Document of The World Bank FOR OFFICIAL USE ONLY Report No. 24476-YU FEDERAL REPUBLIC OF YUGOSLAVIA TRANSITIONAL SUPPORT STRATEGY UPDATE July 18, 2002 South East Europe Country Unit ECCO4 Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ABBREVIATIONS AND ACRONYMS BRA Banking Rehabilitation Agency CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CPAR Country Procurement Assessment Report DM Deutsche Mark EBRD European Bank for Reconstruction and Development EC European Commission EIB European Investment Bank ERTP Economic Recovery and Transition Program EU European Union FIAS Foreign Investment Advisory Service FRY Federal Republic of Yugoslavia GDP Gross Domestic Product GEF Global Environment Facility GNP-. Gross National Product IBRD International Bank for Reconstruction and Development ICTY International Criminal Tribunal for Yugoslavia IDA International Development Agency IDF Institutional Development Fund IFC International Finance Corporation ILO International Labor Organization IMF International Monetary Fund I-PRSP Interim Poverty Reduction Strategy Paper MIGA Multilateral Investment Guarantee Agency NATO North Atlantic Treaty Organization NGO Non-governmental Organization NMP Net Material Product PEIR Public Expenditure and Institutional Review PFSAC Private and Financial Sector Adjustment Credit PRSP Poverty Reduction Strategy Paper SAA Stabilization and Association Agreement SAC Structural Adjustment Credit SEE Southeast Europe SEED Southeast Europe Enterprise Development Facility SFRY Socialist Federal Republic of Yugoslavia SME Small- and Medium-Sized Enterprises SOSAC Social Sector Adjustment Credit TFFRY Trust Fund for the Federal Republic of Yugoslavia TSS Transitional Support Strategy TTFSE Trade and Transport Facilitation Program for Southeast Europe UN United Nations UNDP United Nations Development Program UNEP United Nations Environment Program UNICEF United Nations Children's Fund UNMIK United Nations Mission in Kosovo VAT Value Added Tax WBI World Bank Institute WTO World Trade Organization Vice President: Johannes F. Linn Country Director: Christiaan J. Poortman Team Leader: NancyJ. Cooke, Timothy R. Gilbo FOR OFFICIAL USE ONLY Table of Contents I. Introduction ........................................................1I II. Economic and Political Context .........................................................1 III. The Government's Economic and Social Program and Strategic Agenda ............ ...........4 IV. The Near Term Reform Agenda ........................................................7 V. Medium Term Outlook and Extemal Financing Requirements ........................................ 10 VI. World Bank Group Assistance ........................................................ 13 Pre-membership Assistance ........................................................ 13 FY02 TSS Program Implemetation ................. ....................................... 14 FY03 Program ........................................................ 15 International Finance Corporation ........................................................ 21 The Multilateral Invertment Guarantee Agency ........................................................ 22 VII. Risks ........................................................ 22 Boxes Box 1: The Belgrade Agreement on a Union of Serbia and Montenegro ..................................2 Box 2: Poverty in the Federal Republic of Yugoslavia: A Preliminary Profile ............ ...........5 Box 3: The FRY PRSP Process .........................................................8 Box 4: Donor Support to FRY ........... ............................... . ............ 12 Attachments Attachment I: Matrix of Development Objective Attachment II: Federal Republic of Yugoslavia Recent Structural Reform Process Attachment III: Planned FY03 IDA Program Federal Republic of Yugoslavia Republic of Montenegro Republic of Serbia Annexes Annex 1: Federal Republic of Yugoslavia - At a Glance Annex 2: FRY - Key Economic Indicators Annex 3: FRY - Key Exposure Indicators Annex 4: IBRD/IDA Program Summary Annex 5: IFC & MIGA Programs in FRY Annex 6: Summary of Non-lending Services Annex 7: IBRD/IDA and Grants Operations Portfolio Annex 8: Statement of IFC's Held and Disbursed Portfolio 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. Memorandum of the Executive Directors of IBRD and IDA Transitional Support Strategy Update for the Federal Republic of Yugoslavia (FRY)' I. Introduction FRY succeeded to the membership of the former Socialist Federal Republic of Yugoslavia in the World Bank in May 2001, at which time a Transitional Support Strategy (TSS) was endorsed by the IBRD and IDA Boards of Directors. The TSS outlined a two-phase program of World Bank Group support to FRY - urgent activities in a pre-membership phase funded through a US$30 million Trust Fundfor FRY, and a broader program supporting the Economic Reconstruction and Transition Program (ERTP) encompassed under a threeyear temporary and exceptional IDA envelope. This TSS Update describes recent economic and political developments, updates progress towards the policy objectives outlined in the TSS, underscores the need for continued strong donor support, and provides a strategic framework for continued Bank assistance to FRY during FY03. A full Country Assistance Strategy (CAS) covering FY04-06 is expected to be presented to the Board in the summer of 2003, together with the Government 's full PRSP. A full CAS was not considered appropriate for FRY at this time given the need to substantially enhance knowledge of the causes and determinants of poverty through the PRSP process, and the desire to have a core body of sectoral and analytical work in place upon which to build a longer term strategy. Moreover, this timing of the CAS would allow the ongoing process of redefinition of relations between the republics of Serbia and Montenegro under the Belgrade Agreement to be completed. II. Economic and Political Context 1. The Legacy of the Past. The renewed transition to a market economy in FRY began under very difficult economic circumstances. These were the combined legacy of a decade of negative external and internal factors. 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. FRY accumulated large domestic and external debts, with the latter reaching around 141 percent of GDP in 20002. 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 in the enterprise and banking sectors. FRY's real sector became largely inefficient due to the lack of market orientated ownership structures, the loss of markets, lack of access to working capital, delayed investment and maintenance, and repressive and complicated taxation and regulation. The banking sector, consisting of around 100 socially owned banks, became loss making, with most major banks insolvent. This pushed a significant portion of the economy into the informal sector, eroding the government's revenue base and leaving many residents with little or no access to social protection. The poor economic perforrnance resulted in a decrease in real earnings, with absolute poverty roughly doubling since 1990. This increase was accelerated by a deterioration in social protection and health services, as available financing fell below existing entitlement levels. The centralization of political power at the federal level during the 1990s weakened economic institutions, degraded public X The Federal Republic of Yugoslavia has two constituent republics, Serbia and Montenegro. This paper is an update of Federal Republic of Yugoslavia: Transitional Support Strategy (report No. 22090-YU, June 26, 2001) which was considered by the Board of Directors at the time of FRY's membership in the Bank on May 8, 2001. As with the May 2001 TSS, this TSS Update does not cover the province of Kosovo which remains under UN administration according to UN Security Council Resolution UNSC-1244. 2 GDP figures exclude Kosovo. 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 imposed on FRY from 1992 to 1996 and again in 1998-2000 which severely inhibited trade and investment in the country. During 1999 and 2000, international donors supported Montenegro's stabilization and reform program with substantial grant financing to cover the fiscal deficit. While such financing helped address immediate problems, it also supported loose fiscal policies. In 2000, the consolidated republican deficit reached around 10 percent of Montenegro's Net Material Product (NMP). 2. Political Developments. The main national political debate has recently centered on the redefinition of the constitutional framework of FRY (Box 1). The federal and republican parliaments have ratified the Belgrade Agreement. Constitutional Commission members were appointed in early June, and the process of translating the principles embodied in the Boxf: BelgradeAgreementonaUnion Belgrade Agreement into operational arrangements has begun in earnest. During On March 14, 2002, an agreement entitled Proceeding Points the past year the considerable domestic for the restructuring of relations between Serbia and Montenegro (the Agreement), was signed by representatives of debate on FRY's cooperation with the the federal government and the republics of Serbia and International Criminal Tribunal for Montenegro. The Agreement sets out a general framework for a Yugoslavia (ICTY) has diverted some union between Serbia and Montenegro. The new union would replace the Federal Republic of Yugoslavia and would be called attention of policymakers, although recent the "Union of Serbia and Montenegro " The federal, Serbian and progress on this issue has been made. Montenegrin Parliaments completed the ratification process in May. The Agreement provides for the establishment of a Constitutional Comm-ission, comprised of representatives of the 3. Domestically, the Serbian Government three parliaments, to prepare the Conestitutional Charter which is has been faced with demand for further to be submitted to the three parliaments autonomy from the provincial government in the northern province of Vojvodina. ndulr thae provisi rons of hegretetment, Serbia and Montenegro in the nothem proince of Vjvodina. would have some commnon institutions, including a Presidency, Relations with Kosovo continue to evolve Parliament, and a Council of Ministers, but would operate as and a dialogue between the United Nations two separate economies, including separate currencies and Interim Administration in Kosovo customs systems. The Agreement further provides that after three years, either member of the Union may initiate proceedings (UNMIK) and FRY authorities on a to withdraw from the Union. number of topics has been initiated3. In Montenegro the situation of the Upon promulgation of a Constitutional Charter, laws on the election of new union-level parliamentary reprcsentatives would government has been somewhat affected be adopted by both Serbia and Montenegro. Elections would because of differing views within the then take place and a Parliament of the Union of Serbia and current coalition on the Belgrade Montenegro would be constituted The Parliament would the'n elect the President of the Union. The Council of Ministers would Agreement, although the economic reform have five departments foreign affairs; defense; international program has wide political support. economic relations; internal economic relations; and protection Although these political uncertainties over of human and minority rights. Serbia and Montenegro would iointlv finance these common functions. the past year have occupied the attention of policymakers in both Serbia and Montenegro, they have not derailed the reform effort. The reformist political leaders remain popular, but maintaining this widespread support for continuing reform efforts is likely to be a key challenge throughout the strategy period. Presidential elections in the Serbian Republic are anticipated before the end of 2002, and 3A separate Transitional Support Strategy for Kosovo has been prepared (IDA/R2002-0 132), and is scheduled to be presented to the Board on July 25, 2002. 2 parliamentary elections in both republics could also take place before the end of the year, especially in Montenegro. These elections could somewhat circumscribe the ability of the reformers to continue to move ahead at the current rapid pace. 4. Regional stability and cooperation within South Eastern Europe have greatly improved. On- going efforts by the intemational community to consolidate stability in the region -- especially the establishment of a clear path to European integration through the EU Stabilization and Association process -- have provided strong incentives for reform and cooperation. At the same time, the democratic transition in FRY has also greatly contributed to improved relationships within the region; some acceleration in the return of refugees and the on-going process of regional trade liberalization are tangible results. These developments should reduce the risk that FRY's domestic political challenges could lead to backtracking on economic and political liberalization. 5. Recent Economic Developments. Since late-2000, a renewed focus on adjusting fiscal deficits towards levels financeable from non-inflationary sources has been the key policy instrument for restoration of macroeconomic stability. In Montenegro, this focus was motivated by the very large budget deficit of 2000, the adoption of the German Mark (DM) which precludes monetary financing, and a decline in foreign financing towards more sustainable levels4. At the Federal and Serbian levels, it was motivated by the need to confront and manage the hidden fiscal liabilities which grew out of the unsustainable policies of the past. 6. These tighter macroeconomic policies were first supported by an IMF Emergency Post- conflict Facility for FRY approved in December 2000, followed by an IMF Stand By Arrangement for FRY approved in June 2001. The strong implementation of these programs has brought visible progress while laying the foundations for a more sustained recovery and improved living standards. In Serbia, twelve month inflation declined from 115 percent at end 2000 to 39 percent at end 2001,5 and further to 17 percent in June 2002. The nominal exchange rate of the Yugoslav dinar to the DM/Euro has remained stable and unified since December 2000. Subsequent real appreciation primarily reflects adjustment from an initially undervalued level. Exchange rate unification and liberalization of the foreign exchange market has brought current account convertibility. FRY's official foreign reserves grew to US$1.3 billion (or about three months of goods and service inputs) at end January 2002, easily exceeding targets under the Government's program supported by the IMF. FRY's GDP has rebounded from a steep decline of about 16 percent in 1999 (influenced by the Kosovo conflict), growing by an estimated 5.5 percent in 2001, despite the effects of a transitional recession that contracted recorded industrial sales by around 1 percent of GDP6. FRY's 2001 consolidated fiscal deficit (before grants) of 1.3 percent of GDP (Table 1), relative to an expected deficit of 6.3 percent was achieved through revenue over-performance of about 1 percent of GDP accompanied by expenditure compression of almost 4 percent of GDP relative to initially planned levels for 4The adoption of the DM in 1999 along with substantial levels of donor support successfully insulated Montenegro from some of the more severe impacts of economic mismanagement after 1998, such as high inflation and growing arrears on pensions and social benefits. The DM was replaced by the Euro as legal tender in Montenegro in 2002. 5 Underlying inflation, net of the effects of liberalization of administered prices, is believed to be closer to 15% per year. 6 GDP growth in 2001 was driven by a strong rebound in agriculture, following a severe drought in 2000. 3 200 17. This adjustment reflects a willingness to take necessary steps to align spending with available sources of non-inflationary financing. Reductions in quasi fiscal deficits (e.g. through higher energy prices which helped to contain the losses of state-owned power companies) and a highly concessional November 2001 debt restructuring agreement with the Paris Club further enhance medium term sustainability. 7. In Montenegro, real growth rebounded to low but positive rates of about 4 percent in 2000 and 3.5 percent in 2001. The 2001 upturn was driven by a rebound in tourism, transport (primarily increased transit of goods to and from Kosovo), and construction. In contrast, recorded industrial production contracted by 0.6 percent. Inflation was 25 percent in 2000 and 24 percent in 2001. Montenegro's consolidatedfiscal deficit declined from 10.4 percent of NMP in 2000 to 6.1 percent in 2001. Foreign grants remained the main source of deficit financing. III. The Government's Economic and Social Program and Strategic Agenda. 8. The governments of FRY have defined a vision of a society fully re-integrated with the intemational economy, the Southeast Europe (SEE) region and into Europe, administered by strong and accountable institutions, and in which sustained, broad based increases in living standards are generated by a dynamic private sector. On the basis of this vision, the authorities worked closely with the Bank and the European Commission (EC) to establish a medium-term Economic Recovery and Transition Program (ERTP), which was presented to donors at the June 2001 Donor Conference. The ERTP program lays out near- and medium-term policy reform objectives, and provides a framework for donors to coordinate assistance programs. 9. The ERTP report highlighted that a return to sustained growth in FRY would require both (i) a sustained program of economic reform on the part of the governments of FRY and, (ii) substantial donor support, including external debt relief. At the June 2001 Donor Conference governments and financial institutions pledged a total of US$1.33 billion toward the ERTP estimated financing requirement of US$1.25 billion in CY2001. Overall needs were estimated at US$3.9 billion over a three to four year program (Box 4). In November 2001, FRY concluded an agreement with Paris Club creditors which details a 51% NPV reduction in outstanding obligations to Paris Club creditors (which stood at around US$4.5 billion) upon approval of a three-year arrangement with the IMF, and a further 15% NPV reduction upon successful completion of this arrangement (expected in March 2005)8. Negotiations are continuing with London Club of creditors which is collectively owed US$2.8 billion by FRY. 10. The ERTP, which provides the basis of the overall reform agenda both at the republican and federal levels, identified four closely inter-related strategic objectives: * Restoring macroeconomic stability and extemal balance * Stimulating near-term growth and creating the basis for a sustainable supply response. * Improving the social well-being of the most vulnerable and building human capacity. * Improving govemance and building effective institutions. 7 Figures largely reflect Serbia's progress, as it comprises 94 percent of FRY's total population and contributes about 93 percent of FRY's GDP. 8 The IMF Executive Board approved a three-year Extended Fund Facility (EFF) for FRY of SDR 650 million (US$829 million equivalent) on May 13, 2002, which made effective the first stage of the Paris Club debt reduction agreement. 4 Box 2 - Poverty in the Federal Republic of Yugoslavia: A Preliminary Profile. A long period of instability, international isolation and economic turmoil have adversely affected living standards of a vast majority of population in Yugoslavia. The I-PRSPs from both republics based on the most recent information forcefully attest to the increase of poverty in Yugoslavia during the early 1990's culminating with the 1993 hyperinflation episode; since then poverty held ground, and remains widespread in both republics. Available information on household welfare collected in the various surveys conducted in Serbia and Montenegro during the period 1990-2001 is incomplete, and rough estimates based on this data put the absolute poverty rate by 2001 anywhere between 15 and 25 percent of the population. All available data also suggest clustering of population just above poverty line, indicating that many families in both republics could easily fall into absolute poverty as a result of even a small shock to their income levels. Groups consistently identified as having higher risk of poverty in most studies in FRY include: * Unemployed (existing data suggest that more than half of the unemployed are likely to fall well under the poverty line). * Families with many children and dependents. Families with 3 and more children have as high odds as the unemployed to see their living standards below the poverty line. * People with low education levels (especially in urban areas), who are restricted to low paying jobs or underemployment. On top of being paid lower wages, they also face a much greater probability of losing their jobs during company restructuring and/or privatization. * Families of IDPs and refugees, whose living standards depend to a large extent on (shrinking) external humanitarian assistance. * Disabled and invalids, as minimum disability pensions in both republics have resulted in people to subsist just above the poverty lines. * Elderly receiving minimum pensions and those not eligible for pensions. Although existing household surveys do not provide regionally disaggregated data, poverty is likely to go hand in hand with significant regional differences in income levels (and therefore is likely to be high in South Serbia and in the north of Montenegro). Given that unemployment represents a significant poverty risk, policymakers are focusing considerable attention on possible unemployment increase following the restructuring of enterprises. Even though actual unemployment figures (following ILO definitions) may be only half of the officially registered unemployment rates (26.8 % for Serbia and 28.6 % for Montenegro), true unemployment rates in excess of 14 % in both republics already appear high. The timing gap between the immediate social costs associated with hardened budget constraints, and the future benefits in the form of new employment and income opportunities generated by developing private sector, raise the question of social sustainability. The World Bank is assisting the Serbian and Montenegrin Authorities in the development of policies to mitigate the negative effects of reforms (through structural adjustment lending, technical assistance and learning and innovation loans). The gender dimension of poverty has not yet been well analyzed but gender appears to be a relevant poverty issue. Available data for both republics do not suggest a higher risk of poverty for female headed households. A more general assessment of poverty going beyond income dimensions does however, reveal serious disadvantages facing women. Gender appears to be a relevant poverty issue. Women were more likely to be unemployed or economically inactive than men, and on average earned less than males when employed (i.e. in Montenegro around 20% in the formal sector, but close to 50% in the informal sector). Women from refugee and IDP families do report especially strong biases against them on the labor market. There is an unexplored area for further study regarding gender differences regarding the access to social services, security, protection against violence, participation and empowerment. Over the coming year the authorities plan to: address identified limitations in the assessment of poverty, produce sufficient data to establish an adequate baseline information on poverty to support the PRSP process (see Box 3), and institutionalize poverty monitoring through the survey process. In addition to making serious efforts toward collecting adequate data on living standards it will also require further analysis to fully understand the causes of poverty, as well as its distribution across regions, gender, professional and ethnic groups. 5 1. As nearly all economic policy implementation has de facto rested with the Republican governments, Serbia and Montenegro have each developed complementary programs of economic stabilization measures and structural reforn to address the daunting economic legacy and delayed transition. Policy performance and outcomes have been solid and much has been achieved. GDP and foreign trade volumes have begun to rebound, while fiscal adjustment has supported a reduction of inflation under stable exchange rates. The privatization framework and business environment have been improved, while forceful measures have been taken to restructure the banking sector. Policy reforms and donor assistance have together worked to contain the previously chronic growth of arrears in the social protection system. A detailed summary of reform achievements to date in each republic is presented in Attachment II. A summary of the principal reform achievements against the benchmarks established in the previous TSS is presented in Attachment I. 12. In Serbia, substantial progress towards macroeconomic stabilization has been achieved through initial reforms of public financial management and the tax system, and through progress in containing quasi-fiscal risks in the form of budgetary arrears and losses of key state enterprises and through price liberalization, while maintaining tight monetary policy. Price liberalization and increases in remaining controlled prices (most notably in the energy sector) have been particularly important for enhancing fiscal sustainability. Reform of the financial sector, including the difficult decision to close the four largest banks, the establishment of transparent procedures for the privatization of state- and socially owned enterprises, improvements in the general business environment, and a liberalization of trade policy, have combined to provide a basis for stimulating near-term growth and creating the basis for a sustainable supply response. The tax regime has also been simplified, and labor legislation has been reformed to better meet the requirements of a modern market economy. Protection of the socially most vulnerable and building human capital has progressed, most notably through reforms to improve the sustainability of the pension system and timeliness of social payments, commencement of decentralization of the education system and of initial steps in restructuring of health financing and delivery. Legal and judicial reform efforts, as well as those in public expenditure management, taxes, and customs are backed by an impressive anti-corruption strategy towards improving governance and building effective institutions. 13. The adoption of the German Mark in Montenegro precluded inflationary domestic financing, and priority efforts towards macroeconomic stabilization have concentrated on closing the fiscal gap as sources of donor financing diminish. Energy price rises have been effected to tackle quasi-fiscal liabilities from the energy sector, and to enhance the ability of the electric power industry of Montenegro to address supply shortfalls during the winter. Liberalization of prices and foreign trade have also contributed to stabilization, as well as stimulating near-term growth. Montenegro has completed a mass voucher privatization program, and has made progress in improving the overall business environment. Bank restructuring, with a view to privatization, is progressing and the supervisory capacity of the Central Bank of Montenegro is being enhanced. A modern labor law has recently been submitted to parliament, which will improve labor market flexibility and reduce the burden on businesses. The government has extended rights to family material support and improved the targeting of child allowances to better protect the socially most vulnerable and build human capital. Recently proposed pension reforms will also be critical to improving the reliability and sustainability of the pension system. Montenegro hasalso established an anti-corruption agency and prepared new anti-corruption legislation, and is working to implement legislated reform of public procurement towards the objective of improving governance and building effective institutions. Reform of the judiciary is also 6 advancing, with the adoption of a new law on the courts and establishment of new judicial bodies. IV. The Near Term Reform Agenda 14. While impressive progress has clearly been made, the fragility of near-term economic scenarios underlines the need to maintain the pace of reform and deepen efforts across a broad front in both republics. The federal and republican governments have reaffirmed their commitments to moving ahead with the comprehensive multi-year reform agenda presented at the June 2001 Donor Conference (Box 4). Key features of the near-term reform agenda to be implemented over the next twelve months include: 15. Restoring macroeconomic stability and external balance. A prerequisite for the success of the reform program will be consolidation of the significant gains in achieving macroeconomic stability. The recent PEIR notes that the addition of new sustained budgetary outlays related to restored external debt servicing and the one-off financial and social costs related to enterprise restructuring will put further strain on fiscal performance. As government revenues already represent a high share of FRY's GDP, fiscal adjustment will require reforms to support expenditure containment in other areas where spending is currently high by regional standards and/or inefficient. These areas include the government wage bill, defense, social protection and (in Montenegro) education. Institutional reform priorities for supporting such an adjustment include strengthening the arrangements for budget planning and execution, developing multi- year fiscal planning mechanisms, and improving accountability. Key targets for the next twelve months are: * Continued improvements in macroeconomic performance within the three-year framework supported by the IMF. * Satisfactory progress towards the development of a Medium Terrn Fiscal Framework, further strengthening of the internal audit functions of the Ministries of Finance, and steps towards the establishment of Supreme Audit Institutions in each republic. * Improvements to tax administration, revisions to excise tax, introduction of synthetic personal income tax and preparations for the introduction of VAT (Serbia). Progress in implementing the new tax action plan (Montenegro). 16. Stimulating near-term growth and creating the basis for a sustainable supply response. During the past year the FRY governments made significant progress towards modemizing the legal and institutional framework and stabilizing the banking sector. However, over the coming year, FRY will need to intensify efforts towards: (i) developing an environment where the rule of law is respected, property rights and claims are recognized, contracts can be enforced, economic agents can have access to capital, and lenders feel secure; (ii) creating a level playing field between the existing enterprise sector and the new private sector by restructuring loss makers, and thereby avoiding the crowding out of the new private sector; (iii) reaping the benefits of trade by ensuring full free trade within FRY and by expanding the scope for international commerce through further multilateral, European and regional trade liberalization. The Governments plan to act on the following key measures: 7 * Continued improvements to customs Box 3. The FRY PRSP Process administrations in both republics. The PRSP process was launched in FRY in late April 2002, building on the ERTP framework. Both republican governments prepared interim-PRSPs Federal Republic of Yugoslavia: * Amendments to the Companies law, a Interim Poverty Reduction Strategy and Joint Staff Assessment, new Bankruptcy Law, amendment of (to be submitted to the Board shortly) over a six week period the Privatization Law to strengthen the which present a baseline picture of poverty (Box 2) and define govemment' position as a credito the organizational arrangements for preparing a full government's position as a creditor, participatory poverty reduction strategy by June 2003. Despite progress towards the restructuring of the short timing, the interim PRSP has benefited from initial major systems (Serbia). Progress consultations with a varied group of stakeholders in each of the towards successful tender privatizations republics. The international community has also signaled its of SOEs (Montenegro). strong support for, and willingness to be part of the process. Recognizing the multidimensional nature of poverty, the FRY 1- PRSP acknowledges the need to address not only income and * Implementation of a Supervisory employment opportunities, but also social inclusion, access to education, health and other public services. The Serbian 1- Development Plan for Bank PRSP outlines a three pronged program aimed at (i) promoting Supervision, substantial progress in the growth and enabling private sector employment opportunities liquidation/privatization of directly or with a special focus on small and medium enterprises; (ii) indirectly state-owned banks (Serbia). preventative actions aimed at addressing problems of redundant workers and labor redeployment and (iii) improved targeting of Completion of the resolution process of social programs especially for vulnerable groups. The insolvent banks (Montenegro). Montenegrin l-PRSP focuses on four objectives: (a) maintaining a stable macroeconomic environment; (b) concerted efforts to address problems of the 'gray economy'; (c) strategies to * Continued improvements in the address enterprise restructuring and promote private ownership financial situation of the energy and (d) improved targeting, especially of vulnerable groups. utilities, energy sector strategies and A Joint IMF-World Bank Staff Assessment of the FRY-I-PRSP laws in both republics. notes that the full PRSP will need to: (i) to improve and new energy laws inbothrepubllcs. institutionalize poverty survey instruments and enhance capacity for analysis; (ii) develop an effective system to monitor progress and track improvements; (iii) identify appropriate * Promoting a new labor relations benchmark indicators and linkages to the Millennium framework that would contribute to Development Goals; (iv) ensure that resource allocations greater labor market flexibility and over maintain consistency with the medium term macroeconomic the medium term, stimulate framework supported by the IMF; (v) within the fiscal envelope, identify, prioritize and cost strategic public policies and employment generation (Montenegro). programs, and (vi) elaborate plans for improving the overall business environment; achieving the un-impeded operation of a common internal market; addressing critical infrastructure and * Laying the foundation for the utility investment and maintenance needs; improving public development of national strategies for administration, governance, and health and education service the environment and natural resource delivery. management in both republics. Together with other donors, notably DFID, the EU, Eurostat TA, the EC Food Security Program and the UNDP, the Bank is 17. Improving the social well-being of the helping to improve statistical collection and develop capacity building training programs in Serbia and Montenegro. Building most vulnerable and building human on the substantial body of sectoral and fiduciary work initiated capacity. The political sustainability of the in FY02 (paras. 28 and 36), during FY03 further Bank support reform effort will depend to a large extent to PRSP development will include: poverty profiles including on the government's success over the next background papers on the labor market, gender the social impact of reform and targeting, and a fiscal sustainability year in shielding the most vulnerable from analysis. WBI is sponsoring a number of PRSP seminars and the negative effects of transition, and workshops and the IMF is providing technical assistance for building human capital. The beginning of improvement in statistical capacity. 8 efforts to restructure large enterprises will invariably strain social protection mechanisms and require improved efficiency and targeting of resources in order to not jeopardize fiscal sustainability. Improvements in the sustainability of the health system while improving the quality and efficiency of delivery of health services over the short term will also be a key challenge. Priorities over the next year include: * Developing a full participatory Poverty Reduction Strategy and strengthening the foundation for its implementation in both republics (Box 3). * Improving the targeting of social assistance and child protection benefits based on poverty survey results, further progress on de-linking benefit eligibility from wage levels in both republics. Enactment of a new pension law (Montenegro). Adoption of a new Law on Employment (which governs unemployment programs and active labor market interventions for dismissed workers and existing registered unemployed) and development of a fiscally sustainable program and institutional framework to handle mass redundancies (Serbia). * Strengthening the Health Insurance Fund and preventing accumulation of new arrears; drafting an interim health services restructuring plan and completion of a health information systems master plan, including the establishment of a data base; improving the efficiency of procurement of pharmaceuticals. * Monitoring the impact of education spending across municipalities in accordance with the law on local self-government. Improving the definition of the role of municipalities and school boards in managing education (Serbia). 18. Improving governance and building effective institutions. Political uncertainty, weak state institutions, poor governance, deficient legislation and an inefficient judiciary have been a recognized deterrent to foreign investors, and corruption in state institutions represents a key political liability as well as a fiscal risk. While the restoration of macroeconomic stability dominated early reform efforts, the government has recognized that the building of effective state institutions and implementation of comprehensive legal and judicial reforms is critical to the sustainability of the reform effort and has made this a priority area for action. Among the key elements of the institution building agenda for FY03 are: * Completion of a constitutional charter and laws defining Federal/Republican jurisdiction. Updating of republican laws in line with charter. * Development of a Strategy for public administration reform (Serbia). Initial diagnostic on civil service reform (Montenegro). * Continued progress in establishing republican treasuries and strengthening of other key functions of republican Ministries of Finance (budget inspection and audit, public debt management, budget planning). 9 V. Medium Term Outlook and External Financing Requirements 19. Sustainable growth is achievable under continued decisive reforms and substantial support from donors and creditors. In 2002, real GDP is expected to grow by about 4 percent, slightly below the rate of 2001. This modest slowdown primarily reflects the reversion towards more sustainable growth rates in the important agricultural sector, following last year's sharp recovery from the drought of 2000. Growth in the non-agricultural sector is expected to average 5 percent, led by a recovery of power production (including the impact of more secure energy supply to other sectors) and continued growth of the service sectors, including tourism in Montenegro. Growth will also be supported by the coming on stream of non-inflationary donor support of the budget. These projections assume strong macroeconomic management, a continuation of reforms begun in 2001, well-timed and concessional donor support, as well as further concessional debt rescheduling.9 Under these assumptions, growth could also average about 4 percent during the period 2003-2004 (Table 1).10 While sound policies and productivity improvements will work promote rapid growth, the daunting legacy of the past (including the need to service inherited Table 1: Key Economic Indicators 1997 1998 1999 2000 2001 2002 2003 2004 National Accounts GDP (USS millions) I/ 8071 10861 12841 13849 14993 Real GDP growth (%) -15.7 5.0 5 5 4 0 4.0 4 0 Invesetmnt(%ofGDP) . . .. 145 135 15.4 16.4 172 Gross Domestic Savings (% ofGDP) . -3 6 -8.6 -6 4 4 0 -2 4 Public Sector Balance Expenditures (% of GDP) 40 2 42 9 48 7 47 8 46 7 o/w public investment 3 3 14 31 3 7 4 3 Revenue before grants . .. .. 39.2 41.6 43 0 42 4 41 9 Deficit before grants (% of GDP) I 0 1.3 5 7 5 4 4 9 Extemal Accounts Exports of goods and services (% change) 2/ 19 6 20.9 -45.6 18 6 8.4 14.2 13 1 9 4 Imports ofgoods and services (% change) 2/ 179 2 1 -32 8 13.1 28.9 15 3 73 7 1 Current account balance -1561 -660 -764 -339 -596 -1050 -1285 -1292 as % of GDP - 4.2 -5.5 -8.2 -9 3 -8 6 Indebtedness TDO/XGS 3/ . . 447 9 432 6 272.6 263 5 259 7 TDO/GDP . .. 1413 1100 670 67.9 676 TDS/XGS3/ . . .. 23 3.9 109 125 125 Prices Retail price inflation (eop) . . 113 5 39 0 20 0 10 7 6 4 1/ GDP estimates include Kosovo 2/ Growth rate of dollar values 3/ Exports exclude workers' remittances 9 For illustrative purposes, projections assume debt relief and rescheduling on highly concessional terms (i.e., 66 percent reduction of the net present value of debt) from official bilateral and commercial creditors in 2001/2002. Table I shows historic data for 1997-2000, and projections from 2001-2004. 10 domestic and foreign debts and to manage the social impacts of needed reforms in the enterprise and banking sectors) will divert resources from developmental expenditures. Given FRY's starting point, recovery will take time, even under strong reform and concessional assistance. At an average growth rate of 4 percent per year, per capita income would reach about US$2,300- 2,400, or about 90 percent of the estimated 1990 level, by the end of the decade."' 20. Export performance will be essential to growth and macroeconomic sustainability. The last TSS noted that exports would recover more slowly than dollar GDP. Following the modest export growth of 2001, a more rapid rebound is expected in 2002. The restoration and creation of new business contacts, combined with some financial re-intermediation and greater access to export credits, should now allow FRY to make better use of the opportunities created by the removal of sanctions in 2000, and the signing of numerous international agreements to liberalize FRY's foreign trade thereafter. Over the medium-term, export growth will be supported by: the modernization of obsolete machinery and equipment and key repairs to public infrastructure; increased foreign direct investment (facilitated by the creation of a single economic space within FRY); greater integration into the regional and EU economy (where the SAA process will be important) and the global economy more broadly (through membership in the WTO). As investment needs and interest payments on foreign debt will initially rise more rapidly than national savings, the current account deficit is projected to rise from close to US$600 million in 2001 to about US$1.3 billion in 2004, with the current account as a share of GDP beginning to decline in 2004. 21. Medium-term growth will depend on increased and more effective investments. In the early years, donors will represent an important source of investment finance. Following the recent high levels of support for the Serbian energy sector and for various credit lines, donor support is now set to expand to the transport sector. As a result, overall public investment is projected to grow from a very low 1.4 percent of GDP in 2001 to 4.3 percent in 2004. The primary investment needs are in the enterprise sector (including agriculture, finance and tourism in Montenegro), where modestly higher investments should begin to follow from recent reforms to improve the business environment, to establish enterprise privatization on a basis conducive to attracting new investors, and to implement bank restructuring to restore the public confidence needed for its future revival. Assuming strong progress on these fundamental reforms, private investment is expected to rise from 12.1 percent of GDP in 2001 to 13.2 percent in 2004. 22. Fiscal deficits are expected to grow in the near term. The cash-based consolidated fiscal deficit (before grants) is expected to increase from 1.3 percent of GDP in 2001 to 5.7 percent in 2002. This is because expenditure savings from structural reforms will initially be outweighed by an increase in debt service payments, one-off reform-related expenditures, the containment of arrears through more realistic budgeting, and the inclusion in the budget of some quasi-fiscal activities. As reform-related expenditures diminish while further reforms contain other expenditures, this deficit would then decline to around 5 percent of GDP in 2004. Fiscal deficits would be primarily financed from concessional (including grant) donor financing and privatization revenues. From 2002 to 2004, cash outlays would be reduced by around 1 percentage point GDP per year. As the program would make further inroads into budgetary arrears and other hidden fiscal liabilities, particularly in energy and pensions, it would achieve even greater reductions in expenditure commitments. " A large part of the increase in US dollar growth reflects the impact of real appreciation of the exchange rate from the recent very low levels. 11 23. External financing requirements will remain large in the near term. With large physical rehabilitation needs and the rising cost of debt service following the normalization of relations Box 4. Donor Support to FRY Currently, over 25 multilateral and bilateral donors are providing, or have expressed interest in providing, developmental assistance. Approximately US$500 million was pledged to meet FRY's urgent needs at an initial Donor Coordination Meeting in December 2000. This amount included humanitarian assistance. In June 2001 the Economic Recovery and Transition Program (ERTP) report was presented to donors at a conference in Brussels, which estimated external assistance requirements to return FRY to a path of sustainable growth (in addition to commitments at the December 2000 conference). The ERTP report presented financing needs, on a commitments basis, of US$3.9 billion over three to four years. On a commitments basis, needs for 2001 were estimated at US$1.25 billion, of which US$140 million was needed in quick disbursing budget support. At the conference donors pledged US$1.33 billion towards the 2001 needs as outlined in the ERTP, including US$151 million in budget support. The ERTP recognized that funds committed during 2001 (and in subsequent years) would take time to disburse, depending on the type of assistance. The Joint EC-World Bank Office in Brussels has recently undertaken a survey of donors to gather data on the status of pledges towards the ERTP as of December 31, 2001. Initial results indicate that of the US$1.33 billion pledged towards the ERTP 2001 needs, 81% (US$1.09 billion) had been firmly committed, US$768 million (56%) had been contracted and US$303 million (23%) had been disbursed by the end of the year. Disbursements picked up in the first quarter of 2002 as some large donor operations were finalized. During the past year considerable progress has been made toward improving arrangements for aid coordination. Coordination units in each republic have been established with donor technical support, and have provided the focal points for collection and dissemination of data on economic assistance. The World Bank and the Joint Office in Brussels (WB-EC) has worked closely with these units and directly with the donor community. It is envisaged that the next Donor Conference could take place in late 2002 to take stock of progress and secure funding for the next stage of the reconstruction and transition program. with extemal creditors, FRY will have substantial financing requirements in the next few years. Assuming strong stabilization and reform performance, and further concessional debt rescheduling, average annual gross external financing needs (excluding for debt rescheduling) for 2002-2003 are estimated at around US$2.1 billion. These resources are needed to finance US$1.25 billion of current account deficits (excluding interest and official transfers), US$0.45 billion in increased international reserves, and the remaining US$0.4 billion to service international debt. These needs are expected to be met from several sources. Foreign direct investment and other private sector finance are expected to grow to around US$0.8 billion per year. The remaining nearly US$1.3 billion of annual financing would come from official, multilateral and bilateral sources, much of which would need to be raised at a second Donor Conference for FRY later in 2002. The proposed Bank program would represent a significant share of this financing, and can thus play a crucial role in ensuring a sustainable recovery in FRY. Overall donor assistance will need to include adequate provision of quick disbursing funds strongly tied to performance. The Bank program, with its large share of adjustment lending, will assist in meeting this crucial need. 24. Sensitivity analyses demonstrate the vulnerability of FRY's outlook to slippages in reform effort and insufficient external assistance. In the case of a delayed or weaker-than-expected reform effort or an erosion of fiscal control, donor programs (especially those conditional on policy performance) could be expected to be reduced and to have a smaller impact. Real GDP 12 growth under this scenario is likely to slow to less than I percent per year. Private investment would be cut as enterprise restructuring prospects decline, and exports would fall. Debt indicators would worsen and FRY's debt burden could become unsustainable. On the other hand, a low case could also arise from developments exogenous to FRY, such as an economic slow-down affecting key trading partners or a diversion of donor flows to other countries. This would be likely to lead, despite the government's best reform efforts, to reduced demand for FRY's exports and reduced foreign investment. In such a scenario it would be doubly important to ensure donor support is provided. If not, imports would fall, reflecting the smaller amount of extemal financing. Real GDP growth could be expected to slow to below 1 percent, as under the previous scenario. As donor funding waned, lower capacity to import capital and equipment would cut investment in industry and infrastructure, cutting the increase in employment and creating more persistent poverty. Lower donor spending on social programs would exacerbate this effect. These illustrative scenarios indicate the importance of both a sustained reform effort and strong donor support - and the extent to which the effects of both are inter-linked. VI. World Bank Group Assistance Pre-membership Assistance 25. During the first stage of World Bank assistance to FRY, in view of its urgent needs and concurrent with the arrears clearance process, the Bank established a Trust Fund for FRY (TFFRY) using US$30 million of IBRD surplus net income to provide grant financing for selected priority activities. The TFFRY was approved by the Board of Directors on March 13, 2001. Five grants totaling US$30 million have been approved under the TFFRY and are currently under implementation, laying a foundation for a broader first year IDA-financed program: * a private sector technical assistance grant (US$6 million) designed to provide urgent assistance to the Serbia Agency for Privatization to support up to 28 "early win" enterprise sales to strategic investors, strengthen institutional capacity in the Agencies for Privatization, Foreign Investment and SME Development, and support measures to improve the investment climate; * a financial sector technical assistance grant (US$6 million) intended to strengthen FRY's Bank Rehabilitation Agency and to support the rehabilitation and rapid privatization of some large state banks and support the liquidation and restructuring of insolvent banks not selected for privatization. * a socialprotection grant (US$10 million) for Serbia aiming to improve the equity of the existing safety net while developing a more sustainable framework, support policy development for reform of the social insurance system, and promote a more market- oriented labor relations framework to facilitate initial restructuring. * an electric power emergency reconstruction grant (US$6 million) for Serbia complements an EC-funded program, designed to help restore reliable electricity supply through urgent facility repair. It also supports improvements in the financial management of the electric power company and legal and policy advisory services. 13 * an environmental infrastructure grant (US$2 million) in Montenegro focusing on improving solid waste disposal in the coastal area of Montenegro and improving the quality of the water supply in the republic's Zeta Valley. 26. FY02-04 Transitional Support Strategy. On May 8, 2001, FRY succeeded to membership in the World Bank, and the Bank's Board of Directors endorsed a first Transitional Support Strategy (TSS) for the Federal Republic of Yugoslavia12. It contained a three-year IDA envelope of up to US$540 million for FRY on a temporary and exceptional basis, with actual lending to depend upon performance against agreed performance benchmarks. It was envisaged that up to eighty percent of the program could support policy based lending. The TSS laid out a program of lending, analytical work and advisory services for FY02. FY02 TSS Program Implementation 27. Lending. In line with the core TSS objectives, at end-June 2002, 4 projects totaling US$171.76 had been approved. Consistent with the agreed strategy, the program focused on providing quick disbursing funds to support the initiation of the reform program with selective investments in key sectors aimed at macroeconomic stabilization, stimulating private sector-led growth, protecting the vulnerable and developing human capital, and developing institutional capacity and strengthening institutions in both republics. Core fiduciary work has been completed, and urgently needed TA and advisory services in such areas as financial and private sector development, energy, and poverty monitoring has been provided. The FY02 lending program comprised: * Serbia Structural Adjustment Credit (SAC I), (US$70 million-approved January 2002- fully disbursed), designed to strengthen public expenditure management; and initiate reforms in energy, social protection, health, and labor markets. * Serbia Private and Financial Sector Structural Adjustment Credit (PFSAC) (US$85 million - approved May 2002) designed to assist the Government in: (i) strengthening the financial system through an improved policy and regulatory environment and liquidation of troubled banks; (ii) privatizing and restructuring socially owned- enterprises that crowd out private sector growth, hamper banking sector activity and are a source of quasi-fiscal risk; and (iii) improving the investment climate and business environment. * Serbia Education Improvement Project (US$10 million -approved May 2002) aims to (i) build institutional capacity in the Ministry of Education, (ii) provide systematic information to policymakers to promote reform and improve teaching and learning, and (iii) empower local communities to take responsibilities for the schools. * FRY Trade and Transport Facility Southeast Europe (TTFSE) (US$6.76 million - approved June 2002). The TTFSE is part of a regional program in Southeast Europe. It seeks to reduce non tariff costs to trade and transport and to reduce smuggling and 12A plan to clear FRY's arrears to the World Bank was approved with the membership package that provided for the exceptional consolidation of FRY's arrears and principal not yet due into a new package of IBRD loans. These Consolidation Loans were approved by the Board on December 13, 2001, and became effective in early-January 2002. 14 corruption at border crossings through providing support for customs modernization, improved information systems, enhanced information dissemination among the trading community and border control agencies, equipment for enforcement and pilot initiatives. 28. Analytical and Advisory Assistance. The Bank has completed a set of core fiduciary economic work for FRY. A Public Expenditure and Institutional Review (PEIR) covering both Serbia and Montenegro provides an institutional analysis of public expenditure management, evaluating the efficiency of decision-making and implementation processes in public spending. The findings and recommendations of the PEIR will inform the PRSP process and are expected to underpin further adjustment lending. A Country Financial Accountability Assessment assessed the strengths and weaknesses of FRY's financial management capacity, offered best practice advice and indicated the level of financial accountability risk. A Country Procurement Assessment Report for FRY was also completed. In addition, a Private and Financial Sector Review (Serbia) is being completed focusing on linkages between enterprise restructuring and financial sector reform. This review benefits from experiences in other transition economies. A Diagnostic Study of the Legal, Judicial and Institutional Framework (FRY) was undertaken to identify the principal problems and needs, and the nature and extent of reforms that might be required to modernize the Yugoslav system of justice. It could serve as a basis for both interim reform measures and the development of a longer-term legal reform program. 29. Three Post-Conflict Fund grants for Serbia are currently under implementation: (i) the Southern Serbia Municipal Infrastructure Recovery Project, implemented by UNDP, aims to reduce social tensions through municipal infrastructure rehabilitation; (ii) a grant to the International Committee for the Red Cross is supporting a pilot health care financing initiative; and (iii) a grant to the Center for Liberal Democratic Studies seeks to build consensus on the reform program through a series of workshops and study papers. In FY02 an IDF grant was also extended to the Serbian Ministry of International Economic Relations to support efforts to improve public communications on the governmnent's reform program. 30. Considerable technical assistance has also been provided to both republics through trust funding, IDA credits and the Bank's policy dialogue. The Bank is supporting the development of a sustainable poverty monitoring system, starting with data collection improvements under the Household Poverty Survey which will underpin the PRSP process. The financial and enterprise sectors have received significant assistance through TFFRY grants and energy and social sector reform efforts have also benefited. FY03 Program 31. The Bank's lending program in FY03 will continue to be guided by the principles articulated in the May 2001 TSS. Specifically, the focus will remain on adjustment lending, with up to 80 percent of the Bank's resources supporting policy reform in support of the four key objectives outlined in the TSS. A strong progran of complementary analytical work and technical and advisory services has also been developed to provide input to the policy agenda for the next phase of structural reforms as well as the preparation of the Government's Poverty Reduction Strategy. The IFC and MIGA programs complement and support the realization of these overarching program goals. 15 32. The program envisages policy-based adjustment operations supporting reforms in public expenditure management, and in the financial, private, energy and social sectors. As many donors are providing support to the infrastructure sector, the Bank's role will be primarily in terms of policy advice and support for public-private partnerships in which IFC is expected to play a key role. The full CAS will elaborate plans for a gradual shift in balance toward investment lending and further analytical work. Three projects -- the FRY Export Credit Facility, the Montenegro Energy LIL and the Montenegro SAC -- were originally planned for the FY02 program. All have been negotiated and will be presented to the Board for approval in the first quarter of FY03. Attachment III provides detailed descriptions of the planned FY03 lending and analytical and advisory program at the federal and republican levels. 33. Adjustment Lending. As envisaged in the May 2001 TSS, a program of sequenced adjustment lending has been initiated. In both Serbia and Montenegro adjustment lending will consolidate and build on the reform effort to improve fiscal sustainability and transparency initiated in FY02 operations and address emerging near-term issues. Following the first Structural Adjustment Credit for Serbia which focused on fiscal sustainability and the Serbian Private and Financial Sector Adjustment Credit (PFSAC) which laid the groundwork for an improved policy and regulatory environment, a proposed Social Sector Adjustment Credit (SOSAC) for Serbia would support systemic reform of the pension system, improved targeting, equity and efficiency in the operation of social assistance and child protection programs, reforms in active and passive programs for the unemployed, as well as key reforms in the health sector, including health financing and service delivery. Work on a second Private and Financial Sector Adjustment Credit (PFSAC II) for Serbia would build on and deepen the reforms implemented under the first PFSAC by supporting the process of enterprise restructuring and privatization in close coordination with the restructuring and liquidation of banks through the Bank Rehabilitation Agency. The credit would also support the establishment of sound prudential oversight capacity for banking in FRY, and the development of sound regulatory environment for the non-bank financial sector. In Montenegro a first Structural Adjustment operation (SAC I) would assist the republic in the implementation of a structural reform agenda in (i) public expenditure management; (ii) pensions; (iii) energy sector; (iv) labor markets; and (v) the business environment. During FY03, work on a second SAC for Montenegro would begin, deepening the reforms initiated under SAC I and extending the programn to financial and private sector reforms. 16 Table 2 - Strategic Objectives and the Bank Group Program Strategic World Bank Group Program Objective (Program benchmarks for FY03 are outlined in Attachment I and detailed descriptions are provided in Attachment 11) Restoring macro- FY02 economic stability Lending: SAC I (Serbia) and external AAA: Public Expenditure Review; Country Procurement Assessment Report; Country balance Financial Accountability Assessment FY03 Lending: SOSAC; Montenegro SAC I; Public Finance Capacity Building; (possible Debt and Debt Service Reduction) AAA Fiscal Sustainability Analysis Stimulating near- FY02 term growth and Lending: PFSAC; PSD TA grant; Banking TA grant; Electric Power Emergency creating the basis Reconstruction grant; Montenegro Coastal Environmental Infrastructure grant; Social for a sustainable Protection grant; Trade and Transport Facilitation in Southeast Europe project supply response AAA:, FIAS barriers to entry study IFC, MIGA, FIAS programs; Southeast Europe Enterprise Development (SEED) FY03 Lending: PFSAC II; Enterprise Restructuring and Financial Sector TA project; Montenegro Energy LIL; Labor LIL; Montenegro Environment project; FRY Export Credit Facility; GEF Lake Skadar (Montenegro); GEF on Nutrient Pollution (Serbia) AAA: PS/FSD linkage paper; Energy Sector Study; Agriculture Sector Study; Environment Sector Review; Transport Sector Strategy (Serbia) Environment-Poverty Workshop IFC and MIGA Programs, Public-Private Infrastructure Initiative (IFC) SEED Program Improving social FY02 well-being of the Lending: Education Improvement Project; Social Protection grant; post-conflict grants; most vulnerable Montenegro Coastal Environmental Infrastructure grant and building AAA: Poverty household surveys; Public Expenditure Review human capacity FY03 Lending: Montenegro SAC I; SOSAC; Health Sector Investment; Montenegro Environment Project; Labor LIL AAA: Health Sector Human Resources Strategy; Poverty Profile/Poverty Assessment and background papers; PRSP related assistance WBI - programs in poverty alleviation, community empowerment, health sector reform Improving FY02 govemance and Lending: Serbia SAC I; Education Improvement Project; post conflict grants; building effective AAA: Legal and Judicial Diagnostic institutions FY03 Lending: Public Finance Capacity Building; Health Sector Investment AAA: Fiscal Sustainability Analysis (FRY); Transport Sector Strategy (Serbia) Anti-Corruption TA/advisory services (Serbia) IDF grant on court administration reform (Serbia) WBI - corporate govemance and business ethics 17 34. Investment lending. In both republics, planned IDA investment lending in FY03 has been carefully selected to tackle critical impediments to effective public sector management and private sector development and underpin reforms initiated under the Bank-supported adjustment program. An Export Credit Facility for both republics will support sustainable economic growth by catalyzing and facilitating trade transactions through the creation of the Serbia and Montenegro Export Credit Agency (SMECA) to support both import and export activities through a variety of facilities. In Serbia an Enterprise Restructuring and Financial Sector Technical Assistance credit will support the implementation of measures initiated under PFSAC I and to be continued under the proposed PFSAC II. It would finance necessary advisory services, as well as complement the activities of the IFC and MIGA in private sector development. A Labor Learning and Innovation Loan (LIL) for Serbia will build capacity in the public sector to promote more cost effective labor redeployment programs, pilot innovative services for the unemployed, and promote a balance between social mitigation, fiscal sustainability and facilitating re-entry to the labor market. It would also support efforts to monitor and evaluate the employment and other social impacts of different interventions. A Public Finance Capacity Building credit for Serbia will strengthen the capacity of the Ministry of Finance and other spending units to plan, program and manage the use of public finances. A Health Sector Investment Project for Serbia will complement the policy reforms planned under the SOSAC through reorganization and modernization of the health financing system, implementing a master plan to restructure the health delivery system, and strengthening the capacity of the Government to introduce sound public policy'3. A GEF grant for Serbia on nutrient pollution prevention will also be pursued. 35. In Montenegro, an Energy Sector Learning and Innovation Loan will assess consumer response to the introduction of remote electricity metering and introduce automated billing and demand side management; (ii) facilitate the eventual privatization of distribution services; and (iii) lay the basis for comprehensive institutional strengthening in the energy sector. An environment operation will build on the coastal environment and water supply project, possibly including water supply and sanitation and waste management in the coastal zone and energy- environmnent issues. A GEF grant for Lake Skadar will be developed to assist Montenegro and Albania in the areas of biodiversity conservation and pollution prevention of Lake Skadar, creating a basis for joint management of the lake ecosystem. 36. Analytical work and technical assistance. Over the next twelve months, the Bank will continue work on the following studies: An environmental sector review (covering both republics) will assess policy reforms, identify priority actions, and highlight linkages between economic reconstruction, social policy and environmental protection. It will also serve as a basis for helping the Governments to develop a comprehensive National Environmental Action Plan. A national workshop on environment-poverty linkages will be conducted and the outcomes will be inputs to the PRSP process. Poverty profiles for both republics and supporting background papers on labor market, gender, social impact of reforms and targeting of social transfers will be undertaken. A subsequent participatory Poverty Assessment - feeding into the '3 In the event that FRY is able to conclude a concessional debt restructuring agreement with London Club creditors, the Bank would consider a request from the government to re-align the program to include a Debt and Debt Service Reduction Credit in FY03, within the available resource envelope. Such a credit could be up to US$15million covering both Serbia and Montenegro. 18 PRSP process - will take place on the foundation of the local capacity created at the first stage. An agricultural sector study covering both republics will: (i) identify the major constraints inhibiting productivity and sectoral growth; and (ii) develop the main priorities for short and medium-term action consistent with a coherent long-term strategy for broad based agriculture and rural development. A national workshop is planned to disseminate the results of the study and to bring best practices from several countries in the region. An energy sector study will analyze ways to move the sector toward commercialization and prepare for private sector participation. The study would address the needs of the poor, both in terms of supply needs and the impact of price increases likely to result from privatization on household income 37. In Serbia the Bank will assist the Government in preparing a health sector human resources strategy by undertaking a situation analysis of the health sector human resource problems (HRPs) in the republic. Particular focus will be placed on imbalances in skills mix, issues around low salaries and informal payments, and public/private sector mix. A transport sector strategy for Serbia will provide proposals regarding: (i) priorities for State and donor funding within and across transport modes; (ii) improvements in governance and the regulatory framework; promote the private sector, and control environmental externalities; and (v) increased cost recovery and sound subsidy systems to protect the poor. 38. The Bank has initiated some limited anti-corruption advisory services in Serbia in (i) conflict of interest management and (ii) institutional development of regional anticorruption bodies. A proposal for an IDF Grant to assist Serbia in reforming its court administration system is under development. The proposed Grant would assist the Ministry of Justice and the judiciary to intensify knowledge of the problems, build capacity and skills and prepare short- term measures as well as a medium-to-long-term master plan for modernizing the court administration system. 39. Regional Initiatives. The FRY program will continue to benefit from regional initiatives in support of economic development and cooperation in South Eastern Europe. These include on- going analytical and advisory activities on trade and investment policy, which directly aim at supporting the integration of FRY and the other countries of the region in the world economy, and with Europe in particular. The Trade and Transport Facilitation Program for South Eastern Europe has recently been extended to include FRY; its overall objectives are to reduce non-tariff costs to trade and transport, to reduce smuggling and corruption at border crossings, and to strengthen customs and border control agencies in the region. The Social Development Initiative for South Eastern Europe aims at promoting social cohesion and reducing inter-ethnic tensions through capacity building and community development. The development of a South Eastem Europe Regional Energy Strategy would be initiated in FY03. Finally, the Bank continues to support selected regional initiatives under the Stability Pact, most notably the Investment Compact and the Anti-Corruption Initiative, in collaboration with the OECD and other partners. 40. Partnerships. The FY03 Program would continue to benefit from consultations and partnerships with the donor community and civil society, which will be enhanced within the PRSP framework. Over 25 multilateral and bilateral donors are providing support for FRY's transition and reform program. The European Commission is a key partner, sharing the mandate with the World Bank, to coordinate donor assistance to FRY and the other countries of the region. In addition, the Stability Pact for South Eastern Europe remains an important vehicle for cooperation with the donor community. The Bank is also working closely with the 19 IMF, particularly supporting the Government in the PRSP process. On May 13 the IMF Board of Directors completed a third and final review of FRY's economic program supported under the June 2001 Standby Arrangement. An Extended Fund Facility of SDR 650 million (about US$829 million) to support FRY's 2002-2005 program was approved concurrently. 41. Program Performance and Monitoring. As outlined in the May 2001 TSS, roughly 80 percent of Bank lending over FY02-04 is expected to be policy based. Policy performance against the FY02 benchmarks was strong and, in a number of instances, exceeded expectations. These achievements are detailed in Attachment I, where specific benchmarks for the planned FY03 program are also elaborated. Bank Group support in FY03 would continue to be provided on a performance-linked basis. The FY03 Bank lending program remains heavily weighted toward policy-based lending, under a satisfactory macroeconomic framework. The front-loaded adjustment program is thus largely self-regulating. Compliance with up-front conditionality 'triggers' allows the program to proceed, whereas failure to meet the front loaded conditionality (or significant slippages in policy performance) would preclude subsequent policy lending. The full CAS, anticipated in summer 2003 upon completion of the full PRSP, will provide a more complete framework of performance indicators and monitoring and evaluation. 42. Fiduciary Issues. The Country Financial Accountability Assessment (CFAA) conducted in FY02 identified a number of risks concerning the management of public funds, including: weak capacity, especially in auditing; the central banking structure; and lack of recent experience in implementing Bank-financed projects. To address fiduciary issues related to Bank funding, a number of mitigation measures have been agreed and put in place, including: (i) the use of a small number of pre-screened banks and auditors; (ii) the establishment of appropriate institutional and implementation arrangements for financial management, disbursement and procurement in Bank-assisted projects; (iii) the provision of training on financial management, disbursement and procurement to FRY project staff, (iv) special ring-fencing of deposit account and the correspondent bank account for adjustment operations; and (v) audit provisions for adjustment lending. In addition, the Bank will place an accredited financial management specialist in the Country Office and remain in continuous dialogue with the three levels of government as the new constitutional arrangements take shape. The CFAA will be updated in about 18 months. 43. A first Joint Bank-Government Country Portfolio Performance Review will be conducted during FY03 to take stock of compliance with policy benchmarks and fiduciary measures and to assess overall implementation experience of the FRY portfolio. 44. Field Presence. Since the 2001 TSS the Bank's Belgrade 'mission support office' has been converted to a full Country Office. This Office is contributing significantly to policy dialogue as well as providing on the ground services in key areas. Staffing has been augmented. Bank Group program effectiveness has also been enhanced with the opening of an IFC Office and the IFC- administered Southeast Europe Enterprise Development (SEED) Office in Belgrade. The Loan Department has conducted training workshops and seminars for the central banks and ministries of finance staffs. A program for hands-on procurement advice and training will be initiated together with the discussions on the Country Procurement Assessment Report. 45. World Bank Institute (WBI). WBI, through policy formulation and training services, aims to build national capacity in FRY in four areas: (i) poverty alleviation; (ii) community empowerment; (iii) health sector reform; and (iv) corporate governance and business ethics. 20 While part of the training activities will be offered at the sub-regional level, bringing participants from the neighboring countries of South East Europe, selected FRY-specific activities and policy workshops are also planned. Additional areas for cooperation wil be explored during development of the CAS. . 46. To support the PRSP process, within the Attacking Poverty Program, WBI will offer three type of activities: (i) Development Debate (DD); (ii) the Balkan Poverty Forum; and (iii) Capacity Building in Poverty Measurement and Diagnostics. The objective of the DD series is to add value to national policies and strategies to effectively attack poverty. A Poverty Forum for three PRSP countries in the Balkans is planned for the Fall of 2002. The third type of activity will provide skills training in poverty measurement, poverty monitoring and poverty impact evaluation. 47. WBI's Community Empowerment Program is designed to gradually increase civic participation and citizen involvement in decision making and policy making processes at the local level through partnerships with local government and civil society. Specific activities will include training and sensitizing focus groups in administrative, legal and institutional frameworks under which public servants operate. In addition, WBI intends to offer its core courses on Health Sector Reform, Corporate Governance and Trade and Globalization. International Finance Corporation (IFC) 48. FRY became a member of IFC in May 2001, and an IFC office was opened in Belgrade in September 2001. Since then, 4 projects have been approved, two in financial markets and two in manufacturing, for about US$30 million. In addition, IFC has a robust pipeline in both the financial and manufacturing sectors pursuing an aggressive program of support to private sector development and the facilitation of direct foreign investment in FRY. Its strategic country objectives are to: (i) focus on the financial sector (banks) and develop other financial intermediaries (leasing, funds); (ii) support privatization and the restructuring process; (iii) invest in commercially viable companies, both private and partially private/to be privatized, and provide flexible solutions for their modernization investments and working capital needs; (iv) promote the growth of local entrepreneurship and SMEs; and, (v) provide technical assistance to support capacity building (market focus, business plans, accounting discipline). 49. The financial sector is a focal point of IFC's program in FRY. IFC's strategy in the financial markets is to catalyze strong foreign strategic investors to establish viable financial institutions in the country, assist in bank and insurance privatization, plus very selectively, assist private banks to attract strategic partners. IFC is also looking for opportunities to develop and support the non- bank financial sector, via both investment and technical assistance in leasing and securities market development. Mobilization of financial resources to local intermediaries for on-lending to SMEs remains one of IFC's priorities. IFC is in discussions with two equity fund managers, one for investments in SMEs, and the other for larger equity investments particularly in privatizations. 50. In addition, new project development is under way in garment-textiles, agribusiness mechanical industry, pharmaceuticals, retail distribution, and tourism. IFC is building a broad pipeline of investment opportunities in order to diversify risks and over the past year has intensified its cooperation with the Privatization Agency to help increase results on the ground. 21 IEFC, in cooperation with IDA, is also exploring with the Government possibilities for public- private sector financing partnerships to support the significant infrastructure needs in FRY. 51. Foreign Investment Advisory Service (FIAS) At the Government's request, FIAS prepared a report on barriers to entry which has fed into the Government's Business Environment reform agenda. 52. The Southeast Europe Enterprise Development (SEED) is a multi-donor initiative managed by the IFC. SEED supports SME development and strives to improve overall environment for SME growth and competitiveness in the region in three target areas: (i) enterprise-level investment services; (ii) capacity building; and (iii) improvement of the enabling environment. SEED has a Belgrade Office and anticipates the opening of an office in Montenegro soon. The Multilateral Investment Guarantee Agency (MIGA) 53. On April 9th, 2002 the Federal Republic of Yugoslavia succeeded to the membership of the Socialist Federal Republic of Yugoslavia in MIGA. Programs have begun in two areas: * Guarantees. MIGA is currently accepting applications for projects in FRY. Demand for MIGA coverage is currently in the area of US$200-US$300 million, representing projects in manufacturing, finance and infrastructure sectors. There is one active pipeline project in the finance sector at this time. * Investment Marketing Services. MIGA undertook a detailed assessment of the technical assistance needs of the Serbian Investment and Export Promotion Agency (SIEPA), and proposed a program of assistance to support the start-up phase. MIGA has prepared a development plan for the agency to make it effective and professional. SIEPA is now initiating procurement under an allocation of US$285,000 of the TFFRY PSD Technical Assistance grant , including hiring a long-term adviser to provide assistance on strategic and operational issues. Risks 54. The program faces risks at three levels: external, political, and policy implementation: * Various external shocks could strain FRY's ability to maintain a sustainable macroeconomic framework and return to growth. Even with continued strong performance toward stabilization and reform, a marked slowdown in the economy of key trading partners or a renewal of regional conflict could reduce the growth of exports and/or private capital inflows. Donor flows below pledged levels, and/or inability to secure appropriately concessional debt restructuring from remaining creditors would also exacerbate macroeconomic fragility. Even debt relief on the most favorable terms will lead to a sharp jump in debt service payments, further stretching fiscal and external balances. These risks underscore the importance of IDA financing. While most external shocks cannot be mitigated, the Bank and EC are together monitoring aid flows and working to ensure more timely conversion of pledges into disbursements. * There are several sources of political risk, most importantly, the possible erosion of support for the economic reform program. The challenge of mitigating the short-term social impacts of reforms in the face of public expectations of rising living standards 22 could create pressures to raise transition-related expenditures above the level of available fiscal resources, as well as hamper needed further inroads into hidden quasi-fiscal deficits. Implementation arrangements under the Union Agreement will require agreement on critical but as yet undefined details, including on crucial issues such as the financing of the new union structure and the precise modalities for harmonizing external trade policies and ensuring free inter-republican trade, which could prove more difficult than envisaged. Reform implementation could slow down in the run-up to the anticipated fall republican elections. In addition, although both republics have highlighted the need for improved governance and designed anti-corruption strategies, implementation will require considerable support and close monitoring. Finally, although the regional outlook is more encouraging than in prior years, a deterioration in relations with Kosovo or in southern Serbia could affect program implementation. The Bank is working to mitigate these risks through continued policy dialogue, increased outreach to the public and civil society, and IDF and post-conflict grants to support communication of reform strategies and public dialogue on key policy issues. The PRSP process is also expected to be a unifying force in facilitating a dialogue on priorities within each republic. The establishment of a clear path to European integration through the EU Stabilization and Association process will also buttress the economic reform program. The sequencing of adjustment operations offers the opportunity to both reinforce reforms and to mitigate possible policy slippage. * The program will face implementation and capacity issues which have proved difficult in other economies in transition. Although the federal and republican governments have moved quickly to meet agreed targets and deadlines, existing implementation capacity has been operating at about full capacity and the implementation of follow-up measures may test its limits. To some extent, the coming on stream of the substantial technical assistance available to FRY will mitigate this. Fiduciary risks at both the country and Bank program level are present. Although measures have been identified and put in place to mitigate, this will bear close monitoring. 55. On balance, the risks are outweighed by the potential benefits to be derived by improving the economic environment at a difficult and critical juncture of the reform process, by providing much needed budgetary support, and by creating a more secure and consistent foundation for other donors to provide similar support. Recovery will remain difficult and will not be possible without adequate and timely support from the Bank and other donors. These benefits will be felt not only in FRY, but also in the wider South East European region, as FRY's more rapid and sustainable recovery allows it to become a stabilizing force in the region. James D. Wolfensohn President By Shengman Zhang July 18, 2002 Washington, D.C 23 Federal Republic of Yugoslavia Transitional Support Strategy Update (FY03) Matrix of Development Objectives, Bank Program and Performance Benchmarks Objective Bank Program FY02 TSS Performance Reform progress against Performance FY03 TSS Performance Benchmarks Benchmarks to date Benchmarks (to be completed by end FY03) Restoring FY02 . Macro. [FRY] Government's * Macro. IMF SBA successfully * Macro. [FRY] Government's macro- Lending: SAC I (Serbia) macroeconomic program, completed. 3 year IMF EFF macroeconomic program, economic AAA: Public Expenditure supported by IMF, on track approved. supported by IMF EFF, on track stability and Review; Country Procurement * Public expenditure * Public Expenditure external Assessment Report; Country management. [FRY and * Public expenditure management. Management. [Republics]: balance Financial Accountability republics] Unified, agreed Good progress in both republics on Satisfactory progress towards Assessment budgets; and improved budget formulation. Introduction of development of a Medium Term budget execution monitoring full GFS for 2002 budget. Initial Fiscal Framework. Full setting FY03 systems; [Serbia] progress towards Medium Term up of Treasuries in republican Lending: SOSAC Montenegro Substantially increased Fiscal Framework, more advanced in MOFs. Full disclosure of audits SAC I; Public Finance power tariffs; preparation of Serbia. Power tariff rises effected. of 2001 budget execution. Capacity Building; (possible medium-term expenditure Debt and Debt Service management strategy * Tax Reform: Improvements to Reduction) * Tax reform. [Serbia] Tax tax administration, further AAA Fiscal Sustainability (sales tax, excise) unification * Tax reform. New simplifying tax revisions of excise tax, Analysis and simplification, code implemented, tax base introduction of synthetic- elimination of exemptions; expanded, exemptions reduced personal income tax, adequate [Montenegro] Tax Action [Serbia] Approved Tax Action Plan progress towards -Plan, comprehensive tax code [Montenegro] implementation of tax action * External debt. [FRY] plan. [Montenegro] Concessional rescheduling of * External debt. Paris Club official (2001) and concessional rescheduling deal commercial (2002) completed and effective. Negotiations with London Club * External financing. [FRY] continuing. Mobilization of sufficient * External financing. US$1.34 m in foreign assistance for ERTP pledges raised towards ERTP (annually) program for CYO 1. Preparations ongoing for pledging conference tentatively planned for late 2002. D__ Stimulating FY02 * Trade. [FRY] Revised trade * Trade. Significant improvements to * Trade: Continued improvements near-term Lending: PFSAC; PSD TA legislation; government- legislation, simplified tariff regime, to customs administration. growth and grant; Banking TA grant; approved customs reform greatly reduced licenses and quotas. creating the Electric Power Emergency plan Prepatory work towards WTO and basis for a Reconstruction grant; SAA. Initial steps to combat sustainable Montenegro Coastal corruption and smuggling. supply Environmental Infrastructure response grant; Social Protection grant; * Private sector development. * Private sector development. * Private Sector Development: Trade and Transport Facilitation [Serbia] New foreign Pnvahzahon Agency established, Amendments to Companies in Southeast Europe project investment law; revised new privatization law, foreign Law, new Bankruptcy Law, AAA:, FIAS barriers to entry privatization legislation; investment law, 28 companies amendment to Privatization Law study establishment of privatization contracted to investment banks for to strengthen government IFC, MIGA, FIAS programs; agency; I large and I pool of sale by tender. In addition, new position as creditor, begin Southeast Europe Enterprise 6 medium firms offered for bankruptcy law drafted, draft strategy process of enterprise Development (SEED) sale; 3 large and 4 pools paper for restructuring of 44 restructuring, strengthening and FY03 offered for sale (Jul 2002); 'systems' submitted to govt. [Serbia] capacity building in Privatization Lending: PFSAC II; Enterprise [Montenegro] New company agency to manage restructuring Restructuring and Financial law, bankruptcy law agents. [Serbia] Sector TA project; Montenegro B [B :t art Energy LIL; Labor LIL; * Banking. [Serbia] * Bankin: Implementation of a * Bankne: Preparatlon of a Montenegro Environment Preparation of strategy for strategy for intervention in insolvent Supervisory Development Plan project; FRY Export Credit mtervention in insolvent banks, including closure of largest for Bank Supervision. Facility; GEF Lake Skadar banks; intervention in large four. Completion of audit of most (Montenegro); GEF on Nutrient insolvent banks; new banks. Improvements to prudential Pollution (Serbia) prudential legislation and regulation and enforcement [Serbia] AAA: enforcement manual Diagnostic reports of all banks PS/FSD linkage paper; Energy completed [Montenegro] . . t. Sector Study; Agriculture Sector * Utilities. [Serbia] New * Utilities. Ongoing work towards * Utilites: Continued Study; Environment Sector energy policy, new electricity Energy Law [both Republics] Improvement of financial Review; Transport Sector and regulatory laws Implementation of phased program position of EPS, Energy sector Strategy (Serbia) of price rises and costs containment, strategy [Serbia], new Energy Environment-Poverty Workshop measures to increase efficiency, Law, price increases, increase in IFC and MIGA Programs, reduce demand, decrease in barter collection ratio [Montenegro] Public-Private Infrastructure payments [Serbia] Strategy to Initiative (IFC) mitigate power shortfalls, initial SEED Program work to develop legal/regulatory framework [Montenegro] * Labor: New law on employment, * Labor: [Serbia] Revised law * Labor: New labor law, draft new fiscally sustainable on labor relations employment law [Serbia], draft labor institutional framework for mass law submitted to parliament, redundancies [Serbia]. [Montenegro] Assessment of effectiveness of existing labor market programs [Montenegro] Improving FY02 * Social protection. [Serbia] * Social protection. Substantial * Social Protection: Passage of social Lending: Education Draft social protection improvements through revised new pensions law which wellbeing of Improvement Project; Social strategy; new social welfare pension legislation, introduction of introduces systemic reform, the most Protection grant; post-conflict legislation revised pension uniform republican thresholds for including disability and farmers vulnerable grants; Montenegro Coastal law social benefits, data base on social pensions; New law on and building Environmental Infrastructure welfare institutions[Serbia] New employment. [Serbia] Adoption human grant draft pension law [Montenegro] of new pension law;, steps to capacity AAA: Poverty household * Education. [Serbia] Draft * Education. Education eliminate non-pension benefits surveys; Public Expenditure decentralization strategy; decentralization strategy completed, from pension fund [Montenegro] Review increased share of spending spending on education increased FY03 on education [Serbia] Lending: Montenegro SAC 1; * Health: National Health policy * Health: Complete new Health SOSAC; Health Sector * Health: Health reform prepared, improvements to drug Insurance Law, new Investment; Montenegro strategy and financing plan procurement, audit of HIF pharmaceutical law, Interim Environment Project; Labor LIL (new health insurance law, completed, pilot co-payments Health Services Restructuring AAA: Health Sector Human co-payments system) introduced, [Serbia], Plan completed, Health Resources Strategy; Poverty Information Systems master plan Profile/Poverty Assessment and completed and database background papers; PRSP established. related assistance Povert: [FRY] Preparation Poe__c_ ilteanlyisO wBI - programs in poverty of Interim Poverty Reduction , Povert: FRY I-PRSP completed. * poverty: comy eulsCnpleteanlsso alleviation, communifIntenmPerty Reductlo Imnproved Poverty Surveys in both poverty survey results Comnplete empowerment, health sector atgy republics, poverty assessment; finalize ____ ___ ___ reform Improving FY02 * Civil service reform. * Civil service reform. New laws on * Civil service reform: Complete governance Lending: Serbia SAC 1, [Serbia] New law on the Budget System, Public constitutional charter and laws and building Education Improvement Project; government; public Procurement [Republics], new defining federal/republican effective post conflict grants; administration reform constitutional structure is being jurisdiction. Strategy paper on institutions AAA: Legal and Judicial strategy defined [Federal and Republics], publitcadn.stic for civil service Diagnostic Iiildansi o ii evc FY03 reform [Montenegro] Lending: Public Finance * Judiciary. [Serbia] New law * Judiciary. Adoption of new judicial Capacity Building; Health Sector on independent judiciary. legislation and establishment of new Investment judicial bodies [both republics] AAA: Fiscal Sustainability progress towards development of a Analysis (FRY); Transport judicial reform strategy; Sector Strategy (Serbia) Anti-Corruption TA/advisory services (Serbia) IDF grant on court administration reform (Serbia) WBI - corporate governance and business ethics Attachment II Federal Republic of Yugoslavia - Republic of Montenegro Recent Structural Reform Progress Structural reforms in Montenegro began in 1998 with substantial donor support, and have thus progressed to a different stage than those in Serbia. In Montenegro, the key challenge is now building the capacity and institutions to implement legislated reforms effectively. Recent progress has included: (i) Price liberalization. Montenegro's macroeconomic stabilization efforts have been supported by phased removal of price controls. Following the August 2001 liberalization of the prices of bread and milk, Montenegro now has a set of remaining controlled prices similar to that in other market economies. Progress has also been made in raising the remaining controlled prices towards levels which cover the costs of production. (ii) Foreign trade reform. Although foreign trade policy and customs are constitutionally federal areas of competence, Montenegro gradually obtained de facto autonomy over these areas. It has used this autonomy to establish a liberal trade policy regime. In July 2000, the Government adopted a Temporary Act on Customs Tariffs. Almost 92 per cent of all products are imported at rates of 5 percent or less, and the average tariff rate is just below 3 percent. Montenegro has also established its own customs administration. (iii) Tax reform. An estimated 30-50 percent of the Montenegrin economy lies outside the formal sector. In response, the Government has recently begun to take measures to simplify the tax system and fight the gray economy. A Tax Action Plan delineates measures for the planning and implementation of a comprehensive tax code, with a view to improving tax collection and broadening the effective tax base. A number of new laws were passed in late-2001, including on personal income taxes, property taxes and excises. (iv) Public expenditure management. Gaps in procedures and institutions have contributed to the loss of fiscal control in Montenegro. In response, the Government has undertaken reforms to prepare and execute budgets in ways which better align commitments with available resources and ensure a more transparent and efficient use of public and donor resources. This has been achieved through the development of a consolidated medium-term framework for budget preparation, improved budget execution through implementation of the recently established Treasury system, and reforms to reinvigorate inspection and auditing procedures. In August 2001 the Montenegrin Parliament passed in a new Law on Public Procurement, which moves towards the EU Procurement Directives. (v) Energy. This sector is the source of two significant problems: quasi-fiscal liabilities in the form of chronic losses of key utilities; and the inability of electricity supply to meet demand, particularly during the winter. A phased set of revenue adjustments to return the Montenegrin electricity utility to financial self-sufficiency has been introduced, and the power utility has formulated a strategy to mitigate the supply shortfall problem. The first steps have been taken towards developing a legal and institutional framework for the sector. (vi) Privatization. The extension of the privatization program begun in 1991 has been one of the main expressions of the Government's commitment to market-oriented reforms. In early 1999, the Montenegrin parliament passed a new law establishing the Privatization iv Council, which has been responsible for all activities in this area. Montenegro is relying on a mass voucher privatization (MVP) program for small stakes in selected enterprises as well as tenders and auctions for majority stakes with a view to attracting strategic investors. The MVP program was completed in late 2001 when vouchers were distributed to all citizens and widespread share ownership was established. So far only a few tenders and auctions have been completed. (vii) Improvement of the business environment. The business environment program focuses on removing constraints to the entry and growth of new enterprises, on facilitating the exit of inefficient enterprises, and on completing the system of secured financing to improve enterprise access to capital. A new Enterprise Law was enacted that significantly streamlines the company registration process. Montenegro also has adopted a new Enterprise Insolvency Law, which establishes clearer rules and procedures for enterprise resolution and protection of creditor rights, and is working with USAID to implement the new law. Montenegro has recently adopted a new Law on Secured Transactions and an action plan to implement the new law, including the creation of a centralized computerized pledge registry. (viii) Financial Sector. Montenegro has de facto autonomy in this nominally federal area of competence. In November 2000, its parliament adopted new laws on the Central Bank of Montenegro (CBM) and on the Banking System promoting bank restructuring and strengthening the supervision capacity of the CBM. Diagnostic reports of all 11 banks in Montenegro have been completed. The largest bank in Montenegro, Montenegrobanka, is under administration and is expected to be privatized within 12 months. (ix) Social protection and labor markets. To address hardship among a wider group of the population, the Government has extended the right tofamily material support (the main program of cash social assistance) to include those who are capable of work and responsible for the maintenance of children. At the same time, it has targeted child allowances, which were formerly given to the first three children in all families irrespective of need, to children in families that receive material support and to children with disabilities. While there is need for careful monitoring and assessment, these changes represent important steps in improving the coverage and adequacy of benefits of the social safety net. (x) Pensions. The government has designed a new law on pension and disability insurance which modifies key parameters of the current system to contain fiscal costs, while at the same time planning for a more comprehensive future reform of the pension system including funded elements. (xi) Legal and Judicial Reform. Montenegro has established an Anti-Corruption Agency and has prepared special anti-corruption legislation and also participates in the Stability Pact Anti-Corruption Initiative. The Criminal Code was amended to introduce a number of new criminal offences, particularly in the area of corruption, organized crime, money laundering, computer crimes, human trafficking and domestic violence. Montenegro has also moved ahead with the adoption of a new law on courts, established a new Court of Appeal and a new Administrative Court and a High Judicial Council. v Federal Republic of Yugoslavia - Republic of Serbia Recent Structural Reform Progress The transition to a market economy in FRY and Serbia began with the fall of the previous federal Government in October of 2000, followed by the election of a new govemrnment in Serbia in January of 2001. The overall agenda was elaborated in the 'Structural Reform in Serbia' presented to the June 2001 donor's conference in Brussels, and the World Bank/EC ERTP. Significant progress has been achieved, including: (i) Price liberalization. By early autumn of 2000, the fixing of key prices at well below market clearing levels had led to chronic shortages, particularly of food, fuels and medicines. As one of its last decisions, the outgoing Serbian government freed most of these prices, leaving a small set of controls, similar to that in most ECA countries. The resulting (often several fold) price increases quickly restored balance to product markets and worked to improve incentives, at the cost of further straining the living standards of the most needy. Remaining controlled prices have been raised closer to cost-recovery levels, including more than doubling of power prices during 2001, higher natural gas and district heating prices, and higher pharmaceuticals prices. (ii) Foreign trade reform. The new Federal Government inherited a highly distorted foreign trade regime, which hampered revenue collection and created fertile ground for corruption. In December 2000, the Federal Government moved to suppress the most egregious administrative controls, and (with input from the Bank) to prepare a more fundamental reform of trade policy. This reform, approved in May 2001, drastically simplified the tariff regime (reducing the number of tariff rates from 37 to 6), removed almost all foreign trade licenses, and limited the use of quotas. The Federal Government also began the longer-term process of accession to the WTO and the negotiation of a EU Stabilization and Association Agreement. In addition, it has launched measures to reform the customs system and limit corruption and smuggling. (iii) Tax reform. The new Serbian government inherited a highly complex tax regime, with around 250 different taxes and levies. In spring 2001, it successfully implemented tax reform which sharply cut the number of taxes and levies and widened the tax base. In April 2001, the previously multiple (often earmarked) turnover taxes were unified, while most exemptions were eliminated. Excise taxes were similarly streamlined. In June 2001, expansion of the base for the personal income tax (by bringing in previously non-taxed benefits) allowed a significant cut in the payroll tax rate. All of these measures will work to improve incentives, enhance revenue collections and reduce possibilities for arbitrary application and corruption. (iv) Public expenditure management. Reform efforts have focused on budget preparation and execution, aligning commitments with available resources, and ensuring more transparent and efficient use of public and donor resources. To this end, the Govemment has passed a new Law on the Budget System, which lays the basis for establishing a more consolidated and comprehensive medium-term framework for budget preparation, to improve budget execution through the introduction of a Treasury system, and to improve the transparency of the budget through enhanced inspection, auditing and procurement procedures. vi (v) Energy. The Serbian Government has begun a phased program of revenue and cost containment measures to return the Serbian electricity utility EPS to financial self- sufficiency. This program included a more than doubling of power prices and a containment of initially high real wages in EPS. It has also commenced other reforms to reduce energy demand, reduce costs by increasing productivity, and improve the efficiency of energy use. (vi) Privatization. The Serbian Government moved quickly to halt privatization under the flawed existing framework, which involved opaque procedures and favored insiders. In parallel, and building on the experiences of other transition economies, it quickly developed a new framework allowing 70 percent of enterprise equity to be offered to strategic investors in a transparent fashion, with a view to establishing clearly defined and dominant owners. The new Privatization Law, adopted in June 2001, has been followed by the creation of a privatization agency, the adoption of secondary legal acts, and the beginning of the process of selling about 60 "early win" firms with the assistance of international investment banks. The government has also initiated a process for auction privatization of selected enterprises, through which 60 enterprises are expected to be offered by the end 2002, with several hundred more expected to be in the pipeline for 2003. (vii) Banking reform. Reforms are under way to promote the entry of new banks and improve prudential regulations and their enforcement'4. In tandem, substantial progress has been made towards implementing a strategy to restructure insolvent banks in Serbia (the four largest state owned banks representing 60 percent of the system have been liquidated) and to strengthen the Federal Bank Rehabilitation Agency (BRA) to manage the resolution and liquidation process (again with extensive technical assistance from the Bank). (viii) Business Environment. Considerable work has been initiated on commercial law reform including laws on securities, competition, insurance, company bankruptcy, secured transactions etc. A revised federal Law on Foreign Investment was enacted. Legal and judicial reforms and anti-corruption initiatives complement the effort. (ix) Legal and judicial reform. The Serbian authorities have initiated efforts to make the law-making process more transparent and inclusive. Achievements include (i) Amendments to the federal Criminal Procedure Code in line with European and international standards and to the Serbian Criminal Code to introduce new crimes, especially pertaining to corruption; (ii) Initial steps to implement a comprehensive judicial reform including adoption of five new organic laws on the organization of courts, the status of judges and the prosecutors office, and the establishment of a judicial training center. (x) Anti-corruption. The Serbian government is implementing a multi-pronged strategy ir this area. In addition to measures described above (public expenditure reform, legal reforms, simpler and more transparent trade and tax regimes, customs reform, and a more transparent process of privatization), there has been a clampdown on illegal trade in tobacco and liquid fuels. Both republican and local level bodies are preparing anti- 4 Four foreign cormnercial banks have already conmnenced operations in Serbia. 15 Drafted with the assistance of FIAS and enacted in January 2002, the law is de facto applied on the level of the FRY and in Serbia. Montenegro has passed its own law. vii corruption strategies and legislation. Serbia participates in the Stability Pact Anti- corruption Initiative. (xi) Social protection and labor markets. Pensions have been a particularly large source of budgetary outlays and arrears, and delays in social assistance payments have had a negative effect on the most vulnerable. The government has implemented parametric reforms and improved the administration of the existing pension system as crucial first steps. As a result, the timeliness of pension payments has improved. Reforms to social assistance have been implemented to better cushion the impact of adjustment on the poorest members of society and to place these benefits on a more sustainable financial footing. Reform of labor markets has begun through the passage of a new labor law and the drafting of a new law on employment, which will remove structural impediments to cost containment in the enterprise sector, remove a key bottleneck to reducing overstaffing in, and provide an impetus to growth in employment by increasing flexibility in the labor market. (xii) Reform of the health care system. This sector was also identified as a major source of government expenditures and arrears. Reforms to begin restoring financial balance are also a prerequisite for improving its functioning and its ability to provide basic health care services to all citizens. Initial steps have been taken to reform the system of health care financing (including the introduction of co-payments and the adoption of a more limited essential drugs list). (xiii) Education. The Serbian Ministry of Education and Sports has presented its decentralization strategy to donors, and received World Bank and other donor investment funding to help implement this strategy. In parallel, the share of government resources allocated to education at the Republic level has increased, mostly through higher teacher salaries, while revenue assigned to municipalities has increased to help fund the decentralization effort. Recently adopted amendments to the education laws for primary and secondary education support decentralization efforts by shifting more responsibilities to school boards. viii Attachment III FY03 IDA Program Federal Republic of Yugoslavia FRY Export Credit Facility (US$11.5 million) This project aims to support sustainable economic growth by catalyzing and facilitating trade transactions through the creation of the Serbia and Montenegro Export Credit Agency (SMECA). SMECA will support both import and export activities through the following facilities: export credit insurance; working capital loans and guarantees; exporter performance insurance; medium term import insurance/guarantee; and technical assistance to exporting enterprises on marketing/match- making. Imports will be facilitated through political risk insurance; and limited comprehensive import credit insurance. In the event that FRY is able to conclude a concessional debt restructuring agreement with London Club creditors, the Bank would consider a request from the government to realign the program to allow for a Debt and Debt Service Reduction Credit in FY03. Such a credit could be up to US$1 Smillion covering both Serbia and Montenegro Planned analytical work and technical assistance: * an environmental sector review (both republics) commenced in FY02 is designed to assess policy reforms, identify priority actions, and highlight linkages between economic reconstruction, social policy and environmental protection. The ESR will serve as a pilot for testing the concept of Country Environmental Analysis--analyzing environmental problems from first principles based on economic costs as well as developing the Bank's strategy for the environment sector in FRY. It will also serve as a basis for helping the Governments to develop a comprehensive National Environmental Action Plan. * A national workshop on environment-poverty linkages will be conducted and the outcomes will provide inputs to the PRSP process, emphasizing the following issues : (a) poverty and quality of environment linkages, (b) poverty and sustainability of natural resource management; (c) poverty and vulnerability to natural disasters; and (d) poverty and vulnerable social groups (notably IDP, refugee and Roma communities). * poverty profiles for both republics and supporting background papers on labor market, gender, social impact of reforms and targeting of social transfers will be completed. At the second stage, during 2002-2003 a participatory Poverty Assessment (linked to the PRSP process) will take place facilitated by the local capacity created at the first stage. * an agricultural sector study covering both republics will (i) identify the major constraints inhibiting productivity and growth and (ii) develop the main priorities for short and medium-term action consistent with a coherent long-term strategy for broad based agriculture and rural development. * a broad based energy sector study covering both republics will analyze ways to: (i) move the sector to commercialization in preparation for adoption of EU principles and Directives; (ii) prepare the sector for private sector participation (privatization, concessions, leasing, management contracts); (iii) address the over-staffing problem in the sector and the need to close down or dispose of uneconomic assets; and (iv) address the needs of the poor, both in terms of supply needs and the impact of price increases likely to result from privatization on household income. ix FY03 IDA Program Republic of Montenegro Adjustment Lending: * Montenegro SAC (US$15 million - Negotiated). The operation is designed to assist the republic in the implementation of a structural reform agenda in (i) public expenditure management; (ii) pensions; (iii) energy sector; (iv) labor markets; and (v) the business environment. * Work on a second SAC for Montenegro would begin in FY03, building on the reforms initiated in SAC I and expanding the agenda to focus intensively on private and financial sector reforms. Investment Lending: * Montenegro Energy Sector Learning and Innovation Loan (LIL) (US$5 million- Negotiated ) The LIL is intended to (i) assess consumer response to the introduction of remote electricity metering and introduce automated billing and demand side management; (ii) facilitate the eventual privatization of distribution services; and (iii) lay the basis for comprehensive institutional strengthening in the energy sector * An environmental operation (US$5 million)would build on the coastal environment and water supply project, possibly including: (a) water supply & sanitation and waste management in the coastal zone; (b) forestry; and (c) energy-environment issues. * A GEF grant for Lake Skadar would be developed to assist Montenegro and Albania in the areas of biodiversity conservation and pollution prevention of Lake Skadar by implementing changes in sectoral policies (agriculture, industry, forestry, and others), promoting sustainable fisheries, and ecological tourism and by creating a basis for joint management of the lake ecosystem. x FY03 IDA Program Republic of Serbia Adjustment Lending: * As envisaged in the TSS, the proposed Social Sector Adjustment Credit (SOSAC) (US$61 million) would be the third in a series of adjustment credits. This Credit would support systemic reform of the pension system, improved targeting, equity and efficiency in the operation of social assistance and child protection programs, reforms in active and passive programs for the unemployed, as well as key reforms in the health sector, including health financing and service. * A second Private and Financial Sector Adjustment Credit (PFSAC H) (US$60 million) to Serbia would build on and deepen the reforms under the first PFSAC by supporting the process of enterprise restructuring and privatization in close coordination with the process of restructuring and liquidation of banks through the Bank Rehabilitation Agency. The credit would also support the establishment of sound prudential oversight capacity for banking in FRY, and the development of sound regulatory environment for the non-bank financial sector. PFSAC would be included in the FY04 program. Investment Lending: * An Enterprise Restructuring Technical Assistance credit (US$11.0 million) would support the implementation of measures initiated under PFSAC I and to be undertaken under the proposed PFSAC II. It would finance necessary advisory services, as well as complementing the activities of the IFC and MIGA in private sector development. * A Labor Learning and Innovation Loan (LIL) (US$3.5 million)would build capacity in the public sector to promote more cost effective labor redeployment programs in partnership with a range of actors, piloting innovations in services for the unemployed and promoting an effective balance in privatization and restructuring programs between social mitigation, fiscal sustainability and facilitating re-entry to the labor market. It would also support efforts to monitor and evaluate the employment and other social impacts of different interventions. * A Public Finance Capacity Building credit (US$8 million)would seek to facilitate the implementation of the recommendations of the PEIR and develop to capacity of the Ministry of Finance and other spending units to manage the use of public finances. * A Health Sector Investment project (US$15 million) would complement the policy reforms planned under the SOSAC by ensuring the availability of accurate and timely data for health policy making and developing the capacity of the health system to use these data effectively; reorganizing and modernizing the health financing system; improving the quality and access of health services by implementing a master plan to clinically and physically restructure the delivery system, and strengthening the public health system and the capacity of the Government to introduce sound public policy. xi * A GEF grant for Serbia on nutrient pollution prevention may be developed focusing on: (a) the introduction of better manure management and disposal practices to large pig farms; (b) implementing regulatory and incentive based reforms to popularize non- phosphate based detergents; (c) industrial nutrient pollution reduction ; (d) non-point sources nutrient pollution reduction through implementing best agricultural practices Planned analytical work and technical assistance: * The Bank will assist the Government of Serbia in preparing a health sector human resources study by (i) undertaking a situation analysis of the health sector human resource problems (HRPs) in the republic; (ii) identifying the causes of the HRPs; (iii) prioritizing the HRPs Serbia currently faces, (iv) identifying strategic options for the next 2-3 years, including resources required; and finally, (v) identifying a preferred HR strategy, and explain why it was chosen. Main problems that have been identified include imbalances in skills mix, issues around low salaries and informal payments, and public/private sector mix. * A transport sector study for Serbia will provide proposals regarding: (i) priorities for State and donor funding within and across transport modes; (ii) improvements in governance and the regulatory framework in the sector in order to better use State funds, promote the private sector, and control environmental extemalities; and (v) increased cost recovery and sound subsidy systems to protect the poor. * The Bank is providing anti-corruption advisory services in Serbia in (i) conflict of interest management and (ii) institutional development of regional anticorruption bodies. A report will be prepared describing options and recommendations for the Government of Serbia. In addition, the Bank will provide advice through videoconferencing and email on comparative practice in conflict of interest management. A conference on this topic is also planned. The Bank is also exploring options to provide the Government with a technical advisor on conflict of interest management and anticorruption on a more extended (3 - 6 month) basis, to support their efforts in implementation. * A proposal for an IDF Grant to assist Serbia in reforming its court administration system has been developed. The proposed Grant would assist the MOJ and the judiciary to intensify their knowledge of the problems and needs of the court administration system in Serbia and of existing models in other countries, build capacity and skills for court administration through provision of equipment and training, and prepare short-term measures as well as a medium-to-long-term master plan for modernizing the court administration system. xii Annex 1 Page 1 of 2 Federal Republic of Yugoslavia at a glance 7/16/02 Europe & Lower- POVERTY and SOCIAL Yugoslavia, Central middle- Fed. Rep. Asia Income Development diamond' 2001 Population. mid-year (mnllWions) 1 0.0 475 2,046 Life expectancy GNPpercapita(A0asrmethodr US$) I/ 990 2,010 1,140 GNP (Atlas meUd, US$ billions) 1/ 10.5 956 2.327 Average annual growth, 1995-01 Population (I%) 0.1 0.1 1.0 Labor force (%) 0.5 0 6 1.3 GNI Gross per primary Most recent estimate (latest year available, 1990501) capita *. enrollment Poverty (% of population below nationalpovert line) 2/ 15 - 25 Urban population (I% of total population) 52 67 42 Life expectancy at birth (years) 72 69 69 Infant mortality (per 1000 live births) 13 21 32 Child malnutrition (I% of children under 5) 2 .. 11 Access to improved water source Access to an improved water source (I% of population) .. 90 80 Illiteracy (% ofpopulation age 15+) .. 3 15 Gross primary enrollment (%of school-ge population) 69 100 114 Yugoslavia,FR (Se,tAfont.) Male 69 101 116 Lower-middle-4ncome group Female 70 99 114 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981 1991 2000 2001 Economic rattos- GDP (US$ billions) 8.1 109 Gross domestic lnvestmentUGDP .. .. 14.5 13.5 T Exports of goods and services/GDP .. .. 31.6 25.4 rade Gross domestic savings/GDP .. .. -3.5 -8.6 Gross national savings/GDP .. .. 10.3 8.0 Current account balance/GDP .. .. -4.2 -5 5 Domestic Interest payments/GDP 3 .. .. 0.6 0.7 . Investment Total debtGDP 141.3 110.0 savngs Total debt service/exports 3/ 2.3 3.9 Present value of debtVGDP Present value of debt/exports Indebtedness 108141 199141 2000 2001 200145 (average annual growth) GDP .. .. 5.0 5.5 4.3 Yugoslavia FR (SerbAfont.) GDP per capita .. .. 4.9 5.0 3.8 Lower-middle4-ncome group Exports of goods and servkes .. .. 34.8 9.4 10.7 STRUCTURE of the ECONOMY 1981 1989 2000 2001 Growth of Investment and GOP (%) (% of GDP) 20 Agricufure 10.1 17.6 .. 1 Industry 43.1 37.6 . o Manufacturing . .. .-10 95 7 08 o o o Services 468 448 20 .30 Private consumption 85.0 90.2 -40 General govemment consumption 18 5 18.4 GDI - GDP Imports of goods and services 49.6 47.5 (averageannualgro )1981491 1991401 2000 2001 Growth of exports and Imports (%) (average annual growth) Agriculture .. .. -20.0 25.0 40 Industry .. .. 10.9 0.0 20 Manufacturing .. .. .. .. o Services .. .. .. . 0 97 0 so 01 Private consumpton .. .. 20.0 14.8 -40 General govemment consumption .. .. -24.5 5.2 -40 Gross domestic investment .. .. 17.5 5.8 Exports lnTorts Imports of goods and services .. .. 28.6 30.0 Note: 2001 data are preliminary estimates. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. 1/ Estimate for 2000, excludes Kosovo and is calculated using the market exchange rate 2/ Estimated range. 3/ On a cash basis. Annex I Page 2 of 2 Yugoslavia, FR (Serh. lont.) PRICES and GOVERNMENT FINANCE 1981 1991 2000 2001 Inflation I%) Domestic prices (% change) 100 Consumer prices 71 8 91 1 8 - Implici GDP deflator 768 91 7 60 40i Government finance 20 (% of GDP, Includes cunrent grants) o Current revenue 4/ . 40.0 42.3 96 97 98 99 00 01 Current budget balance . 3.2 0.7 GDP deflator C CPI Overall surplus/deficit . -0 2 -0.6 TRADE (US$ millions) 1981 1991 2000 2001 Exportand importlevels (US$ mill) Total exports (fob) 1,923 2,003 6,000 Food 297 5,000 Other fuel . . . 50 Manufactures 694 4.000 l Total imports (fob) 5/ 3,711 4,838 3,C Food . . 552 2,00 : Fuel and energy 52 1 Capital goods 1,012 0 Export pnce index (1995=100) .. . . .. Import price index (1995=100) .. . . .. 0 Exports H Imports Terms of trade (1995=100) .. .. .. BALANCE of PAYMENTS (USS millons) 1981 1991 2000 2001 Current account balance to GDP (%) Exports of goods and services . 2,547 2,762 0 - i Imports of goods and services .. .. 4,004 5,160 -1 95 96 97 98 9i ri Ot. Resource balance .. .. -1,457 -2,398 23 I " . Net income -1 -26 -4 L Net curTent transfers 1,119 1,828 + Current account balance -339 -596 .6 Financing items (net) . 585 1,120 89I L. Changes in net reserves 6/ .. .. -246 -524 -9 i Memo: Reserves including gold (US$ millions) . 516 1,169 Conversion rate (DEC, locaYUSS) . 44.4 66 7 EXTERNAL DEBT and RESOURCE FLOWS 1981 1991 2000 2001 (US$ millions) Composition of 2001 debt (US$ mill.) Total debt outstanding and disbursed 11.407 11,949 IBRD 7/ . 1,812 1,840 IDA 0 0 A 1,840 Total debt service .. 56 107 c 272 IBRD 0 0 0 0 IDA 0 0 0 0 F 4,424 Composition of net resource flows D 595 Official grants . .. 271 591 Official creditors .. 377 333 Private creditors 0 0 49 202 Foreign direct investment . 25 165 Portfolio equity ,, 0 0 E 4,818 World Bank program Commitments 0 0 0 0 A A. eRD E - Bilateral Disbursements 0 0 0 0 B- IDA D - Other multilateral F - Private Principal repayments 0 0 0 0 C- IMF G - Short-term Net flows 0 0 0 0 1 Interest payments 0 0 0 0 Net transfers 0 0 0 0 Development Economics 7/16/02 4/ Includes current grants 5/ Breakdown is preliminary VWB staff estimate 6/ On a gross basis. 7/ Includes interest arrears and penafty interest. Federal Republic of Yugoslavia - Key Icononiic Indicators Annex 2 Page 1 of 2 Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 National accounts (as % of GDP) Total Consumption 104 109 106 104 102 Gross domeshc investment .. 15 13 15 16 17 Government investment 3 1 3 4 4 Private investment .. .. 11 12 12 13 13 Exports (GNFS)' . 32 25 25 26 26 Imports (GNFS) .. . 50 48 46 46 46 Gross domestic savings .. -4 -9 -6 -4 -2 Gross national savings .. . 10 8 7 7 9 Memorandum items Gross domestic product . . 8071 10861 12841 13849 14993 (US$ million at current pnces) Real annual growth rates (%, calculated from 2000 prices) Gross domestc product at market prices -.. .. 15.7 5.0 5 5 4.0 4.0 4.0 Real annual per capita growth rates (%, calculated from 2000 prices) Gross domestic product at market pnces .. .. . 5 0 3 5 3.7 3.8 Total consumption . .. . 20.7 7.3 1 5 2.8 Private consumption .. .. . . 15.7 8 2 3.2 3.1 Balance of Payments (US$ millions) Exports (GNFS)' 3265 3947 2148 2547 2762 3154 3566 3900 Merchandise FOB 2447 3033 1677 1923 2003 2250 2616 2900 Imports (GNFS)' 5161 5270 3539 4004 5160 5949 6385 6838 Merchandise FOB 4799 4849 3296 3711 4838 5567 5985 6424 Resource balance -1896 -1323 -1391 -1457 -2398 -2795 -2819 -2938 Net current transfers 310 655 668 1119 1828 2046 1875 2022 Current account balance -1561 -660 -764 -339 -596 -1050 -1285 -1292 Net private foreign direct investment 740 113 112 25 165 400 450 500 Long-term loans (net) 54 25 12 213 502 950 926 813 Ofticialb 54 25 12 213 333 787 747 634 Pnvate 0 0 0 0 169 163 179 179 Other capital (net, mcl. etrors & onuissions) 749 407 529 347 453 162 327 464 Change in reserves' 18 115 111 -246 -524 -462 -418 -485 Memorandum items Resource balance (% of GDP) .. .. . -18.1 -22.1 -21.8 -20.4 -19.6 Annual dollar-value growth rates Merchandise exports (FOB) 19 8 23.9 -44.7 14.7 4.2 12.3 16.3 10.9 Merchandise imports (CIF) 17.0 1.0 -32.0 12.6 30.4 15.1 75 73 (Continued) Federal Republic of Yugoslavia - Key Iconomic Indicators Annex 2 Page 2 of 2 Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 Public finance (as % of GDP at market prices)d Current revenues and grants . .. 40.0 42.3 44.0 43.5 42.8 Current expenditures .. .. .. 36.8 41.6 45.6 44.1 42.4 Current account surplus (+) or deficit (-) .. .. .. 3.2 0.7 -1.6 -0.6 0.4 Capital expenditure .. .. .. 3.3 1.4 3.1 3.7 4.3 Overall balance -0.2 -0.6 -4.7 4.3 -4.0 Monetary indicators M2/GDP' .. .. .. 9.1 8.5 8.9 11.0 14.0 Price indices( 2000 =100) Real exchange rate (US$/LCU)r . .. .. 100.0 134.0 146.3 145.3 147.0 Retail price index (% change) .. .. 49.9 113.5 39.0 20.0 10 7 6.4 a "GNFS" denotes "goods and nonfactor services." b. Includes use of IMF resources. c. On a gross basis. d. Consolidated general governmet. e. Comprises Serbian money supply only. f. "LCU" denotes "local currency units " An increase in US$/LCU denotes appreciation. Federal Republic of Yugoslavia - Key Exposure Indicators Annex 3 Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 Total debt outstanding and 11407 11949 8598 9397 10130 disbursed (TDO) (US$m)3 Net disbursements (US$m)a 0 0 0 229 502 950 899 991 Total debt service (TDS) (US$m)b 0 0 0 56 107 343 444 487 Debt and debt service indicators (%) TDO/XGSc .. .. .. 447.9 432.6 272.6 263.5 259.7 TDO/GDP .. .. .. 141.3 110.0 67.0 67.9 67.6 TDS/XGS .. .. .. 2.3 3.9 10.9 12.5 12.5 IBRD exposure indicators (%) IBRD DS/public DS 0.0 0.0 0.0 0.0 0.0 34.9 29.3 24.7 Preferred creditor DS/public DS(%)d 0.0 0.0 0.0 0.0 51.1 50.9 45.5 53.0 IBRD DS/XGS 0.0 0.0 0.0 0.0 0.0 4.8 4.3 4.1 IBRD TDO (US$m)' 1144 1128 1148 1119 1012 1834 1834 1919 IDA TDO (USSm)' 0 0 0 0 0 290 450 535 a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital. b. Reflects debt service relief. c. "XGS" denotes exports of goods and services. d. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. e. Excludes interest arrears and penalty interest through 2001. Federal Republic of Yugoslavia Annex 4 IBRD/IDA Program Summary As of 7/05/02 Proposed 1BRD/EDA Base-Case Lending Program a Strategic Implementation Fiscalyear Proj ID US$(M) Rewards b b Risks (HI/M/L) (I l/M/L) 2003 EXP FIN FAC 11.5 M M HEALTH 15 0 H H LABOR LIL 3 5 M M MONTENEGRO EMG POWER LIL 5.0 M M PFSAC 2 60 0 H H PRIV & RESTR OF BANKS & ENTERPRISES TA 11 0 H H SAC (MONTENEGRO) 15.0 H H PUBLIC FIN. CAP BUILDING 8 0 H M MONTENEGRO ENVIRONMENT 5 0 H M SOSAC 61.0 Hi H Result 195.0 Annex 5 Federal Republic of Yugoslavia IFC and MIGA Program, FY 2000-2003 As of 07/15/02 IFC approvals (US$m) 32.12 Sector (%) FINANCE & INSURANCE 25 FOOD & BEVERAGES 21 PLASTICS & RUBBER 54 Total 100 Investment instrument(%) Loans 75 Equity 14 Quasi-Equity I I Other Total 25 MIGA guarantees (US$m) 0.00 Annex 6 Federal Republic of Yugoslavia Summary of Non-lending Services As of 7/05/02* Product Completion FY Completion Cost Audience' Objectiveb Recent completions Country Procurement Assessement FY02 80 G, D, B, PD KG, PS Country Fin. Accountability Assessment FY02 109 G, D, B, PD KG, PS Legal and Judicial Diagnostic FY02 65 G, D, B, PD PS, KG Baniers to Entry (FIAS) Completed FY02 G PS, KG Underway Public Expenditure and Institutional Review FY03 368 G, D, B, PD KG, PS Agriculture Sector Study FY03 229 G, D, B, PD KG, PS, PD Environmental Sector Review FY03 159 Poverty Assessment FY03 155 Poverty Household Survey FY03 203 Pnvate Sector/Financial Sector Linkages FY03 94 Anti-Corruption Advisory Service FY03 25 G PS, KG Health Sector Human Res Strategy FY03 77 G, D, B, PD KG, PS, PD Planned Fiscal Sustainability FY03 75 G, D, B, PD KG, PS Energy Sector Study FY03 80 G, D, B, PD KG, PS, PD Transport Sector Review FY03 80 G, D, B, PD KG, PS, PD a Govemment, donor, Bank, public dissemination. b. Knowledge generation, public debate, problem-solving. ^ Estimated Federal Republic Of Yugoslavia Operations Portfolio (IBRD/IDA and Grants) As of 7105/2002 Closed Projects I IBRD/IDA 0 Total Disbursed (Active) 84.81 of which has been repaid 0.00 Total Disbursed (Closed) 0.00 of which has been repaid 0.00 Total Disbursed (Active + Closed) 84.81 of which has been repaid 0.00 Total Undisbursed (Active) 116.95 Total Undisbursed (Closed) 0.00 Total Undisbursed (Active + Closed) 116.95 Active Proleet Difference Between- Last PSR Expected and Actual Supervision Rating Orleinal Amount In USS Millions Disbursements a/ Project ID Project Nste Developent Imnplementation Fiscal Year IBRD IDA GRANT Cancel. Undisb. Orig. Frm Rev'd Project ID Project Nanse Ob~~~~Qkktletv-es Proureas25 P074127 FINSECDEVTTAGI S . S 2001 6.00 4.02 1.80 P074145 PRIV SECT DEVTTA S S 2001 6.00 4.50 2.50 P074618 MONT. ENV. INFRAS S S 2002 2.00 2.00 - P074124 SOCASSTGRANT S S 2002 10.00 0.60 0.60 P074136 EMG ELEC POWER F S S 2002 6.00 4.07 3.10 P074586 SERBIA SAC S S 2002 70.00 - - P074090 TRADE & TRANSPOI S S 2002 6.76 6.76 P074486 PFSAC S S 2002 85.00 85.00 P075189 EDUC IMPRVMT S S 2002 10.00 10.00 - Overall Trsult Result 171.76 30.00 116.95 8.00 Federal Republic of Yugoslavia Annex 8 Statements of IFC's Held and Disbursed Portfolio As of 7/05/2002 (In US Dollars Millions) Held Disbursed FY Apprc Company Loan Equity Quasi Partic Loan Equity Quasi Partic 2002 Fresh&Co 7.17 0.00 0.00 0.00 4.78 0.00 0.00 0.00 1982/87 Igalo 8.06 0.00 0.00 0.00 8.06 0.00 0.00 0.00 1985 Jugobanka 4.06 0.00 0.00 0.87 4.06 0.00 0.00 0.87 1980 Monte Hotels 2.00 0.00 0.00 0.00 2.00 0.00 0.00 0.00 1980 Radoje 1.17 0.00 0 00 0.00 1.17 0.00 0.00 0.00 2002 Raiffeisen Yug 0.00 2.33 0.00 0.00 0.00 0.94 0.00 0.00 1980 SMSIE Yugo 1.08 0.00 0.00 0.00 1.08 0.00 0.00 0.00 2002 Tigar Tyre 14.89 0.00 3.72 0.00 5.59 0.00 0.00 0.00 1987/89 Vojvodjanska 38.09 0.00 0.00 18.94 38.09 0.00 0.00 18.94 Total Portfolio: 76.52 2.33 3.72 19.81 64.83 0.94 0.00 19.81 Approvals Pending Commitment Loan Equity Quasi Paric 2002 MFB Yugoslavia 4.00 1.00 0.00 0.00 Total Pending: 4.00 1.00 0.00 0.00 IMAGING Type CAS 24476 YU Report No.: 2446SY Type:'. A