as the Special Account, into which counterpart funds will be transferred in full. When a supplier payment falls due, the requisite amount of funds will be transferred from the Special Account to the project account, and a single payment will be made to the supplier. Bank funds will be mingled with counterpart funds for not more than one business day. In subsequent periods, the full cost of the Project will be budgeted by the General Secretariat and all payments will be made through the Treasury system. When a supplier payment falls due, the requisite amount of Bank funds, sitting in the Special Account, will be deposited in to an account 42

51 of the Treasury, and a single payment will be made to the supplier. Bank funds will be mingled with counterpart funds for not more than one business day. Staffing of the AccountinglFinance Function The TSU has an accountant/disbursement officer with several years of experience as a financial manager in both the commercial and non-profit sectors. The TSU is currently servicing the Health System Improvement Project. TSU capacity is adequate to manage the transactions of both the Health and the Pensions projects. As more projects become effective, resources are available to increase the capacity of the TSU. Accounting Policies and Procedures As part of the preparation for the Health project, an operations manual was prepared by the TSU and approved by the Bank. With only minor changes, this manual will describe the operations, procedures and policies in respect of the (PSAIP). The TSU will prepare project financial reports on the cash basis. Reporting and Monitoring The TSU will prepare financial monitoring reports (FMRs) on a quarterly basis. The FMRs will initially include: 0 Project Sources and Uses of Funds e Uses of Funds by Project Activity 0 Special Account Statement e Procurement report The first Financial Monitoring Report will be furnished to the IDA not later than 45 days after the end of the first calendar quarter after the Effective Date, and will cover the period from the Effective Date to the end of the first calendar quarter. Draft FMR formats have been agreed with the TSU and are included in the operations manual. Information Systems The TSU has installed an off-the-shelf accounting package, designed for small business users. This package runs under MS Windows XP, contains adequate user access controls and is capable of automatically generating FMRs2'. The same software is currently being used to manage the Health project and other Bank-financed projects in SAM, and a number of other agencies will be adopting it to manage forthcoming Bank-financed projects. With assistance from USAID and EAR, the Treasury department of the MOF of Montenegro has installed and is operating SAP (budget, treasury and general ledger modules). Initial discussions indicate that it would be possible to incorporate the Bank-financed Projects into SAP and for the 2o Procurement planning reports are not integrated - these will be maintained on a spreadsheet. 43

52 system to generate all reports required by the Bank (a number of programme budgeting pilots are currently running - the Bank-financed projects are analogous to identified programmes ). The Bank and the TSU will work with Treasury and its IT group to develop the Project reporting system, with a target implementation date of January 1, Until such time as the Bank and the Borrower are satisfied that the Treasury system is capable of producing reliable FMRs, the TSU will continue to maintain records in its existing system i.e. there will be a period of parallel operation. If, in the final analysis, it is not feasible to use the Treasury system to produce Project reports, the TSU will continue, throughout the life of the Project, to maintain accounts on its existing system. The Ministry of Finance of Montenegro would be responsible for initiating the move to reportbased disbursements. This would be done via a written request to the Association when the following criteria have been met: The Republic of Montenegro has established that report-based disbursement would be a more efficient mode of disbursement; The Republic of Montenegro has for at least two quarters provided the Association with accurate forecasts (plus/minus 10 percent) of quarterly disbursements, prior to moving to report-based disbursement; The Republic of Montenegro has provided timely and accurate quarterly financial monitoring reports for project expenditures in a format similar to that agreed in the Technical Services Unit Operations Manual for at least two quarters, prior to moving to report-based disbursement. Supervision Plan The project implementation progress reports will be monitored in detail during regular supervision missions. FMRs will be reviewed on a regular basis by the Belgrade-based FMS and any issues arising will be followed up promptly. The frequency of on-site FM supervision missions will be determined based on the Project s FM risk rating, which will be generated using the ECA s financial management risk model. Audited financial reports of the Project will be reviewed and identified issues followed up. External Audit The Director of the TSU will be responsible for ensuring that the project financial statements and the financial statements of the Pension and Disability Fund (Fund PIO) are audited by an independent auditor acceptable to the IDA, in accordance with standards on auditing that are acceptable to the IDA. TORS for the audit of the project financial statements, in accordance with International Standards on Auditing, are included in the operations manual, as is the list of auditors that have been unconditionally pre-qualified to audit IDA funded projects in SAM. The cost of the audit will be financed from the proceeds of the credit. The following chart identifies the audit reports that will be required to be submitted by the Borrower together with the due date for submission. 44

53 Audit Report Fund PI0 Project, SOE* and I Special Account or FMRs. if used as the basis for disbursement -Due Date Within five months of the end of each fiscal year Within five months of the end of each fiscal year and also at the closing of I the project The Directorate of Public Revenues, a beneficiary under the project, is audited as part of the annual audit of the consolidated Republican Budget. The audit is performed by an independent external audit firm. A copy of the audited consolidated budget report will be provided to the Bank Disbursement Arrangements The project is expected to be implemented over a period of four years, which includes six months for the completion of accounts and the submission of withdrawal applications. Disbursements from the IDA credit will initially follow the transaction-based method, Le., the traditional IDA procedures including reimbursements with full documentation, direct payments, SOE procedures and special commitments. It is anticipated that the project will migrate to report based disbursement during To facilitate timely project implementation, the MOF will establish, maintain and operate, under conditions acceptable to the Bank, a Special Account in Euro, in a bank acceptable to hold Special Accounts. An initial Special Account allocation of 80,000 will be established. The authorized allocation of the Special Account will be 170,000, once the aggregate disbursements of the Credit total SDR 410,000 or more. Replenishment applications should be submitted by the TSU monthly or when one third of the funds of the SA have been used, whichever occurs first, and must include reconciled bank statements as well as other appropriate supporting documents. Should the Project migrate to report based disbursement, the maximum balance that may be maintained on the Special Account will no longer be limited to the authorized allocation. Transfers from the Credit Account to the Special Account will be made on a quarterly basis, in accordance with the Borrower s (TSU s) forecast of expenditures to be made via the Special Account during the subsequent two quarters. Requests for replenishment will be supported by Expanded FMRs (regular FMRs plus a number of additional schedules) and copies of Special Account bank statements. The project will not migrate to report based disbursement until such time as the Bank is satisfied that the Borrower is able to produce Expanded FMRs and to accurately forecast expenditures. Retroactive Financing. Retroactive financing of up to SDRl80,OOO would be applied to expenditures made after June 1, 2004 for (a) consultant services for extending the functionality of tax and pension system; and (b) incremental operating cost related to local fees for a Project Coordinator. 45

54 Financial Covenants The Borrower is responsible for ensuring the maintenance of a satisfactory Project Financial Management System, including records and accounts, and for ensuring that financial statements are prepared in accordance with accounting standards satisfactory to the Bank. The Borrower is responsible for ensuring annual project accounts and audit reports are provided to the Bank within five months of each fiscal year (with the audit to be carried out by independent auditors in accordance with International Standards on Auditing, and TORS satisfactory to the Bank). The Borrower is responsible for ensuring that quarterly Financial Monitoring Reports (FMRs) are prepared, which will include, at a minimum: 0 A statement of sources and uses of funds for the Project showing year to date and cumulative amounts and explains variances between the actual and planned uses of such funds; 0 A statement of the Special Account, showing the opening balance, movements during the period and the closing balance; and 0 A statement of the status of procurement under the Project The first FMR will be furnished to the Association not later than forty-five (45) days after the end of the first calendar quarter after the Effective Date. 46

55 Annex 8: Procurement SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project General Procurement for the proposed project would be carried out in accordance with the World Bank s Guidelines: Procurement Under IBRD Loans and IDA Credits dated May 2004; and Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2004, and the provisions stipulated in the Legal Agreement. The general description of the Procurement Arrangement involving international competition are summarized in Table A For each contract to be financed by the Credit, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan in Table B. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Other procurement information, including capability of the implementing agency and the IDA S review process etc. is presented in Table B1 and Table B2. The project will be financed from the proceeds of the proposed US$5.0 million IDA credit and the local expenditure contributions from the Government of Montenegro (US$l.599 million). The total cost of the project would be US$6.556 million. 1. Procurement of Goods and Technical Services Goods and related technical services consisting of information systems/technologies, computer hard-wares would be grouped to the extent possible and considering project objectives, in package sizes that would encourage competitive bidding. The following methods of procurement would be followed: (9 (ii) International Competitive Bidding (ICB) procedures would be used for contracts above US$1 00,000 equivalent for the procurement of computer equipment, system software and technical services. Shopping. This procedure would be used for off-the-shelf goods such as office and computer equipment and technical services for public education campaign relating to pension reform, estimated to cost less than US$lOO,OOO per contract. Shopping, which requires to obtain three quotations, is used here because more competitive methods are not justified on the basis of cost or efficiency. The ECA Regional sample format for shopping Invitation to Quote available on the ECA Procurement Web Site will be applied. (iii) Direct Contracting (DC) would be used, subject to the Bank s prior approval, to procure spare parts or equipment of a proprietary nature. 47

56 2. Selection of Consulting Services Contracts shall be packaged for consulting services from firms and individuals required for increasing tax and contribution compliance, restructuring of pension fund system, strengthening capacity for pension policies and project management, etc. Short lists of consultants for services estimated to cost less than US$lOO,OOO equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. The following methods of procurement would be followed: Quality and Cost-based Selection (QCBS) procedures would be used for contracting consulting services for extending the functionality of the tax and pension systems. Consultant Qualification procedures would be used for contracting most qualified firms for public education campaign relating to pension reform and training (workshop) under us$loo,ooo. Least Cost Selection procedures would be used for auditing services contracts for annual audit throughout the life of the project. Individual Consultants would be hired in accordance with Section V of the Guidelines. Individual consultants would be hired for small assignments of short-term duration for consulting services related to tax and pension policy restructuring and capacity building. Single Source procedures would be used for direct contracting very specialized, low value contracts in the areas of pension reform. Expenses for the study tours under the project related to the project will be covered under training category and disbursed based on SOE. Incremental Operating Costs The operating costs, which would be financed by the project, would be procured using the implementation agency's administrative procedures which were reviewed and found acceptable by the IDA. 5. Notification of Business Opportunities A General Procurement Notice (GPN) would be published in the UN "Development Business'' on -line (UNDBonline) and in the Development Gateway's dgmarket around the period of Credit Negotiation. For ICB goods contracts and large-value consultants contracts (more than US$200,000), Specific Procurement Notice would be advertised in the Development Business on-line (UNDBonline) and in the Development Gateway's dgmarket and national press, and in the case of NCB, in a major local newspaper (in the national language). 48

57 6. Review by the IDA of Procurement Plan Procurement Plan. The Borrower, at appraisal, developed a Procurement Plan for project implementation which provides the basis for the procurement methods. This plan has been agreed between the Borrower and the Project Team on April 25,2004 and is available at the TSU office. It will also be available in the Project's database and in the Bank's external website. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Procurement of goods and services for the project would be carried out in accordance with the agreed procurement plan in Table B. 7. 0) (ii) Prior Review Goods and Technical Services: Prior review of bidding documents, including review of evaluation, recommendation of award and contract would be conducted for all ICB and DC. Consulting Services: Requests for Proposal (RFP), short lists, terms of condition of contracts as well as evaluation reports and recommendation for award would be prior reviewed by IDA for contracts for individual consultants above US$25,000 and firms above US$50,000. All documents and recommendations involving single source for firms and sole source for individual consultant contracting would be subject to IDA prior review. Terms of reference for consulting assignments may be reviewed by the Project Team. After award of contracts, should any material modifications or waiver of terms and conditions of a contract resulting in an increase or decrease above 15 percent of the original amount, IDA would undertake a prior review of such modifications (including modifications to contracts for consulting services). 8. Custom Duties and Taxes All custom duties and taxes for goods specifically imported for the project and for all technical assistance would be financed by the Borrower. 9. Assessment of the Agency's Capacity to Implement Procurement Overall responsibility for project coordination would rest with the Project Coordinator under the Office of Deputy Prime Minister. The Project Coordinator would be supported by the central Technical Services Unit (TSU) consisting o f Head, Procurement Specialist and Accountant. An assessment of the capacity of the TSU has been carried out by Yingwei Wu in December The assessment reviewed the organizational structure for implementing the project and the interaction between the TSU and the line ministries. This report indicates "High" risk based on the fact that TSU has little experience with World Bank procurement, and the procurement staff 49

58 hired in TSU is untrained and unfamiliar with World Bank procurement practices. The capacity of the TSU without outside support and immediate training would be inadequate to handle the procurement activities workload under the project. Therefore, procurement training plan and hiring of an international procurement advisor are recommended to assist in building procurement capacity for the project. Most of the issues/ risks concerning the procurement for implementation of the project have been identified. FWPs and bidding documents for the first year of project implementation are being prepared and ICB for procurement of computer equipment and system software as shown in Table A1 would be ready prior to the negotiation. RFPs under two QCBS packages in Table A2 would not be feasible for the borrower to develop before Board presentation for many reasons. It is assessed that the Client does not have the necessary level of technical knowledge and experience to produce the detailed specification needed for the terms of reference for a complex application development. This will have to be created by the individual consultant assignment planned under retroactive financing in the procurement plan in Table By which will last for a minimum of three months. Based on assessment of the capacity for procurement administration of the project, the following Action Plan to strengthen the procurement administration capacity of the TSU and the Project Coordinator is recommended: An international procurement advisor hired under the funding of the PHRD for Montenegro Health System Improvement Project, shall assist the Project Coordinator and the TSU in undertaking tasks under this project, for logistical planning, development of procurement plans, training plan, and preparation of operating procedures and standard bidding documents for procurement activity. The Project Coordinator and the TSU Head and Procurement Specialist would be given the opportunity to receive on-job training on Bank procurement by the international procurement advisor and at Bank s regional procurement workshop. Initiating a Project Launch Workshop in September 2004 before the credit effectiveness, as part of the project implementatiodcapacity building initiatives, especially in procurement. The project would be subject to the intensified supervision by the Bank. During the first year of project implementation, there would be at least two supervision missions. Periodic ex-post review by the Bank of 1 in 5 contracts during the supervision missions. Overall Procurement Risk Assessment: High 50

59 ~~ ~ ~ Table A. Procurement Arrangement Involving International Competitive Bidding 1. Goods. 1 Ref. No. MPSAIP (a) List of contract Packages which will be procured following ICB : Contract Estimated Procure P-Q Domestic (Description) cost ment Preference (US% Method (yeslno) I Computer 1 Equipment& 1 Svstem ICB 1 N.A. 1 No. 7 Review by Bank (Prior I Post) Prior 819/ 1 1 Ex;ed Comments Y-i Opening April Consulting Services. (a) List of Consulting Assignments with short-list of international firms. 1 Ref. No. MPSAIP (1)- 1 MPSAIP(~) Estimated Selection Cost Method Description of Assign men t Software development for extending hnctionality of I Software development for extending hnctionality of pension system (US% (Prior I Submission Post) Prior I Nov-04 [ 0.52 I QCBS I I I I 51

60 ~ uva ls31ql NOU31dW03/AUUlIl30 OLtVfllVA3 NId IO4 NOU33PBO-ON anq ls3fl031 IOUQ3l~llQllOlNOLQlllQN H NOU33MOON PUS 1S3n03L UVa NOUQl/IV\NI t130n31 3lOflO 01 NOUQllMV300 ON1~~1E'ddY'b01'SlS.U~OHS no. 3iva a3nona.a 3lOllO 01 NOUVlIANV30a ONlaalB'ddU' tlol'slslunohs BZllQNId flsl M3uUY 1SOdRlOlYd aoh13w ln383tlfl30yd :ln3nodw038fls 01 33N3Y3d3> 'SON Ed1 3OW3Qd 3003 NOUV31dUN3al

61

62

63 Table B1: Thresholds for Procurement Methods and Prior Review Expenditure Category 1. Goods 2, Services by f m s 3. Services by individuals Contracts Subject to Contract Value Threshold Procurement Prior Review (US$) Method (US$ millions) Over 100,000 ICB 2.62 less than 100,000 Shopping 0.15 Over 50, less than 50, Over 25, less than 25, Table B2: Procurement and Technical Assistance Requirements Ex-post Review Section 1: Ex-post review mechanism: Review carried out in accordance with Para. 4 of Appendix 1 of the Bank s Guidelines and reviews during supervision missions. Frequency of procurement supervision missions proposed: One every six months and once a year during subsequent years (includes special procurement supervision for post-review) Section 2: Training, Information and Development on Procurement Estimated date of Project Launch Workshop: September 2004 Estimated date of publication of General Procurement Notice: May 2004 Indicate if there is procurement subject to mandatory SPN in Development Business: Yes Domestic Preference for Goods: No. Domestic Preference for Works, if applicable: No Retroactive financing: Yes. Advance procurement: Yes. For six individual contracts at an estimate of total US$260,000. Explain briefly the Procurement Monitoring System: All procurement related documentation that requires IDA s prior review would be cleared by Procurement Accredited Staff (PAS) and relevant technical staff. Packages above mandatory review thresholds would be reviewed by the RPA. The TSU of the Borrower would maintain complete procurement files, especially for the contracts subject to Post-review, which would be reviewed by IDA s supervision missions. The Procurement Plan would be updated annually. Procurement information would be recorded by the Project Coordinator and submitted to the IDA as part of the quarterly and annual progress reports. This information would include: revised cost estimates for the different contracts; revised timing of procurement actions, including advertising, bidding, contract award, and completion time for individual contracts. A Management Information System (MIS), with a procurement module would help the TSU monitor all procurement information. Co-financing: No Section 3: Procurement Staffing Indicate name of Procurement Staff or Bank s staff part of Task Team responsible for the procurement in the Project: Name: Yingwei Wu Ext: Explain briefly the expected role of the Field Office in Procurement: N.A. 55

64 Annex 9: Economic and Financial Analysis SERBIA AND MONTENEGRO: Montenegro Pensions System Administration Investment Project Forecasts of the Pension System (a) Impact of Reform on the PIO s Budget The impact of the new reforms (as introduced under the new laws introduced in September 2003, and effective since January 2004) on the Fund PIO s budget is presented in the table below. The results are presented in three separate reform layers, to provide a sense of the relative importance of each of the three primary reform measures. Impact of Reform on PIO s Budget (Values presented as % of GDP) 22 Section A of the table shows the gap between contributions and expenditures, and Section B shows contributions plus the transfer for official Budget obligations, minus expenditures. Thus, the values in section B represent the projected deficits of the pension system. In the no reform scenario, these deficits would have grown to more than 10 percent of GDP by If the retirement ages are increased by 5 years, the deficits will grow to 7 percent of GDP. If, in addition to the retirement age increase, pensions are indexed at half the rate of wage growth plus half the ratio of inflation, the deficit will grow to about 4.5 percent of GDP. Finally, if the full reform package as has been adopted, the long-run deficit will be about 2 percent of GDP. 21 Drawn from An Analysis Of The Impact Of The Proposed Pension Reform Upon PI0 and Upon Individuals, April 7,2003, by Patrick Weise. 22 Drawn from An Analysis Of The Impact Of The Proposed Pension Reform Upon PI0 and Upon Individuals, April 7, 2003, by Patrick Weise. 56

65 The forecasts of the preceding table are based on the assumption that real wages will grow at a steady rate of 2.5 percent per year. Faster economic growth would generate stronger fiscal results, while weaker economic growth would generate less favorable fiscal results. Below, comparison is made of fiscal forecasts under three different sets of assumptions: real wage growth of 1.5 percent (pessimistic), real wage growth of 2.5 percent (base case), and real wage growth of 3.5 percent (optimistic). For the sake of simplicity, only the results for the full reform package are shown (rather than for each separate layer of reform), and only the deficits of the pension system (which are equal to contributions plus the 1.9 percent of GDP transfer, minus expenditures). Forecast Scenarios for the Pension System Under the pessimistic scenario, the system runs long run deficits of nearly 3 percent of GDP. Under the optimistic scenario, long run deficits are merely 1.3 percent of GDP. Under the pessimistic scenario, a transition to a two-pillar system would be very challenging, because the temporary surpluses are not large. The introduction of a second pillar could easily consume these small surpluses, possibly driving the system into deficit. In contrast, under the optimistic scenario, a transition to a two-pillar system could be well within reach. The following assumptions were used for forecasting the impact of reforms: The costs of providing care for disabled and blind persons will decline gradually, over the next 25 years, from 0.22 percent of GDP to 0.0 percent of GDP. A decline to zero is inevitable because the reform prohibits the award of new benefits of this type. The cost of benefits for bodily injury will remain fixed at 0.15 percent of GDP. Annual benefits for funeral costs will equal 1.3 percent of annual pension expenditures. Wage subsidies for persons with shortened working hours or persons waiting for reemployment will decline from 0.15 percent of GDP to 0.0 percent of GDP over the next 10 years. A decline to zero is inevitable because the reform prohibits the award of new benefits of this type. The cost of rehabilitation, cultural programs, and accommodation for pensioners will drop from 0.15 percent of GDP in 2003 to 0 percent of GDP in 2004, because the law will eliminate these benefits. Pension delivery costs will decline from 0.23 percent of GDP to 0.13 percent of GDP over the next 5 years, as efforts are made to improve efficiency. PI0 labor costs will remain fixed at 0.23 percent of GDP, and supply costs will remain fixed at 0.21 percent of GDP. The budget transfer for expenditures that are an obligation of the budget is assumed to remain fixed at 1.94 percent of GDP. 57

66 (b) Impact of the Reform on the Level of Pensions Pensions of the current stock of pensioners will rise in real terms in the future. Under the new reforms, pensions rise at the rate of nominal wage growth plus half the rate of inflation. To illustrate the impact of reform, let us assume that inflation is 3 percent per year and wage growth is 6 percent per year. A pensioner who currently receives a pension of 100 Euros would receive the following stream of pensions in the future: Example of Pension Growth for a Current Pensioner Note that under the new law, the pension continues to grow in real terms. Thus, purchasing power for the stock of current pensioners will increase over time. Pensions for future retirees will probably remain fairly constant in real terms for about ten years, and then begin to rise. During the next decade, the expansion of the earnings period from 10 to 40 years will have a downward impact on pensions for new pensioners. However, this downward force will be counterbalanced by the indexation of the point, which will increase in value at half the rate of inflation plus half the rate of wage growth. An example based on inflation of 3 percent and wage growth of 6 percent is presented in the table below. The first entry in the table is 100 Euros, for 2003, which roughly corresponds to the pension that an average worker would receive for 25 years of service. Comparison of Pensions of Stock of Pensioners with Pensions of Future Retirees The reform is likely to result in a slight, short-term decline in the real value of pensions for new retirees, while the stock of existing pensioners will experience a rise in the value of their pensions. Thus, today s pensioners are treated more favorably than future retirees. This is a consequence of the switch from a 1 0-year earnings period to a 40-year earnings period. 58

67 (c) Impact of Pension Reform on the overall Fiscal Balance of the Pension System Looking at stocks rather than flows, the overall NPV of the system (all pension-related revenues minus pension-related expenditures) should move in a positive direction as a result of reforms. The following table shows how the overall fiscal balance of the pension system is affected by reform. The table gives stock numbers, expressed in present value terms. NPV using GDP growth as the Discount Rate 1. Reformed Mono-Pil1arz4 4% NPV using CPI plus 5% as the Discount Rate 9% The table shows two sets of NPVs. The first set is calculated using GDP growth as the discount rate. This methodology gives equal weighting to all future cash flows as a percentage of GDP. This methodology yields NPVs that can easily be converted into average annual cash flows. For example, if the NPV of revenues minus expenditures is negative 300 percent of GDP over a 100- year period, this implies an average annual deficit of 3 percent of GDP (300/100=3). The second set of NPVs was calculated using inflation plus 5 percent as the discount rate. This methodology is the standard approach, and gives more weight to cash flows in the immediate future than to cash flows in the distant future. Cost Benefit Analvsis The following direct benefits flow from the project: (i) an improved consolidated budget fiscal balance through pension reform, (ii) improved tax compliance, (iii) improved services to beneficiaries, (iv) improved services to payers, and (v) reduced administrative costs. It is easier to identify the benefits from the project, however, than to develop estimates of the quantitative importance of each of them. Ultimately, the greatest benefit of the project will be the ability to tighten the administration both on the collections and on the payments side. This project will support that result through the development of a client database of personalized accounts, which is crucial to the administration of the reform. How this project affects the extent of the sustainability of the pension system - the ultimate goal of these reforms, cannot be calculated, without separating the effects of the real economy versus the gains through administrative tightening. And, of course, it would be difficult to estimate these benefits with and without the project, but presumably better technical 23 The term T-Bills refers only to those T-bills that are purchased using contributions to the second pillar. Such T- bills are used specifically to finance the introduction of the second pillar and are hence an important component of ension-related revenues and expenditures. A hypothetical second pillar with a 6 percent contribution rate, would help reduce the Government s financing burden even more, leading to NPV s of 9 percent and -14 percent under the two scenarios respectively. 59