FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION AND RESULTS REPORT (LOAN NO 7829-MK, GRANT NO TF096329) FOR

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No: ICR IMPLEMENTATION COMPLETION AND RESULTS REPORT (LOAN NO 7829-MK, GRANT NO TF096329) FOR THE FIRST PROGRAMMATIC DEVELOPMENT POLICY LOAN IN A TOTAL AMOUNT OF EUR 20.5 MILLION (US $30 MILLION EQUIVALENT) TO THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA JUNE Poverty Reduction and Economic Management (ECSP2) South East Europe country Unit (ECCU4) Europe and Central Asia (ECA)

2 GOVERNMENT FISCAL YEAR January 1-December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of June 30, 2011) Currency Unit = Macedonian Denar (MKD) US$1 = MKD 43.2 Weights and Measures: Metric system ABBREVIATIONS AND ACRONYMS BBP CB CCT CEM CFAA CFAA CPAR CPS DIF DPL DRG EBF EBRD ECA ECB ESW FDI FSAP GDP GoRM HBS HCI HIF IBRD ICRR IFC IMF Basic Benefits Package Cash Benefits Conditional Cash Transfers Country Economic Memorandum Country Financial Accountability Assessment Country Financial Accountability Assessment Country Procurement Assessment Report Country Partnership Strategy Deposit Insurance Fund Development Policy Loan Diagnosis-Related Group Extra Budgetary Fund European Bank for Reconstruction and Development Europe and Central Asia Region European Central Bank Economic and Sector Work Foreign Direct Investment Financial Sector Assessment Program Gross Domestic Product Government of the Republic of Macedonia Household Budget Survey Health Care Institution Health Insurance Fund International Bank for Reconstruction and Development Implementation Completion and Results Report International Finance Corporation International Monetary Fund IPA ISA LDP LFS MLSP MOF MOH MoU NATO NBRM NPL NTR OECD PBG PDIF PCL PDO PER PIT PRO SAO SIC SP SPIL SRA SWC TSA TA TF VAT Instrument for Pre-Accession Insurance Supervision Agency Letter of Development Policy Labor Force Survey Ministry of Labor and Social Policy Ministry of Finance Ministry of Health Memorandum of Understanding North Atlantic Treaty Organization National Bank of the Republic of Macedonia Non-Performing Loan Non-Tax Revenues Organization for Economic Cooperation and Development Policy Based Guarantee Pension and Disability Insurance Fund Precautionary Credit Line Program Development Objective Public Expenditure Review Personal Income Tax Public Revenues Office State Audit Office Social Insurance Contribution Rate Social Protection Social Protection and Implementation Loan Special Revenue Accounts Social Welfare Center Treasury Single Account Technical Assistance Trust Fund Value Added Tax Vice President: Country Director: Sector Director: Sector Manager: Task Team Leaders: ICRR Team Leader Philippe H. Le Houerou, ECAVP Jane Armitage, ECCU4 Yvonne M. Tsikata, ECSPE Satu Kahkonen, ECSP2 Evgenij Najdov/Marina Wes, ECSP2 Evgenij Najdov, ECSP2

3 THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA FIRST PROGRAMMATIC DEVELOPMENT POLICY LOAN (Loan No 7829-MK Grant No TF ) CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring 1. Program Context, Development Objectives and Design Key Factors Affecting Implementation and Outcomes Assessment of Outcomes Assessment of Risk to Development Outcome Assessment of Bank and Borrower Performance Lessons Learned Comments on Issues Raised by Borrower/Implementing Agencies/Partners Annex 1: Bank Lending and Implementation Support/Supervision Processes Annex 2: Beneficiary Survey Results (if any) Annex 3: Stakeholder Workshop Report and Results (if any) Annex 4: Summary of Borrower s ICR and/or Comments on Draft ICR Annex 5: Comments of Co financiers and Other Partners/Stakeholders Annex 6: List of persons interviewed MAP

4 DATA SHEET A. Basic Information First Programmatic Development Policy Loan 7289-MK Country: FYR Macedonia Program ID: P ICRR Date: June 30, 2011 Lending Instrument: DPL Original Total Commitment: EUR 20.5 Million Program Name: First Programmatic Development Policy Loan L/C/TF Number(s): IBRD-7829MK; TF ICR Type: Core ICR Borrower: The Former Yugoslav Republic of Macedonia Disbursed Amount: EUR 20.5 Million Implementing Agency: Ministry of Finance Co-financiers and Other External Partners: Co-financed (EUR 7 million) by the Netherlands Trust Fund with the Bank acting as administrator. B. Key Dates First Programmatic Development Policy Loan 7289-MK Process Date Process Original Date Revised/Actual Date(s) Concept Review: September 17, 2009 Effectiveness: April 1, 2010 April 1, 2010 Appraisal: October 14, 2009 Restructuring(s): NA NA Approval: December 15, 2009 Mid-term Review: NA NA Closing: December 31, 2010 December 31, 2010 C. Ratings Summary1 C.1 Performance Rating by ICR Outcome: Risk to Development Outcome: Bank Performance: Borrower Performance: Satisfactory Moderate Satisfactory Satisfactory 1 All ratings given by the ICR should use a six-point rating scale (Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, or Highly Unsatisfactory), except for the rating of Risk to Development Outcome that use a four-point scale (Negligible to Low, Moderate, Significant, High). i

5 C.2 Detailed ratings of Bank and Borrower Performance (by ICR) First Programmatic Development Policy Loan 7289-MK Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Satisfactory Quality of Supervision: Satisfactory Implementation Agency/Agencies: Satisfactory Overall Bank Performance: Satisfactory Overall Borrower Performance: Satisfactory C.3 Quality at Entry and Implementation Performance Indicators First Programmatic Development Policy Loan 7289-MK Implementation Performance Indicators QAG Assessments (if any) Rating Potential Prob. Program at any time (Yes/No): No Quality at Entry (QEA): Problem Program at any time(yes/no): No Quality of Supervision (QSA): DO rating before Closing/Inactive status: Implementation Performance Potential Prob. Program at any time (Yes/No): No QAG Assessments (if any) Quality at Entry (QEA): Problem Program at any time(yes/no): No Quality of Supervision (QSA): DO rating before Closing/Inactive status: D. Sector and Theme Codes Satisfactory First Programmatic Development Policy Loan 7289-MK Sector Name code and % of Bank Financing Sector name Code Original Actual Central Government Administration BC Other Social Services JB Comp Pension/Unemployment BE Health JA Theme name Public Expenditure Financial Management and Procurement Social Safety Nets Tax Policy and Administration Health System Performance Other Economic Management ii

6 E. Bank Staff Positions At ICR At Approval Vice President: Philippe H Le Houerou Philippe H Le Houerou Country Director: Jane Armitage Jane Armitage Sector Director: Yvonne M. Tsikata Luca Barbone Sector Manager: Satu Kahkonen Bernard Funck TTL: Evgenij Najdov Evgenij Najdov/Marina Wes ICRR Team Leader: ICRR Primary Author F. Results Framework Analysis Evgenij Najdov Sudhir Chitale Program Development Objective: The First Development Policy Loan (DPL1) was envisaged as the first of a two-loan series, designed to achieve the following three objectives: (i) ensure the budget supports macroeconomic stability by improving public expenditure outcomes; (ii) ensure adequate support to vulnerable groups by reforming the social safety net and improving its administration; and (iii) ensure systemic risks in the banking sector are identified timely and corrective action is undertaken by strengthening the resilience of the sector. During the preparation of the second operation, DPL2, the authorities requested a Policy Based Guarantee (PBG) rather than a loan (see Section 2.4 for a discussion of the reasons). In line with the Bank s policies on DPL lending and guarantees, the DPL series was terminated after DPL1 (April 2011), and the DPL2 was converted to a stand-alone PBG operation, with largely the same policy matrix as originally envisaged under the DPL2. Since the DPL series was terminated, as per Bank guidelines, this Implementation Completion and Results Report (ICRR) was prepared for the DPL1. The progress towards the specific development objectives measured by the results indicators and benchmarks set in the Program Document (PD) for the DPL1 is presented below. Wherever needed, the results matrix recognizes that since the DPL1 was the first of a two-operation series, many of the results indicators were set to be met only after completion of reforms implemented under the combined program envisaged for DPL1 and DPL2 (now PBG). iii

7 (a) PDO Indicators Note: Detailed PDO indicators are presented in Table 6: DPL1 Results Matrix in the main text of the ICR. (b) Intermediate Outcome Indicators: Not applicable G. Ratings of Program Performance in ISRs Not applicable. There was no ISR for DPL1. Supervision was undertaken as part of the preparation of the follow-up operation (previously DPL2 now PBG). H. Restructuring Not applicable iv

8 1. Program Context, Development Objectives and Design 1.1 Context at Appraisal The First Programmatic Development Policy Loan (DPL1) was requested by the Government when the international economic crisis brought to a halt the acceleration of economic activity in the former Yugoslav Republic (FYR) of Macedonia in the second half of As the crisis spread through the region, FYR Macedonia faced a sharp fall in the demand for and prices of its main exports and a fall in FDI flows. Consequently, following growth rates of close to 6 percent in 2007 and the first three quarters of 2008, real GDP fell by 0.9 percent in In 2009, exports dropped sharply by nearly 11 percent, industrial production dropped by 8 percent, FDI declined by nearly 70 percent from US$ 600 million to US$ 186 million, business confidence fell 2, financing conditions became tighter and labor market performance deteriorated. Fiscal accounts were also adversely affected. Tax revenues fell sharply by nearly 2 percentage points of GDP over Finally, there was great uncertainty about the intensity of the crisis and how long it would last. Strong reforms and prudent macroeconomic policies in years prior to the crisis provided some buffers against the immediate impact of the crisis. Still, policies had to be adjusted considerably. Furthermore, any effort to address the macroeconomic crisis had to go hand in hand with policies to protect the poor. Poverty was persistent and did not decline significantly even during the high growth period before the crisis 3. Moreover, although on a declining trend, unemployment was high at 34 percent of the labor force in Most of the jobs created during the robust growth phase prior to the crisis were low paid jobs or unpaid family work and did not contribute to poverty reduction. As a result, FYR Macedonia was experiencing a growing number of working poor. The authorities proactively responded to the crisis to stem the fall in output. In response to a collapse in exports, industrial production, FDI, and the general decline in business confidence, the Government carried out a sizable fiscal stimulus in late 2008 and in early In addition, a moratorium on tax and interest liabilities was introduced to help businesses facing liquidity shortages, customs duties were reduced and a multiyear infrastructure program was announced. However, by April 2009, it was becoming evident that tax revenue outturns were lower than projected earlier. In response, the Government cut expenditures to match the projected shortfall in tax revenues of almost 3.2 percent of GDP. It introduced two supplementary budgets in April and October These measures helped preserved the fiscal deficit target of 2.8 percent of GDP in The expenditure restructuring was achieved by: lowering spending on less productive capital investments, lowering goods and services spending, and a freeze on public sector wages and employment. At the same time, the Government was careful to maintain allocations for the well targeted social transfers to protect the poor and reduce social insurance 2 The assessment of the current situation by businesses began to decline rapidly in early 2009 and by November 2009 it fell to -18.4, compared to the high of 12 in August The assessment fell further to by March 2010, before beginning to recover. 3 Regional experience indicates that poverty responds to growth but generally with a lag. Furthermore, this coincided with the 2008 surge in world oil and food prices which off-set the impact of higher employment and wages. 1

9 contributions to help employment and competitiveness. This fiscal strategy was continued in the 2010 budget which targeted a fiscal deficit of 2.5 percent of GDP. Despite the increase in fiscal deficits to 2.8 and 2.5 percent of GDP in 2009 and 2010, respectively, from less than 1 percent in 2008, and small surpluses before that, FYR Macedonia still had one of the lowest fiscal deficits in Europe and Central Asia (ECA). As per the most recent debt sustainability analysis which envisages a gradual reduction in the deficit level over the medium-term to around 1 percent of GDP, FYR Macedonia s fiscal deficit remains in line with sustainable long-term solvency indicators and available financing. As a result of the prudent regulation and supervision in the period before the crisis, FYR Macedonia entered the crisis with a resilient banking sector. The capital adequacy ratio was high, non performing assets were falling 4 and were adequately provisioned, and the liquidity across the sector was high. The commercial banks were largely financed by domestic deposits and as a result, an abrupt credit crunch was avoided. Hence the focus of Government polices was on creating a responsive crisis resolution framework rather than specific measures to manage the financial sector. The Bank was well placed to quickly assist the Government in responding to the crisis through the DPL1. First, the Bank had already worked closely with the Government through a series of three budget support operations over ; the Programmatic Development Policy Loans (PDPL 1, 2 and 3) for a total of US$ 85 million 5. In addition the Bank was also engaged in implementing a Conditional Cash Transfer (CCT) Loan and a Social Protection Implementation Loan (SPIL), both of which supported the reform of the social safety net. Second, the Bank had carried out considerable analytical work (including a Country Economic Memorandum, Public Expenditure Review, Poverty Assessment, a set of Labor Market Policy Notes, Financial Sector Assessment Program Report etc.) which informed the next phase of reforms pursued by the government in addressing the crisis. Drawing on this work, the Bank was well-placed to quickly prepare a policy note in 2009, which specifically analyzed the crisis and outlined reform priorities. These formed the basis of the program supported by the DPL1. The DPL1 was approved in December 2009 on the basis of prior actions implemented during the course of The Loan Agreement with the Bank was signed in March The operation was declared effective and the Euro 20.5 million loan amount was withdrawn in a single tranche on April 20, The Bank s operation was co-financed by a Euro 7 million grant provided by the Government of Netherlands. The Administration Agreement between the Bank and the Donor was signed in December 2009 followed by the signing of the Grant Agreement between the Bank and FYR Macedonia in March 2010 and disbursement of the funds in April As mentioned before, the DPL1 was envisaged as the first of the two development policy lending operations which were to be executed sequentially in 2009 and The operation was designed: (i) to help the Government maintain a sound macroeconomic and fiscal framework, while implementing measures to improve public expenditure outcomes and to improve competitiveness; (ii) to cushion the impact of the crisis on the poor and vulnerable; and (iii) to 4 Non-performing loans were 6.5 percent of all loans by the third quarter of 2008 down from 7.5 percent at the end of 2007 and historically the lowest level registered. 5 Prior to the PDPL series the Bank had supported the Government s reform program in the Public sector through the Public Sector Management Adjustment Credit and Loan (PSMAC and PSMAL). 2

10 strengthen the resilience of the financial sector. It focused on three policy areas and contained six prior actions and six benchmarks. However, since it was the first of a two operation series, many of the results indicators in the Program Document (PD) were set to be met only after completion of the entire program (including reforms to be implemented under DPL2). However, during the preparation of the DPL2, the authorities requested a Policy Based Guarantee (PBG) rather than a loan. In line with the Bank s policies on DPL lending and guarantees, the DPL series was terminated after DPL1 (April 2011), and DPL2 was converted to a stand-alone PBG operation, with largely the same policy matrix as originally envisaged under the DPL2. Since the DPL series was terminated, as per Bank guidelines this ICRR was prepared for the DPL1. The DPL series of loans is an important component of the Banks Country Partnership Strategy (CPS) and was identified in the March 2009 CPS Progress Report. The DPL1 operation contributed to the following CPS outcomes: (i) labor market: increasing flexibility of labor market outcomes and decreasing the tax wedge; (ii) health: improving the efficiency and transparency of Health Insurance Fund Operations; and (iii) social protection: improving administration and targeting of cash benefits and strengthen the pension system. The Bank maintains a close working relationship with the IMF resulting in largely shared views on the economic situation. The IMF provided an assessment letter to the Bank 6 endorsing the Government s macroeconomic policies, which was attached to the Program Document of the Operation. Since then, on the grounds of the country s sound macroeconomic fundamentals (including a moderate fiscal stance and adequate monetary policy), limited balance of payments needs and generally favorable economic prospects; the IMF Board approved a Euro million Precautionary Line of Credit (PCL) in January The PCL was originally approved as an insurance mechanism in case of an unexpected balance of payment shock. Since then, however, the Government decided that the 2011 budget deficit is best financed by external resources to avoid crowding out domestic credit to the private sector; however, the authorities also faced constraints accessing the capital markets 7. Consequently in early 2011, the Government withdrew Euro 220 million from the Euro million available under the PCL. The Bank has maintained a robust dialogue with the donor community on issues related to the DPL. The Bank team benefitted from regular consultation with the IMF, the USAID and the European Commission (EC). Finally, the DPL1 was co-financed by the Dutch Government. In addition to the budget support, the Dutch also provided technical assistance (TA) funds to finance analytical work, including in the health and financial sectors. 1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved): The Government s program supported by the DPL1 had three development objectives. The measures implemented to achieve these and the performance indicators, as presented in the PD and in the legal documents, were grouped under three pillars as indicated below: 6 The letter was attached to the PD. 7 Financial turmoil in selected Eurozone countries kept borrowing costs high and access limited. In addition, the declaration of early elections for June 5, 2011, prevented the authorities from incurring new debt. 3

11 Pillar 1 The budget supports macroeconomic stability. This was to be achieved by implementing an overall fiscal policy stance supportive of macroeconomic stability as well as by implementing measures to improve public expenditure outcomes. The key performance indicators for this PDO were: Government approval of the draft budget for 2010 with a target budget deficit of 2.5 percent of GDP. Implement first stage of tax reform by reducing social insurance contributions from 32.5 percent of gross wage in 2008 to 28.4 percent in Government approval of draft amendments to the Law on Health Insurance to establish a treasury function for the public health sector within the Health Insurance Fund. Freeze nominal wage and employment for the employees funded from the central government budget, at least throughout Pillar 2 Ensure adequate support to vulnerable groups and improve administration of social safety system. This was to be achieved by reforming the social safety net and improving its administration. The key performance indicators for this PDO were: Levels of spending for social protection maintained at the level set forth by the original 2009 budget in all its subsequent supplementary budgets adopted for this year. Enact new Law on Social Protection to establish a framework to improve the regulation of cash benefits, to streamline the procedures for the administration of social safety net programs and enable further harmonization of the said programs and to enable rapid response to crisis. Pillar 3 Systemic risks are identified timely and corrective action is undertaken. This was to be achieved by strengthening the resilience of the financial sector. The key performance indicator for this PDO was: Endorsement of an MOU on crisis preparedness outlining key responsibilities and coordination mechanisms is obtained from all stakeholders. 1.3 Revised PDOs and Key Indicators There were no revisions. 1.4 Original Policy Areas Supported by the Program (as approved) The policy areas supported by the DPL1 were grouped into three pillars as shown below. Each of these policy areas contained measures which constituted prior actions for DPL1 as per legal documents as well as benchmarks to measure progress of the reform program. Since DPL1 was a one tranche operation, from a strictly legal point of view, all prior actions were met before the 4

12 loan was submitted to the Board (see Table 1). In addition, as indicated in Table 1, all the benchmarks for DPL1 set in the PD have also been met. As originally designed, the DPL1 was the first of two lending operations. Hence the measures implemented under the DPL1 were the first cut of a program that continued to be implemented and forms a basis for the Policy Based Guarantee (PBG) operation currently under preparation. The impact of the measures implemented under the DPL1 and their follow up is discussed in Section 3.2, on achievement of program development objectives. Table 1: Policy Areas, Prior Actions and Benchmarks Supported by the DPL1 Policy Areas supported by DL1 Prior Actions as per the Program Document Benchmarks as per the Program Document Pillar 1 Implement budgetary policies to support macroeconomic stability by improving public expenditure outcomes. Approve a draft budget for 2010 with a deficit of 2.5 percent of GDP. (Met) Implement the 2009 Budget in line with the deficit target stipulated in the second supplementary budget. (Met) Establish Inter-Ministerial committee on public administration. (Met) Pillar 2 Ensure adequate support to vulnerable groups by reforming the social safety net and improving its administration. Implement the first stage of payroll tax reform by reducing the social insurance contributions from 32.5 percent of GDP in 2008 to 28.4 percent of GDP in (Met) Approve draft amendments to the Health Insurance Law which establish a treasury function for the public health sector within the Health Insurance Fund. (Met) Freeze nominal wages and employment for employees funded from the Central Government Budget throughout (Met) Maintain levels of spending for social protection at levels set forth in the original 2009 budget in all its subsequent Supplementary Budgets adopted during (Met) Enact a new law on social protection to establish a framework to improve the regulation of cash benefits, streamline the procedures for the administration of social safety net programs and enable further harmonization of the said programs to enable rapid response to crisis. (Met) Initiate analysis of the impact of labor taxation reforms on the sustainability of the pension system. (Met) Amend Pension and Disability Insurance Law to improve the current sustainability of the PAYG system (reduce indexation coefficient from 50:50 CPI: Wages; to 50:20 in 2009). (Met) Initiate an analysis of the impact of labor taxation reforms on the sustainability of the health system. (Met) Pillar 3 Enable timely identification of systemic risks and undertake corrective action by strengthening the resilience of the financial sector. Source: DPL1, Program Document. Obtain an endorsement from all stakeholders of a MOU on crisis preparedness, outlining key responsibilities and coordination mechanisms. (Met) 5

13 1.5 Revised Policy Areas: Not applicable 1.6 Other significant changes: Not applicable 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance: The full amount of the DPL1 (Euro 20.5 million) was disbursed in a single tranche on April 20, The Dutch Government co-financing of Euro 7 million was also disbursed in a single tranche at the same time. The program supported by the DPL1(see Table 1 above) contained six prior actions and six benchmarks focusing on three policy areas. It was implemented timely and effectively reflecting the Government s commitment to the program as well as the Bank s ability to rapidly respond to the request of the client by providing sound policy advice and financing as well as leveraging support from other donors. All actions under the program were implemented as initially envisaged. 2.2 Major Factors Affecting Implementation: There were four factors which contributed to the successful implementation of the operation. First, the Government was committed to the program. The authorities had a clear long term vision for development building on sound macroeconomic fundamentals and ambitious reform. Furthermore, the main development objectives were largely shared across party lines. The Government also had a consultation process with labor, representatives of the business sector and other important stakeholders. Second, the program (the prior actions) was based on extensive analytical work which was discussed and agreed upon with the Government. This included the CEM, the PER, the Poverty Assessment, the Financial Sector Assessment Program (FSAP), and most importantly a policy note prepared specifically to define an appropriate policy response to the crisis. In addition, valuable support was provided by the Dutch technical assistance TF, especially in the health and financial sectors. Third, the operation was well designed taking into account lessons learnt from the earlier PDPL series. The operation set clear and achievable objectives focusing on only six prior actions and six benchmarks. Fourth, FYR Macedonia was fortunate that the global crisis receded during 2010 and This resulted in restoration of growth (albeit low) and improvement in export performance and current account deficit, which precluded implementation of further harsher fiscal measures. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization: The Monitoring and Evaluation (M&E) systems in FYR Macedonia are evolving. In general, while individual ministries and institutions have made progress in developing their M&E systems, they tend to operate in silos. Therefore, The Government still has some way to go 6

14 before it can have a coherent system of integrating the data and messages from individual agencies for overall policy formulation and implementation. The implementation experience shows that it was relatively straightforward to monitor macroeconomic outcomes, budgetary allocations and outturns, the pension system developments and the developments in the financial sector, where the National Bank of Republic of Macedonia (NBRM) has the capability to track developments. While basic information on the effectiveness of policies in the health sector and the social safety net can be extracted from the household budget survey (HBS), the quality of monitoring the performance indicators in these sectors need to improve further. The overwhelming focus of these agencies is on formulating and spending budgets rather than on tracking outcomes; a shortcoming that the DPL1 attempted to address. The Government has some way to go before the authorities can generate policy-oriented indicators, such as tracking out of pocket payments going to vulnerable segments of the population (a results indicator set for the overall DPL program). Similarly, while much progress has been made (supported by a Bank project) in developing databases of the social cash benefit recipients and establishing network between the Social Welfare Centers and the Ministry, it will take some time until it is able to track cash benefits going to vulnerable sections of the population and the processing time; both outcome indicators for the overall DPL program. 2.4 Expected Next Phase/Follow-up Operation The DPL1 was the first in a series of two operations designed to be sequentially disbursed in 2010 and The reform program defined in the PD continues to be pursued and the policy matrix for the DPL series largely forms the basis of the next operation. For the next operation, the Government requested a standalone Policy Based Guarantee (PBG) rather than a loan (DPL2) as originally envisaged. The PBG is considered a preferred instrument for the following reasons. First, although FYR Macedonia s macroeconomic situation has stabilized and the financial system has weathered the crisis well, being a small country with some neighboring economies in severe financial difficulties, FYR Macedonia continues to face market access challenges. The 2009 Eurobond was issued at unfavorable terms and efforts to tap the bond market in 2010 were not successful. The use of an IBRD guarantee would help the Government of FYR Macedonia improve its access to international financial markets at lower cost and longer maturities. Second, given that access is an issue and FYR Macedonia s financing needs are high, the PBG would allow FYR Macedonia to access larger amounts of financing than the alternative of US$ 30 million DPL. Third, the PBG presents an opportunity to expand the investor base on relatively favorable terms and is expected to have positive spillover effects for corporate borrowers. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation Rating: Satisfactory The DPL1 had clear and relevant objectives -- to respond to the crisis by maintaining macroeconomic stability, protect the vulnerable from the inevitable expenditure cuts and strengthen the resilience of the financial sector. The design of the operation was simple; focusing on three reform areas linked to the Government s ongoing reform program and 7

15 contained six prior actions and six benchmarks. The DPL1 operation was quickly processed and was in the nature of a first cut of an ongoing reform program which continues to be pursued and now forms a basis of the PBG operation. 3.2 Achievement of Program Development Objectives: Macroeconomic framework. Maintaining a viable macroeconomic framework was one of the overall objectives of the Government s program supported by the Bank. At the time of approval of the DPL1, the PD had evaluated and judged the macroeconomic framework to be appropriate and this view was endorsed in the assessment letter from the IMF. Since then, as a result of the fiscal and monetary policies followed by the Government, and improved external environment as the crisis receded, the macroeconomic situation has improved 8. As indicated in Table 1, GDP grew by 0.7 percent in compared to a mild contraction in 2009 and is projected to grow by 3.5 percent in Exports grew by about 24.3 percent in 2010 resulting in a marked improvement in the current account. There was also some recovery in FDI flows which financed the current account deficit and restored the foreign exchange reserves to around five months of imports by end Recent debt sustainability analysis (undertaken as part of the preparation of the PBG in early 2011) indicates that the gross external debt of about 60 percent of GDP and Government debt of 24.8 percent of GDP in 2010, should be sustainable under most plausible economic scenarios. Table 2: Selected Macroeconomic Indicators ( ) Proj. National Accounts GDP ($ Billion) Real GDP Growth (%) Fiscal Accounts (% of GDP) Revenues Expenditures Wages and Salaries Social Expenditures (MKD Billion) Fiscal Balance Government Debt External Accounts (% of GDP) Exports of Goods and Services Imports of Goods and Services Current Account Balance FDI ($ million) Official Reserves (Months of Imports) External Debt Gross External Debt (% of GDP) Debt Service (as % of Export of G&S) Consumer Prices (Period Average) Source: Ministry of Finance, NBRM and State Statistics Office, World Bank staff for projections. 8 Government s macroeconomic policies were endorsed by the IMF in their most recent Article IV consultation concluded in November During 2010 there was a steady acceleration of growth from -1.7 percent, on an annual basis, in the first quarter of 2009 to 2.3 percent in the fourth quarter of 2009; resulting in growth of 0.7 percent for the year as a whole. 8

16 As discussed below, the Government has largely succeeded in achieving most of these PDOs of the DPL1 in line with the results anticipated in the PD. However, achieving some of the expected results will depend on reforms currently ongoing and supported by the PBG (previously DPL2). Pillar 1. Implement Budgetary Policies to Support Macroeconomic Stability through Improving Public Expenditure Outcomes. Rating: Satisfactory The Government met the PDOs set for this pillar in the PD. Overall deficit targets have been met, as well as targets for limiting public sector wages and salaries and reducing social insurance contributions. As discussed in detail below, the measures in the context of the DPL1 are only a first cut of measures necessary for achieving longer-term financial sustainability. The financial situation of pension and health funds, although somewhat improved, continues to remain fragile and will require sustained policy measures and institutional reforms (including some planned under the PBG) to make these funds fully financially sustainable. Maintain the 2010 budget deficit at 2.5 percent of GDP. Government s challenge in responding to the crisis was to maintain the overall budget deficit at levels that would provide some support to the economy but remain in line with financing and solvency constraints, while at the same time, continuing with restructuring of expenditures to improve conditions in the labor market and protect critical social expenditures for vulnerable groups. The Government responded to the crisis by announcing a number of measures in late 2008 and early A sizable fiscal stimulus was undertaken in late In addition, measures were introduced to help firms facing liquidity problems due to liabilities towards the public sector, but also included reduction of customs duties and additional tax exemptions (including on corporate income tax). However, by April 2009, it was becoming evident that tax revenue outturns were lower than projected earlier. In response, the Government introduced two supplementary budgets in April and October The April and October supplementary budgets kept the fiscal deficit target at 2.8 percent of GDP in 2009 and restructured expenditures to match the projected shortfall in tax revenues of almost 3.2 percent of GDP. The expenditure restructuring was achieved by: decreasing spending on less productive capital investments, decreasing goods and services spending and a freeze on public sector wages and employment. In parallel the Government was careful to maintain allocations for the well performing social transfers to protect the poor and reduce social insurance contributions to help employment and competitiveness. This fiscal strategy continued in the 2010 budget, which targeted a fiscal deficit of 2.5 percent of GDP. Results: As a result of the measures implemented above, as indicated in Table 2, the fiscal deficit was 2.7 percent of GDP in 2009, below the targeted deficit of 2.8 percent of GDP. Similarly, the 2010 fiscal deficit target of 2.5 percent of GDP was also met. The fiscal policies pursued by the authorities during this period allowed the central government to keep its debt low at 24.8 percent of GDP by end-2010 and below the DPL1 target of 29 percent of GDP. Despite the increase in fiscal deficits to 2.7 and 2.5 percent of GDP in 2009 and 2010, respectively, from less than 1 percent in 2008, and small surpluses before that, FYR Macedonia still had one of the lowest fiscal deficits in Europe and Central Asia (ECA). The most recent debt sustainability 9

17 analysis (performed as part of the preparation of the PBG operation in early 2011) indicates that FYR Macedonia s fiscal deficit remains in line with sustainable long-term solvency indicators and available financing. Freeze the nominal wages and employment in This was a difficult and an unpopular policy measure because the Government had to defer the third installment of a three year 10 percent p.a. increase in public sector salaries. In addition, the Government froze all new employment 10, with the exception of new employment on the grounds of the implementation of the Ohrid Framework Agreement and the European integration processes. Results. As a result of these measures, total wage and salaries 11 were kept below the DPL1 benchmark of 10.5 percent of GDP in 2009 and 2010 (Table 2) and is estimated to have fallen to 9.8 percent of GDP by At the same time, other spending categories were also tightly controlled. Spending on goods and services was cut to 3.5 percent of GDP in 2010 (down from 4.6 percent in 2008), while capital expenditures were reduced to around 3.5 percent of GDP (down from 4.9 percent in 2008 but still close to the average for the period before). Reduce social insurance contributions. Overall labor taxation in the form of social insurance contributions of 32.5 percent of gross wages for the average wage earner in 2008, while not excessive by regional standards, did act as a powerful disincentive for formal employment (especially for low-wage labor) and was one of the reasons behind the high unemployment rate (34 percent of the labor force) in The labor tax wedge was also slightly regressive since low-wage workers (earning less than 50 percent of the average wage) paid their social insurance contributions on 50 percent of the average wage rather than the actual wage. To address these issues, the Government introduced a comprehensive reform aimed to streamline wage payment, introduce greater transparency and reduce the labor costs. Table 3: Social Insurance contributions as a Percentage of Gross Wage Social Insurance Contributions (SIC) as a % of gross wage o/w Pension Insurance contribution Health Insurance contribution Unemployment Insurance contribution Memorandum Item Unemployment Rate (for age 15-64) Source: Ministry of Finance Results. As of January, 2009, total social insurance contribution (SICs) rates were reduced from 32.5 percent of the gross salary to 28.4 percent, a prior action for DPL1 (Table 3). Going ahead, the SICs were further reduced to 27 percent of the gross salary in Originally the Government had planned to reduce contributions to almost 22.5 percent in However in 10 These policies were implemented through a decree issued by the Government. 11 Refers to the wage bill of the General government and the public health sector. 10

18 view of the financial sustainability of the pension and health insurance funds, the SIC rates were maintained at 27 percent 12 in In addition to the reduction in SIC contributions, the Government broadened the tax base by including fringe benefits, harmonizing income bases for social security, and moving from a net wage to a gross wage basis for calculating contributions. The reduction in social contributions is probably one of the reasons behind the relatively moderate impact of the crisis on the unemployment rate and is also expected to improve the competitiveness of the economy over the medium term. Reaffirm the sustainability of the pension system. The 2008 PER concluded that although the pension system was generally financially sustainable as a result of reforms during the last decade (including measures supported by the SPIL), number of challenges remained. Moreover, some measures implemented prior to the crisis had further strained the affordability of the system. These included: (i) more generous indexation of pensions using the 50:50 ratio (Consumer Price Index (CPI): wages indexation) instead of 80:20; and (ii) additional ad-hoc increases of pensions. In addition, the labor market impact of the crisis as well as the reduction in the pension insurance contribution rate from 21.2 percent of the gross wages in 2008 to 18 percent in 2010, further adversely affected the financial sustainability of the Pension and Disability Insurance Fund (PDIF). To ensure the fiscal sustainability of the pension system, the government introduced a number of measures over 2009 and First, after reviewing the financial sustainability of the pension system in light of the new environment, the government substantially slowed down the originally planned reduction in pension insurance contributions (see Para. 30). Second, the indexation formula was amended from 50:50 to 50:20 in 2009 to limit the impact of the change in the wage definition on pension growth. Third, valorization coefficients were revised in the pension determination formula for the wages received during the period and fourth, eligibility criteria for survivor pensions were tightened generating expenditure savings. Results. As a result of these measures, the sustainability of the pension system improved somewhat by end-2010: (i) the replacement rate in the pension system was reduced from a baseline of 55 percent in 2008 to 47.5 percent in ; and (ii) pension spending was maintained at less than 9 percent of GDP in These results are in line with the targets set in the PD. Even with these reforms in place, the viability of the pension system needs to be strengthened further. While the labor market impact of the crisis was generally moderate, formal employment was hit in 2009 and has not fully recovered. The number of workers with paid pension contributions fell from 418,958 persons in 2008 to 407,887 in Since then, with the gradual recovery of the labor market the number of contributors has increased to 413,797 at the end of Drawing on the actuarial analysis and the analysis of the impact of the planned reduction in contribution rates carried out in the context of the DPL1, the government may need to formulate and introduce additional measures to safeguard the system. 12 This flexibility was anticipated and built in the design of the DPL series. The analysis and the discussions carried out by Bank staff contributed to the moderation of the planned reductions in the SIC. 13 More than half of the reduction, or about 3-4 percentage points can be attributed to the redefinition of wages in 2009 to include benefits. The rest, about 2-3 percentage points is a real reduction in pension benefits and will help the financial sustainability of the pension system. 11

19 Table 4: Financial Sustainability of the Pension System Pensions (MKD billion) Pension (% of GDP) Number of Formal Contributors 418, , ,797 Replacement Rate Source: Pension Fund (PDIF), Ministry of Finance and World Bank Staff calculations Improving the sustainability of the health sector. Despite a number of reforms implemented prior to the onset of the crisis (including activities supported by the Dutch technical assistance TF on drugs policies and outputs-based financing), the long term sustainability of the health sector financing remains fragile and needs to be strengthened. Combined public and private health spending in FYR Macedonia in 2008 was around 6.5 percent of GDP, down from close to 9 percent in Access and quality of services remain important issues. Public opinion polls consistently rate health services as poor or very poor, while household budget surveys show that out-of-pocket payments for health care are significant and pose financial access barriers for poor households. The impact of the crisis and the reductions in contribution rates in the context of the DPL1 reduced the financing available to the health sector and complicated an already difficult situation. The resulting financial stress could potentially have adverse impact on the quality of health services. In an effort to improve spending efficiency, the Government decided to introduce a treasury function for the public health sector within the Health Insurance Fund (HIF) and adopted the necessary legal framework as a prior action for DPL1. The hardware and software required for the treasury function were purchased under a Dutch Trust Fund (TF) for technical assistance. However, there were some concerns that a treasury function may undermine the autonomy of health institutions. The Bank helped facilitate the dialogue between key stakeholders to ensure that the concerns are adequately addressed resulting at the end in shared agreement on the functioning of the treasury. The system became fully functional on January 1, This measure improved the financial management and control in the health sector and alerts the authorities to budget over-commitment or overspending by the HIF and the Health Care Institutions (HCIs). Results. The immediate impact of creating a treasury function was keeping the arrears in the public health sector (HIF and Health Care Institutions) to less than 0.3 percent of GDP in 2009 and This was an outcome indicator for the DPL1 and was met. The gains achieved through improved financial management (introduction of the treasury function) while important, are necessarily of a limited, short-term nature. While the arrears were kept below 0.3 percent of GDP, further efforts would be required to ensure these are brought firmly under control and eliminated. A significant medium term impact would require bold reforms, including a reform of the Basic Benefits Package (BBP) that is being attempted in the context of the DPL2 (now PBG). Some progress towards the reform of the BBG has already been achieved. However, critical actions lie ahead and, given the political sensitivities, their success is by no means assured. First, a detailed actuarial analysis was carried out to cost out the current BBP. Second, the Government adopted a Memorandum on the revision of the BBP in November It recommends options for reform, including revision of the list of services to 12

20 be covered, change of co-payment policies as well as promotion of voluntary health insurance. Given the political sensitivity of these reforms, further background work and definition of these proposed reforms will be required. These activities should define concrete actions related to the BBP, including establishment of clear guidelines for inclusion of services in the BBP and are being supported by the PBG operation. Pillar 2: To Ensure Adequate Support to Vulnerable Groups. Rating: Satisfactory Protect levels of spending for social protection. FYR Macedonia has a complex social safety net system that provides support to a large part of the country s population. The safety net performs reasonably well by regional standards but suffers from both leakages and exclusion. In 2008, around 30 percent of social assistance benefits ended up in households in the highest three quintiles, with almost 7.6 percent going to households in the top quintile. Results. As a prior action for the DPL1, social assistance transfers were protected from spending cuts necessitated by the crisis. Despite cutting expenditures by 9 percent in the April 2009 Supplementary Budget and a further 3 percent with the October budget revision, the budgetary allocation for social protection transfers was preserved at MKD 2.9 billion (Table 1). As a result, government spending on social financial assistance increased from 1.8 percent of Core Central Budget spending in the original 2009 Budget, to 2.0 percent in the final 2009 budget. In addition (as a part of the DPL1 program), the Parliament also approved a new Law on Social Protection which lays the basis for medium-term improvements of the functioning of the social protection system. Beyond the DPL1, the Government has a strong agenda aimed to improve the administration of the social safety net and improve protection of the vulnerable, supported under the PBG (under preparation) and in close coordination with CCT/SPIL operations: Prepare and enact by-laws that set the regulatory framework for the implementation of the new law on social protection (achieved). Develop a unique registry of social cash benefit recipients (ongoing and at an advanced stage). Create a policy unit which issues regular monthly reports on social protection (ongoing). Implement an energy poverty program to mitigate the impact of the planned electricity price reforms on the poor (achieved). Introduce a Conditional Cash transfer (CCT) program (ongoing). These measures, when fully implemented, are likely to result in: (i) a higher percentage of cash benefits going to the poorest quintile (compared to 43 percent in 2008), and (ii) reduced processing time for social financial assistance (from a baseline of 30 days in 2008). These results indicators will be tracked in the follow up operation and during the supervision of the investment loans in the sector (CCT/SPIL). 13