Document of The World Bank Report No: 87603-MK IMPLEMENTATION COMPLETION AND RESULTS REPORT ON THE PUBLIC EXPENDITURE POLICY BASED GUARANTEE OF EUR155 MILLION (US$ 201.5 MILLION EQUIVALENT) TO THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA May 27, 2014 Poverty Reduction and Economic Management Unit (ECSPE) South East Europe Country Unit (ECCU4) Europe and Central Asia Region (ECA) GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 12, 2014) Currency Unit Macedonian Denar MKD 1.00 US$ 0.022 US$ 1.00 MKD 44.73 WEIGHTS AND MEASURES Metric System ABBREVIATIONS CBMIS Cash Benefits Management and LTROs Long Term Refinancing Options Information System M&E Monitoring and Evaluation CCT Conditional Cash Transfers MOF Ministry of Finance CDS Credit Default Swap MOH Ministry of Health CPI Consumer Price Index MOLSP Ministry of Labor and Social Policy CPS Country Partnership Strategy MKD Macedonian Denar DIF Deposit Insurance Fund NBRM National Bank of Republic of FYR DPL Development Policy Loan Macedonia (Central Bank) EC European Commission PAs Prior Actions ECB European Central Bank PBG Policy Based Guarantee EIB European Investment Bank PEPBG Public Expenditure Policy Based EU European Union Guarantee EUR Euro PD Program Document FDI Foreign Direct Investments PDO Program Development Objectives FSAP Financial Sector Assessment Program PFM Public Financial Management FSC Financial Stability Committee PHCI Public Health Care Institutions FSI Financial Soundness Indicators RFP Request For Proposals FYR Former Yugoslav Republic SFA Social Financial Assistance GDP Gross Domestic Product SME Small and Medium Enterprise HBS Household Budget Survey SWC Social Welfare Center HCI Health Care Institution SILC Survey on Income and Living HIF Health Insurance Fund Conditions IBRD International Bank for Reconstruction TA Technical Assistance and Development TTL Task Team Leader ICR Implementation Completion and UN United Nations Results Report USAID United States Agency for IMF International Monetary Fund International Development ISR Implementation Status and Results VAT Value Added Tax Report Vice President: Laura Tuck Country Director: Ellen Goldstein Sector Director: Roumeen Islam Sector Manager: Satu Kahkonen PEPBG Task Team Leader: Birgit Hansl ICRR Task Team leaders: Stella Ilieva/Doerte Doemeland CONTENTS A. Basic Information...................................................................................................................................... ii B. Key Dates .................................................................................................................................................. ii C. Ratings Summary ...................................................................................................................................... ii D. Sector and Theme Codes..........................................................................................................................iii E. Bank Staff (some fields are entered by the system) .................................................................................iii F. Results Framework Analysis ..................................................................................................................... iv G. Ratings of Program Performance in ISRs ................................................................................................ vi H. Restructuring (if any) ............................................................................................................................... vi 1. Program Context, Development Objectives and Design ........................................................................ 1 2. Key Factors Affecting Implementation and Outcomes .......................................................................... 8 3. Assessment of Outcomes ...................................................................................................................... 10 4. Assessment of Risks to Development Outcome ................................................................................... 16 5. Assessment of Bank and Borrower Performance ................................................................................. 18 6. Lessons learned..................................................................................................................................... 19 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners....................................... 20 Annex 1. Bank Lending and Implementation Support/Supervision Processes ............................................ 21 Annex 2. Borrower’s ICR ............................................................................................................................ 22 Annex 3. List of Supporting Documents, and Persons Interviewed ............................................................. 29 Map A. Basic Information Public Expenditure Policy Country FYR Macedonia Program Name Based Guarantee (PEPBG) Program ID P133791 L/C/TF Number(s) Not Applicable ICR Date May 27, 2014 ICR Type Core ICR Government of FYR Lending Instrument PBG Borrower Macedonia Original Total Commitment US$201.5 Million Disbursed Amount US$201.5 Million Revised Amount Implementing Agencies: Ministry of Finance (MOF), Ministry of Health (MOH) and Ministry of Labor and Social Policy (MOLSP) Cofinanciers and Other External Partners Deutsche Bank B. Key Dates Revised / Actual Process Date Process Original Date Date(s) Concept Review: September 27, 2012 Effectiveness: January 11, 2013 Appraisal: November 05, 2012 Restructuring(s): None Approval: January 8, 2012 Mid-term Review: None Closing: December 31, 2013 C. Ratings Summary C.1 Performance Rating by ICR Outcome: Highly satisfactory Risk to Development Outcome: Moderate Bank Performance: Highly satisfactory Borrower Performance: Highly satisfactory C.2 Detailed ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Highly satisfactory Government: Highly satisfactory Quality of Highly satisfactory Government/Implementation Highly satisfactory Supervision: Agency/Agencies: Overall Bank Highly satisfactory Overall Borrower Highly satisfactory Performance: Performance: ii C.3 Quality at Entry and Implementation Performance Indicators Implementation Performance Indicators QAG Assessments (if any) Rating: Potential Problem Program at any time No Quality at Entry (QEA) None (Yes/No): Problem Program at any time Quality of Supervision No None (Yes/No): (QSA) DO rating before Closing/Inactive Not applicable Not Applicable status D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Public Expenditure and Management 33 33 Health 33 33 Social Protection 33 33 Original Actual Theme Code (as % of total Bank financing) Public expenditure and management 33 33 Health 33 33 Social Protection 33 33 E. Bank Staff (some fields are entered by the system) Positions At ICR At Approval Vice President: Laura Tuck Philippe Le Houerou Country Director: Ellen Goldstein Jane Armitage Sector Manager: Satu Kahkonen Satu Kahkonen Country Manager Tatiana Proskuryakova Lilia Burunciuc Task Team Leader Birgit Hansl Birgit Hansl ICR Team Leaders: Stella Ilieva/Doerte Doemeland ICR Primary Authors: Stella Ilieva/Doerte Doemeland iii F. Results Framework Analysis Program Development Objectives (PDOs): The main Program Development Objectives (PDOs) of the Public Expenditure Policy Based Guarantee (PEPBG) were to help FYR Macedonia respond to the economic slowdown triggered by the worsening Eurozone outlook by strengthening public financial management practices and eliminating VAT refund and payment arrears; 1 improving the efficiency of service provision in the health sector; and strengthening social protection and inclusion. In parallel, the PEPBG assisted FYR Macedonia to implement a borrowing strategy to maintain sustainable fiscal accounts by tapping funding from the international bank loan market, on improved terms. In line with the International Bank for Reconstruction and Development (IBRD) policy on PBGs, the PEPBG helped to expand the country’s investor base as the commercial bank sold participation notes and shares to international investors. In line with these objectives, the Government used the PEPBG to borrow EUR250 million in January 2013, covering 46 percent of the total financing requirement in 2013 at a reasonable cost (3.915 percent interest rate) 2 in two tranches of 5 and 7 years maturity. The PEPBG also improved the leverage of the Bank’s capital by allowing FYR Macedonia to contract a sizable commercial loan of EUR 250 million out of which only 62 percent, i.e. EUR155 million, equivalent of US$201.5 million, was guaranteed by IBRD. (a) PDO Indicator(s) Baseline Value Original Target Formally Revised Actual Values (from approval Values Target Values Achieved documents) (from approval at Completion or documents) Target Years Indicator 1 Decrease in the stock of VAT arrears. Value 0.6 percent of Zero Zero (quantitative or GDP qualitative) Date September 2012 December 2013 March 2013 Comments Target achieved. Target achieved ahead of the target date. Indicator 2 Decrease in the stock of payment arrears. 3 Value 0.5 percent of Zero Zero (quantitative or GDP qualitative) Date September 2012 December 2013 March 2013 1 The PEPBG focused on the clearance of arrears on VAT refunds and payments of goods and services that are recorded in the central government treasury. These arrears amounted to about 1-2 percent of GDP by September 2012. They did not include arrears to the Health Insurance Fund and Health Care Institutions. These arrears were treated under the Policy Based Guarantee (PBG) 2011 for FYR Macedonia and not covered under the PEPBG since all public health institutions are covered under a separate Health Single Treasury Account. 2 There was a EUR75 million unguaranteed loan contracted on 7/12/12, with a maturity of 5 years and which carried an interest rate of 6.465 percent. 3 As mentioned above, this indicator referred to payments recorded in the central government treasury. iv Baseline Value Original Target Formally Revised Actual Values (from approval Values Target Values Achieved documents) (from approval at Completion or documents) Target Years Target achieved. Target achieved ahead of the target date. Comments Indicator 3 Decrease in the average unit price of most frequently used drugs Value MKD 1200 Decreased by at Decreased by 22 (quantitative or least 10 percent percent qualitative) Date September 2012 December 2012 December 2012 Target achieved. The prices for both generic and non-generic drugs were further Comments decreased in March and October 2013 realizing a total saving of 25 million Euros for these two adjustments. Indicator 4 Decrease in average unit price of centrally procured optical medical devices. Value MKD 3700 Decreased by at Decreased by 38.6 (quantitative or least 33 percent. percent. qualitative) Date February 2012 December 2012 December 2012 Target achieved. The actual decrease in optical device prices was larger than the Comments target set in the PD. Increase in the number of health service provider contracts in previously underserved Indicator 5 areas. 0 or 1 PHC At least doubling of See comment. Value provider contracts PHC provider (quantitative or in 16 least well- contracts in 5 least qualitative) served regions. well-served regions. December, 31 Date June 2012 December 31, 2013 2013 Target achieved. 26 pharmacies and 8 health facilities were opened in 7 least well Comments served regions where there were none before. Increase in the number of social safety net beneficiaries from active labor market Indicator 6 policies (ALMPs) Value (quantitative or 5,700 10,000 11,308 qualitative) Date December 2011 December 31, 2013 December 31, 2013 Comments Target achieved. Improved service access by a reduction in number of documents needed by Social Indicator 7 Financial Assistance claimants for registration and renewal procedures. v Baseline Value Original Target Formally Revised Actual Values (from approval Values Target Values Achieved documents) (from approval at Completion or documents) Target Years Value Five documents Only one document One document (quantitative or needed. needed. needed qualitative) Date achieved September 2012 November 2012 October 2012 Target achieved. The MoLSP linked the Cash Benefits Management and Information System (CBMIS) with databases of all relevant agencies in July 2012 and the system became operational in October 2012. As of October 2012, a claimant to Social Comments Financial Assistance only needs to show his/her identification and sign a document allowing the Centers for Social Work, which administers the Social financial Assistance, to access his/her linked information databases of six other agencies. Increase in the benefit level for the Social Financial Assistance and Permanent Indicator 8 Assistance. Value MKD 3800 and Five percent 5 percent increase MKD 4800, increase for both. for both. (quantitative or respectively. qualitative) 2012 2013 March 2013 Target achieved. Through Official Gazette no 166/12, 5 percent increase for both Comments went into effect in on March 1, 2013, and an additional 5 percent increase went into effect on March 1, 2014 by Official Gazette no 187/13. (b) Intermediate Outcome Indicator(s) Not Applicable G. Ratings of Program Performance in ISRs Date ISR Actual Disbursements No. DO IP Archived (USD millions) BTOs March and Satisfactory Satisfactory $201.5 May 2013. H. Restructuring (if any) Not Applicable vi 1. Program Context, Development Objectives and Design 1.1 Context at Appraisal The Economic Situation at Appraisal 1. The Public Expenditure Policy Based Guarantee (PEPBG), was requested by the Government as the gradual recovery during 2010 and the first half of 2011 appeared increasingly threatened by the worsening Eurozone outlook. By June 2012, it became clear that growth in Germany, Italy and Greece, which are among FYR Macedonia’s key trading partners, was slowing down, sharply reducing demand for Macedonian exports. In FYR Macedonia, real output growth of 2.9 percent in 2010 and nearly 4.7 percent in the first half of 2011, was reduced to 1 percent in the second half of 2011 and turned negative in the first half of 2012, driven by a slow-down in exports. . Real GDP growth contracted in 2012 and the current account deficit in terms of GDP widened from 2.5 percent in 2011 to 3.0 percent in 2012 (Table 1). 2. The Government was concerned that the output contraction in 2012, and the uncertain economic environment would adversely affect living conditions, in particular for lower income Macedonians. In the past, FYR Macedonia faced challenges promoting shared prosperity and inclusion. Overall inequality as measured by the Gini coefficient, increased from 37 to 40 percent between 2003 and 2008. Similarly, although overall consumption (based on household survey data) grew by 1.1 percent p.a. over the same period, consumption for the bottom 40 percent declined by 1.5 percent p.a. The most recent Survey on Income and Living Conditions (SILC) showed that in 2010 nearly 27.3 percent of the population lived in poverty and in 2012, unemployment, the main threat to inclusive growth, though falling slowly, remained high at about 31 percent of the labor force 4. 3. The Government proactively responded to economic slowdown and its adverse social consequences through significant fiscal stimulus, increasing social and capital spending. Between 2011 and 2012, capital spending of the central government increased from 3.9 to 4.1 percent of GDP and social spending from 19.7 to 20.8 percent of GDP. In parallel, the Government continued its policy of a freeze of public sector wages, which held the public sector wage bill to the same level in 2012 as in 2011. To encourage growth, the Government implemented measures to improve credit availability for the private sector by providing additional capital for the Macedonian Bank for Development Promotion and a sovereign guarantee for an European Investment Bank (EIB) loan to the small and medium enterprise (SME) sector. In addition, in line with the Government’s objective of improving FYR Macedonia’s competiveness and supported by the Bank’s First Competitiveness DPL (November 30, 2012), the Government implemented a number of measures to improve competitiveness. These included measures to improve the environment for high value added manufacturing and agribusiness; improve trade logistics and labor market flexibility. The fiscal deficit on a cash basis widened from 2.5 percent in 2011 to 3.9 percent in 2012 and the government built up arrears in the central Government treasury on VAT refunds and payments on goods and services, which together amounted to about 1-2 percent of GDP by September 2012. In addition, the health sector, which has its own treasury function, had payments obligations amounting to nearly 0.5 percent of GDP by end 2012 5. Growth in 2012, still, turned negative but was significantly above the regional average. 4 Youth unemployment rates are exceptionally high. More than 56 percent of the active population aged 15-25 years is unemployed. 5 In DPL1 and in the first PBG operation the Bank had assisted with the creation of the separate treasury function for all public health institutions which helped reduce public health sector arrears. 1 Table 1: Selected Macroeconomic Indicators 2010 2011 2012 2013 2013 Actual Actual Actual As per PD Actual Real Economy (% change) Real GDP 2.9 2.8 -0.4 2.0 3.1 Investment -2.7 3.2 7.8 3.0 N/A Fiscal Accounts (% of GDP) Revenues 30.4 29.8 30.1 28.8 29.6 Expenditures 32.9 32.3 34.0 32.3 33.6 Central Government Balance -2.4 -2.5 -3.9 -3.5 -4.1 External Accounts (% of GDP) Current account balance -2.1 -2.5 -3.1 -3.5 -1.9 Trade balance -20.5 -21.9 -23.6 - -20.6 Real Exports Growth (% p.a.) 23.6 10.5 0 5.0 4.5 Real Imports Growth (% p.a.) 9.5 10.4 4.2 4.8 -2.1 Foreign Direct Investment 2.2 4.5 1.0 2.0 3.3 Gross International reserves 5.0 4.1 4.8 4.3 4.4 (Months of imports) External Debt 58.2 61.7 67.3 66.8 67.7 Source: Ministry of Finance, NBRM and World Bank Staff Estimates. 4. Financing needs in 2013 were projected to be high in the Program Document due to a sustained fiscal deficit and a maturing Eurobond. In September 2012, the Government publicly acknowledged the presence of arrears, and included provisions in the 2013 budget to eliminate them by February 2013, which widened the 2013 fiscal deficit. Wages and salaries were budgeted to remain flat in line with the Government’s policy of the freeze on wages. Current expenditures were budgeted to increase by 4.6 percent in nominal terms compared to the 2012 budget mainly to accommodate the preannounced increase in pensions. Capital expenditures were budgeted to increase by nearly 18.2 percent compared to the 2012 outturn mainly to stimulate construction activity and were expected to be financed through external loans. In addition, a large payment (EUR 175 million) on a maturing Eurobond was falling due in early 2013 and increased the Government’s financing need. At appraisal, the Government’s 2013 budgetary financing needs amounted to about EUR 545 million. Even if the Government had rolled over all the domestic debt, borrowed a small amount of EUR 59 million domestically and drawn down Government deposits (EUR 175 million), it would still have been left with an external financing gap of about EUR 320 million (59 percent of the total financing requirement), which, given the turmoil in the Euromarkets seemed a very risky financing strategy. Table 2: Financing Requirements for Fiscal Accounts ( EUR Million) 2012 2013 Actual As in PD Total Financing Requirements 376 545 Deficit 289 288 Amortization 88 257 o/w Maturing Eurobond 175 Total Financing Sources 376 545 Government Deposits -195 165 Domestic Borrowing 446 59 External Borrowing 123 320 o/w Policy Based Guarantee 250 o/w WB Competitiveness DPL 39 Others 2 1 Source: Ministry of Finance and World Bank Staff Estimates 2 Rationale for the PEPBG operation 5. Against the background of large financing needs and an uncertain external environment, the Government of FYR Macedonia approached the Bank in late 2012 for a PEPBG to tap funding from the international loan market at a reasonable cost as a part of its overall borrowing strategy. In developing its borrowing strategy, the choice of a policy based guarantee (PBG) as the appropriate instrument was guided by three considerations: First, increased domestic borrowing was not a viable option. While domestic banks were liquid, it would have been very difficult to borrow the needed EUR 200 to 300 million with 5-7 year maturity from domestic banks. The domestic market did not have enough large institutional investors and the cost of borrowing would have been high. Second, despite having sound fundamentals, the option of borrowing from the commercial market without a guarantee was very expensive and risky. Although FYR Macedonia had borrowed from the private commercial market in the past without a high grade guarantee 6, plans to raise EUR 250 million in market funding at a five year maturity earlier in 2012 partly failed and had to be scaled down to EUR 75 million. The financing was arranged with a high interest cost of 6.456 percent p.a. Finally, at appraisal, market soundings suggested that, given the Eurozone turmoil, in the absence of a high-grade guarantee, FYR Macedonia could access the international markets only at a spread of 650-700 bps over EURIBOR (about 8 percent in aggregate). A number of financial institutions were skeptical that such a transaction could even be closed at that time. Third, the Government preferred a PBG to backstop a commercial loan, rather than a public bond 7 issuance for three reasons: (i) transaction risk of engaging lending banks directly was lower, and pricing could be guaranteed ex ante through a loan, while the cost structure of a bond would be more difficult to lock in earlier and would be more vulnerable to market volatility at closing; (ii) a, bond issue of the targeted size would be considered relatively small and therefore illiquid for bond investors, which would hamper the efficiency of the pricing and trading of the instrument,8 and (iii) the pricing efficiency for a bond would be capped by the credit rating of the instrument, which would improve only marginally from the underlying issuer rating, a consideration which does not generally exist with non-rated commercial bank loans. 6. The Bank moved quickly to assist the Government in responding to the deteriorating economic situation by supporting its reform program as well as helping with the overall borrowing strategy. The Bank modified the 2011-14 Country Partnership Strategy (CPS) as set out in the CPS progress report on November 1, 2012. The modifications included a development policy loan (DPL) topped with crisis response financing, selected investment lending and addressing FYR Macedonia’s knowledge and capacity building needs through AAA. The CPS progress report also included a second PBG to support the Government’s borrowing strategy for 2013. In line with this strategy, in 2012, the Bank carried out analytical work and a DPL operation to improve competitiveness in November 2012. The Bank had an ongoing Conditional Cash Transfer (CCT) operation, which contributed to formulating the reforms in social protection. The PBG approved in November 2011 supported reforms in public finance management, health sector, social protection, and competitiveness. The deteriorating economic situation 6 FYR Macedonia had borrowed twice from the international bond market, with widely varying results. In 2005, strong credit fundamentals and favorable market conditions allowed the Government to issue a 10-year global bond at a spread of 120 bp (or 4.625 percent coupon). But in 2009, global financial turmoil led to a far less favorable 3.5- year bond issue at 620 bp (or 9.875 percent coupon). A planned bond issue in 2010 was cancelled because the available terms were not acceptable to the Government. 7 This is an emerging market bond issued in the Eurozone. 8 These conditions exacerbate the already illiquid nature of a partially guaranteed (and therefore hybrid) instrument, for which a natural pool of investors does not exist. 3 called for extending all of these reforms. Finally, the Bank had an ongoing program of analytical work in competitiveness, health sector efficiency, labor markets and public finance management (Table 3) all of which informed the next phase of reforms pursued by the Government in addressing the crisis. Table 3: Bank Analytical Work by Area and Links to PEPBG AAA work Main recommendation PEPBG supported agenda Public o Review and begin reforming the generous health Reforming the procurement Expenditure benefit package; process in public health Review (2008) o Consider shifting a part of the financing of healthcare institutions; from payroll taxes to general revenues; Adopting the Medical o Strengthen the capacity of the HIF, MOH and the Network; health care institutions (HCIs) to help limit cost Keeping the fiscal deficit pressures and eliminate wasteful spending. and public debt at sustainable levels; Improvements in PFM practices. Strengthening safety nets South East Europe o Maintain prudent fiscal stance Keeping the fiscal deficit Regular Economic o Continue improving competitiveness and advancing and public debt at Report investment climate reforms sustainable levels; o Strengthening safety nets and job creation Improvements in PFM practices’ Strengthening safety nets. Poverty o Reduce administrative cost of public sector Increase Social Financial Assessment (2009) o Improving the social welfare system, especially the Assistance; social assistance program, can help to reduce poverty Improvements to the cash by expanding coverage of the poor while reducing benefits management leakage to the affluent information system (CBMIS). Regional Social o Further refine criteria to reduce leakages and exclusion Improvements to the Assistance Review errors CBMIS. (2010) 7. In terms of its choice of instrument, there were three considerations behind the Bank’s decision to support the Government’s request for a PEPBG. First, there was a clear, large financing need. The task team convincingly argued that the PEPBG would help FYR Macedonia increase its borrowing volume and in this way leverage Bank’s capital better than a DPL 9. Although, hypothetically, FYR Macedonia could have obtained a competitively priced EUR$ 200 million loan from the World Bank, there was a real risk that a separate unsecured market borrowing might not materialize under any acceptable terms. Second, FYR Macedonia met the three criteria to be eligible for a PBG: (i) the country had a strong track record of performance and its structural, social and macroeconomic policy package was satisfactory; (ii) the country had a sustainable external financing plan; and (iii) the country had a coherent borrowing strategy which would enable it to become a borrower in its own name without a guarantee in the medium term. Third, as discussed in the PBG ICR, the Bank has had a very positive experience with the first PBG, through which the cost of financing the 2011 fiscal deficit was significantly reduced. In addition, the experiences of Montenegro and Serbia with PBGs were also encouraging. In both cases, PBG- supported borrowing was able to extend maturities and result in savings of up to 400 basis points p.a. over unsecured borrowing. 9 The PEPBG is a useful instrument since it does not count 1:1 but 1:4 against World Bank’s exposure. 4 The PEPBG Operation 8. The PEPBG was prepared quickly, in less than three months, and was approved by the Board on January 8, 2013, on the basis of prior actions implemented during the course of 2012. (scope of the operation is described in detail in section 1.2). In parallel, immediately following ROC approval on November 2, 2012, the Government began the process of contracting the loan. The Government approached fifteen international commercial banks with a Request For Proposal (RFP) and selected Deutsche Bank AG to contract the loan. A parliamentary approval was obtained when all the agreements were in place. The Loan agreement was signed on January 9, 2013, and the funds were withdrawn on January 29, 2013. 9. The PEPBG covered EUR155 million of the EUR250 million principal of the loan. The unguaranteed portion of the loan had a 5-year maturity bullet repayment structure and the guaranteed portion of the loan had a 7-year maturity bullet repayment structure. The loan carried a fixed interest rate of 5-year euro swap rate plus 275 bps. The average interest rate on the loan was 3.915 percent. The lenders also charged an arrangement fee of 150 bps. Relationship with IMF and other Development Partners 10. The Bank maintains a close working relationship with the IMF and the two institutions largely agree on an assessment of the economic situation. The IMF provided an assessment letter to the Bank endorsing the Government’s macroeconomic policies, which was attached to the Program Document (PD) of the Operation. The IMF Board approved a Euro 475.6 million Precautionary Line of Credit (PCL) in January 2011. The PCL was originally approved as an insurance mechanism in case of an “unexpected balance of payment shock”. In March 2011, the Government withdrew Euro 220 million (286 percent of the quota) from the Euro 475.6 million available under the PCL. The arrangement expired in January 2013. The Government has not sought successor arrangements. IMF management has initiated Post Program Monitoring with two reviews completed in June 2013 and February 2014, respectively. 11. The Bank has maintained a robust dialogue with the donor community on issues related to the PEPBG. The Bank team benefitted from regular consultation with the IMF, the European Commission (EC), and USAID – FYR Macedonia’s main development partners. The measures in public finance management included in the PEPBG have benefited from the technical assistance provided by the IMF, and much of the thinking on the health sector reforms was carried out through technical assistance provided by the Dutch Government. 1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved) 12. The main PDOs of the PEPBG were to improve the efficiency of public expenditures by strengthening public financial management practices; improving the efficiency of service provision in the health sector; and strengthening social protection and inclusion. The overarching goal was to ensure that fiscal policy, and public expenditure policy in particular, supported an environment conducive to robust growth, more effective social protection and improved service delivery. The eight prior actions implemented to achieve these, as presented in the PD and in the legal documents, were grouped under three “pillars” as indicated below and in more detail in Table 4: Pillar 1 Strengthening public finance management. (1) Establishing an inventory of the payment and VAT refund arrears, and establishing a timeline to clear them; and 5 (2) Implementing amendments to the Manual of Treasury Operations to record multi-year liabilities, and putting in place provisions to ensure that expenditures are carried out within the budget without incurring arrears. 10 Pillar 2 Improving the efficiency of spending and service provision in the health sector. (3) Adopting a new methodology, which resulted in setting lower reference prices for the most frequently used drugs. (4) Introducing centralized international procurement for optical medical devices and for orthopedic devices, and (5) Expanding health provider coverage in underserved areas. Pillar 3 Strengthening social protection and inclusion. (6) Implementing measures to encourage social safety net beneficiaries to actively seek employment opportunities. (7) Improving the administration of social safety net benefits by linking the CBMIS to the administrative registries of the Employment Service Agency (ESA) and Pension and Disability Insurance Fund (PDIF). (8) Using the savings from an improved targeting of the social safety net system to increase the level of means tested cash benefits. The key performance indicators are presented in Table 4. 1.3 Revised PDO and Key Indicators, and reasons/justification: Not Applicable 1.4 Original Policy Areas Supported by the Program 13. The policy areas supported by the PEPBG were grouped into three “pillars” as above. Each of these policy areas contained measures, which constituted prior actions for the PEPBG as per the legal documents as well as outcome indicators to measure progress of the reform program. Since the PEPBG was a one-tranche operation, from a strictly legal point of view, all prior actions were met before the loan was submitted to the Board. In addition, as indicated in Table 4, all the outcome targets for the PEPBG have been met within the timeframe set in the PD. The impact of 10 It is important to clarify here that the arrears addressed by the PEPBG, as defined in the PD and agreed upon with the Government were Treasury arrears. Treasury payment arrears were defined as liabilities for payments that were outstanding beyond the period specified in contracts and standard payment clearance practice at the Treasury. VAT refund arrears were defined as approved refunds that have not been processed within the standard clearance period at the Public Revenue Office (PRO) and the Treasury. Arrears covered by the PEPBG specifically excluded arrears in the public health sector, which at end 2012 amounted to roughly 0.5 percent of GDP. In FYR Macedonia’s PFM system, the health sector has its own treasury function and therefore the overdue obligations to the public health sector (to hospitals and the Health Insurance Fund) are not monitored or resolved by the Treasury. 6 the measures implemented under the PEPBG and their follow up is discussed in Section 3.2, on “achievement of program development objectives”. Table 4 : PEPBG Prior Actions and Outcome Indicators Objectives PEPBG Prior Actions Outcome Indicators and Expected Results PILLAR I: Strengthening public financial management Improve (1) The MOF to establish an inventory of its payment arrears and Decrease in the stock Public VAT refund arrears, and establish a timeline and plan to clear the of VAT arrears from Financial stock starting in October 2012. (met) 0.6 percent of GDP in Management September 2012 to zero by December 2013. (met) 2) The MOF to implement the following measures to improve the Decrease the stock of management of financial commitments: payment arrears from • Amend the Manual of Treasury Operations to: (i) set forth 0.5 percent in how multi-year liabilities will be recorded, reported and September 2012 to validated; and (ii) prohibit the Treasury Department from zero by December approving payment requests if liabilities are not properly 2013. (met) registered. • Circulate the Amendments to the Manual of Treasury Operations to all budget users with a confirmation that the statutory penalties provisioned in the Law of Budgets will be applied for failure to meet the requirements of (i) reporting commitments and (ii) meeting expenditures within the available budget without incurring arrears. • Establish a Working Group within the MOF (Decision number 04-27553/1) to (i) prepare changes to the Treasury Information System to incorporate entry and monitoring of multi-year liabilities; and (ii) adopt a plan on activities; and (iii) commence implementation of such plan. (All three prior actions were met by board presentation) PILLAR II: Improving efficiency of spending and service provision in the health sector Increase (3) The MOH has introduced and published revised reference Decrease in the efficiency of prices for a list of drugs for which prices were reduced as a result average unit price of service of improvements to the methodology for setting prices for most frequently used provision in registered drugs (Official Gazette No. 156/11 from November 9, drugs from MKD the health 2011) in order to generate health expenditure savings. (met) 1200 in September sector. 2012 by at least 10 percent by end December 2012. (met) (4) The MOH has concluded centralized international procurement Decrease the average for optical lenses and disposables for 2012-2014 and has unit price of optical commenced centralized international procurement for orthopedic medical devices from devices in order to generate price savings and improved terms of MKD 3700 in delivery. (met) February 2012 by at least a third by end December 2012. (met) (5) The MOH has introduced criteria defining the standards for At least double the health service provision, specifically for contracting providers, in number of PHC order to expand provider coverage in underserved areas, through provider contracts in 5 adoption of the by-law establishing the Medical Network (Official least well-served 7 Gazette No. 81/12 from June 28, 2012). (met) regions by end December 2013. (met) PILLAR III: Strengthening social protection and inclusion Better social (6) Adopted (on June 26, 2012) revisions to the 2012-2013 Increase in the number protection Operation Plan on Active Labor Market Policies containing of social safety net and additional measures to encourage Social Safety Net Beneficiaries beneficiaries from inclusion. to actively seek employment opportunities, to increase social 5,700 in December inclusion. (met) 2011 to 10,000 by end December 2013. (met) (7) The MOLSP to improve the efficiency of social safety net Reduce the number of administration and service access by (i) entering into a documents required Memorandum of Understanding with each of the Employment for registration and Service Agency (ESA) and the Pension and Disability Insurance renewal procedures by Fund (PDIF) in order to establish a system that links the CBMIS financial assistance with the administrative registries of the ESA and the PDIF; and (ii) claimants from five in make such system operational. (met) September 2012 to only one by November 2012. (met) (8) The Council of Ministers has adopted (on October 16, 2012) Increase in the benefit the draft Law on Amendments to the Law of Social Protection in level for the Social order to use savings from improvement of the targeting Financial Assistance performance of the Social Safety Net System to increase the level and Permanent of the means-tested cash benefit. (met) Assistance from an average of MKD3,800 and MKD4,800 respectively in 2012, by at least five percent in 2013. (met) 1.5 Revised Policy Areas Not Applicable 1.6 Other significant changes None 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance 14. The full amount of the Deutsche Bank commercial loan amounting to EUR 250 million was accessed within a few days of signing the indemnity agreement. This was made possible because the Government worked closely with this commercial bank. The program supported by the PEPBG contained important policies that helped the Government to improve the credibility of the budget, strengthen controls on timely payment of financial obligations, and enhance the effectiveness of health and social protection spending. All prior actions (see Table 4 above) were completed prior to the Board presentation and all outcome targets were achieved well within the timeframe outlined in the PD. This reflects Government’s commitment to the program as well as the 8 Bank’s ability to rapidly respond to the request of the client by providing sound policy advice as well as leveraging support from other stakeholders. 2.2 Major Factors Affecting Implementation 15. A number of factors contributed to the broadly successful implementation of the PEPBG. The key factors are the following: • Government commitment and ownership of the program. The PEPBG was closely aligned with the Government’s overall reform program and the Government was closely involved in the design of the operation. • Good analytical basis: The PEPBG built effectively on a substantial amount of high quality and relevant analytical work. This is well documented in the PD (Table 6) summarizing the analytical work by area and links to the PEPBG. • The PEPBG took into account lessons learnt from the earlier PBG operation. These included engaging the line ministries early and throughout the preparation. This helped build capacity in sector ministries and set realistic, achievable prior actions and outcome indicators. On this basis, the PEPBG set clear and achievable objectives focusing on only eight prior actions and eight outcome indicators. • Broad support from senior management of the Bank. The PEPBG was a very high profile operation. With the approval of the PEPBG, the Bank has approved only six PBGs, of which two have been for FYR Macedonia. The Bank’s senior management was fully supportive of the task team from the very beginning. This enabled the task team to argue for and include in the PEPBG difficult but high impact measures, such as public acknowledgement and elimination of arrears; substantial reduction of prices of medicines, and extension of auctions to procurement of optical devices. • Bank presence on the ground and link to the Bank’s program: The program supported by the PEPBG was well linked to key areas of Bank’s engagement in FYR Macedonia, such as the social protection program and health sector reforms – which have been supported in almost all previous programmatic lending operations. Past familiarity with the sectors and the presence of key sector staff in health, social protection and an economist in the field, helped lay the basis for the design, fast processing and implementation of the PEPBG. • Early and close engagement with commercial banks was essential to sound out the market and to provide the best instrument to the client. The PBG allowed the Government of FYR Macedonia to develop a professional relationship with commercial banks involved in the transaction. Commercial banks indicated that the instrument allowed them to engage in a country that they would not have otherwise considered due to lack of familiarity and difficult external macroeconomic environment. They noted that it was of key importance to have had the Bank help facilitate the entry of FYR Macedonia into the international loan market. Having gone through the process (for example, having worked with a local legal counsel) increased their likelihood to consider follow-up transactions with FYR Macedonia. Banks also noted that there was a wider market impact, through increased interest from the limited pool of banks considering sovereign lending due to the positive reporting on the transaction in the international press. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization: 9 16. The M&E of the PEPBG relied on Government’s arrangements, consistent with the PEPBG policy matrix. The Ministry of Finance (MOF) was responsible for monitoring and the overall implementation of the PBG, including coordinating actions among other concerned ministries and agencies. Other agencies involved included the Ministry of Labor and Social Policy (MOLSP) and the Ministry of Health (MOH). Bank staff, especially those in the Country Office, worked closely with the MOF and the other agencies to monitor actions and review implementation progress on a day to day basis. This approach worked well and there was continuous tracking of reforms and outcome indicators. 2.4 Expected Next Phase/Follow-up Operation 17. Projections of FYR Macedonia’s fiscal accounts and macroeconomic framework (Table 5) indicate that FYR Macedonia has large financing requirements in 2015 and beyond, a part of which will have to be financed by external borrowing. 11 At the same time, many of the policy reforms initiated under the PEPBG operations need to be sustained to lay the basis for growth (see Para. 40). It is likely that the Government will request financial support from the Bank to provide much needed budget support as well as to accelerate the reform process. The exact form of this support is difficult to predict. Much will depend upon the recovery in the Eurozone and the resulting improved market access at a reasonable cost. In this respect, feedback from commercial banks that worked with the Government on the PBGs is encouraging. Having gone through the process under the two PBGs, the Government is now familiar with, and has valuable experience in accessing commercial debt markets. Nevertheless, the success of FYR Macedonia’s ability to access the commercial loan market depends on factors such as the recovery of the Euro Zone, strength of the economy especially the fiscal accounts and the balance of payments. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation Rating: Highly Satisfactory 18. The PEPBG had clear and relevant objectives -- to respond to the economic slowdown triggered by the worsening Eurozone outlook, by strengthening public financial management practices, eliminating VAT refund and payment arrears 12 (crucial for improving the business environment), improving the efficiency of service provision in the health sector and; strengthening social protection and inclusion. In parallel, the PEPBG assisted FYR Macedonia in tapping funding from the international loan market, on improved terms in the context of a highly uncertain external environment. The design of the operation was simple; based on ongoing Government reforms, focusing on three reform pillars, eight prior actions and eight measurable outcome indicators. The PEPBG operation was quickly processed in response to the Government’s request and was considered as an important component of the overall crisis-related assistance program defined in the Bank’s 2010-2014 Country Partnership Strategy (CPS) and the 2012 CPS progress report. 11 Since the approval of the PEPBG, a US$ 50 million second Competitiveness DPL was approved on March 23, 2014. 12 The PEPBG focused on the clearance of arrears on VAT refunds and payments of goods and services that are recorded in the central government treasury and did not include arrears to the Health Insurance Fund and Public Health Care Institutions. 10 3.2 Achievement of Program Development Objectives: Sustainable Macroeconomic Framework and Borrowing strategy. 19. Macroeconomic Framework. As presented in the PD, maintaining macroeconomic stability and meeting the budgetary financing needs through a coherent borrowing strategy was a key objective of the Government’s program. Macroeconomic developments in 2013 confirm that the Government largely succeeded in achieving this objective. Fortunately FYR Macedonia’s macroeconomic performance in 2013 benefited from a nascent recovery in the Eurozone. By the first half of 2013, the “crisis” atmosphere in the Eurozone had dissipated and there was modest growth after nearly six quarters of contraction 13. Consequently, there was higher demand for Macedonian exports, restoration of capital outflows and a reduction in borrowing costs. As indicated in Table 5 below, the economy grew by 3.1 percent in 2013 compared to a decline of 0.4 percent in 2012. This acceleration in growth is based on a surge in construction activity (33 percent) enabled by higher private and public investment (Skopje 2014 and Corridor X highway projects). Mining and manufacturing also contributed significantly to growth, driven by an increase in FDI from 1 percent of GDP in 2012 to 3.3 percent of GDP in 2013. Overall exports grew by 4.5 percent in real terms and coupled with subdued imports, the current account deficit in 2013 narrowed to 1.9 percent of GDP and gross international reserves remained at 4.4 months of imports. Table 5: Macroframework and Budgetary Financing Requirements (EUR Million) 2012 2013 2013 2014 2015 2016 Actual As in PD Actual Proj. Proj. Proj. Real GDP growth (% p.a.) -0.4 2 3.1 3 3.5 3.7 Real Export Growth (% p.a.) 0 8 4.5 9 8.5 8 Real Import Growth (% p.a.) 4.2 7.5 -2.1 8.2 8 6.8 Current Account Balance (% of GDP) -3.0 -1.9 -1.9 -4.5 -5.7 -5.2 Fiscal Balance (% of GDP) -3.9 -3.5 -4.1 -3.5 -3.2 -2.6 Revenues (% of GDP) 30.1 28.8 29.6 29.7 30.3 30.4 Expenditures (% of GDP) 34 32.3 33.6 33.2 33.5 32.9 Budgetary Financing Requirements and Financing Financing Requirements 376 545 529 439 607 466 Deficit (includes interest) 289 288 313 294 281 243 External Debt Amortization 88 257 216 145 326 223 o/w Maturing Eurobond 175 175 o/w IMF PLL Repayments 83 111 28 Financing Sources 376 545 529 439 607 466 Use of Government Deposits -195 165 -3.5 243 0 0 Domestic Financing (net) 1/ 446 59 247 82 54 75 External Financing 123 320 306 114 554 391 o/w Policy Based Guarantee 250 250 o/w WB Competitiveness DPL1 39 39 o/w WB Competitiveness DPL2 36 Others 2 1 -20.5 0 -1 0 Memo item Nominal GDP 7457 7920 7711 8352 8925 9510 Source: Ministry of Finance and Bank Staff Estimates and Projections. 1/ Assumes rollover of all short term debt and amortization on medium term bonds. 13 See: World Bank, “Slow Road to Recovery”, December 2013, Washington DC 11 20. A key objective of the PEPBG was to facilitate financing of the fiscal deficit in 2013. As the pattern of deficit financing presented in Table 5 shows, the availability of external financing (made possible by the PEPBG) made it possible for the Government to avoid a drawdown in Government deposits. At appraisal, the total financing required 14 in 2013 (Table 5) was projected to be financed by domestic borrowing (10 percent), a drawdown of Government deposits (30 percent), while external borrowing financed the remaining 60 percent. The 2013 fiscal outturn shows that the Government met nearly 43 percent of the total financing requirement through domestic borrowing 15 and about 58 percent from external markets, and used these additional resources to add to Government deposits. This strategy puts the Government in a strong position to meet fiscal financing requirements in 2014, when almost 55 percent of the total financing could be met by a drawdown of Government deposits. 21. Over the medium term, growth prospects in FYR Macedonia are brightened by the continued recovery in the Eurozone 16. Early signs of recovery in the second half of 2013 have gained momentum. Real GDP growth in the Eurozone was 0.3 percent in the fourth quarter of 2013; the third straight quarter of growth after an 18 month recession. In FYR Macedonia, growth is expected to accelerate to reach 3.7 percent by 2016 mainly from increased investments and sustained export growth (Table 5). The fiscal deficit is projected to fall from 4.1 percent of GDP in 2013 to 2.6 percent of GDP by 2016 in line with the Government’s medium term fiscal strategy. Securing such a reduction will require sizeable consolidation, including sustained control of the wage bill and expenditures on goods and services and additional tax effort. Even with this reduction in fiscal deficits, fiscal projections indicate a sharp increase in financing requirements in 2015 and 2016. Even if a part of these can be met by domestic borrowing and by tapping into Government deposits, there will still remain a gap, which indicates a need for external borrowing. 22. How successful will the Government be in accessing international loan markets at a reasonable cost in 2015 and 2016? This will depend on the strength of recovery in the Eurozone 17, growth prospects, successful fiscal consolidation, and deepening of the domestic bond markets in FYR Macedonia 18. Discussions with Government counterparts, in particular, the MOF indicated that the PEPBG provided them with valuable insights into the workings of the financial markets while the commercial banks gained a deeper understanding of the FYR Macedonian economy. These intangible benefits – which were the medium term objectives of the PEPBG, would be invaluable should the Government of FYR Macedonia approach the international loan or the bond market in future. 23. Achieving PDOs. As discussed below, the Government has succeeded in achieving (and in some cases overachieving) the PDOs of the PEPBG in line with the outcomes anticipated in the PD. 14 Deficit + External Debt Amortization 15 In 2013, the government was able to issue a bond at an average interest rate of 4.65 percent p.a. compared to 5.2 percent p.a. in 2012. 16 Eurozone brief, PREM Europe and Central Asia, April 9, 2014. 17 Our analysis (April Eurozone brief) indicates that sovereign borrowing costs have declined significantly since their peak during the crisis. 18 If the government is able to raise 5 year plus maturity bonds, lower amounts need to be raised in the external loan/bond markets. In January 2013, the Government issued two 10-year bonds. Even though the amount was symbolic (EUR 2.9 million), it marked a beginning of the Government’s efforts to lengthen the maturity of domestic government securities. 12 Pillar 1. Strengthening Public Finance Management 19. Rating: Highly Satisfactory 24. The Public Finance Management (PFM) system in FYR Macedonia is sound compared to that in other countries in the region. The economic downturn, however, exposed weaknesses in the PFM system, most importantly in the areas of multi-year budgeting and commitment controls, which resulted in the emergence of payment arrears. The prior actions supported by the PEPBG therefore focused on two areas. First, the Government committed to eliminate VAT refund and payment arrears, which had grown to about 1-2 percent of GDP by September 2012, by December 2013. Second, the Government implemented institutional reforms to ensure that arrears will not build up in future. These reforms included making amendments to the Treasury Manual to provide for recording multi-year liabilities, and reforms in commitment control, which explicitly prohibited the treasury from making payments unless they were properly budgeted/registered. This was complemented by setting up a high-level working group to implement and transmit these changes clearly to all departments to ensure compliance. 25. Results: The Government confirmed to have eliminated about 50 percent of VAT refund and payment arrears by end 2012, and the remainder by end-February 2013, well ahead of the target date of December 2013 included in the PD20. The informal feedback received from the Government indicated that although there was a broad consensus within the Government to eliminate the arrears, inclusion of this outcome indicator in the PEPBG provided a crucial impetus to accelerate the process. The Government also confirmed that there has been no further buildup of arrears since February 2013, which indicates that the changes to the Treasury Manual and their implementation by the line Ministries were effective. Discussions with the Budget Department also indicated that the budgeting for multi-year liabilities helped by alerting the treasury in advance of large expenditures falling due in the near future. This has helped medium-term expenditure management and has contributed to averting the buildup of new arrears. Going beyond the prior actions in the PD, the Government sustained the PFM reforms by presenting the Law on Financial Discipline to Parliament and by publishing for the first time a medium- term fiscal framework in December 2013. Pillar 2. Improving the efficiency of spending and service provision in the health sector. Rating: Highly Satisfactory 26. Health sector reforms were a primary focus of the 2008 PER. Reforms supported under DPL1 and more recently under the PBG supported amendments to the health insurance law, introduced competitive pricing of drugs and helped establish a separate treasury function in the health sector which helped generate savings and control health sector arrears. The PEPBG supported reforms in the following three areas to improve efficiency of health delivery services. 27. Procurement of Drugs. In January 2012, the MoH revised the methodology for setting the reference prices 21 of registered drugs by expanding the group of reference countries 22. On the basis of the new methodology the MOH estimated and published in the Official Gazette, in March 2012, new 19 The reforms in the PFM are supported by TA from the Fiscal Affairs Department of IMF (June 2011), and informal note on PFM by Bank staff (May 2012). 20 There remain some central government arrears in the health sector, which are estimated to be around 0.5 percent of GDP as of end 2013. The Government has taken several steps to reduce these arrears and prevent the accumulation of future arrears by increasing transfers to the health sector, and by establishing lower reference prices for medicines. 21 Rather than procuring drugs, under the reference pricing formula, the HIF reimburses a fixed amount covering the cost of a drug. 22 Mainly by including non-EU countries such as Russia and Turkey. 13 reference prices for all registered drugs. These reference prices are maximum prices (with regulated markups) at which suppliers can sell drugs to the hospitals and retail pharmacies. 28. Results. As per the revised reference prices, the average unit price of most commonly used drugs 23 dropped by nearly 22 percent by December 2012, thereby overachieving the outcome target of 10 percent set in the PD. Going beyond meeting the outcome indicator targets in the PD, the Government has been successful in achieving a sustained reduction in drug prices. As indicated in Table 6 below, the Government has reduced the reference prices in each of the price announcements since March 201224, thereby achieving an estimated cost savings to consumers of nearly 46 million Euros. It is also important to note that even when the new methodology reduced the prices of nearly 1299 drugs, as in Table 6, no supplier chose to exit the market, thereby maintaining competition in service provision. Table 6: Drug Price Changes and Savings Kind of Drug Mar-12 Oct-12 Mar-13 Oct-13 Generic Number of Drugs with price 1025 207 110 415 reduced Price reduction (%) 28 15 12 23 Non-Generic (Prescription) Number of Drugs with price 766 139 92 337 reduction Price reduction (%) 34 9 16 17 Total Savings (Million Euro) 17 4 2 23 Source: Government of FYR Macedonia 29. Centralization of the procurement of medical devices. As a prior action for the PEPBG, the Government extended the centralized procurement process to optical lenses and disposables as well as orthopedic devises. 30. Results: As anticipated in the PD, the average price of optical lenses and disposables after the auction declined by nearly 39 percent from its value before the auction in February 2012, thereby surpassing the outcome indicator of 33 percent. Price reductions for specific devices are indicated in Table 7 below. Table 7: Price Change of common Optical Devises Before and After Auction (MKD) Price before Price after auction auction Soft hydrophobic intraocular 9400 5500 posterier chamber lenses Intraocular posterier chamber 9400 5700 lenses Hard intraocular PMMA posterier 6990 1250 chamber lenses Solid PMMA intraocular lenses 6990 3280 Source: Ministry of Health 23 These were defined at appraisal as (about 40) drugs, for which more than 100,000 tablets were procured. 24 As per the current system price revisions are announced in March and October every year. 14 31. Extending provider coverage in underserved areas. Until recently, the HIF did not take into consideration the demand for health services as a factor in the process of contracting with health service providers (HSPs). This resulted in an oversupply of HSPs in urban areas while a number of (mainly rural) areas remained underserved – with only zero or one provider. As a prior action of the PEPBG, in June 2012 the Government adopted a by-law for the establishment of the medical network, which set a maximum limit for contractors in over-served areas. In addition, the MOH announced the creation of 360 new concessions in underserved areas for which tenders were expected to be received by late 2012. 32. Results. As a result of the new by-law, and the new tendering focused on underserved areas, the Government has succeeded in significantly increasing the supply of health service providers in 16 underserved areas (Table 8) which had only zero or one health service providers prior to the new law. The data indicate that there were no exits from existing providers. This exceeds the outcome indicator in PD that only targeted doubling of such contracts in only five underserved regions by end December 2013. Table 8: Number of Additional Health Service Provider Contracts in 16 Underserved Areas 1/ 2012 2013 2014 Primary General 20 53 3 Gynecological 1 2 5 Dental 34 54 32 Pharmacies 0 26 0 Source: Government of FYR Macedonia 1/ Underserved areas are areas defined as having either 0 or 1 provider contracts. Pillar 3. Strengthening social protection and inclusion. Rating. Highly Satisfactory 33. Targeting active labor market programs to the recipients of social assistance. An important shortcoming of social protection and labor market systems in FYR Macedonia was that if the recipients of social financial assistance accepted even a short-term job, they would lose their access to social assistance. On June 26, 2012, the Government revised the regulations for ALMPs to specifically target them to the beneficiaries of the social financial assistance. Under the revision, Social Financial Assistance did not terminate automatically for certain kinds of jobs. In addition, the 2013 budget increased the outlay for active labor market policies by 7.3 percent from MKD 300 million to MKD 322 million. The measures included a public works program, subsidies for firms that employed vulnerable people and unemployed, loans for self-employment, and a firm-specific training program for unemployed. 34. Results. As a result of these efforts, the number of social safety net beneficiaries who benefited from the ALMPs increased from 5,700 in December 2011 to 11,308 by end-December 2013. This exceeded the outcome targets set in the PD of 10,000 by end-December 2013. 35. Improvements in efficiency of social safety net administration and service access. The reforms supported by the PEPBG were aimed at reducing the transaction costs of accessing social services. Typically the applicant was required to submit a number of documents from a number of agencies while applying for social service benefits. To address this problem, in July 2012, the MOLSP signed an MOU linking the Ministry’s CBMIS with the registries of the ESA and PDIF. The system links were established in August 2012 and the system was since then tested and became operational in October 2012. 36. Results. As a result of the linkage of the registries of the three agencies, the number of forms beneficiaries are expected to complete for registration or renewal of Social Financial Assistance has now 15 been reduced from five to only one. Typically a claimant to Social Financial Assistance only needs to show his/her identification and sign a document allowing the Centers for Social Work, which administers the Social Financial Assistance, to access his/her personal data stored in databases of six other agencies. 37. Increase in Social Financial Assistance and Permanent Assistance Benefit. In 2012, the Government realized savings from the improvements in the targeting performance of the social safety net system by eliminating inclusion errors. This was mainly due to an upgraded IT system and more stringent controls. Despite a difficult fiscal environment, the Government took a decision to increase Social Financial Assistance and Permanent Assistance benefits by five percent, starting in March 2013. 38. Results. In line with the outcome indicators in the PD, starting in March 2013, Social Financial Assistance and Permanent Financial Assistance were increased from MKD 3,800 and MKD 4,800 respectively by five percent. In total, about 45,000 households are benefiting from the planned increase of both transfers. In continuation of this policy, a further increase of five percent went into effect on March 1, 2014 (Official Gazette no 187/13). 3.3 Justification of Overall Outcome Rating (Combining Relevance, Achievement of PDOs): Rating: Highly Satisfactory 39. The PEPBG operation is rated highly satisfactory on the basis of setting clear and relevant objectives, achieving macroeconomic stability and in most instances over-achieving the outcome targets for the three pillars, as discussed above. The ratings are based on the implementation of the policies and the achievements of the outcome targets set at appraisal and not on a broader assessment of the development challenges facing the Government. 40. While much has been achieved in the context of the PEPBG, further reforms are needed to lay the basis for sustained growth and improvements in shared prosperity in FYR Macedonia. As pointed out in the PD (Para. 66), additional PFM reforms are needed to improve medium-term fiscal planning, fiscal reporting and transparency. The health arrears have continued to remain at 1-2 percent of GDP and need to be eliminated. In parallel, the Government should consider a program of hospital restructuring and measures to further improve the efficiency of health spending. Towards improving the social safety net, the measures in the PEPBG need to be extended by consolidating the number of social assistance benefits, implementing measures (such as revising the Social Assistance Rule Book) to further narrow errors of inclusion and exclusion and strengthen oversight mechanisms. 3.4 Overreaching Themes, Other Outcomes and Impacts (if any, where not previously covered or to amplify discussion above): (a) Poverty Impacts, Gender Aspects, and social Development 41. At a macro level, a sustained acceleration of growth from -0.4 percent in 2012 to 3.1 percent in 2013 can be expected to have a significant impact on poverty and employment. The main direct impact on poverty in the context of the PEPBG is through the measures implemented under Pillar 3. These measures, as described above in section 3.2, have made it easier for the poor to access Social Financial Assistance; increased the Social Financial Assistance and the Permanent Assistance Benefit; and improved the working of the Active Labor market Policies. 16 (b) Institutional Change/Strengthening (particularly with reference to impacts on longer term capacity and institutional development) 42. Under each of the three Pillars, the program supported by the PEPBG included institutional strengthening. As described above in section 3.2, under Pillar 1, the PFM reforms included strengthening the working of the Budget Department for better expenditure and arrears control. In the health sector PEPBG reforms contributed to the capacity building within the MOH for setting/revising minimum drug prices; and the procurement of drugs and optical devices. In Pillar 3, the institutional innovations and strengthening the CBMIS carried out in the context of the PEPBG contributed to the improved working of the ALMPs and the Social Safety Net. (c) Other Unintended Outcomes and Impacts (positive and negative): NA 3.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops (optional for Core ICR, Required for ILI, details in annexes: NA 4. Assessment of Risks to Development Outcome Rating: Moderate 43. Development outcomes are subject to three main risks as indicated below. In the aggregate, these risks are moderate. 44. External/regional economic risk: The first risk pertains to a possible worsening of the external environment. The World Bank fiscal projections show that there are large financing gaps in 2015 and beyond, which will require external funding. There is a risk that renewed turmoil in the Euro markets could make it expensive for FYR Macedonia to borrow. To mitigate this risk, the Government needs to maintain its previous track record on prudent macroeconomic management and make progress on fiscal consolidation. 45. Political risks: Political risks are mainly related to the stalling of progress in EU and NATO integration, as the country’s name issue with Greece is yet to be resolved. The prospect for future EU accession was a major impetus for reforms in the past. The political situation in the country continues to evolve. The ruling coalition won both the parliamentary and the second round of the presidential elections on April 27, 2014. While international observers have declared the elections fair, the opposition has complained of fraud and negotiations to form a stable Government have been protracted. On balance, however, the risks to the derailing of the reform program are not high since the reforms have been supported across party lines. 46. Program risks: The risk of a slowdown in the implementation or reversal of reforms is low in the foreseeable future. The Government has a strong track record and support for the reform cuts across party lines. Still, further improvements in public financial management are very important in order to maintain central government debt and overall public debt at a sustainable level and improve the effectiveness and efficiency of government spending. There is also a need for strengthening capacity with respect to data collection, preparation and reporting in many different areas of the Government. Further, there remains a residual risk related to implementation capacity. Avoiding government arrears will require a continued commitment to fully adhere to and implement the processes outlined in the Manual of Treasury 17 Operations. Implementation capacity of some public sector institutions, such as the health sector and institutions engaged in social transfers, while much improved over the past few years, remains stretched. (See Para. 40 for a discussion of the next phase of reforms) 5. Assessment of Bank and Borrower Performance 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry (i.e., performance through lending phase Rating: Highly Satisfactory 47. Strong efforts were made by the Bank team to design a robust program, based on considerable analytical work. The PEPBG program was: (i) aligned with Government’s reform program; (ii) consistent with the higher-level objectives of the CPS and the CPS Progress Report; and (iii) focused on key reform areas (See section 2, Para. 16 on factors affecting implementation). (b) Quality of Supervision Rating: Highly Satisfactory 48. Supervision of the PEPBG was continuous, as the TTL visited the country often and several sector experts resided in the country. Since the operation was based on prior actions, which had been implemented before the PEPBG was approved by the Bank’s Board of Directors, much of the subsequent supervision consisted of tracking the progress of the reform program ensuring that there was no backtracking and there was progress in achieving the outcome indicators. Detailed supervision missions were conducted in March 2013 and September 2013, by which time most of the outcome targets were already achieved. (c) Justification of Rating for Overall Bank Performance Rating: Highly Satisfactory 49. For reasons noted above, the overall Bank performance is rated highly satisfactory. 5.2 Borrower Performance Rating: Highly Satisfactory (a) Government performance 50. The Government was quick to respond to the crisis and took difficult decisions. These included publicly recognizing VAT refunds and payment arrears, introducing a supplementary budget in 2012, which slashed expenditures by nearly 4.5 percent of GDP, freezing wages and employment. At the same time, the Government improved efficiency of health expenditures, reduced drug prices and protected expenditure outlays for the vulnerable. The performance of the MOF was especially commendable. The MOF was responsible for overall program implementation and coordination with concerned ministries and agencies. The MOF Debt Department was able to move with exceptional speed in organizing the RFP, negotiating and selecting the bank and concluding the loan agreement in parallel with the Bank approval of the PEPBG. The setting of lower reference prices for key pharmaceuticals, without major suppliers exiting the market, is a testament to the performance of the staff in the MOH. Similarly the 18 MOLSP performed well in rationalizing the documentation for access to Social Financial Assistance. This is a useful reform since it significantly simplifies the access to assistance for the poor. (b) Implementing Agency or Agency Performance 51. Discussed above in Para. 50. (b) Justification of Rating for Overall Borrower Performance: 49. For the reasons noted above, the overall borrower performance is rated highly satisfactory. 6. Lessons learned (a) Bank wide lessons 52. A PBG can be a useful instrument for leveraging Bank resources to facilitate a much larger resource transfer through commercial bank markets. Moreover, it is attractive from an operational perspective since under the current incentive structure, guarantees count 1:4 against Bank exposure. PBGs are also popular with the recipient countries, especially among smaller countries in the region since they allow for a far larger access to resources than a typical DPL. Experience with the PEPBG, however, raises a number of issues for the Bank if these operations are to be used more widely and scaled up. These include the current incentive structure for exposure, the implications for the Bank’s balance sheet, the extent to which countries should substitute typical DPLs with policy based guarantees and investing in staffing and skill to work with commercial bank markets (see below). (b) Operation specific lessons 53. The PEPBG confirmed general good practice lessons such as: work closely with the Government, build on the Government’s program, have strong analytical foundation, work closely with sector specialists and focus on a few achievable objectives which have the greatest impact (see para. 16 on the factors behind successful implementation). There are, however, two ways in which PBGs differ from standard DPL operations. • First, PBGs require a highly rapid and time sensitive response. Operations such as the PEPBG are often requested when there is a large financing gap. Moreover, given the volatility in the commercial bank markets have to be processed quickly; and the commercial bank loan has to be contracted almost as soon as the guarantee operation is approved. Therefore a lot of preparation is needed to lay the groundwork for issuing the RFP for banks, making sure that there is broad participation, and preparing for parliamentary approval in parallel with the preparation of the Bank operation25. • Second, PBGs require staff who have a good understanding of commercial loan markets and finance. Continuous involvement of staff from the Bank’s Financial Advisory and Banking services played an important role for the success of the PEPBG. The Bank’s financial staff worked closely with the Government team in MOF, helping approach the commercial banks, providing market soundings and an analysis of approaching the market with alternative financial instruments. 25 In the case of the PEPBG, the preparations for approaching commercial banks began as soon as the operation was approved by the Regional Operations Committee (ROC). 19 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners (a) Borrower/Implementing Agencies: (b) Cofinanciers: (c) Other partners and Stakeholders (e.g. NGOs/private sector/civil society): 20 Annex 1. Bank Lending and Implementation Support/Supervision Processes Task Team members P125837 – FYR Macedonia Policy Based Guarantee (PBG) Responsibility/ Names Title Unit Specialty Birgit Hansl Task Team Leader ECSP2 Zeljko Bogetic Lead Economist ECSP2 Simon Davis Economist ECSP2 Bojan Shimbov Research Analyst ECSP2 Michael Edwards Lead Financial Sector Spec. ECSF1 Johannes Koettl Senior Economist ECSHD Gianfranco Bertozzi Sr. Financial Officer FABBK Lewis Hawke Sr. Financial Management Specialist ECSO3 Anthony Mole Sr. Counsel LEGSO Zoran Anusic Senior Economist ECSH3 Bojana Naceva Senior Education Specialist ECSH2 Lewis Hawke Senior Financial Management Specialist ECSC3 Julie Rieger Senior Counsel LEGLE Anthony Gaeta Lead country Officer ECCU4 Neil Ashar Counsel LEGCF Denis Boskovski Sr. Country Operations Officer ECCMK Jose C. Janeiro Senior Finance Officer CTRFC Jasminka Sopova Program Assistant ECCMK Mismake Galatis Program Assistant ECSP2 Nancy Davies-Cole Program Assistant ECSP2 Staff Time and Cost P125837 – FYR Macedonia Policy Based Guarantee (PBG) Staff Time and Cost (Bank Budget Only) Stage USD Thousands (including travel and No. of staff weeks consultant costs) Lending 38.35 186.77 Supervision 1.30 28.74 21 Annex 2. Borrower’s ICR 22 23 24 25 26 27 28 Annex 3. List of Supporting Documents, and Persons Interviewed Documents World Bank. 2012. FYR Macedonia CAS Progress Report for the Period FY11-14, Report Number - 71635 - MK World Bank. 2012. FYR Macedonia – Program Document for a Proposed PEPBG- Report No. 72845- MK World Bank. 2013. South East Europe Regular Economic Reports. Slow Road to Recovery. Report No. 5, December 2013, Washington, DC.. World Bank. 2013. Program Document for the Second Programmatic Competitiveness Development Policy Operation. Report no. 80756-MK . World Bank. 2011. Program Document for a Proposed Policy Based Guarantee for FYR Macedonia. . Report No. 59914-MK World Bank. 2013. Implementation Completion and Results Report on the first PBG for FYR Macedonia - Report No. ICR 2790. World Bank. OPCS Guidelines on ICRs (2006 and 2011 Update). Indemnity Agreement for PEPBG Term Facility Agreement for PEPBG Report NO. G-2170-MK IMF. 2013. FYR Macedonia. Article IV and Second Post-Program Monitoring Report (February 2014). IMF. 2011. Strengthening the Medium Term Budget Process, Fiscal Affairs, (June 2011) . European Economic Forecast. Winter 2014. European Economy 2|2014, EC Economic and Financial Affairs Claudia Habl. 2012. Comments on the Proposed Pharmaceutical Pricing Policy in FYR Macedonia, WHO Mission Note , February 2012. Mission Field Mission to Skopje, March 9-14, 2013 Interviews Government of the Republic of FYR Macedonia H.E. Dime Spasov, Minister of Labor and Social Policy H.E. Nikola Todorov, Minister of Health Dimitar Bogov, Governor, NBRM 29 Petar Gosev, Former Governor of NBRM Jovika Andonovski, Deputy Minister, MOH Jovan Grpovski, Chief of Cabinet, MOH Suzana Peneva, State Advisor, MOF Dejan Nikolovski, Head of Debt Management, MOF Verica Prokovic, Budget Department, MOF Mara Srezovska, Head of Treasury, MOF Jordan Trajkovski, Head of Macroeconomic Department, MOF Biljana Trajkovska, Chief of Cabinet, MOLSP Private Sector Antonije Martinoski, Director, Ohridska Banka World Bank Bojan Shembov, Research Analyst Tatiana Proskuryakova, Country Manager for FYR Macedonia Denis Boskovski, Senior Operations Officer Johannes Koettl, Senior Economist Indhira Santos, Senior Economist Snjezana Plevko, Senior Economist Bojana Naceva, Senior Education Specialist Gianfranco Bertozzi, Senior Financial Officer Birgit Hansl, Lead Economist 30 Maop Map 28