former yugoslav republic of macedonia -...

Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 38840-MK

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

AND

INTERNATIONAL FINANCE CORPORATION

COUNTRY PARTNERSHIP STRATEGY

FOR

THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

FOR THE PERIOD FY07-FY10

March 2, 2007

South East Europe Country Unit (ECCU4)Europe and Central Asia Region (ECA)

Southern Europe and Central AsiaInternational Finance Corporation (IFC)

The date of the last Country Assistance Strategy was September 9, 2003.

CURRENCY EQUIVALENTS(as of March 2, 2007)

Currency Unit = Macedonian Denar (MKD)US$ 1.0 = MKD 46.24

GOVERNMENT FISCAL YEARJanuary 31st – December 31st

ABBREVIATIONS AND ACRONYMS

AAA Analytic and Advisory ActivitiesADR Alternative Dispute ResolutionALMP Active Labor Market ProgramsAPE Agency for Entrepreneurship PromotionAPL Adaptable Program LoanAS Advisory ServicesBEEPS Business Environment and Enterprise

Performance SurveyBERIS Business Environment Reform and

Institutional Strengthening CARDS Community Assistance for

Reconstruction, Development and Stabilization

CAS Country Assistance StrategyCEFTA Central European Free Trade AgreementCEM Country Economic MemorandumCFACFAA

Country Fiduciary AssessmentCountry Financial Accountability Assessment

CFPs Country Financing ParametersCPAR Country Procurement Assessment ReportCPC Commission for Prevention of CorruptionCPPR Country Portfolio Performance ReviewCPS Country Partnership Strategy CPSPR Country Partnership Strategy Progress

ReportCSW Center for Social WorkDIF Deposit Insurance FundDPL Development Policy LendingEBF Extra Budgetary FundEBRD European Bank for Reconstruction and

DevelopmentEC European CommissionECA Europe and Central AsiaECAA European Common Aviation AreaECSEE Energy Community of South East EuropeEDI Electronic Data Interchange EIB European Investment BankEIOP European Investor Outreach Program

ELEM Electric Power Generation CompanyESM Electric Power Company of Macedonia

/Electric Power Distribution CompanyESW Economic and Sector WorkEU European UnionFDI Foreign Direct InvestmentFESAL Financial and Enterprise Sector

Adjustment LoanFSAP Financial Sector Assessment Program FY Fiscal YearfYR Former Yugoslav RepublicGDLN Global Distance Learning NetworkGDP Gross Domestic ProductGEF Global Environmental Facility HACCP Hazard Analysis of Critical Control PointsHBS Household Budget Survey HCI Health Care InstitutionHIF Health Insurance FundIBRD International Bank for Reconstruction and

DevelopmentICR Implementation Completion ReportIDA International Development AssociationIDF Institutional Development FundIEG Implementation Evaluation GroupIFC International Finance CorporationIFC AS IFC Advisory ServicesIMF International Monetary FundIRRP Irrigation Rehabilitation and Restructuring

ProjectIT Information TechnologyJPPR Joint Portfolio Performance Review LDP Liberal Democratic PartyLJIIS Legal and Judicial Implementation and

Institutional Support ProjectMAFWE Ministry of Agriculture, Forestry and

Water EconomyMAPAS Pension Supervisory AgencyMDGs Millennium Development GoalsMEPSO Electric Power Transmission Company

ii

MIGA Multilateral Investment Guarantee Agency

MILES Macroeconomy, Investment, Labor, Education and Safety framework

MIPD Multi-Annual Indicative Planning Document

MK fYR Macedonia, MacedonianMKD Macedonian DenarMLSP Ministry of Labor and Social PolicyMOH Ministry of HealthMSE Micro and Small EnterprisesNATO North Atlantic Treaty OrganizationNBRM National Bank of the Republic of

MacedoniaNGO Non-Governmental OrganizationOECD Organization for Economic Cooperation

and DevelopmentOED Operations Evaluation DepartmentPDF Pension and Disability Insurance FundPDPL Programmatic Development Policy LoanPEP SE Private Enterprise Partnership Southeast

EuropePER Public Expenditure ReviewPHC Primary Health CarePIT Personal Income TaxPIU Project Implementation UnitPPP Public-Private PartnershipPSMAC Public Sector Management Adjustment

CreditPSMAL Public Sector Management Adjustment

LoanRECRP Real Estate Cadastre and Registration

ProjectREPARIS Road to Europe –Program of Accounting

Reform and Institutional StrengtheningRIA Regulatory Impact AssessmentROSC Report on Observance of Standards and

CodesSAA Stabilization and Association AgreementSAO State Audit OfficeSAP Stabilization and Association ProgramSBA Stand-by ArrangementSDSM Social Democratic Union of Macedonia

PartySEE South East EuropeSEED Southern Europe Enterprise DevelopmentSFRY Socialist Federal Republic of YugoslaviaSME Small and Medium EnterpriseSOE State Owned EnterpriseSSO State Statistics OfficeTA Technical AssistanceTF Trust FundTTFSE Trade and Transport Facilitation in South

East EuropeUF Unemployment FundUN United NationsUNDP United Nations Development ProgrammeUSAID United States Agency for International

DevelopmentUSD United States Dollar VAT Value Added TaxVMRO-DPMNE

Internal Macedonian Revolutionary Organization – Democratic Party for Macedonian National Unity

WB World BankWBG World Bank GroupWHO World Health OrganizationWMO Water Management Organization

World Bank IFCVice President Shigeo Katsu Edward A. Nassim

Country Director Orsalia Kalantzopoulos Shahbaz MavaddatTask Team Leader Sandra Bloemenkamp Gjergj Konda

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FORMER YUGOSLAV REPUBLIC OF MACEDONIACOUNTRY PARTNERSHIP STRATEGY

Table of Contents

EXECUTIVE SUMMARY.........................................................................VII. INTRODUCTION................................................................................1II. COUNTRY CONTEXT.........................................................................1

A. Regional Context and Political Developments........................1B. Economic Developments Since the Last CAS...........................3C. FYR Macedonia’s Poverty Profile............................................4III. FYR MACEDONIA’S LONG-TERM VISION, MEDIUM-TERM PLANS, AND

OUTLOOK..........................................................................................6A. FYR Macedonia’s Long-Term Vision and European Integration. 6B. The Medium-Term Economic Outlook......................................8

IV. FYR MACEDONIA’S DEVELOPMENT CHALLENGES...............................10A. Accelerating Economic Growth and Job Creation....................10B. Improving Governance in fYR Macedonia..............................15C. Improving Public Service Delivery........................................23

V. WORLD BANK GROUP’S CURRENT PORTFOLIO...................................26A. Past Bank Assistance and Quality and Management of the Existing Portfolio...................................................................................26B. Lessons Learned from the CAS Completion Report (CASCR).. .28C. FYR Macedonia’s Country Financing Parameters (CFPs).........29

VI. THE WORLD BANK GROUP PARTNERSHIP STRATEGY..........................29A. Key Features and Pillars of the Results Based Partnership Strategy

29Pillar 1: Foster Growth and Job Creation, Increase Living Standards for All......................................................................30Pillar 2: Public Service Delivery and Supporting Good Governance....................................................................................35

B. The Framework for Bank Assistance and Financing Scenarios 37C. The Programmatic Development Policy Lending Program (PDPL)

40D. Partnerships and Participation.............................................40

VII. RESULTS-BASED MONITORING AND EVALUATION..............................42VIII. RISKS AND MITIGATION REMEDIES................................................43

IX. Concluding Remarks...............................................................44

AnnexesAnnex 1: FYR Macedonia CPS FY07-FY10 Results Matrix........................................................45Annex 2: FYR Macedonia’s CAS Completion Report, FY04-FY06............................................56Annex 3: IFC in fYR Macedonia...................................................................................................85Annex 4: MIGA Assistance Program and Guarantee Outstanding Exposure...............................91Annex 5: CPS Consultations and Outreach...................................................................................93Annex 6: Donor Assistance to fYR Macedonia by Program.........................................................95Annex 7: FYR Macedonia Country Financing Parameters...........................................................96Annex 8: FYR Macedonia’s Relations with the EU.....................................................................97Annex 9: Governance Activities in World Bank Program..........................................................101Annex 10: EU Partnership Priorities and World Bank Assistance..............................................103Annex 11: Standard CPS Annexes..............................................................................................118Annex 12: Fund Relations Note..................................................................................................128

TablesTable 1: FYR Macedonia –Key Economic Indicators.....................................................................9Table 2: Indicators of World Bank Lending Portfolio (FY03 - FY06).........................................27Table 3: Proposed ESW Program FY 2007-2010..........................................................................37Table 4: Proposed Lending Program FY 2007-2010.....................................................................38Table 5: Triggers for Lending........................................................................................................39

FiguresFigure 1: Labor market developments are critical to poverty alleviation in FYR Macedonia........5Figure 2: Major Obstacles to Firm Activity in fYR Macedonia, 2005.........................................11Figure 3: Customs Clearance Times Have Fallen in Kumanovo..................................................17Figure 4: Bribes at Customs Have Fallen Dramatically................................................................17Figure 5: Bribes for Business Licensing Have Fallen Dramatically.............................................18Figure 6: Bribes Related to Courts Have Fallen, Process of Enforcing Contracts Has Improved 19Figure 7. Bribes Related to Procurement Have Not Fallen...........................................................22

BoxesBox 1: Improving Governance in the Health Sector in fYRMacedonia........................................21Box 2: Client Survey.....................................................................................................................41Box 3: Anticipated Development Challenges which the CPS is Designed to Influence...............43

The following World Bank staff contributed to the preparation of the CPS: James Anderson, Husam Mohamed Beides, David S. Bernstien, Gordon Betcherman, Zarko Bogoev, Denis Boskovski, Rajna Cemerska, Sarbani Chakraborty, Olav Rex Christensen, Bruce J. Courtney, William R. Dillinger, Gary J. Fine, Michele Gragnolati, Paulus A. Guitink, Dominic S. Haazen, Ardo Hansson, Bekim Imeri, Robert A. Jauncey, Peter Johansen, Christine Kessides, Andrew C. Kircher, Julian A. Lampietti, Toby Linden, Silvia Minotti, Bojana Naceva, Evgenij Najdov, Snjezana Plevko, Kirsten Burghardt Propst, Sarosh Sattar, Jasminka Sopova, Victoria Stanley, Erik van der Plaats and Jasminka Varnalieva.

The preparation team also includes Gjergj Konda, Margo Thomas and Zoran Martinovski from IFC,

John R. Wille and Mario Marchesini from MIGA.

The CPS team acknowledges the strong support from OPCS colleagues (Erika Jorgensen and Poonam Gupta) and FINCR (Paul Levy).


EXECUTIVE SUMMARY

i. Background. Progress in the former Yugoslav Republic of Macedonia (fYR Macedonia) over the past few years has been impressive. In 2001, the country was an IDA borrower and recovering from the economic, political and social fallout of an internal conflict. Today (2007), fYR Macedonia is an IBRD borrower and enjoys EU candidate status. On the economic front, macroeconomic stability and predictability have steadily increased, inflation has remained under control, and barriers to market entry and exit have been reduced by simplifying and accelerating registration and bankruptcy procedures. Meanwhile, though, economic growth and formal sector job creation have been disappointing. Growth has averaged only 3.5 percent over the 2003-2006 period. Such growth rates place fYR Macedonia among the slowest growing economies in ECA in this period. Also, the recovery remains narrowly based on a few key sectors and unemployment remains high. While official data have consistently overstated unemployment, at over 30 percent, fYR Macedonia’s official unemployment rate is among the highest in the region.

ii. Since 1990, the Bank has actively supported the country’s transition. During the 1990s, Bank support was focused on building the foundations of a market economy and a stable macroeconomic framework. Bank assistance was primarily focused on reform of the financial and enterprise sector, agriculture, human development public sector reform, infrastructure and energy, through a series of sector adjustment loans accompanied by investment lending. Since fYR Macedonia joined the World Bank Group in 1993, IDA and IBRD commitments to the country through 38 operations total approximately US$ 780 million and IFC commitments total over $93 million in IFC funds and more than $25 million in syndications.

iii. Performance during the FY04-06 CAS picked up following concerted efforts to address key issues and accelerate implementation. During the FY04-06 CAS period, the Bank worked with the government to deliver a high case lending program of $166 million, including $60 million for adjustment. The Bank’s program gradually shifted from a public sector to a private sector focus. The Bank also delivered a program of Economic and Sector Work (ESW) and technical assistance that contributed to policy dialogue during the CAS period. The quality of portfolio performance significantly improved since 2003. In 2005, fYR Macedonia gained direct access to foreign capital markets; it has received a credit rating just below investment rate and successfully issued its first Euro bond in December 2005 on relatively favorable terms.

iv. EU accession. On December 16, 2005 the European Council granted candidate country status to fYR Macedonia. The Council made this decision on the basis of the substantial progress made in completing the legislative framework related to the Ohrid Framework Agreement, as well as fYR Macedonia's track record in implementing the Stabilization and Association Agreement (SAA). While no date to open actual negotiations is specified, the EU

perspective is a very positive element in reaching consensus across ethnic lines, crucial against the backdrop of the Kosovo discussions.

v. A new government took office with great ambitions. After four years of opposition, a new coalition was elected to office in July 2006 on a very concrete election manifesto entitled "Rebirth in 100 Steps." Building on progress made over the last few years, and in the context of overarching goals of EU accession and NATO membership, these 100 steps focus predominantly on reforms to accelerate economic growth from its current level of 3.5-4 percent to 6-8 percent in the next few years. The manifesto was endorsed by all coalition partners, and, in July 2006, the government presented their new program for the period 2006-2010 to the Parliament. The program aims to improve the living standards of all citizens, increase employment, strengthen the fight against corruption, develop the democracy, and improve inter-ethnic relations political stability.

vi. The WBG will support fYR Macedonia in its efforts to join the European Union. Overall, the proposed Country Partnership Strategy aims to accelerate fYR Macedonia’s perspective to join the European Union. The proposed program is well grounded in the policy priorities of the government and takes full account of the priorities as defined in the Stability and Association program (SAp), and results from consultations with the government and other stakeholders. In the next four years, fYR Macedonia needs significant investments in its institutional capacity. The road to Europe will not only require the country to design and adopt EU-compatible standards and regulations, it also requires building the capacity to implement them. The WBG program over the next four years expects to play an important role in this process, including by providing “bridge” financing to allow fYR Macedonia to benefit faster from EU pre- accession funds.

vii. The CPS aims to support the government’s program around two core pillars: i) fostering economic growth, job creation, and increasing the living standards of all; and (ii) improving the governance and transparency of public service delivery to support the market economy.

viii. Pillar 1: Foster Growth and Job Creation, Increase Living Standards for All. The WBG will support the governments’ ambitious goals on accelerated growth and job creation through an integrated and multi faceted program. Under this pillar, the WBG will aim to (i) maintain macro economic stability, while ensuring proper integration of EU priorities into the budget; (ii) improve business environment, including regulatory reform and proper enforcement of contract and creditor rights; (iii) reduce the costs of capital; (iv) improve the enterprise sector’s competitiveness, (v) improve agricultural competitiveness; (vi) establish a functioning land market and institutions; (vii) improve infrastructure for growth by strengthening the framework for public-private partnerships and invest selectively in energy and transport; (viii) remove rigidities in labor market regulations and reduce the labor tax wedge; (ix) develop a productive and appropriately skilled labor force; and (x) use cash transfer systems to encourage school enrolment and preventive health.

ix. Pillar 2: Public Service Delivery and Supporting Good Governance. Under this pillar, the CPS aims to support fYR Macedonia in continuing the progress made in improving

governance and reducing corruption, while deepening reforms in key sectors where governance weaknesses continue to undermine progress in the economic reforms necessary to strengthen the economy and create jobs. Improved transparency and accountability in service delivery is critical to meet the government program on growth, foster human capital, and meet EU standards. The WBG will support fYR Macedonia in its efforts to (i) continue its efforts to improve the environment of legal uncertainty and lack of confidence in the judicial system; (ii) apply proper public finance principles and governance standards at the municipal level, including to municipal public enterprises and utility companies; (iii) continue improving the efficient use of public resources and performance monitoring in the provision of affordable and quality health services, and (iv) make cash transfer systems more targeted and introduce incentives to encourage school enrolment and preventive health.

x. The need for Bank lending is significant over the next four years but is subsequently likely to wind down as fYR Macedonia moves toward EU Accession and eventual graduation. The volume of the proposed lending envelope under the CPS is significant. The proposed base case lending envelope equals the high case lending envelope of the 2003-2006 CAS. This level accommodates the government’s intention to work closely with the WBG on key areas of their reform agenda in order to accelerate conversion towards EU levels and to help build the capacity to access and implement EU pre-accession funds. At the end of the CPS period, however, it is expected that the country will have gained access to significant EU pre-accession funds, reducing subsequent borrowing significantly.

xi. Actual lending will be determined by the pace of reforms in key sectors. The pace of reforms thus far, combined with fYR Macedonia’s creditworthiness and low, but stable growth, warrant a program of lending support that would encourage progress under the two main pillars of the CPS. The base case includes both investment and adjustment lending, and envisages two or three new loans per year, for a total of US$220 million over the four years. Under the high case scenario, this lending program could be augmented by two more investment loans, for a total of an additional US$60 million over the four years. Triggers for the base case require continued satisfactory macroeconomic performance, and proposes selected indicators to make continued progress on the business climate, while maintaining stability and a continuation of satisfactory portfolio performance. The triggers for the high case require meeting all fiscal targets included in the IMF program as well meeting specific triggers on the energy sector and on the competition agenda. Developments in fYR Macedonia are changing rapidly; the lending program will be reviewed during the planned CPS Progress Report (FY09), to ensure that WBG support remains fully responsive to evolving needs in the country.

xii. Risks. Regional instability, especially against the backdrop of the Kosovo discussions, could greatly influence the sustainability of the economic reform efforts. It could also have a negative impact on fYR Macedonia’s ability to attract much needed new investments. Domestic political tensions pose a risk to the implementation of the government’s reform program as well. Finally, lack of progress in the EU accession process could weaken the consensus on the direction of the reforms, and could consequently result in a slow down of reforms. However, successful implementation of the program as supported by this CPS, would strengthen fYR Macedonia’s economy, raise living standards of its citizens, and would help fYR Macedonia to continue to play its model role as a functioning multi-ethnic state in the Balkans.

Country Partnership Strategy for fYR Macedonia FY07-10


I. INTRODUCTION 1. Progress in the former Yugoslav Republic of Macedonia (fYR Macedonia) over the past few years has been impressive. In 2001, the country was an IDA borrower and recovering from the economic, political and social fallout of an internal conflict. Today (2007), fYR Macedonia is an IBRD borrower and enjoys EU candidate status, albeit without a clear date to start the negotiations. The country has applied for NATO membership, and hopes to join in 2008. Successive Macedonian governments have made considerable efforts to implement the Ohrid Framework Agreement, which provided the basis for resolving the 2001 ethnic conflict. To complement this political progress, fYR Macedonia governments have been pursuing an ambitious economic reform program and have successfully preserved macro-economic stability, though growth performance has not been stellar, especially by regional standards, and unemployment levels remain extremely high.

2. The proposed CPS for FY07-10 builds on the experience of the World Bank Group (WBG) since the early 1990s. It aims at harnessing the contributions of all parts of the World Bank Group, including IFC and MIGA, and building on fYR Macedonia's progress during the past few years. At the same time, the strategy is designed to support the government's goals of tackling the stubborn challenges of growth and unemployment that face the country. Overall, the CPS aims to accelerate fYR Macedonia’s perspective to join the European Union. Proposed activities envisaged under this CPS are focused on two pillars: (i) fostering job-creating economic growth, and increasing living standards for all, and (ii) improving governance and transparency in public sector delivery to support a market economy. The CPS will employ a selected mix of investment and policy lending, along with a robust program of Analytical and Advisory Activities (AAA) work to support the CPS goals.

II. COUNTRY CONTEXT A. Regional Context and Political Developments

3. FYR Macedonia is a small, land-locked country of about 2 million people with a multi- ethnic population in the middle of the Western Balkans.1 The country embarked upon the transition process as one of the smallest and poorest of the six republics of the former Socialist Federal Republic of Yugoslavia (SFRY). Income per capita at the start of transition was only one third of that in Slovenia and one half of that in Croatia, while open unemployment stood at above 20 percent of the workforce. It inherited an economy narrowly based in low value-added sectors such as agriculture, textiles and iron and steel production. Tensions were high throughout the 1990s due to spill-over effects of nearby hostilities, which severely affected

1 According to the 2002 census, the population consists of ethnic Macedonians (64 percent), ethnic Albanians (25 percent), ethnic Turks, (4 percent), ethnic Serbs (1.7 percent), Roma (2.7 percent), and some other small minority communities.


the transition process and economic development of the country. Free flow of passengers, trade and transport was interrupted as a result, and hampered further by many new cross border requirements for international trade-oriented companies, increasing trade and transportation transaction costs.

4. The Western Balkans region is now much calmer and the EU perspective is clearer, but the road is still long and risks remain. More than a decade after the end of the Bosnia war and more than six years after the fall of the Milosevic regime in Belgrade, the Western Balkans is a relatively stable region with free elections and no military conflicts. In Thessaloniki in June 2003, the European Union committed itself to integrating the countries of the region, and reaffirmed the European perspective based on a fair and rigorous conditionality as set out in the Stabilization and Association Process and the Thessaloniki Agenda. The experience of Central and Eastern Europe illustrates best how the institutionalization of the European integration perspective is the most efficient way to foster the overall political, economic and administrative reforms in prospective new member countries. This is crucial in the Western Balkans. However, actual EU accession is a long term proposition and the region is still faced with major outstanding issues, including the status of neighboring Kosovo that could disrupt the progress made over the past years.

5. Political developments in fYR Macedonia. Over the past 15 years, fYR Macedonia has been mostly spared from direct violence seen elsewhere in the region. The exception was an inter-ethnic conflict in 2001, which ended six months later with an internationally mediated peace agreement called the Framework Agreement for Peace (also known as the Ohrid Agreement), that provided for the cessation of hostilities and the increased protection of the rights of ethnic Albanians and other minority groups. Since 2003, considerable progress has been made in implementing the Ohrid Agreement, including in enhancing the representation of minorities in governmental structures. In this context, fYR Macedonia embarked on a significant decentralization program. The country’s ambition to accede to the EU also provides strong reintegrating forces that -under the broader framework of harmonization with Europe- are fostering increasing economic and political ties within the region and beyond. The two consecutive regular parliamentary elections in 2002 and 2006 were held peacefully and largely democratically. Challenges remain, however, as tensions between the ruling coalition and the opposition are severe. As pointed out in the latest EC Progress Report (November 2006), the limited political dialogue seriously impedes the country’s ambition to accede to the EU.

6. EU accession. On December 16, 2005 the European Council granted candidate country status to fYR Macedonia. The Council made this decision on the basis of the substantial progress made in completing the legislative framework related to the Ohrid Framework Agreement, as well as fYR Macedonia's track record in implementing the Stabilization and Association Agreement (SAA). While no date to open actual negotiations is specified, the shared goal of EU integration is a very positive element in what is still occasionally a tense political and ethnic dialogue within the country, crucial against the backdrop of the Kosovo discussions. The first EU accession progress report, presented in November 2006, recognized progress achieved, but noted a slowdown in the pace of reforms in 2006, probably due to the elections in mid 2006. The report outlines specific recommendations of the Commission in a number of areas, stressing areas such as police and judicial reforms, the fight against corruption


and organized crime, the need to secure depolitization and capacity in the public sector, and the need to sustain efforts in implementing the Ohrid Framework Agreement.

7. Decentralization and urban development. Decentralization, a major element of the Ohrid Agreement, has been unfolding in stages. It was formally launched in mid-2005. The associated fiscal and administrative reforms could help unlock the economic and especially job-creating potential of fYR Macedonia’s cities and ease ethnic pressures, provided that public management at the local level is strengthened further. Ensuring effective local service delivery and good governance will require continued cooperation between the central government and the elected municipal governments, as well as cooperation among the municipalities themselves.

B. Economic Developments Since the Last CAS

8. The civil conflict in 2001 disrupted a brief period of positive economic momentum. Although direct damage from the conflict was limited, investment activity markedly dropped, and output contracted by 4.5 percent in 2001. Defense-related expenditures pushed the budget and current account deficits to 7 percent of GDP. The effects of the conflict were still clearly felt in 2002 as investment and export growth remained sluggish while budget and current account deficits remained high.

9. Economic recovery gradually took hold in subsequent years as the budget deficit was quickly eliminated in 2003 and structural reforms gradually resumed. The budget has remained roughly balanced since 2003 while expenditures were reduced from 40 percent of GDP in 2002 to about 35 percent of GDP in 2005. The tight fiscal policy contributed to a reduction in the current account deficit. In 2005, the current account deficit fell to 1.4 percent of GDP following a 4 percentage points of GDP increase in recorded private transfers to 17.7 percent of GDP, the highest in Southeast Europe. These transfers increased by an additional 1 percentage point of GDP in 2006 as the current account moved to a small surplus of 0.4 percent of GDP. The overall balance of payments has strengthened considerably as gross reserves increased to about 4.5 months of imports. In this environment, external and public debt ratios have gradually declined to less than 40 percent of GDP.

10. While prudent macroeconomic policies have firmly established macroeconomic stability, economic growth and formal sector job creation have been disappointing. Recorded growth has averaged only 3.5 percent over the 2003-2006 period. Such growth rates place fYR Macedonia among the slowest growing economies in ECA in this period. Also, the recovery remains narrowly based on a few key sectors and unemployment remains high. While official data have consistently overstated unemployment, fYR Macedonia’s official unemployment rate is among the highest in the region. High and persistent unemployment statistics reflect low new job creation in the formal sector. In part this is due to an overly restrictive labor market and a high tax wedge.2 It is also due to the poor corporate governance which emerged following a mainly insider-oriented privatization process in the mid-nineties, which brought neither adequate knowledge and capital transfers, nor access to markets and finance. On the contrary, fYR

2 The new Labor Law adopted in July 2005 significantly eased labor market restrictions. The new government has already reduced the tax wedge and is contemplating a switch to general budget financing of health expenditures in an effort to further reduce payroll taxes.


Macedonia’s corporate structure still tends to favor status quo over encouraging new entry and increased competition. An overly burdensome business regulatory environment until recently hampered new business startups and job creation. Collectively, these forces have contributed to a high unemployment rate by encouraging informality. The informal economy in fYR Macedonia may be well over 40 percent of GDP, significantly above the estimated regional average.

11. Conversely, at about 20 percent of GDP the investment rate in fYR Macedonia has lagged significantly behind faster growing economies in the region. The flow of FDI into fYR Macedonia has also been disappointing over the past decade. Apart from the spike in FDI in 2000 and 2001 when the largest bank and the telecom company were privatized and in 2006 when the electricity distribution company was sold, FDI has averaged 1.5 percent of GDP, one of the lowest rates among transition countries. Business climate surveys indicate that the most serious obstacles to private sector development include: an inefficient and opaque judicial system, poor access to credit, heavy regulation (especially in labor markets), political risks, corruption, uncompetitive practices, and policy unpredictability.

12. Exports, a major source of growth in transition economies, have performed poorly during the last decade growing by an average of around 4 percent a year in real terms. The country’s share in world exports recovered slightly in 2005-2006 but it is still below its level in the mid-1990s. Macedonian exporters have been able to regain market share in some of its traditional trading partners, in particular Serbia, Greece, and Germany, but lost shares in eastern markets such as Ukraine and Russia, and have been unsuccessful in penetrating new markets. fYR Macedonia still specializes in low-value added goods (iron and steel, textiles, tobacco, agriculture produce) and the lack of FDI has kept the country out of intra-industry trade linkages preventing transfer of technology and limiting market access. In absence of productivity-increasing investments, the country has managed to remain competitive only due to strong prices in recent years and through lowering labor costs.

C. FYR Macedonia’s Poverty Profile

13. With only moderate economic growth, poverty has not decreased since 2002. An estimated 21 percent of the population lives below the absolute poverty line indicating that they are unable to meet their basic food and nonfood needs. Some 7 percent of the population has expenditures so low that they are unable to even acquire a minimum level of calories. However, the stagnation in the level of poverty masks internal changes occurring in fYR Macedonia: urban poverty in secondary towns has risen while rural poverty has fallen. This is not surprising, taking into account that these areas were largely dependent on employment by former SOEs which failed to restructure successfully.

14. Not holding a job is a major cause of poverty and unemployment affects younger people disproportionately. Only 33 percent of the poor working age population is employed, compared with 46 percent of the non-poor population.3 The differences are particularly important in urban areas. While the poor tend to be active to almost the same extent as the non-poor, they suffer from much higher unemployment rates – some 60 percent of the poor in Skopje

3 Household survey data, 2004


were unemployed in 2004. The average unemployed person is 35 years old, compared to 41 years for the employed; two fifths of the unemployed are less than 30 years old, compared to 17 percent of the employed. Labor markets are therefore critical to understanding the poverty situation.

Figure 1: Labor market developments are critical to poverty alleviation in FYR Macedonia. Average consumption (2002=100) and poverty Labor market indicators, poor and non-poor, 2004.

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2002 2003 200415

17

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P.c. consumption (left) Urban Poverty (right) Rural Poverty (right)

60.4

45.3

64.5

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Activity rates Unemployment rates

Poor Non-poor

15. Growth has generated some jobs –but few well paying jobs– which may explain the slow poverty reduction. Between the first quarter of 2004 and the second quarter of 2006, employment rates4 increased from around 33 percent to around 35 percent. The higher employment rates reflect an increase in activity rates –more people holding or looking for a job– coupled with a small fall in unemployment rates. Poverty data are not available for this year, but given the strong correlation between poverty and unemployment, chances are that they will have fallen, if only slightly. The welfare of the poor in particular has been adversely impacted by the low level of job creation leaving the poor’s rate of unemployment to stand at 50 percent compared to about 30 percent for the non-poor. Moreover, the jobs poor people find tend to be poorly paid, insecure and seasonal jobs. As a result, poor people derive more of their income from informal sector activity and social assistance compared to the non-poor.

16. Employment status, household size and the educational level of the head of household determine income per capita. Thus, people with limited education obtain low paying jobs on which they usually have to support large families, including economically inactive adults. In contrast to the difficulties of the prime age population and their dependents, poverty systematically declines with age, and poverty among the elderly is lower than among other age groups. This suggests that pensions play an important role in mitigating old age poverty. Finally, a cross-cutting correlate of poverty is ethnicity with poverty being higher among the Roma as well as ethnic Albanians.

17. Non-monetary dimensions of poverty (in particular, poor housing conditions and low education) affect another 30 percent of the population. However, poverty in all dimensions for individuals is rare, meaning that few persons suffer across all dimensions of income and non-income poverty. Health indicators, school enrollment rates and access to and reliability of infrastructure services appear to be in line with national income per capita. In particular, there have been large improvements in access to secondary and tertiary education over

4 The share of the population aged over 15 that actually was employed


the last 15 years. This being said, access and quality of the services received by the poor or less affluent people lag considerably behind the non-poor.

III. FYR MACEDONIA’S LONG-TERM VISION, MEDIUM-TERM PLANS, AND OUTLOOK

A. FYR Macedonia’s Long-Term Vision and European Integration

18. Prospects for faster growth have improved. Over the last four years, a number of important reforms have been implemented. Macroeconomic stability and predictability have steadily increased, inflation has remained under control, and barriers to market entry and exit have been reduced by simplifying and accelerating registration and bankruptcy procedures. The launch of a new “one-stop shop” business registration system in January 2006 significantly eased the time, cost and burden of registering new business. The new system provides a transparent registration for new businesses and has reduced registration time from 48 days to 5 days. A comprehensive judicial reform was launched in 2005 which, if vigorously implemented, will firmly establish the rule of law including creditor, contract and property rights. After engaging in a critical dialogue with social partners regarding an overhaul of the labor law and institutions to introduce more flexibility into fYR Macedonian labor markets, a new Labor Law was enacted in July 2005. In the banking sector, supervision, regulations as well as governance are being strengthened. Finally, the country has been successfully brought to candidacy status of the European Union. The latest Progress Report of the European Commission notes that fYR Macedonia is well advanced in establishing a functioning market economy, having maintained a broad consensus on the essentials of economic policies, though sustained efforts will remain critical to enable the country to cope with competitive pressure and market forces within the Union in the medium-term.

19. But challenges remain. Enterprises in fYR Macedonia have not undergone the dynamics of restructuring witnessed in other countries in the region. This is in part due to the poor corporate governance which emerged following privatization (see paragraph 41 below). Unfair competition practices still occur and may discourage potential new firms from entering the market. In fact, fYR Macedonia has been much less successful than other countries in the region in attracting greenfield FDI and new domestic firms. In a number of transition countries, de novo small and medium enterprises have been a major source of new job creation. Unfortunately, fYR Macedonia lags far behind in this area. FYR Macedonia’s investment to GDP ratio also lags behind faster growing transition countries. Institutional weaknesses, such as cumbersome administrative procedures and corruption, as well as a low degree of legal certainty and predictability of economic and regulatory policies encumber the business climate and a proper functioning of the market economy. Labor and financial markets are still functioning unevenly, and the informal sector distorts the economy, resulting in unfair competition practices and weaker consumers’ protection. These flaws in the investment climate have been compounded by weak public sector governance which further undermines investor sentiment. Improvements in this area will be essential, also to deal with the complex EU accession requirements.


Priorities of the government

20. A new government took office with great ambitions. A new coalition was elected to office in July 2006 on a very concrete election manifesto entitled "Rebirth in 100 Steps." These 100 steps focus predominantly on economic reforms aimed at accelerating economic growth from its current level of 3.5-4 percent to 6-8 percent in the next few years. The Manifesto was endorsed by all coalition partners, and, in July 2006, the government presented their new program for the period 2006-2010 to the Parliament. The main goals of the program are to improve the living standards of all citizens, increase employment, strengthen the fight against corruption, further develop democracy, and improve inter-ethnic relations and political stability.

21. EU and NATO membership. The program says EU and NATO integration are of paramount priority for fYR Macedonia, and plans to finalize the remaining reforms, while promoting peace and stability in the country and in the region through respect of democratic principles.

22. Spur dynamic economic development, reduce the grey economy and create jobs. To achieve the stretched goals of accelerated growth and job creation, the government’s strategy includes a wide ranging set of policies to spur economic activity and create jobs and increase living standards of the population. Some active labor market policies are envisaged as well. Within a disciplined, though slightly more relaxed fiscal policy framework, the government has started to reduce taxes and redirect public spending towards capital investments.

23. Improve business climate. Structural reforms to improve the investment climate are central to the program, in particular by: (i) reducing the burden of superfluous business regulations by introducing a regulatory “guillotine” (for existing regulations) and requiring a regulatory impact assessment (for new regulations); (ii) reducing the business registration process time further from five to three days; (iii) completing the land cadastre and real estate registry; (iv) ensuring a more efficient and competitive financial system; (v) further increasing labor market flexibility; and (vi) protecting ownership rights, contract enforcement and shareholders rights.

24. Increase fYR’s Macedonia competitiveness, and improve the performance of the agriculture sector. Investments in technology, knowledge and education will be increased to improve the competitiveness of the Macedonian economy, including its agricultural sector. Agriculture will also be supported, inter alia by the development of the agricultural land market, the international promotion of Macedonian agricultural products, increased access of farmers to credit and the development of certified organic foods.

25. Attract new market entrants to boost competition. The government’s strategy places a great deal of emphasis on attracting new entrants to the market. The government is actively seeking to promote greenfield FDI and has appointed two ministers without portfolio and a number of consulting agencies to attract foreign investment. It is strengthening staffing, funding and international network for its investment promotion agency (MacInvest). The government


has also started advertising heavily in major western business publications and is providing a package of incentives to potential investors.

26. Governance and public service delivery. Under government plans, public service delivery would be improved through increased transparency and quality of public institutions to implement reforms. The program calls for improved governance, including implementation of the judicial reforms, and a decisive fight against corruption. Telecommunication costs will be reduced by increasing competition, and investments to expand road, electricity generation, and irrigation networks, including through concessions and public-private partnerships (PPPs), are envisaged. Railways will be modernized and internet penetration stimulated. The functioning of the energy market will be improved. Increased enrolment in (higher quality) education will be stimulated, as will enhanced quality in the health care sector through increased transparency and efficiency. Decentralization will continue, with adequate attention for a clearer definition of the competencies of local authorities. Finally, social policies will be more closely linked to the job market.

27. Implementation of the program has started. A number of concrete steps of the Program have already been implemented. Within months of taking office, the government reduced the VAT for selected agriculture inputs and –effective January 2007– corporate and personal income tax rates were reduced and unified. At 12 percent, these rates are now among the lowest in the region. The zero taxation policy on reinvested profits has been introduced as well, with a 50 percent cap to limit loss of revenue. A third mobile telephone provider was licensed in February 2007, the regulatory “guillotine” system was launched in January 2007, and many other measures are under preparation.

B. The Medium-Term Economic Outlook

28. FYR Macedonia could achieve faster growth in the medium-term. The projections presented here assume continuing improvements in regional stability, domestic political stability, prudent macroeconomic policies and strong and sustained reform implementation. Under these assumptions, the medium-term macroeconomic outlook is positive.

29. Increasing investment to GDP. The government’s reform program builds on recently improving growth prospects by focusing on sustained improvements in the investment climate. Acceleration of economic growth to levels recently achieved in neighboring countries ultimately will depend on a positive private sector response to these emerging improvements in the investment climate. Attracting new entrants to the market, both greenfield FDI and de novo small and medium enterprises, gradually increasing the investment to GDP ratio, continuing the expansion of credit and reduction in real lending rates, will be essential ingredients for accelerating growth, exports, and job creation.

Table 1: FYR Macedonia –Key Economic Indicators2004 2005 2006 2007 2008 2009 2010

Actual Estimate Projected


National AccountsGDP (US$ million) 5,368 5,766 6,217 6,699 7,216 7,730 8,278Real GDP growth rate 4.1 3.8 3.2 4.5 5.0 5.0 5.0Investments (percentage of GDP) 21.4 20.0 22.1 22.8 23.2 23.8 24.6Gross National Savings (percentage of GDP) 13.7 18.6 22.5 19.6 19.8 19.8 19.7

Fiscal Accounts (percentage of GDP)

Expenditures 36.1 35.3 34.7 33.7 33.3 33.5 33.5Revenues, including grants 36.5 35.5 34.2 32.7 32.2 32.4 32.5Deficit, including grants 0.4 0.2 -0.5 -1.0 -1.0 -1.0 -1.0

External Accounts (percentage of GDP)

Exports of Goods and Services 38.8 43.6 48.2 49.0 49.1 49.3 49.5Imports of Goods and Services 60.5 62.5 67.7 69.5 70.3 70.5 70.6Current Account balance, including transfers -7.7 -1.4 0.4 -3.2 -3.5 -4.0 -4.9External debt* 37.9 39.1 38.4 38.0 38.7 38.8 38.7Gross Reserves (months of next year's

imports) 3.3 3.8 4.5 4.4 4.8 4.6 4.4

InflationConsumer Prices (period average) -0.4 0.5 3.2 3.1 2.4 1.8 1.8

*/ includes short-, medium- and long-term debt.

30. Reduce perceived political risks. Sustained improvements in the investment climate would also require a reduction in perceived political and geopolitical risk. The continued implementation of the Ohrid Agreement, continued progress toward eventual EU membership, and the successful implementation of a final status arrangement in neighboring Kosovo ultimately could prove as important to the investment climate in fYR Macedonia as the envisaged economic reform program.

31. The government’s medium-term fiscal strategy is ambitious. It aims at continuing the gradual decline in public debt ratios achieved in recent years and reducing the burden of distortionary taxation. The government has already announced plans to further reduce corporate and personal income tax rates to 10 percent in 2008. Its proposed reallocation of public expenditures towards public investment concurrent with a gradual reduction in the expenditure to GDP ratio and efficiency gains could better support growth.

32. Moderate current account deficit. The current account deficit is projected to grow gradually to about 5 percent of GDP as aggregate demand increases. Prospects for export growth should slowly improve as structural reforms introduce greater competition and attract FDI which will gradually increase the competitiveness of Macedonian firms and their ability to produce higher-value added goods and services. Planned privatizations would finance the increased current account deficit in the next two years and a gradual increase in greenfield investment in the medium-term would help ensure that external debt remain modest at around 40 percent of GDP.

33. Gross external financing requirements are expected to remain modest at about $1 billion per year over the medium-term. These would be required to finance a current account deficit of $350 to $400 million, amortization payments of a similar magnitude and a gradual


increase in net foreign reserves. Net FDI flows could cover roughly 40 percent of total financing needs. Debt ratios would remain modest and stable. Debt sustainability is not likely to be a concern during this CPS period.

IV. FYR MACEDONIA’S DEVELOPMENT CHALLENGES

A. Accelerating Economic Growth and Job Creation

34. Accelerating and sustaining growth is needed to achieve the government’s ambitious economic and social objectives and for putting fYR Macedonia on the road to EU Accession. It is primarily through job creation that the benefits of this growth will be transmitted to Macedonian citizens. Improving employment obviously will require greater demand for labor through economic growth. But it will also call for supply-side interventions to enhance the skills of the labor force and to provide incentives for workers to increase their participation in the labor market. Job creation will be crucial to increase living standards and reduce poverty, ensure financing for public investments in health, education, and social protection, maintain political stability and enable fYR Macedonia to take fuller advantage of EU accession. As high unemployment has been a long lasting problem for fYR Macedonia, addressing this issue will not be easy.

35. The job creation challenge can only be met through a multi-faceted approach that encompasses both labor demand and supply. FYR Macedonia has now approved a National Employment Strategy and a National Action Plan for Employment. These documents have been prepared with support and assistance from the EU. However, while the strategy and action plan addresses many important issues, the country’s jobs agenda must be broader in scope, involving reforms in many sectors beyond the labor market. A comprehensive approach to improving employment requires efforts in a number of areas that encompass sound economic and regulatory policies, an attractive investment climate, efficient labor market regulations and institutions, education and training systems that develop relevant and high-quality skills, and a social safety net that offers protection while encouraging employability.5

36. The current macroeconomic situation should be favorable for growth and job creation, but continued prudence is essential. Macro stability, for the most part, is not a binding constraint to investment in fYR Macedonia. Inflation is low, foreign debt levels are moderate (below 40%), the budget deficit has been maintained at below 1 percent of GDP, and the current account deficit is, at below 2 percent, the lowest in the region. Concurrent with the decline in the current account deficit, international reserves have increased substantially. With these developments, the Central Bank has been a net purchaser of foreign exchange since early 2005 and has been able to ease monetary policy while maintaining the de facto pegged exchange rate regime. Private sector credit has grown by more than 20 percent per annum over the past few years and is likely to continue to grow at such a pace as interest rates continue to decline. With the new flat tax of 12 percent, fYR Macedonia now has the lowest personal income tax and

5 This approach is consistent with the MILES framework that has been used in recent labor market assessments.


corporate income tax in Europe. Continued prudence in macroeconomic management will be key to attracting investments and enabling firms to grow and create jobs.

37. Making the business climate more favorable for investors is critical. Firm surveys consistently indicate that an unfavorable investment climate is among the most important constraints to growth and job creation in fYR Macedonia. The results of the latest BEEPS survey of firms demonstrate the range of constraints in the investment climate that limit growth and job creation in fYR Macedonia (Figure 2). Most important are issues related to financing, anti-competitive practices and corruption, enforcement of contracts, the functioning of the judiciary, and licensing and regulations. While access to land, workforce skills and infrastructure weaknesses are farther down the list, experience elsewhere shows that they will rise in importance as soon as the economy starts taking off. Most of these factors originate from national policies and institutions, but can also be affected by the municipalities, especially if they become more proactive.

38. The cost of capital needs to be reduced and access to capital improved. Despite falling interest rates over the last three years, the cost of financing remains the most important reported factor constraining business activity. Recent reductions in the Central Bank rates have only partially been translated into commercial banks rates, suggesting a relatively uncompetitive banking climate, low banking efficiency and difficulties in assessing credit risks of potential borrowers. Better financial information on enterprise performance would help improve access to capital. It will also help lenders and investors to better evaluate corporate prospects, and make informed investment decisions.

Figure 2: Major Obstacles to Firm Activity in fYR Macedonia, 2005(% of firms reporting as major or severe obstacles)

0 0.15 0.3 0.45 0.6 0.75

Title or leasing of land

Access to land

Transportation

Skills and education of w orkers

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Electricity

Labour regulations

Organised crime/mafia

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Business licensing and permits

Tax administration

Uncertainty about regulatory policies

Access to f inancing

Functioning of the judiciary

Tax rates

Corruption

Contract violations

Anti-competitive practices of others

Cost of f inancing

Source: BEEPS 2005


39. Changes have been introduced to make the costs of doing business low and predictable, but further reforms are needed. Progress has been made to improve the investment climate, including judicial reforms to ensure better contract and property protection, land and real estate cadastre, enterprise registration, and bankruptcy legislation. However, these reforms are incomplete, and the agenda needs to focus on some of the key remaining bottlenecks. An illustration of the remaining challenge is that fYR Macedonia is still at a disappointing 92nd place on the overall “ease of doing business measure” in Doing Business 2007.

40. Addressing concerns of uncertainty over business regulations is now a priority. The government is strongly committed to regulatory reform and is in process to revamp regulations affecting the business sector, improving the quality of both existing and new regulations. A proper institutional framework has been designed to guide the process at the central government level. To deal with the existing stock of business regulations, a so-called “guillotine” system has been launched in February 2007, requiring a vigorous re-evaluation and re-justification of current business regulations. For future regulations, the government will implement a regulatory impact assessment (RIA) system and institutionalize mandatory consultation mechanisms with the business community.

41. Promote Competition. The enterprise restructuring process that followed the privatization of the 1990s has not led to the innovation and managerial improvements that would increase the competitiveness of the private sector. About 60 percent of all privatizations in fYR Macedonia in the 1990s occurred through “insider” buy-outs and this still affects –even after 10 years– the efficiency, managerial performance, and competitiveness of Macedonian enterprises. Although the private sector share in GDP is close to 65 percent, and growing, EBRD’s Transition Indicators still score fYR Macedonia rather low for enterprise restructuring. Remaining opportunities for unfair competition practices, (e.g., tolerated arrears in taxation, wage and social contribution or energy bills) need to be addressed rigorously. There are serious problems in the implementation of the public procurement law and the related sub-legislative instruments that result in unfair competitive practices in public procurement; these problems must be addressed. Moreover, the remaining liberalization agenda requires aggressive implementation, in particular in the telecommunication and air transportation sectors, where lack of competition is resulting in extremely high prices, hurting the private sector and the public alike.

42. Foreign Direct Investment (FDI) and trade with more developed countries will help improve the competitiveness of Macedonian companies. In general, Macedonian companies need to improve their competitiveness; they are adjusting too slowly to new market opportunities and investing too little in technology adaptation, development of new products, and in training and skills upgrading of their managers and staff. Experience elsewhere shows that FDI and increased regional and global trade have important side benefits, such as faster transfer of knowledge, technology and improved managerial capacity and better access to foreign markets. FDI levels have been very low even by Western Balkan standards, and significant greenfield FDI is only starting now. Improving this record is a top priority for the government and it plans to implement various measures to this end. Trading with countries that have a more advanced knowledge and technology base can also generate positive “learning” spillovers. However, trade with more technically sophisticated EU partners is relatively low. With the recent accession of


Bulgaria and Romania to the EU, fYR Macedonia now enjoys two EU borders (with Greece to the south). This allows for increased investments and access to the deep EU market, but also bears the risk that trade and transit more easily bypasses the country altogether. Thus, actions to alleviate non-tariff cross border barriers become even more pressing.

43. Improving agricultural competitiveness is especially important, also in view of the EU accession process. Agriculture accounts for 16 percent of GDP and some 20 percent of employment. The sector is also crucial for the rural economy, where almost half the population lives. Sector performance over the last decade has been mixed, largely dependent on weather conditions. Constraints to competitiveness include low levels of investment in farm technology and supply chains as well as underdeveloped land and rural credit markets. As with other countries in the region, increasing trade liberalization and modernization of the economy are transforming Macedonian agriculture. While opportunities presented by increased trade are great, unless producers and agro-processors can become more competitive, they will have trouble maintaining and increasing external and internal market share as low-cost, high-quality imports increase.

44. Overcoming these constraints calls for effective public sector actions to resolve market failures and create an enabling environment for the private sector through transparent, predictable policies and regulations and investment in public goods. FYR Macedonia’s recently acquired status as an EU candidate country presents opportunities in the form of significant additional assistance for the sector, but also imposes additional institutional and regulatory requirements. In light of increasing resources and competition in regional markets, fYR Macedonia urgently needs to raise Ministry of Agriculture, Forestry and Water Economy’s (MAFWE’s) weak institutional and human capacity to facilitate agriculture modernization. In addition, the labor shedding that will occur once the sector becomes more competitive will require careful management.

45. Efficient infrastructure and energy supply are also necessary for spurring growth, increasing international trade and improving the business climate more generally. Except for some bottlenecks, the capacity of the road and rail transport infrastructure is sufficient but management and maintenance is inadequate. Structural reforms and institutional strengthening are necessary to improve efficiency in transport asset conservation, based on well-informed programming and budgeting of maintenance needs. International transport links are crucial for the country, and fYR Macedonia’s active participation in the core transport network strengthening between the European Union and its neighboring countries is very important. The fragmented railway system can only fully benefit from new freight transportation opportunities in steel and other industries, if it ensures uninterrupted longer distance railway links. Furthermore, like the other SEE countries, fYR Macedonia has signed the European Common Aviation Area (ECAA) agreement, but to reap the benefits of this extension, the country will have to implement ambitious aviation sector reforms. Finally, fYR Macedonia is a signatory of the Energy Community of South East Europe (ECSEE) Treaty to promote integration of SEE energy markets. Due to its advantageous location, and with further improvement in the performance of its energy sector and increased investment in infrastructure, the country is in a position to take full advantage of its participation in the regional power market.


46. Labor market regulations and institutions are important for protecting workers, but they also can play a key role in supporting growth and job creation. The 2005 Labor Law represents an important step in bringing Macedonian labor market rules in line with the norms of a market economy, but the reform agenda is still incomplete. Enterprise surveys suggest that almost one-third of firms still consider labor regulations as a severe factor constraining their growth and, therefore, job creation. Further reforms to make contracting more flexible are needed. Moreover, compliance with labor laws is still problematic, which hinders both worker protection and the formalization of employment. Although more appropriate regulations should naturally lead to better self-enforcement, improving the enforcement capacity of the Labor Inspectorate will also be needed to reduce non-registration and other forms of non-compliance.

47. Reducing the labor tax wedge would encourage job creation. In fYR Macedonia, the labor tax wedge is around 40 percent with little variation by wage levels. The tax wedge has already been reduced slightly with recent changes in the income tax. The government is considering reducing payroll taxes further by switching to general budget financing of health expenditures. Cuts in social contributions need to be analyzed carefully to assess both the likely employment payoff as well as the fiscal implications for the social insurance funds. The administration of the collection should be addressed as well. The new system of collecting pension contributions has been implemented since January 2006 and allows better control of compliance, although –as for all social contributions– the enforcement system still needs to be strengthened. The important harmonization of contribution bases across the different systems is now underway. The basis for calculating contributions should be shifted from the current net-wage basis to a simpler gross-wage formula that is considered best practice, and has already been implemented elsewhere in the region. 48. Skills of the workforce need to be upgraded. In fYR Macedonia, about one-quarter of firms identify the skills of the workforce as a serious obstacle to growth, but in more dynamic sectors, skills appear to be a more serious problem. As the country further integrates into the European and global economies, it will need to seriously reform education at all levels to ensure that its workforce remains competitive. As these efforts are long term in nature, action needs to be taken now. Education and training have simply not kept up with the changing demands of the post-transition economy. At least 40 percent of today’s youth do not finish secondary school. International assessments of learning outcomes consistently show that young Macedonians have not achieved the skill levels of their counterparts in the EU and other OECD countries. The government has proposed making secondary education compulsory and this is an important step. But it needs to be accompanied by a significant shift in the type of curriculum and teaching offered to students; away from narrow vocationally-oriented courses towards stronger general education competencies plus encouraging creativity, team work, and problem-solving. There is also virtually no opportunity for the large number of dropouts to get back on track through second chance programs. In higher education, fYR Macedonia needs to press ahead with reforming the curriculum to make it more relevant to the labor market, to fulfill the requirements of integration into the European higher education area (the Bologna Process), and to restructure its research capacity.

49. Social protection programs can safeguard the income of workers from shocks to employment, and can help them reintegrate into the labor market. The task of cushioning


adjustment costs for workers is hampered by a relatively small but complicated and non-transparent social assistance system, with few incentives or support to reintegrate into the labor market. The government plans to revamp this system, including introducing conditional cash transfers for poor families with children to break the inter-generational poverty cycle. At the same time, the ongoing pension reform should eventually reduce the burden on the contribution rate while broadening and improving the support offered by the system.

50. The effectiveness of the other two key elements of social protection for workers – unemployment benefits and active labor market programs (ALMPs) – also needs to be significantly improved. Currently, unemployment insurance does not play its intended role of offering temporary support to active job seekers. Most of the current recipients are, in fact, long-term beneficiaries who are being given unemployment benefits as a transition to eventually receiving pensions. While addressing the problem of laid-off workers is complex, this solution eliminates any possibility for an actuarially balanced Unemployment Fund (UF) and for a truly effective unemployment benefit system. Active labor market programs have been used on a very limited scale until now. The government does intend to increase its investment in these programs with the assistance of the EU and others and, if implemented effectively and taking into account lessons learned from international experience, this could enhance employment.

B. Improving Governance in fYR Macedonia

51. As in countries throughout Central and Eastern Europe, by the late 1990s governance issues became seen as key constraints to progress in fYR Macedonia. As recently as 2005, most firms continued to rank corruption as an obstacle to the operation and growth of business.6 Addressing corruption concerns continues to be a high priority of Macedonian citizens (following unemployment and poverty).7 Other obstacles voiced by firms also point to weaknesses in the system of governance; firms complain about the functioning of the judiciary and, as a direct consequence, about contract violations by suppliers and customers. Dramatic improvements in the business environment for firms are required, both through better governance of the regulatory bodies that impinge upon business activity, and through more efficient and transparent provision of the public goods and services upon which Macedonians rely.

52. All governments since 1998 have won elections on strong anti-corruption platforms, and the 2006 elections raised the profile even further. The lists of legislation adopted and institutions established covering this area and the governance framework more broadly is extensive and mostly in line with good international experiences. In addition to passing an anticorruption strategy and action plan –common first steps in many countries– fYR Macedonia has followed up with the implementation of legislation guaranteeing free access to information, introduction of e-government procedures in some areas, establishment of a special commission to check asset disclosures of public official and investigate cases of corruption, and

6 EBRD-World Bank Business Environment and Enterprise Performance Survey 2005 (BEEPS)7 UNDP Early Warning Report Macedonia, December 2006. http://www.undp.org.mk; While only 3.9% of respondents said that reducing corruption should be the top priority of the government, some 42% said that corruption was one of the top three issues that worry them.

http://www.undp.org.mk/


has gradually been strengthening the capacity of key oversight institutions such as the State Audit Office.

53. The government has taken steps to repair the disconnect between the anti-corruption legal framework and enforcement actions. Charges have been brought against high-ranking current and former officials, judgments were issued in some long-lasting corruption cases, and other signs of serious intentions have begun to build credibility for the government anticorruption programs. However, these efforts need to be sustained in order to avoid suffering the same outcome as similar efforts in the past and in order to have an impact on the perceptions of corruption and trust in institutions.

54. The signing of the Stabilization and Association Agreement (SAA) with the EU has increased consensus among political parties on the need to sustain progress in improving governance. The experience of the EU’s newest members, Bulgaria and Romania, has made it clear that the European Commission places great importance on controlling corruption as a precondition for accession. The Macedonian authorities -both through statements and actions- have signaled that they intend to be proactive in addressing corruption. Although certain principles of good governance are universal -transparency, accountability, and voice for example- the binding constraints are not the same in all sectors. In some areas the institutions of transparency are strong, while the capacity for implementation is weak; in others major sector reorganizations may be required to reduce the incentives for corrupt behavior. This CPS calls for an expanded focus on the most critical governance weaknesses and the ways that the WBG can work with fYR Macedonia to address them. Some activities will be oriented directly toward improving cross-cutting institutions of governance, while others will address weaknesses in key sectors.

Recognizing progress in key sectors, and helping to achieve even more

55. Improving governance requires transparent, open and accountable public institutions, but also greater efficiency in the public sector. FYR Macedonia’s efforts to improve transparency in customs and to build accountability through monitoring provide real evidence of how reforms can benefit the business community and reduce corruption at the same time. Through the TTFSE project, border crossing times were closely monitored in four pilot border and inland facilities. The clearance times were steadily reduced through the life of the project (Figure 3), and this also coincided with a dramatic reduction in the prevalence of bribery at customs as measured by two independent surveys of firms (Figure 4). At the same time, the levels of corruption reported by firms remain worse than the average for 10 new members of the EU, and worse yet compared to the average of the original four EU Cohesion countries. FYR Macedonia’s poor ranking in the Doing Business indicators for Trading Across Borders also highlights the need to continue to make administrative procedures for trade more friendly for business. Nevertheless, the progress to date in reducing the barriers to trade has been particularly important for business development in a small country such as fYR Macedonia, and the present CPS aims to build on these successes.


Figure 3: Customs Clearance Times Have Fallen in Kumanovo

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56. Other reforms have similarly led to improvements in the manner in which government bodies interact with the business community. Recent reforms such as the introduction of the “one-stop shop” for business registration have considerably improved the process, reducing the time to register a business8 from 48 to 18 days, and should bolster gains that had already been achieved in reducing the frequency of bribes for business licensing (Figure 5). The ongoing regulatory reform effort is also expected to reduce opportunities for corruption.

8 Doing Business 2007


Figure 5: Bribes for Business Licensing Have Fallen Dramatically and Procedures Have Also Been Streamlined

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57. Progress in improving business entry is beginning to be matched in imposing discipline on firms through business exit and payment discipline. The myriad of governance issues that gave selective benefits to well-connected firms through soft-budgets, under-priced utilities prices, and an ineffective bankruptcy procedure have begun to receive more prominent attention by the Macedonian authorities. A new Bankruptcy Law is expected to expedite bankruptcy proceedings and, more importantly, to help deal with conflicts of interest among bankruptcy trustees. Similarly, fYR Macedonia’s nascent regulatory institutions have begun to exercise their authority in controlling the practice of giving subsidized energy prices for large energy consumers and the excessive tolerance of arrears. These lingering practices leave unsubsidized firms at a clear disadvantage.

58. The dual challenge of building a well-governed state regulatory system for utilities, while also ensuring that the (monopolistic) providers achieve cost recovery, is aptly illustrated by the energy sector. In addition to the impact that soft budget constraints have on competition, there is a very direct impact on this sector. Poor payment discipline for electricity bills by state owned organizations and large consumers is a key factor contributing to the financial deterioration of the energy sector in fYR Macedonia. While the government fully recognized this problem, and provided additional budget allocations for state organizations to meet their obligations in its supplementary 2006 budget, actual payment discipline by budgetary institutions has yet to be improved and requires constant monitoring by the government. Combined with weaknesses in the regulation of the energy sector –electricity tariff filings lag significant increases in the price of electricity imports and are insufficient to cope with the maintenance and investment needs of the electricity sector– the utilities have difficulty maintaining cost recovery.

59. Improving financial markets and facilitating access to credit remain critical to support business entry and growth and, ultimately, job creation. While the legal and supervisory framework for banking is increasingly in line with international standards and EU requirements, continued efforts to strengthen banking supervision are needed to further promote market discipline and efficiency, and enforce strong bank governance. The government is also committed to address weaknesses in the insurance sector, where ineffective supervision together


with poor governance arrangements have impeded the sound development of the sector –one of the smallest in the region– and provide inadequate protection to policy holders.

Figure 6: Bribes Related to Courts Have Fallen, Process of Enforcing Contracts Has Improved . BEEPS 2002-2005 (high numbers are worse)

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Rank for “Enforcing Contracts” 2005 and 2006 (lower numbers are better)

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Notes: Bribes Related to the Courts has Fallen Slightly; According to Firms, the Process of Enforcing Contracts has also Improved Somewhat

60. Judicial corruption in fYR Macedonia has largely been tied to the politicization of the selection and disciplining of judges, as well as opaque court proceedings and lack of enforcement. Significant steps were taken in 2005 and 2006 to address this situation with the adoption of constitutional amendments and fundamental legislation. However, implementation of this legal framework will require time, resources and commitment from the government and the judiciary. The adoption of new Laws on Civil Procedure, Enforcement, Administrative Disputes and Misdemeanors are designed to reduce the backlog in the courts and speed the judicial resolution of disputes. While new private enforcement agents have begun to operate, implementation of the other laws remains a challenge. The revision of sector laws, continued training and supervision of private enforcement agents and the creation of an Administrative Court all must take place for the legislative changes to have an impact in improving judicial efficiency and effectiveness. These reforms are closely linked to efforts to control administrative corruption and ineffective service delivery in other sectors, both of which continue to be


challenges for fYR Macedonia. A recent report from the Administrative Inspectorate made clear that agencies such as the denationalization commissions are neither operating effectively nor quickly enough to satisfy the needs of the citizens. Improved monitoring and reporting by the Inspectorate and more efficient resolution of citizen complaints against administrative actions will require additional capacity building and resources.

61. Governance problems need to be addressed in many state agencies and in remaining public enterprises. For example, unofficial payments for official land or real estate registrations or even to receive information are not unusual, creating a key constraint over real property rights. Another example relates to the maintenance in fYR Macedonia’s road system, which has been hindered by both lack of transparency in oversight authority and by substantial leakages in the collection of tolls. It is not difficult to find similar examples in other public enterprises and agencies. The government is working on plans to deal with this, either by privatizing, for example, the public enterprise for housing, or by adopting a comprehensive strategy for sector reform, for example, in forestry. However, without broad reform of the process of selection and accountability of public sector managers, these are not likely to give lasting results.

62. Moreover, local public enterprises still remain largely unaccountable, with little commercial orientation. Most public utilities operate on the local level9 –specifically, the communal services enterprises and utilities providing water and sanitation, solid waste management, and urban transport. The institutional and legal framework for these enterprises provides insufficient incentives for operational or financial efficiency, and incentives to select managers based on qualification is often absent. With the government intent on pursuing large investment projects (most notably in energy and infrastructure) over the next few years, the legal framework on use of concessions, unsolicited bids and private-public partnerships needs to be carefully reviewed to ensure that these are made in a transparent, competitive, and cost-effective manner.

63. In education and health there have been steps to improve accountability. While corruption remains a problem in education,10 in order to improve transparency, fYR Macedonia is now developing a high quality and comprehensive student assessment and testing system. The full-scale introduction of a national examination at the end of secondary education (Matura) in 2008 will improve the objectivity of access to tertiary education, and a series of national assessments will measure system performance. In addition, capacity and accountability have improved at the school level, because all schools now have School Boards with representation from parents, that are required to prepare a school development plan, and will undergo a period evaluation (including both external and internal processes). Ensuring these systems work effectively is essential and the priority for the next period. FYR Macedonia also has yet to make good use of the emerging data on performance. In health, notorious for its governance issues, many steps are taken as well, as described in Box 1.

9 Exception include the railways, the airport, road maintenance, forestry, public housing.10 For example, almost one-third of participants in the higher education report to have been asked for a bribe at some point during the last five years.


Box 1: Improving Governance in the Health Sector in fYRMacedonia

Various studies conducted in fYR Macedonia highlight severe governance failures in the health sector. Despite high public spending on the sector (5-6 percent of GDP), citizens make substantial out-of-pocket payments, mostly on an informal basis. The public generally views the health sector as corrupt and providing poor services. Addressing governance in the health sector has been a key emphasis of World Bank lending and non-lending services during the 2003-2006 CAS period.

Until a few years ago, the Health Insurance Fund (HIF) was paying 30 percent higher prices for drugs than neighboring countries. Encouraged by the Bank’s dialogue, and as part of the PSMAL2, the HIF initiated competitive procedures for purchasing generic drugs in 2005. HIF was able to save approximately Euro 10 million on its annual supplies of drugs.

A key focus of the World Bank Health Sector Management project as well as the PDPL-program is to improve transparency and accountability of the HIF and health care institutions (HCIs). The HIF Board, an important mechanism for improving governance of the HIF, has undergone major reforms. The number of board members has been reduced, the selection of Board members by the Parliament was stopped, Board members are now required to sign conflict of interest clauses and the number of doctors on the HIF Board was balanced in comparison to members of other groups. The minutes of Board meetings are published on the HIF website, increasing transparency and accountability to the public. Formal training of Board members is also being supported through the Bank-financed project. The HIF now requires HCIs to regularly produce monthly financial reports, which are also posted on the HIF website, and HCI managers have also been trained in budget and general management. The plans are now for HIF to monitor key performance indicators (e.g. admission rate, referral rate, patient satisfaction) among HCIs and also report these on the HIF and MOH website.

The current government is committed to addressing poor governance in the health sector. Further changes aimed at improving the governance in the sector have been endorsed, including the “four-eyes” principle by introducing two directors for HCIs, with a view to ensure improved control and accountability of the HCIs management structures. Provisions prohibiting conflicts of interest have been systematically implemented as well. Under the upcoming CPS period, there are plans to continue to strengthen governance in the health sector by aggressively addressing the problem of informal payments, changing the legal framework for health care institutions to become more accountable to MOH, HIF and the public for results, as well as continue to build the capacity of HIF as a transparent purchaser of health services. The capacity of the Ministry of Health and other institutions (e.g. Drug Bureau) for regulation and system oversight will also be strengthened.

Strengthening the institutions of oversight

64. The demand side for good governance remains weakly developed, although this is gradually improving. Civil society has yet to meet its potential as a control mechanism over the government, though some of the country’s NGOs are characterized by political influence and conflict of interests themselves. FYR Macedonia’s new Free Access to Information Law, a model law in many ways, shows great potential for strengthening the supply of information for citizens, the media, and NGOs, although implementation has been uneven and it will take time for the value of such a law to be fully utilized by civil society. A new Law on Conflict of Interest is currently under discussion by the Parliament.

65. The institutions of financial oversight have gradually been strengthened. An independent State Audit Office (SAO) was established and staffing has grown consistently to the point where the SAO routinely produces audit reports valuable for identifying corruption.11

11 The largest corruption case currently being prosecuted came to light when the Commission for the Prevention of Corruption (CPC) noted a single sentence in an SAO report to the effect that the SAO could not uncover why the


Internal audit has also been strengthened and capacity is expanding. Strong support for the further development of both the internal and external audit functions is now being provided by the EC as an integral component of conformance with Chapter 32 of the acquis. All government transactions are executed through the Single Treasury Account providing sound controls over collection and spending. The transparency of government spending has improved as well– monthly Budget execution reports are posted on Ministry of Finance web-site, as are all SAO reports. While these measures have increased the visibility of corrupt practices and reduced public tolerance, bribery to receive government contracts is reported to remain a considerably bigger problem for doing business than in other ECA countries (Figure 7) The violations uncovered by SAO auditors almost invariably involve procurement violations, and with few exceptions, follow-up on the findings remains weak.

Figure 7. Bribes Related to Procurement Have Not FallenBEEPS 2002-2005 (high numbers are worse)

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66. Establishing a meritocratic and professional public administration has not yet been achieved, despite it being a priority of successive governments. The Law on Civil Servants, setting-up employment, pay and career rules, covers only 13 percent of the public administration, though there is evidence that even this law is not fully implemented. Administration issues in other parts of the public administration remain non-transparent. As a result, changes and replacements are frequent (especially after political changes) resulting into a politicized public service, which was one of the main concerns of the latest EC Progress Report. Furthermore, efforts to contain the wage-bill without a corresponding reduction in public employment levels translated into a low-paid unattractive public service highly vulnerable to corrupt practices. The decompression of civil service salaries, completed in 2006, has set a good example, but more is needed to address similar issues in the public administration at large.

67. The need to closely monitor implementation of governance-oriented laws is acute. The conclusions of the 2006 Conference on the Implementation of the State Program for Prevention and Repression of Corruption called for establishment of monitoring indicators that would enable careful tracking of the implementation of the Program.12 A broad effort was

Ministry of Defense paid a large sum in damages from a court case without first appealing the verdict. After investigation, the CPC determined that the court case was an elaborate method of defrauding the state of some 700,000 Euros.12 “Conference on assessment of the implementation of the State Programme for Prevention and Repression of Corruption”, Conference materials – November, 2006.


launched over the last year, resulting in sets of baseline indicators on the implementation of the Program and also providing valuable information on the state of the governance framework in the country. The results of this activity have not been encouraging, as progress in some sectors and areas has not been met in others. Helping the government improve performance in strengthening governance is a key goal of this CPS.

C. Improving Public Service Delivery

68. Decentralization is progressing, but challenges remain. Urban areas in fYR Macedonia may eventually become centers of economic growth, private investment and job creation. Their efficient functioning is therefore critical to the agenda of generating employment, and managing the city economy essentially involves ensuring responsive local government and effective service delivery. Urban management is a particular concern in fYR Macedonia because of the uncharacteristically high rates of urban unemployment and urban poverty, implying missed opportunities.

69. The government has made substantial progress in enacting the legislative framework for decentralization, as specified in the Ohrid agreement. New laws on Local Self-government, on Local Government Finance and on Territorial Reorganization were approved over the last years. Nevertheless, much remains to be done in terms of implementation. Eventually, municipalities will not only be responsible for communal services and public transport, urban planning and its implementation (including construction, permits and inspection), construction and maintenance of local roads, parks and sports facilities, but also for child and elderly care, and, most notably, for establishing, financing, and administering all primary and secondary schools. Recently-enacted laws on communal services confirm the municipalities’ responsibilities as owners of these local public enterprises and give the municipal governments wide-ranging rights in tariff-setting, investment decisions, and personnel matters. The regulations are unclear, do not encourage commercialized management, and improved efficiency in service delivery is necessary.

70. More effective urban and municipal management is needed. Municipalities are increasingly at the front-line of confronting fYR Macedonia’s social and economic challenges. Progress in the urban and municipal agenda will therefore be crucial to the country’s success in sustaining economic growth and job creation, improving welfare for all citizens, and furthering integration into the European Union. Municipalities cannot succeed, however, without strong support from the central government, which sets the regulatory and legal conditions, helps ensure that the municipalities acquire and retain a secure financial status, and create an incentive structure for sound investment planning, essential to access future EU structural funds. Municipal financial management, including improving revenue mobilization, investment selection, allocation of fiscal transfers, the need for wider public participation, and mechanisms for inter-municipal collaboration need to be addressed. The provision of communal services requires significant reform to ensure financial sustainability and quality of services over the medium term. Renewed attention is also needed to the planning and management of urban land use, which is central to the efficiency and environmental quality of urban areas, and to the affordability of housing for the population and of real estate for businesses. Coordination among


the municipalities is needed so that they can make the best use of scarce human and other resources, and achieve economies of scale in their administrative functions and services.

71. More effective, accountable and fiscally sustainable health services are needed. Improving the governance, transparency and management of the health sector is critical for improving “value for money” and strengthening quality and efficiency in the delivery of health services. FYR Macedonia spends about 9 percent of GDP on health, which is higher than the average for EU10 countries and at the same level as OECD countries. Three percent of GDP consists of private payments, most of which occur on an informal basis. Health arrears threaten the fiscal sustainability of the sector. In addition to the fiscal and corruption risks posed by poor financial management within HIF, there are also concerns with the quality and accessibility of health services. Public opinion polls have consistently rated health services as “poor” or “very poor”, including a recent survey where over 58 percent of respondents chose one of those two ratings. Although health outcomes have improved –and are better than in countries with similar GDP per capita– substantial gaps still exist when fYR Macedonia is compared to EU countries.

72. In education services, eventually to be delivered in a decentralized setting, major upgrading is required. FYR Macedonia uses its physical and human resources in primary and secondary education intensively. Schools are large on average, there is widespread use of two shifts, and pupil-teacher ratios at both primary and secondary levels are higher than elsewhere in Europe on average and are comparable at the tertiary level.

73. Municipalities are already responsible for funding non-teacher recurrent costs of primary and secondary schools; and there are plans to decentralize teacher salaries sometime after July 2007. While this might make sense in the longer run, this represents a major risk to an education system where capacity is still underdeveloped at the municipal level and where education spending is already significantly inequitably distributed despite the fact that most funding comes from the central government.13 An effective equalization mechanism is needed. In addition, ways will need to be found to reverse a recent trend whereby the number of primary school pupils is falling but the number of teachers is increasing. The fiscal and physical implications of the introduction of mandatory secondary education must be properly planned as well. Moving ahead with decentralization, therefore, will require careful attention to all of these aspects, as well as careful analysis of various policy options.

74. The Bologna agenda will have a major impact on fYR Macedonia’s tertiary education. In tertiary education, there remain significant challenges in the organization and governance of the system. Universities remain a loose confederation of faculties (a practice common across the former Yugoslav countries) resulting in significant inefficiencies and lack of cross-disciplinary work which is the norm in European countries. While fYR Macedonia has a significant number of students in private tertiary institutions, the regulatory framework for both public and private institutions is inadequate. Good evidence on the quality and practices of different institutions is not available and fYR Macedonia needs to catch up with regional neighbors on the development of standards in secondary and tertiary education, including a national qualifications framework.

13 For example, for primary education the highest cost municipality spends 4.3 times per student what is spent in the lowest cost municipality.


75. A new pension system has been introduced but the agenda is not complete. The new multi-pillar old age pension system creates a pension system that is relatively well adjusted to the demographic ageing and structural change (projected pension expenditures are expected to decline and future fiscal pressures will be lower), though some areas of the system still need to be addressed, such as level of fees, pension fund participation, strengthening of administrative and supervisory processes. In addition, it is necessary to complete the legislation with the framework for benefit payments. Disability, survivor and privileged pension systems are still based on rather lax criteria that allow misuse. On the administrative side, some improvements have been made in the Pension and Disability Insurance Fund (PDF) business processes and procedures and the establishment of the Pension Supervisory Agency (MAPAS). Work remains, however, on further improvements in administrative, regulatory and supervisory capacities of the pension institutions, as well as on the development of the policy-making and monitoring capacities in the Ministry of Labor.

76. Social protection programs need further rationalization. FYR Macedonia’s small social assistance system includes a myriad of cash benefits and social services, and is burdened with legislative constraints and vacuums, a mismatch between legislation and implementation capacity, inadequate management procedures and practices and weak communication and network systems between the implementing institutions. To ensure successful decentralization of social services, management and governance in the Centers for Social Work (CSWs) need significant reform as well. To address these problems effectively, the government needs to put in place a clear outcome-based strategy for social protection. This would allow better technical quality of policy formulation, with proper attention for available policy options, human and financial costs implications, and a proper process of internal and external consultation.

77. Social assistance programs can also be used to address inter-generation poverty cycles and inequalities. The latest Poverty Assessment (FY06) indicates that fYR Macedonia has not achieved sufficient progress on equality in schools due to low completion rates from minorities such as Albanians, Turks and Roma (especially girls). Participation in pre-primary education varies greatly by ethnic group, by region, by urban versus rural area, by income level, and especially by gender. Overall gross secondary school enrollment rates (around 65 percent) in fYR Macedonia are low by both regional and international standards. Other forms of deprivation in educational achievement exist in the form of sporadic school attendance, highly unequal quality of education or financial barriers to secondary (and tertiary) education. Although some key MDG-related indicators for health show achievements given the level of income (i.e. child mortality, maternal mortality and tuberculosis control), one of the key issues in the health sector in fYR Macedonia is severe under use of basic/primary health care services, especially among rural populations and vulnerable groups (such as the Roma). Taken together, these issues create an important outstanding agenda for ensuring full social inclusion, and the government intends to use incentives under cash benefits program more effectively to address these inequalities.

78. FYR Macedonia has made significant progress in restructuring and liberalization of the energy sector. As a member of the Energy Community of South East Europe (ECSEE) Treaty, fYR Macedonia is supporting the full integration of the energy markets in the regional


power market. The formally vertically integrated state owned monopoly –Electric Power Company of Macedonia (ESM)– had been unbundled in 2006 into separate generation (ELEM), transmission (MEPSO) and distribution (ESM) companies. The distribution company was privatized and a tender for the sale of Negotino thermal power plant is underway. Despite this progress, much remains to be done to improve sector efficiency and financial performance. Current electricity tariffs are still below full cost recovery and commercial losses in the power networks as well as poor payment discipline especially by large consumers and budgetary organizations remain a problem. Therefore, urgent attention by the government is needed to address the sector performance issues in order to sustain an affordable and efficient electricity supply necessary for economic growth. In this context, proper social protection mechanisms to provide affordable electricity supply to poor households are needed to mitigate increases in electricity prices that may be necessary for these prices to fully recover the cost of supply.

79. Further reforms in road, rail, and aviation sectors are needed to enhance institutional accountability and allow liberalization of transport services. In the road sector, regulatory and institutional weaknesses and non-transparent priority programming result in increasing maintenance backlogs. In railways, transparent performance accountability of various services (passenger, freight, and infrastructure) will enhance financial viability, productivity, and effectiveness of operations and pave the way for a multiple operator market. The aviation sector requires further regulatory and institutional reforms to enhance efficiency of operations, routes, and airports.

V. WORLD BANK GROUP’S CURRENT PORTFOLIO

A. Past Bank Assistance and Quality and Management of the Existing Portfolio

80. Since 1994, the Bank has actively supported the fYR Macedonia’s transition. Bank assistance was initially focused on ensuring a stable macroeconomic framework and building the foundations of a market economy, with a particular focus on reform of the financial and enterprise sector, agriculture, human development and infrastructure and energy. This assistance was delivered through a series of sector adjustment loans accompanied by investment lending. Since fYR Macedonia joined the World Bank in 1993, IDA and IBRD commitments to the country through 38 operations total approximately US$ 780 million. The Bank and the IMF have been instrumental in assisting the government in establishing the foundations for its public financial management (PFM) system. The recent acceptance of fYR Macedonia as an EU candidate country has meant a significant EC involvement in harmonization assistance for the Macedonian financial management and procurement laws, systems and processes with the requirements of the acquis. Since fYR Macedonia became a member of IFC in 1993, the country has received commitments of over $93 million in IFC funds and more than $25 million in syndications. Since fYR Macedonia became a member of MIGA, the Agency has issued over US$19 million in guarantee coverage. WBG assistance to the country during FY04-FY06 has been evaluated as satisfactory (see the CAS Completion Report, Annex 2). The proposed strategy both builds on the lessons of the previous CAS and relies on the existing portfolio of eight projects to achieve the expected outcomes and results in the next four years.


81. Performance of the investment lending portfolio picked up following concerted efforts to address key issues and accelerate implementation. During the FY04-06 CAS period, the Bank worked with the government to deliver a high case program of $166 million, including $60 million for adjustment. The Bank also delivered a program of Economic and Sector Work (ESW) that contributed to policy dialogue during the CAS period. The 2003 Country Portfolio Performance Review (CPPR) identified almost half of the operations as being at risk in achieving their development objectives or being slow on implementation progress. By undertaking a strategic and decentralized management of the portfolio, the situation has greatly improved. Table 2 presents key portfolio indicators.

Table 2: Indicators of World Bank Lending Portfolio (FY03 - FY06)FY03 FY04 FY05 FY06

Number of projects 8 11 10 10Average age of projects (years) 3 3 3 2Net Commitment Amount (US$) 151.3 155.8 84.4 121.9Disbursement Ratio (%) 30.5 35 35 24Disbursements in FY (US$) 16.7 19.4 10.7 7.0Projects at Risk 2 0 0 0Commitment at Risk (%) 29.4 0 0 0Realism Index 50 N/R N/R N/RProactivity Index 100 100 N/R N/R

82. For projects closed between FY97 and FY06, IEG rated 85 percent of the project outcomes (by value) as satisfactory; 90 percent had substantial institutional development impact and 80 percent were considered to have likely sustainability.

83. The 2005 Joint Portfolio Performance Review (JPPR) showed that the Bank’s lending program and analytic work were well aligned with key CAS objectives. This has produced significant benefits, including support for major reforms and institutional development programs in a number of high priority sectors. Several factors were identified as contributing to the success of the portfolio, including the close linkages between policy and investment operations, and between high quality analytic work and key policy reforms.

84. Effective donor coordination on key reform issues has greatly contributed to helping to “soften” our IBRD loan terms, especially appreciated by the government to help finance technical assistance. Strengthened coordination with bilateral donors (especially the Dutch Government) has contributed to their involvement in co-financing projects in the education, irrigation, public finance, cadastre, community development and other sectors, sometimes bringing contributions larger than the loan amount (such as the education modernization project). Also Trust Funds to help financing technical assistance to implement key reforms included in our policy loans have been successful.

85. Since FY05, all new projects are being implemented through existing government structures. The JPPR concluded that the implementation of projects through Project Implementation Units (PIUs) had reduced the potential impact of projects on institutional development and sustainability. As a result, the JPPR recommended that to the maximum extent


possible, all new projects be implemented within existing government structures. When necessary skills (e.g., financial management, procurement, etc.) are lacking in the public administration, they will be externally contracted to assist in the project implementation. Such external consultants, however, will report in all cases to Project Directors or coordinators that are regular staff of concerned government agency or ministry. This implementation policy will continue for all new projects proposed under the CPS. It may take longer to build the implementation capacity, but the result is much more sustainable.

B. Lessons Learned from the CAS Completion Report (CASCR)

86. The CASCR (Annex 2), endorsed conclusions of the JPPR and identified a number of lessons that formed the basis of this CPS. Some of those lessons include:

The shift in focus in the Bank’ program over the 2003-2006 CAS period from public sector reform to private sector development issues was timely and appropriate, and should continue. Between 2002 and 2006, fYR Macedonia regained strong macro discipline and transformed from a post-conflict country to an EU candidate. In response, the Bank shifted its program appropriately to deal more directly with economic growth constraints. This should continue in the next CPS.

The Bank needs to increase its focus on fYR Macedonia’s integration with the EU. EU accession is a top priority for fYR Macedonia, and the Bank needs to assist the country in meeting the accession criteria and the EU acquis, including on building the institutional capacity to effectively implement EU regulations.

The EU accession process has major implications on budget allocation and priorities. The Bank’s funding could serve as critical bridge financing to enable fYR Macedonia to access EU pre-accession funds. The new Public Expenditure Review slated for delivery in FY07 should analyze and provide recommendations to the Macedonian Government on the fiscal policy challenges the country faces in the run-up to EU accession.

Stronger economic growth and job creation must be achieved. In order to maintain popular support for the reform agenda, there is a need for fYR Macedonia to show that its successful macro economic discipline and structural reform initiatives do translate into stronger growth, job creation and improvement of living standards for all.

FYR Macedonia’s competitiveness needs attention and role of education reform needs to increase. If Macedonian companies are to compete in the regional and international markets, their competitiveness needs to improve. Such a stronger competitive edge also requires a better match between the quality of education in fYR Macedonia with the needs of the 21st century and the knowledge economy.

The multi year Policy Development Program has served the Bank’s program well. The ongoing three-year PDPL program helped in the shift of policy priorities, has been well connected to a number of investment projects, and helped secure continuity and predictability in the reform program. It even helped in the transition period following the recent governments change, as the already agreed upon PDPL policy framework and related conditionality played an instrumental role in the continuation of specific reform efforts.

Decentralization is critical to ensuring the peace and reforms. Decentralization is a key part of the implementation of the Ohrid Peace Agreement. Key for its success will be


that local communities are able to fully take part in the country’s development. The challenge for the CPS07 is to calibrate the Bank’s interventions carefully, through sector work and lending, to assist in urban development, including in the provision of public services at the municipal level. This will require close cooperation with many other donors already active at the local level, often better placed to finance and implement resource intensive community-based activities.

C. FYR Macedonia’s Country Financing Parameters (CFPs)

87. Country Financing Parameters (CFPs) for fYR Macedonia were established in April 2005 after consultation with the government (see Annex 7). The CFPs for fYR Macedonia provide for added flexibility in allowing Bank financing of up to 100 percent of project costs, although the Bank will still encourage cost sharing as a demonstration of ownership. The actual cost sharing percentage would be determined during project preparation on a case-by-case basis. The CFPs also allow recurrent cost financing on a selective basis, and Bank financing of local and foreign costs in any proportion. The CFP will greatly facilitate Bank operations in fYR Macedonia and reduce the transaction costs of implementing Bank-financed projects. The additional flexibility will support project implementation and is fully consistent with the approach of the CPS in emphasizing government ownership of the underlying project objectives. The maximum flexibility allowed by the CFPs will nonetheless be applied selectively, in reflection of the different levels of mutual agreement on sector reforms and approaches across different areas, and with due regard to sustainability and fiduciary oversight. Since the establishment of CFPs, two projects have adhered to changes instigated by it and have utilized the flexibility and benefits. There is a strong preference, both on the government and on the Bank side, to continue designing the future projects along the same path.

VI. THE WORLD BANK GROUP PARTNERSHIP STRATEGY

A. Key Features and Pillars of the Results Based Partnership Strategy

88. The WBG will support fYR Macedonia in its efforts to join the European Union. The proposed program is well grounded in the policy priorities of the government and takes full account of the priorities as defined in the Stabilization and Association Agreement (SAA), and results from consultations with the government and other stakeholders. The road to Europe will not only require the country to design and adopt EU-compatible standards and regulations, it also requires building the capacity to implement them. The WBG program over the next four years expects to play an important role in this process, including by providing “bridge” financing to allow fYR Macedonia to benefit faster from EU pre-accession funds.

89. The CPS aims to support the government’s program around two core pillars: i) fostering economic growth, job creation, and increasing the living standards of all; and (ii) improving the governance and transparency of public service delivery to support the market economy.


90. The program intends to support the government’s wide ranging reform effort by combining the implementation of the ongoing lending program with a proposed new lending program for the next four years, comprising of a maximum of 10 new investment projects, as well as the completion of the ongoing three-year DPL program and the start of a new series of DPLs towards the end of the CPS period. A full program of analytical support and technical assistance will help inform the government on future policy decisions in key economic and sectoral areas.

Pillar 1: Foster Growth and Job Creation, Increase Living Standards for All

91. The WBG will support the governments’ ambitious goals on accelerated growth and job creation through an integrated and multi faceted program. This will encompass both the demand for and the supply of labor in fYR Macedonia. Under this pillar, the WBG will aim to support government efforts to: (i) maintain macro economic stability, while ensuring proper integration of EU priorities into the budget; (ii) improve business environment, including regulatory reform and proper enforcement of contract and creditor rights; (iii) reduce the costs of capital; (iv) improve enterprise sector’s competitiveness, (v) improve agricultural competitiveness; (vi) establish a functioning land market and institutions; (vii) improve infrastructure for growth by strengthening the framework for public-private partnerships and invest selectively in energy and transport; (viii) remove rigidities in labor market regulations and reduce the labor tax wedge; (ix) develop a productive and appropriately skilled labor force; and (x) use cash transfer systems to encourage school enrollment and preventive health.

92. Maintain macroeconomic stability and reduce government expenditures. Macroeconomic stability will remain critically dependent on pursuing reforms with particular emphasis on fiscal and external sustainability. The Bank will support measures to ensure this stability through continuation of the current DPL program and the design of a new series over the CPS period. A Public Expenditure Review assessing the fiscal impact of EU accession will help prioritize expenditures and rebalance current and capital expenditures. A Country Financial Assessment, currently underway, has identified a number of systemic problems in the public procurement system that will require concerted attention. Recommendations will focus on: (i) improvements to laws and sub-legislative instruments; (ii) practices and processes for tender preparation, bid evaluation, and contract supervision; (iii) complaints processing; and (iv) the composition and training of procurement officials within the ministries.

93. Improve the business environment, including regulatory reform and proper enforcement of contract and creditor rights. During the entire CPS period, support to improving the business environment will continue through the ongoing Business Environment Reform and Institutional Strengthening (BERIS) project approved in FY05. The project supports the government’s efforts to stimulate economic growth based on increased domestic and foreign investment by strengthening public sector capacity to increase competitiveness of the business sector in an EU-oriented context. Regulatory reform is also an important part of the policy program supported by the ongoing three-year PDPL program, and the BERIS project provides resources to fund advisory services in this area.


94. The Legal and Judicial Institution and Implementation Support project (LJIIS, FY06, which is described more fully under pillar II) will support efforts to better protect contract, creditor and property rights, crucial to enhance the environment for private sector investment in fYR Macedonia. By supporting activities aimed at improving efficiency and effectiveness of the judiciary in resolving (commercial) disputes and streamlining administration in some key commercial areas –bankruptcy and administrative disputes– the assistance should contribute to reducing the cost of doing business and facilitating the reallocation of resources to job-creating activities. To ease the burden on the courts, IFC Advisory Services (IFC AS) through its PEP SE facility has been working to support legislation reform through the ADR Mediation Program since 2004. Besides the changes in the legislation and training for the mediators, the IFC will establish a Pilot Mediation Center in cooperation with Skopje Primary courts.

95. IFC AS will continue to work on the development of the recycling industry, focusing on financial, training and market needs of the companies, the improvement of corporate governance practices through their work with student population and helping Macedonian companies to meet international and EU technical requirements for export. Also, IFC AS is expected to include: (i) technical assistance on the “guillotine” review of the stock of business licensing and inspections regulations; and (ii) a regional project for value chain analyses for the agri-business, general manufacturing and services sectors starting with the agri-business.

96. In addition, IFC will provide assistance on cleaning up the stock of licensing, inspections, and permit regulations as well as streamlining administrative procedures affecting businesses on the municipal level, including delivery of services through municipal one-stop shops. There will be direct links with MIGA’s investment outreach and investment promotion capacity building activities.

97. Lowering the cost of capital and improving access to capital. On the policy side, the Bank will assist the government in the completion of the financial sector reform agenda, critical for the dynamic growth of the enterprise sector. In FY08, an update of the 2003 Financial Sector Assessment Program (FSAP) will assess progress made towards the completion of the financial sector reform agenda and inform the design of the new series of PDPLs to address remaining constraints to financial sector development. These policy loans are expected to continue to support policy measures associated with financial sector development, and strengthen the governance of financial institutions, including the insurance sector. To further improve access to capital, through the REPARIS program and a TF funded by the Dutch and Austrian governments, the Bank will continue to support the implementation of the country action plan on corporate financial reporting that will align fYR Macedonia’s regulatory with international standards and the relevant portions of the EU acquis communautaire. IFC will support the development of new products in the financial sector such as energy efficiency and support the development of housing, factoring and leasing. IFC will continue to support commercial banks and micro-lending institutions and look for opportunities to facilitate banking sector consolidation through supporting mergers and acquisitions. MIGA will also support projects in the financial sector which are expected to result in improved access to finance.

98. Improve enterprise sector’s competitiveness, encourage technological change and further promote a level playing field for investment. The Bank will enhance support –through


its DPLs– to policies and measures for eliminating barriers to entry, operations and exit that limit growth opportunity of the business sector, and will also support the elimination of soft budget constraints as well as other measures to strengthen governance of public institutions. On the investment side, a new Competitiveness/Technological Change/Higher Education project (FY08) will further contribute to sustainable economic growth and job creation by fostering the adoption of new technology for production of higher quality goods, especially for the export market, improve the link between research and development and the private sector, encourage improvement of managerial skills in the private sector and develop skills able to match the business sector’s emerging needs (see also below under labor market). Competitiveness on sub-national level is part of IFC AS program, focused on better business regulation, simplification of administrative procedures, better service delivery, developing a system of rating the competitiveness of localities and private investment and value addition to firms.

99. Improve competitiveness in agriculture. The EU accession agenda has magnified the importance of agriculture in fYR Macedonia’s overall policy agenda, since agriculture constitutes a significant part of the EU pre-accession requirements. The proposed operation will help create the infrastructure to use EU assistance to improve competitiveness through on-farm investments, and redirect government assistance toward investment rather than subsidies, in a manner consistent with the EU’s pre-accession requirements. The operation will strengthen the capacity of MAFWE to support the sector, building the institutions necessary to access and absorb pre-accession assistance, helping producers and agro-processors meet EU veterinary and phytosanitary standards, and improving access to irrigation. The operation will incorporate lessons learned from earlier Bank interventions in the agriculture and rural sector, especially from the Private Farmer project closed in 2003 and the Irrigation Rehabilitation and Restructuring Project (IRRP) closed in November 2006.

100. The proposed operation benefits from the ongoing Real Estate Cadastre and Registration Project, which indirectly helps develop rural real estate markets by improving access to information and reducing transaction times. It will also benefit from the ongoing BERIS project which strengthens the capacity of the government to improve selected areas of the business environment in an EU-oriented context. Finally, the proposed operation will benefit from the proposed FY09 Feeder Roads project, as this will result in key public infrastructure investments that reduce transportation costs and thus improve the supply chain and farmer and processor competitiveness. On its part, IFC AS may work on value chain analyses for the agri-business, general manufacturing and services sectors. This program is part of regional value chain program, aiming to assess the competitiveness of BiH, fYR Macedonia, and Serbia in the context of CEFTA and the EU. 101. Establish a functioning land market and institutions. The current Real Estate Cadastre and Registration Project (RECRP, begun in 2005) seeks to build an efficient and effective real estate cadastre and registration system, contributing to the development of efficient land and real estate markets. The project provides support to complete the systematic first registration (the real estate cadastre), improves overall transparency and accountability of the land administration system and helps to improve on-going registration services, reducing the time to register for sales transactions to one day by project completion. The project also assists in the development of government’s capacity to address the land policy issues necessary to


achieve the broader project goals of improving tenure security and promoting the development of efficient land and property markets. The project will work together with the ongoing Legal and Judicial Implementation and Institutional Support Project (LJIIS, FY06) to provide joint training on property rights protection and the operation of the cadastre.

102. The CPS could build on the RECRP –as well as on the Urban Development Project planned for FY09– by a Land Administration II Project, considered for FY10, which could focus on improving land use management for both urban and agricultural land, formalization of illegal construction, improved property valuation for market information and taxation purposes, and continuing improvements to service delivery. For proper enforcement it will also be crucial to ensure proper understanding for judges and court staff and improved cadastre relations with the judicial system. Should the project be confirmed in the CPRPR (FY09), it will be informed by the lessons learned during the RECRP, as well as by a land policy note (FY07) and by land issues identified under the planned urban development project and the Agriculture/EU accession Project.

103. Improve infrastructure for growth by strengthening the framework for public-private partnerships and invest selectively in energy and transport. In energy, the WBG will continue to provide analytical and advisory support for the restructuring of the energy sector and improvement of its financial performance in order to sustain an affordable and efficient electricity supply necessary for economic growth. Through the Power System Improvement Project, closed in June 2005, the World Bank supported rehabilitation and increase efficiency of fYR Macedonia's six largest hydro plants. The World Bank’s on-going investment lending to the energy sector includes the Energy Community of South East Europe - APL3 fYR Macedonia Project (FY06) that aims to strengthen the transmission and dispatch capacity and improve efficiency of the power transmission company (MEPSO) to support its functioning in the context of the regional power market. Technical assistance is being provided through two trust fund grants to support the development of a framework for private sector participation in hydropower development. IFC will consider opportunities in financing mini-hydro power plants in sizable packages. Furthermore, the Sustainable Energy Project (FY07), funded by GEF, will assist in the development of a sustainable market for renewable energy sources and energy efficient technologies in fYR Macedonia through technical assistance and investment support.

104. Going forward, the WBG will provide analytical and advisory support to the development of a strong and sustainable energy sector that can provide households and businesses with a secure, reliable, efficient and high-quality energy supply. The analytical base of these activities will be provided through support for the development of a National Energy Strategy (FY08) and continued dialogue and advisory support to the energy sector. In addition, IFC and the Bank will start preparing (in FY08) a joint policy note on concessions and public-private partnerships (PPPs) to help improve the environment for mobilizing private sector investments in infrastructure. Implementation of key recommendations of this analytical work would attract more private interest to invest in fYR’s Macedonia’s energy sector, and would enhance opportunities for IFC’s sequential involvement in helping structure and mobilize financing for pioneering infrastructure projects.


105. Informed by this analytical work, a planned Energy Project (FY09) will provide investment support for high-priority energy infrastructure project(s) aimed at improving the efficiency of existing assets and meeting the growth in energy demand. Such energy infrastructure project(s) could include rehabilitating and expanding existing hydro-electric generation plants, development of regionally high-priority electricity transmission interconnections, or investments in gas supply infrastructure. On its part, IFC through its advisory services, will work closely with the Bank and pursue investment opportunities in PPPs, including in the gas distribution sector.

106. In transport, the proposed TTFSE II operation (FY07) will support the development of an efficient and effective transport system, reducing economic distance to markets. The project will promote electronic inter-agency and cross-border exchange of trade data, and strengthen the functioning of key transport corridors. The proposed activities are oriented towards compliance with the EU pre-accession requirements and reflect the commitments agreed in the MoU for the development of the core transport network between the European Commission and Western Balkan countries (Luxembourg, June 2004). The proposed operation benefits from the recently completed TTFSE project, which supported modernization of customs procedures and facilities, and from the ongoing Railways Reform project (FY05) which improves the financial viability, productivity and efficiency of railways operations, and paves the way for liberalization of railways services. Finally, it will benefit from and supplement the ongoing Business Environment Reform and Institution Strengthening project (FY05) which strengthens the capacity of the government to improve selected areas of the business environment in an EU-oriented context.

107. The WBG will continue its analytical work in the transport sector, through a Transport Sector Study (early FY09) to be followed by a new transport project, most likely focused on feeder roads, providing better access from the farmgate/local markets to the main transport corridors (late FY09). This work will be informed by a regional study on feeder Roads. Underpinned by the joint policy note on concessions and public-private partnerships referred to above, IFC, jointly with the Bank and relevant authorities, will pursue opportunities to implement PPPs in the transport sectors through PEP SE Infrastructure (its advisory services) or direct financing of private sector projects.

108. Remove rigidities in labor market regulations and reduce the labor tax wedge. Given the importance of this area for achieving CPS goals on growth and job creation, the World Bank Group plans to support reforms in this area primarily through future PDPL programs. Analytical support may be provided through the next CEM (FY08). A currently ongoing regional labor market study will also provide important input for reforms in this area.

109. Develop a productive and appropriately skilled labor force. Education and skills development play a key role in ensuring a productive and appropriately skilled labor supply, crucial for fYR Macedonia successful integration into the European and global economies. The ongoing Education Modernization Project (FY04) will: (i) improve the teaching and learning environment in primary and secondary schools, so that graduation rates improve and graduates are better equipped for the next stage of their lives; (ii) enhance the transparency of and evidence base for decision making in the central government, by establishing an integrated education


information management system and a student performance evaluation system, and by building the capacity of Ministry staff in strategic planning and financial management; and (iii) enable the public and other stakeholders to get information about the performance of the education system, through the results from the student assessment system and school evaluation process.

110. Additional support will be provided by the proposed Competitiveness/Technological Change/Tertiary Education project (FY08) which –as far as education is concerned– would likely: (i) establish a quality assurance system in tertiary education under which public institutions are held more accountable for their use of public money and in which students and the public have information about the performance of different institutions; and (ii) improve the efficiency of spending on research and development to ensure it is used to tackle the identified priorities of the government in ways which leverage private sector investments. IFC may provide long term financing to reputable private education institutions with high quality standards and professional management.

Pillar 2: Public Service Delivery and Supporting Good Governance.

111. The WBG’s partnership strategy with fYR Macedonia aims to build on the progress that fYR Macedonia has made in improving governance and reducing corruption, while deepening reforms in key sectors where governance weaknesses continue to undermine progress in the economic reforms necessary to strengthen the economy and create jobs. Improved transparency and accountability in service delivery is critical to meeting the government program on growth, fostering human capital, and meeting EU standards.

112. Through the DPL program and selected sector work (PER, FY07, PER update, FY09, annual Programmatic Poverty Assessments, as well as through Country Fiduciary Assessments (FY07 and FY10), the Bank will continue to support the efficient and transparent use of public resources. An IDF to improve public accounting will help as well. Furthermore specific attention will be given to improve governance aspects in all sector interventions included in the strategy (please note Annex 9, summarizing governance issues and the WGB program). For this CPS, the WBG will support building of quality institutional capacity to improve the transparency and regulatory capacity of governmental structures in all areas included in the strategy.

113. The WBG will support fYR Macedonia in its efforts to: (i) continue reducing the legal uncertainty and lack of confidence in the judicial system; (ii) apply proper public finance principles and governance standards at the municipal level, including to municipal public enterprises and utility companies; (iii) continue improving the use of public resources and performance monitoring in the provision of affordable and quality health services; and (iv) develop more targeted cash transfer systems and introduce incentives to encourage school enrollment and preventive health.

114. Decrease the legal uncertainty and lack of confidence in the judicial system. Implementation and institution building support provided by the ongoing LJIIS Project (FY06) aims to increase accountability and transparency in the judicial sector and reduce overall corruption in fYR Macedonia. The Project supports the implementation of the new framework


for judicial and court operations and improve efficiency and effectiveness of the judiciary in resolving (commercial) disputes and streamlining administration in some key commercial areas – bankruptcy and administrative disputes. LJIIS also aims to reduce political influence and improve the quality of the judiciary, by supporting the new Republic Judicial Council in implementing efficient processes for monitoring and evaluating judicial performance against high ethical standards and implement transparent procedures for judicial selection and disciplining judicial misconduct. Given the long term nature of addressing these issues, a follow-on of this project may be considered for FY10. A final decision on this will be taken during the CPSPR (FY09).

115. Apply proper public finance principles and governance standards at the municipal level, including to municipal public enterprises and utility companies. The proposed Urban Development Project (FY09) aims to support fYR Macedonia by addressing needed improvements in the performance of urban economies and the quality of urban governance, through components addressing sustainable municipal financing, municipal service delivery, urban planning and/or land management. The World Bank’s Urban Policy Note (FY07) looks at a range of issues in how cities are being managed. The report focuses on the policy agenda in three areas. The first is municipal financial management, which is a core element of municipal performance and of local governance. The second area concerns the provision of communal services; there are many issues in the institutional framework for governance of the communal enterprises, and in investment selection, that will affect financial sustainability and quality of services over the medium term. Third, renewed attention is needed to the planning and management of urban land use, which is central to the efficiency and environmental quality of urban areas, and to the affordability of housing for the population and of real estate for businesses. The proposed project would provide financing for priority infrastructure investments in a set of municipalities and their communal services enterprises.

116. Continue improving the use of public resources and performance monitoring in the provision of affordable and quality health service. World Bank support in the health sector to date, provided under subsequent adjustment loans, including the ongoing three-year PDPL program, as well as under the Health Sector Management Project (HSMP, FY04), has focused on establishing appropriate governance and financial management structures to improve controls, transparency and accountability of the Health Insurance Fund (HIF) and health care institutions. Key results of these interventions include: improved transparency and controls over the pharmaceutical procurement process and reduction in outpatient drug expenditures by the HIF, development and implementation of strengthened budget management processes both in HIF and health care institutions, and a strengthened oversight framework for the HIF. During this CPS period, the Bank will support the government’s agenda of reforming health care institutions for strengthened clinical performance and public accountability, further enhance the HIF’s capacity as a strategic and transparent purchaser of health services and strengthen the role of the Ministry of Health as the steward of the health sector. A key element to these reforms is putting in place appropriate information sharing structures between HIF, HCIs and MOH that will enable better purchasing, improved quality of care and transparent reporting of results to the public (E-health initiative). A potential investment project to help finance this initiative will be considered during the CPSPR (FY09) for inclusion in the FY10 lending program.


117. Use the cash transfer system to incentivize school enrolment and preventive health. The Conditional Cash Transfer (FY08) project will aim at alleviating poverty while working towards improving beneficiaries’ future opportunities to develop earning skills and capacities and become self-reliant. This can be done through conditioning cash benefits on behaviors that build human capital, such as pre- and primary school attendance, strengthening access to basic/primary health care services, especially among rural populations and vulnerable groups, especially during the pre- and peri-natal phases, and attendance of parenting classes.

Table 3: Proposed ESW Program FY 2007-2010FY07 FY08 FY09 FY10

Core Diagnostics PER Programmatic

Poverty Assessment CFA Macro monitoring

CEM FSAP Update Programmatic

Poverty Assessment Joint Portfolio

Review Macro

monitoring

Programmatic Poverty Assessment

PER update Macro

monitoring

FSAP Programmatic

Poverty Assessment CFA Macro

monitoring

Pillar I: Foster Growth and Job Creation, Increase Living Standards for All Agriculture and EU

Accession Competitiveness

Study Urban Policy Note Land Policy Note REPARIS

supervision MIGA TA (EIOP) IFC AS

National Energy Strategy

REPARIS supervision

Transport Sector Study

MIGA TA (EIOP)

IFC AS

Joint IBRD/IFC Policy Note on concessions and PPPs

REPARIS supervision

MIGA TA (EIOP)

IFC AS Other (tbd in

CPSPR)

REPARIS supervision

MIGA TA (EIOP)

IFC AS Other (tbd in

CPSPR)

Pillar II: Public service delivery, good governance Urban Policy Note

Competitiveness Study CFA IDF public accounting

National Energy Strategy

Transport Sector Study

IDF public accounting

Social Inclusion Assessment

Other (tbd in CPSPR)

CFA Other (tbd in

CPSPR)

Note: The ESW program will be augmented by annual Poverty Assessments and REPARIS supervision activities, as well as regional studies on health care financing, employment and pensions in SEE, railways in SEE (FY08), feeder roads in SEE (FY08) and gas sector in SEE (FY08).

B. The Framework for Bank Assistance and Financing Scenarios

118. The need for Bank lending is significant over the next four years but is subsequently likely to wind down as fYR Macedonia moves toward EU Accession and eventual graduation. The volume of the proposed lending envelope under the CPS is significant. The proposed base case lending envelope equals the high case lending envelope of the 2003-2006 CAS. This level accommodates the government’s intention to work closely with the WBG on key areas of the reform agenda in order to accelerate conversion towards EU standards and to


help building the capacity to access EU pre-accession funds and implement associated programs. At the end of the CPS period, however, it is expected that the country will have gained access to significant EU pre-accession funds, reducing subsequent borrowing significantly.

Table 4: Proposed Lending Program FY 2007-2010Base Case High Case

FY Project Amount ($Mil.)

Project Amount ($Mil.)

FY07 TTFSE2 20 TTFSE2 20 GEF Energy Efficiency Grant GEF Energy Efficiency Grant

Agriculture 20 Agriculture 20 PDPL2 30 PDPL2 30 Subtotal 70 Subtotal 70

FY08 Conditional Transfer Implementation 25 Conditional Transfer Implementation 25 PDPL3 25 PDPL3 25

Competitiveness/Technological Change/Higher Education

25

Subtotal 50 Subtotal 75FY09 Urban development 25 Urban development 25

Transport (feeder roads) 25 Transport (feeder roads) 25Energy project (gas, electricity) 30

Subtotal 50 Subtotal 80FY10 Investment Loan 1 * 15 Investment Loan 1 20

Investment Loan 2 15 Investment Loan 2 15PDPL (new series) 20 PDPL (new series) 20

Subtotal 50 Subtotal 55 Total 220 Total 280

Note: *Investment loans will be determined during CPSPR. Options include follow-on investment projects in land management, Judicial reform and/or health approved as part of the last CAS, or environmental investment to strengthen compliance with EU standards.

119. Actual lending will be determined by the pace of reform in key sectors. A lending program sufficient to support progress under the two main pillars of the CPS is warranted by the pace of reforms thus far, combined with fYR Macedonia’s creditworthiness and stable, albeit low, growth. The base case includes both investment and development policy lending, and envisages two or three new loans per year, for a total of US$220 million over the four years CPS period. Under the high case scenario, the base case lending program could be augmented by two additional investment loans, adding US$60 million to the lending envelop for the period. The base case requires continued satisfactory macroeconomic performance, satisfactory progress in creating a conducive business environment and satisfactory portfolio performance. The high case scenario requires strengthened macroeconomic performance, further progress in creating a conducive business environment and good portfolio performance. It also requires actions to increase market competition and to increase payment discipline in the energy sector, to ensure that the policy environment is appropriate to proceed with additional investments in competitiveness and energy. Specific actions listed in the table of triggers (table 5) would form the basis for judgment by the Region as to whether policy performance is appropriate for moving between cases.


Table 5: Triggers for LendingTriggers for lending in the Base case Triggers for lending in the High case

Continued satisfactory macroeconomic performance

- Decline in public debt to GDP ratio - Contain inflation to EU average range- Maintain prudent fiscal and monetary policies

Strengthened macroeconomic performance - improvement in overall creditworthiness, as indicated by

improvements, inter alia of debt indicators, increases in FDI, investment to GDP ratio, and BOP performance

- contain inflation to EU average range- satisfactory progress in fiscal , monetary and financial

policies Continued satisfactory progress in creating a

conducive business environment- Reduced cost and time for business to comply

with business regulations --Base line: dealing with licenses 222 days (doing business 2007)--

- Continued progress in implementation of the regulatory guillotine

Continued satisfactory progress in creating a conducive business environment, as indicated by actions such as:

- Start Implementation of the Regulatory Impact Assessment

- Improve Access to Business related regulations- Adoption of at least two Land policy acts related to

business environment- Improve service delivery of court system --Baseline:

number of days for enforcement of contract 385 days Target: annual decrease of 5%.

Continued satisfactory portfolio performance- 70 % of the portfolio is implemented

satisfactory

Increased market competition by removing barriers to entry and exit and create a level playing field for public contracts [prior to proceeding with the proposed competitiveness investment in FY08].

- Substantial compliance with government policy to complete business registration within 5 days

- Remove 3- case limit for bankruptcy trustees Improved energy payment discipline of the

budgetary/state-owned entities and large consumers [prior to proceeding with proposed energy investment in FY09]

- Implement action plan to improve financial performance of energy sector

Continued satisfactory portfolio performance- 80 % of the portfolio is implemented satisfactory

120. If base case triggers are not met. In the event that regional events affect the security situation and overall developments in fYR Macedonia, the Bank, in a supporting macroeconomic and policy environment, will reorient assistance to focus on investments to support social cohesion. In the event that internal factors result in a sustained deterioration in macro economic stability, a serious discontinuation or reversal in the implementation of key reforms, or if the quality of the portfolio performance seriously deteriorates, the Bank will not proceed with significant new lending. Instead, the program will focus on implementation of ongoing operations and ESW/TA activities. Only very limited lending for global public goods (for example avian flu) or direct poverty alleviation investments would be considered in that case.

121. The program, as well as the priorities for analytical work in the last two years of the CPS, will be assessed in the FY09 CPSPR. Developments in fYR Macedonia are changing rapidly. The mid-term CPS Progress Report (CPSPR FY09) will assess performance against CPS results. The outcomes and milestones reflected in the results matrix (Annex 1) will be used to assess progress in implementing the reform agenda. The development of indicators in a number of areas will continue during the CPS implementation, and the results matrix will likely


be updated at the time of the CPS progress report. The structure and sequencing of the lending program, especially for FY10, will be reviewed in light of fast evolving developments and changes in priorities. This will depend on implementation progress under the current legal and judicial and land registration projects, as well as on potential emerging of new priorities. For example, the government has already indicated that it may want to consider requesting the Bank’s support to help build the institutional framework for meeting EU requirements in the environmental area. The government has also indicated interest in building on current health sector investments with support for an e-health program. Ultimately, trade-offs will have to be considered to ensure that priorities are determined given the lending slots and volumes that may be available. During the CPSPR, the authorities and the Bank will also start discussing priorities for assistance beyond the CPS period, as this may have implications for lending preparation and ESW in the outer years of the CPS period.

C. The Programmatic Development Policy Lending Program (PDPL)

122. The proposed policy lending under this CPS provides continuity with the 2003-2006 CAS and this new CPS. Under the 2003-2006 CAS, a new three-year PDPL series was launched. The first of the proposed three PDPLs was approved by the Board on October 27, 2005. The goals of the PDPL are in line with the new CPS. The program aims to promote economic growth and job creation through reforms to improve the investment climate and reforms to strengthen the governance and efficiency of the public sector. The PDPL reforms are being implemented in conjunction with a number of investment projects approved by the Board during the last CAS. The Health project, the Business Environment project, and the Legal and Judicial Reform project have all been designed and implemented in many respects to support the PDPL-supported reform program. All of these investment loans will have an implementation period which will carry them through this CPS. PDPL 2, the second in the series is being presented to the Board together with this CPS. A proposed PDPL 3 is envisaged for FY08.

123. To ensure continuity with the next CPS, the first of a new multi-year PDPL series is envisaged to be launched in FY10, the last year of this CPS period. The scope of the new series will be informed by the core diagnostics envisaged for FY07-10 including the CEM, CFA, the programmatic poverty assessments, the PER and PER update, and the FSAP. Lessons learned from an evaluation of the current PDPL series will also inform the design of the new series.

D. Partnerships and Participation

124. Extensive consultations underpinned the preparation of the CPS (Annex 5). The country office started internal consultations in late 2005 with a Country Team retreat and continued throughout the year. A CPS government counterpart team was formed to guide the preparation of the strategy. Consultations with stakeholders took place throughout 2006. A Client Survey brought first hand information on the views of our clients on the areas that the Bank should focus on and confirmed the importance of the Bank’s work in the country. Four workshops with local authorities, private entrepreneurs and civil society representatives were


held in different regions of the country, which were held to examine youth priorities and their expectations for the new CPS. The draft CPS outline was presented to other international partners in late January 2007.

Box 2: Client Survey

In May and June 2006, 438 stakeholders of the World Bank in fYR Macedonia were invited to participate in a Client Survey to obtain systematic feedback regarding (i) the general situation in fYR Macedonia; (ii) perceived value of the World Bank in fYR Macedonia; (iii) overall impressions of the World Bank as related to poverty reduction, personal relationships, effectiveness, knowledge base, collaboration, and the Bank’s day-to-day business operations; and (v) perceptions of the World Bank’s communication and outreach in fYR Macedonia.

The findings from the survey suggest that on a number of levels the World Bank is doing well and the environment welcomes Bank involvement. Some areas, however, require greater focus and attention.

Overall environment. EU accession and economic growth (closely linked by the respondents) are the two key issues. The survey indicates that other issues are seen as much less important at this time, including poverty reduction or education. The survey suggests that stakeholders are especially interested in economic growth to ensure accession to the EU. The greatest percentage of respondents reported that “government commitment” will have a very significant impact on sustainable growth and development.

The Bank’s role. Survey analysis suggests that there is broad support for the Bank in fYR Macedonia, without a noticeable negative constituency. Approximately 45 percent of respondents indicates that the Bank should be more involved in the country, a similar percentage believes that Bank’s involvement is at the appropriate level, and only 7% said the Bank should be less involved. At this point the balance seems right.

Two-thirds of surveyed stakeholders believe the Bank has an important role to play in economic growth. Attracting foreign direct investment and poverty reduction are also areas where stakeholders believe the Bank could play a valuable part. The survey suggests that public support for reforms grows if they are clearly linked with either the growth agenda or the EU accession process.

Respondents overwhelmingly identify “knowledge” as the greatest Bank contribution to fYR Macedonia. This contribution distinguishes the Bank from other institutions, and it is recognized and valued. Other important contributions are “ability to build implementation capacity” and “lending when others won’t.” This finding is critical for the Bank, especially since the country has other sources of financial support,

In general, relationships with the Bank are sound. Clearly, the Bank is doing an excellent job interacting with stakeholder groups in terms of personal interactions (respect and overall enjoyment working with the Bank).

The Client Survey suggests that the Bank should pay special attention to flexibility and speed up disbursements, should devote even more attention to high priority areas including economic growth, including helping to reduce corruption, and explore what more it can do to help fYR Macedonia prepare for EU membership.

125. The EU plays a central role in defining fYR Macedonia’s development agenda. The Bank enjoys a close relationship with the EU, both in Skopje and in Brussels. This close relationship has ensured a good match between EU and Bank activities (see Annex 10 for detailed information on Bank support in relation to the European Partnership program). As part of the CPS preparation process, Bank and EC country teams meet at least once every year for a “fYR Macedonia Coordination Day”. The meeting in 2006 focused on comparing the strategic direction of EC (progress reports, multi-annual program support [MIPS]) and WBG programs, as well as explored ways to deepen operational collaboration. At project level, Bank operations closely follow (sometimes evolving) EU requirements to ensure consistency in policy advice.


126. The Bank will maintain coordination with the IMF, which is expected to continue to monitor the macroeconomic framework under its ongoing three-year SBA, and will continue macro monitoring even without an active arrangement. The PDPL program has been developed in close cooperation with the IMF. Also, sectoral advice and lending (for example health and energy) continues to be coordinated with Fund staff. Without a Fund arrangement, the Bank will have to take a more substantial role in assessing macroeconomic performance, and will initiate periodic assessments in this area.

127. Harmonization with other development partners, in particular with the EC, USAID, the Dutch and Swedish Governments and the EBRD and the UN, is a critical element of the CPS implementation strategy. The need to leverage technical and financial resources provided by other development partners, often on a concessional basis, is crucial. In line with principles developed under the Paris agenda on Aid Effectiveness, the government takes an increasingly active role in aid coordination, organized through its Secretariat for EU Integration, which hosts monthly donor coordination meetings in all major reform areas, usually co-hosted by a leading donor in the area. In addition, line ministries and other institutions host donor meetings in their respective sectors, attended by the most active donors in their sectors.

128. Accordingly, the Bank intends to design programs and projects that integrate the comparative advantage of the development partners and ensure an optimal investment impact for fYR Macedonia. In this framework, the Bank will continue to offer its international expertise and design systemic approaches which will enable other partners to participate in financing and cost sharing.

VII. RESULTS-BASED MONITORING AND EVALUATION

129. CPS results monitoring will be undertaken jointly with the government. Monitoring will track progress towards achieving outcomes influenced by Bank interventions agreed to be undertaken as part of the CPS. Box 3 puts forward the major results and outcomes to be influenced by the Bank and achieved by the government during the CPS period, with more details outlined in the CPS Results Matrix (Annex 1). More specific results frameworks will be built into the individual Bank interventions. The Bank will primarily depend on government systems and agencies for the compilation and verification of results and milestones. The statistical system of fYR Macedonia is capable of producing reliable and high quality statistics. The coverage of the vital registration system is relatively complete. With technical assistance from bilateral and multilateral agencies (including the World Bank), the Macedonian authorities have made significant progress in upgrading the statistical system, including basic data collection, standards, and methodology for economic and financial statistics. The sample-based household surveys are fairly up-to-date. The bank will also undertake a strategic AAA program to ensure good tracking of results, including: (i) macroeconomic monitoring; (ii) Programmatic Poverty Assessment (FY07-FY09); (iii) Public Expenditure Reviews (FY07 and FY09); (iv) FSAP (update in FY08 and full in FY10) and (v) Country Fiduciary Assessments (FY07 and FY10).


Box 3: Anticipated Development Challenges which the CPS is Designed to InfluenceOverall: Good progress towards European integration.

Pillar 1: Foster Growth and Job Creation, Increase Living Standards for All Sustained macroeconomic stability. Improved regulatory environment for businesses. Improved enforcement of contract and creditor rights. Increased capacity of road and rail transport and lower trade and transport related transaction costs. Increased exports of horticultural products, improved capacity of MAFWE and related institutions to design and

implement agricultural and rural development policy. Improved efficiency in land markets and secure land and property rights. Improved efficiency and sustainability of the energy sector. Progress toward appropriately skilled labor force.

Pillar 2: Public service delivery and supporting good governance Decreased legal uncertainty and increased confidence in the judicial system. Improved service delivery, proper finance principles and governance standards at municipal level. More efficient use of public resources in the health sector, with more cost-effective services, reduced informal

payments and increased patient satisfaction. Strengthened targeting and rationalization of social assistance services.

VIII. RISKS AND MITIGATION REMEDIES

130. Regional (in)stability in the region will greatly influence the sustainability of the economic reform efforts and EU accession ambitions of fYR Macedonia. Political instability and uncertainty in the region, mainly related to the resolution of the Kosovo status, affects the investment climate in fYR Macedonia and adverse developments in the region could spill over to fYR Macedonia, as was the case with the Kosovo crisis in 1999. The political consensus in the country on fostering peaceful cooperation with its neighbors and strong consent and cooperation with the international organizations are important preconditions for successful management of such risks. The prevailing political commitment across the region toward EU integration will further serve to mitigate political risks. The many initiatives to encourage further regional integration, such as CEFTA, should help mitigate these risks as well. The Bank will monitor regional developments closely and make necessary adjustments to the support strategy if warranted.

131. Domestic political developments also pose a risk to the implementation of the reform program. Political divergence between the various ethnic parties can cause a slowdown of implementation of the reform program that will be supported by this CPS, and can delay critical reforms necessary for EU integration as well. Second, the government is composed of a coalition that includes several smaller parties. Regroupings within the coalition are possible, which in turn, may limit the government’s ability to pursue necessary far-reaching reforms that


may require qualified majorities in Parliament. Flexibility in the CPS program will enable the Bank to adjust its support strategy should the political conditions warrant.

132. A delay in EU membership could result in political turmoil that could adversely impact the implementation of the reform program. The EU accession process, a top priority for all political parties and strongly supported by the population at large, is a strong incentive to achieve consensus for key structural and institutional reforms. This strategic direction helps focus the government efforts on critical reforms, especially those identified in the EC Progress Reports. Also, strengthening institutional capacity to ensure effective absorption of EU funds is an important incentive for continuing progress in this area. These incentives will become weaker if progress on the road to Europe would slow down. The EC closely monitors progress on reforms regularly, and the monitoring of the Bank’s program can also help identify areas that require additional efforts to address this risk to the Bank program.

IX. CONCLUDING REMARKS

133. FYR Macedonia has made an impressive leap from a post-conflict country to an EU candidate country in only four years, preserving its macroeconomic stability, which bodes well for the outcome of the overall reform program during the CPS period and building the level of confidence essential to fostering growth and investment. FYR Macedonia needs to accelerate and sustain the economic growth for the benefit of all citizens, while increasing the efficiency and transparency of the public services. The Bank will continue to be a strong partner with fYR Macedonia as it faces these challenges in the coming four years and is committed to helping the government to achieve the results described in this CPS. A mid-term review of the CPS (CPSPR in FY09) would take stock of progress towards achieving the CPS outcomes and results and propose appropriate adjustments to the support strategy for FY09-FY10.

Country Partnership Strategy for fYR Macedonia FY07-10 Annex 1

Annex 1: FYR Macedonia CPS FY07-FY10 Results Matrix

Country Development Goals

Issues and Obstacles CPS Outcomes Milestones WBG program

Pillar 1: Foster Growth and Job Creation, Increase Living Standards for AllMaintain macroeconomic stability as precondition for economic growth

Maintain sustainable debt ratios

Keep debt levels moderate

Maintain low inflation

Reduce government expenditures as part of GDP and increase share of capital expenditures as share of total budget

Challenge of implementing reform program with tight budget deficit

Remaining weaknesses in budget processes, especially in linking government priorities to budget allocation to public procurement, accounting and reporting, internal controls, underperforming capital investments

Weak institutional capacity in public finance management

Maintain satisfactory macroeconomic performance while better prioritize budget expenditures and rebalance the composition of public expenditures between current/capital expenditure Maintain prudent fiscal and

monetary policies Decline in debt to GDP ratio Contain inflation to 2-4

percent

Increase budget allocation for strategic priorities (baseline 10% of total budget, target 12% of total budget)

Increase capital expenditures as share of total expenditure (baseline 10%, target 12% )

Improve public procurement implementation

Improve capacity in public finance management

FY07-10: Continued satisfactory macroeconomic performance

FY08-10: Increase budget for strategic priorities by 0.5% annually

FY08-10: Implementation of key recommendations of PER (FY07)

FY08-10: Remedy deficiencies in the public procurement system by implementing key recommendations of the CFA(FY07)

FY08-10: Establish permanent training center for Public Finance Management

Analytical Work and TA: PER (FY07); CFA (FY07 and FY10); CEM (FY08); PER Update (FY09); Macro monitoring; Annual Poverty Assessment; Planned lending: PDPL programs; IDF Capacity Building in Public Accounting Partners: IMF, EC, Dutch government

Improve functioning of financial sector,

Poor governance of the banks; hindering evolution of

Strengthened financial sector regulation, supervision and

Analytical Work and TA: Insurance TA/advice (FY07)




lower cost of capital and improve access to capital

Development of a more efficient and competitive financial system

banking competition, slow new products and interest spread reduction, poor transparency and accountability of insurance companies, high costs of capital and poor access to finance

governance Enhanced supervisory powers

and tools to increase accountability of bank boards and harness market discipline; implement the Supervisory Development Plan for Banks

Improved financial and credit information transparency and disclosure Enhanced financial reporting

for financial and non-financial enterprises

Adequate implementation of the country Action Plan on corporate financial reporting

FY08: NBRM approves strengthened fit and proper screening procedures in compliance with the new legislation

FY09: NBRM tests draft risk management manual on three largest banks

FY10: NMBR adopts risk management manual

FY09: Establish and start operation of new credit information bureau within NBRM

FY09: New curriculum based on the use of IFRS and ISA introduced

FY10: Portions of the EU acquis communautaire related to accounting and auditing implemented and enforced

REPARIS (FY07-FY10); FSAP Update (FY08), full FSAP (FY10); IFC and MIGA support to financial sector; Ongoing lending: BERIS (FY05) Planned lending: PDPL 2 and 3 (FY07 –FY10);Partners: EC, IMF, EBRD, Dutch government

Improve the business climate, including improving the judicial system to increase contract and property right protection

Reduce regulatory burden on businesses

Ease entry of new businesses

Expedient, three-day company registration

Unfavorable perception of domestic and foreign investors of the investment climate and high administrative and regulatory barriers to investment; cumbersome licensing and rigid regulation, inefficient and non-transparent procedures for firm-entry and exit, weak banking governance structure, inadequate corporate governance

Reduced regulatory and administrative barriers to entry and exit Implement the “regulatory

guillotine” to eliminate unnecessary regulatory burden on enterprises

Implement the Regulatory Impact Assessment to ensure proper cost-benefit analysis of new business regulations

FY08: Start abolishing unnecessary business regulations

FY08: RIA system introduced FY09-10: RIA system

implemented FY07-FY10: 15% annual

increase of the number of

Analytical Work and TA: IFC AS; Ongoing lending: BERIS (FY05), LJIIS (FY06) Planned lending: PDPL 2 and 3;Partners: EC, EBRD, UN, USAID, Netherlands, Sweden, Austria, Switzerland, Germany




procedure 500 formal

regulations identified and simplified

Efficient implementation of the Law on Enforcement to expedite enforcement of court judgments

Fully implement the new Bankruptcy Law to increase the efficiency of exit procedures

Increased protection of shareholders’ rights

Simplified court procedure with regard to mortgage payment

Judicial system is inefficient and overloaded, with significant delays in processing contract and property rights enforcement cases and ineffective bankruptcy procedures

Increased predictability/stability of regulatory matters/policies and improved business sector access to information on regulations Ease access to business

regulations

Strengthened protection of contract, creditor and property rights Improved enforcement of

judicial decisions Improved efficiency and speed

of bankruptcy proceedings Improved efficiency and

effectiveness of the judiciary in resolving commercial disputes

newly created business (as measured by new business registration with the Central Registry)

FY08: Reduced cost and time for business to comply with business regulations and reduced unofficial payments - base line: dealing with licenses 222 days (Doing Business 2007)

FY09: 25% reduction of formalities and administrative hurdles (including certificates, permits, statements and other forms) affecting businesses

FY08: Establish national electronic registry of business regulations

FY08: Supervision office for private enforcement agents established in Ministry of Justice and relevant enforcement regulations implemented

FY08: Supervision office for bankruptcy trustees in Ministry of Economy and Chamber of Trustees functioning

FY08-10: 80% of complaints against bankruptcy trustees resolved by Trustee Chamber




FY8-10: Number of days to enforce contract reduced by 15% over 2007 baseline of 385 days, Doing Business 2007)

Improve enterprise sector’s competitiveness, encourage technological change and further promote a level playing field for investment

Ensure the flow of knowledge and information between the universities and the private sector

Implement education reform in accordance with the requirements of the market economy

Insufficient absorption of technology and knowledge, and poor managerial skills, reduced competitiveness of the enterprises in domestic and foreign markets (or limited growth opportunities and new job creation)

Private and public investment in research and development is very low; and public investment does not leverage private investment

Universities are weak federations of faculties, which increases inefficiency of human and financial resource use and dilutes accountability for performance

The licensing and accreditation framework for universities is weak and non-transparent; and has the effect of dampening private sector provision of quality education

Remaining anti-competitive practices and gaps in liberalization of telecom and air-transport sectors reduce growth opportunities for

Strengthened public sector’s capacity to promote increased competitiveness of the enterprise sector Strengthened capacity of the

Metrology, Standardization, Testing and Quality (MSTQ) institutions to deliver EU-compatible services

Promote level playing field for enterprise sector

Strengthened public sector capacity to address distortions in market competition

Strengthen institutional capacity to stimulate technology and knowledge absorption

FY07-FY10: 20% annual increase of the number of ISO certified firms

FY10: Institute for Standardization of the Republic of Macedonia (ISRM) will have adopted at least 5000 EU compatible standards (Baseline: 1800 standards as at December 2006)

FY07: Facilitate new entry: baseline: business registration process completed in 5 days

FY08: Facilitate bankruptcy proceedings: remove 3 case limit for trustees

FY08: Make inventory of soft budget constraints in the enterprise sector

FY09: implement action plan to reduce/eliminate soft budget constraints

FY09: Establishment of a system to monitor and evaluate the competitiveness of the enterprise sector, including its

Analytical Work and TA: Competitiveness Study (FY07); IFC AS; Ongoing lending: BERIS (FY05); Planned lending: PDPL, Competitiveness/Technological change/Higher Education project (FY08); IFC’s International and EU Standards project; FIAS program;Partners: EC, USAID




unsubsidized/not favored firms and weaken consumers welfare/protection

Improve efficiency of spending on R&D

Established quality assurance system in tertiary education

technological capability

FY08-10: Improvement on the biennial assessments of integration into European Higher Education Area (Bologna Process)

FY09: Prepare an action plan for monitoring progress towards the EU Lisbon Jobs and Growth Agenda

Improve agricultural competitiveness

Stimulate competition and eliminate monopolistic behavior

Support activities for promotion of national brands of agriculture products

Development of functional agricultural land market

Immature land and rural credit markets; low levels of investment in farm technology and supply chains; weak institutional and human capacity, translating into lack of transparency and predictability of agricultural policy and implementation of program

Improve the delivery of government assistance to the agriculture sector in a manner consistent with the European Union’s pre-accession requirements Improved MAFWE ability to

disburse and track the use of rural development funds and to evaluate their impact on the agri-food sector

EU IPARD funds are paid to farmers in an EU compliant manner

FY08: MAFWE restructured in a manner consistent with the implementation EU pre-accession programs, launch development of modern management information system, increase in staff qualified to implement EU pre-accession programs

FY8-10: Agricultural information database, consistent with EU requirements developed;

FY09: EU accredited Paying Agency established and capable of making IPARD payments to qualifying beneficiaries

FY10: Functioning CAP Pillar

Analytical Work and TA: Agriculture and EU accession; IFC AS Planned lending: Agriculture/EU project (FY07), Feeder Roads project (FY09); Partners: EC, UN, USAID, Netherlands, Sweden, Germany




Timely delivery of EU compliant food safety certification to producers and agro-processors; beneficiary participation in irrigation schemes

1-type payment system established

FY10: Food safety certification available in a timely manner

Establish a functioning land market and institutions

Establish a functioning real estate registration system and policies to support an effective property market

Uncertain property rights, constraints on collateral and mortgage financing, incomplete real estate cadastre, lack of functioning land market and land policy, unofficial payments for official registration; weak institutional capacity; very long court processes

Efficient land administration system established Improved service delivery and

transparency in registration

Improved policy making capacity on land use management

FY09: Time to register sale transactions reduced to one day in 90% of cadastre offices

FY09: 20% of increase in the number of transactions in all cadastre offices

FY10: Established real estate cadastre in all urban and peri-urban areas by end-2009

FY07: High level land policy advisory committee established

FY08:Two land policies adopted

Analytical Work and TA: Land Policy Notes; Ongoing lending: RECRP (FY05), Planned lending: Urban Development project (FY09); (tentatively) Land Management 2, (FY10); Partners: Sweden, Japan, Norway

Increase the capacity of road and rail transport and lower trade and transport related transaction costs

Modernize corridor VIII and X road infrastructure, as well as selected regional

Non-reformed transport sector, with significant institutional weaknesses, including the lack of transparency in road management responsibilities result in increasing backlog in road maintenance; poor financial oversight and substantial ‘leakages’ in toll collection; existing potential

Facilitate trade by improving the capacity, efficiency and quality of trade data processing and transport systems

Develop efficient transport system supported through reduction of physical bottlenecks on main corridors,

Elimination of cross-subsidization from rail freight

FY09: Enhanced border crossing capacity and reduced border congestion and waiting times

FY10: Modernized and upgraded border crossing

Analytical Work and TA: Transport Sector Study (FY08), Regional Feeder Roads Study (FY08); Joint IBRD/IFC Policy Note on concessions and PPPs (FY09); PEP SE infrastructure; Ongoing lending: Railways Reform Project (FY06), Planned lending: TTFSE 2 project (FY07), Feeder Roads




roads Modernize and

restructure railroad company

Improve environment to attract private investment in transport sector

for rent-seeking by border agency inspectors, inefficient and insolvent railway system without cost centers accountability

to rail passenger transport and existence of public service contracts for non-profitable passenger lines

Harmonize trade related data requirements along rail corridor X, using Electronic Data Interchange based applications to speed up border processing of freight trains

Enhance transparency and efficiency of toll revenue collection through new toll collection system

Improved access from local markets to the main transport corridors through improved road management and maintenance programming, including institutional reforms and outsourcing of maintenance tasks

facilities and access routes on key transport corridors

FY10: Implement new telecommunication system along the key railway corridor X and integrated inter-agency rail freight data sharing, compatible with EU requirements

FY10: Automated vehicle classification system at toll stations fully operational

.

FY09: review policy framework on PPPs and concessions

project (FY09); Partners: EC, EBRD, EIB, UN

Improve the efficiency and sustainability of the energy sector

Development of long-term energy policy and an efficient energy sector which will serve as the basic impetus of Macedonian economy

Poor financial performance of energy sector entities and low sustainability of efficient electricity supply due to increased reliance on high price imports, poor payment discipline, tariffs which do not fully cover cost, high commercial losses in power distribution and lack of investment in new supply

Improve the efficiency and sustainability of the energy sector

Comply with the requirements of the SEE regional electricity market

Improve the financial performance of the electricity sector entities

FY08-10: Positive assessments in ECSEE status reports

FY07: Improved energy payment discipline of the budgetary/state-owned entities

Analytical Work and TA: Policy Advice on Improving Financial Performance of Energy Sector (FY07); PPIAF on Private Sector Participation of Hydro Power (FY06); IFC PEP SE Advisory Services; National Energy Strategy (FY08); Joint IBRD/IFC Policy Note on Concessions and PPPs (FY09); Ongoing




Improve environment to attract private investment in energy sector

infrastructure

Implement medium term Sustainable Energy Strategy

Improve energy efficiency and support sustainable market for renewable energy sources

Investment in high-priority energy infrastructure projects

and large consumers FY07: Adopt action plan for

improved financial performance of the electricity sector entities

FY08: Implement the action plan

FY09: MEPSO achieves a self financing ratio of at least 35%

FY09: Adopt Medium Term Sustainable Energy Strategy

FY09: Introduce an enabling regulatory and incentive framework for Renewable Energy (RE) based power and heat production

FY09: review policy framework on PPPs and concessions

project: ECSEE APL3 (FY06); GEF Sustainable Energy project (FY07), Planned project: Energy project (FY09); Partners: EC, EBRD, EIB, UN, USAID

Improve the level of the workforce skills

Implement fundamental education reform in accordance with the requirements of the market economy

Macedonia performs very poorly on international assessments of student performance: for example, scoring below all other European countries on the TIMSS and PISA assessments (for mathematics, science and reading)

High youth unemployment, especially for secondary education students, indicates

Improve education systems at primary, secondary and tertiary level Improved teaching and

learning environment in primary and secondary schools

enhanced transparency and evidence base for decision making in the central government

quality assurance system in tertiary education established

FY10: Reduce time taken to find first job after leaving initial education14

FY08-10: Improve graduation rates from primary and secondary education from primary and secondary education of disadvantaged populations15

FY08-10: Improvements in

Analytical Work and TA: Competitiveness Study (FY07); PER (FY07) Ongoing projects: Education Modernization project (FY04); Planned project: Competitiveness/Technological change/Higher Education project (FY08); (tentative) IFC investment in higher education;Partners: EC, Dutch Government, Austria

14 This information is not currently gathered on a systematic basis.15 This information should be gathered through the Education Modernization Project.




weak supply of skills to the labor market

Enrollment rates in secondary and tertiary education and below economic competitors which reduces incentives for FDI

international assessments of student performance (TIMSS, PISA, PIRLS)

Pillar 2: Improving the Governance and Transparency of Public Service Delivery to Support Market EconomyDecrease legal uncertainty and lack of confidence in the judicial system

Increase the efficiency and the speed of court proceeding

Address the backlog of cases in the courts and Supreme Court through court specialization, including the creation of an Administrative Court

Inefficient and slow judiciary facing large backlog of cases; lack of capacity to implement increased judicial competencies provided by Constitutional amendments; ineffective administrative decision making and dispute resolution system create opportunities for corruption and lead to slow service delivery

Efficiency and effectiveness of judiciary improved Enhanced facilities for courts

with specialized jurisdiction

Improved capacity of administrative inspectors and more efficient administrative dispute resolution process Improve capacity of judges

and efficiency of courts

FY09: Established monitoring and reporting system in the Administrative Inspectorate

FY09: Strengthened capacity of the Administrative Inspectorate to oversee the operations of government agencies and increase public awareness of administrative rights and obligations

FY08: Administrative Court established and operating

FY10: Automated case management system is enhanced and rolled out to courts

FY09: Capacity of the revised Republic Judicial Council is improved to provide: (i) efficient processes for monitoring and evaluating judicial performance against high ethical standards; and (ii) transparent procedures for judicial selection and

Ongoing lending: LJIIS (FY06); Planned lending: PDPLs, (tentatively) Judicial 2 project (FY10); Partners: EC, USAID




disciplining judicial misconduct

FY10: 25% increase in the general satisfaction with the operation of the courts over 2007 baseline (as measured by Court Users Survey in 2010)

Apply proper finance principles and governance standards at municipal level

Weak governance and institutional capacity at local level

Improve performance of urban economies and quality of urban governance (including utility companies) Improve municipal finances

Improve business environment at local level

Improve urban planning

FY09: Established mechanisms for sustainable municipal financing, including transparent formulation of investment budgets

FY10: Streamlined processing of business services and permits

FY10: Municipal planning and urban management developed

Analytical Work and TA: Urban Policy Note (FY07), Planned lending: Urban Development project (FY09); Partners: EC, USAID, UN, Netherlands, Germany, Austria, UN, UK, Switzerland

Improve the effectiveness, accountability and fiscal sustainability of health services

Improved quality of primary health care services

Increase the efficiency of HIF in allocation of funds and procurement of pharmaceuticals

Fragmented and duplicative health services delivery system with no controls over patients (excessive use of expensive hospital-based services, inefficiencies and poor quality of care, limited accountability of the health sector to the public); informal payments for health services; weak capacity of Health Insurance Fund, MOH and regulatory bodies to carry-out their functions; weak accountability framework governing health care

Improve the effectiveness, accountability and fiscal sustainability of health services Improved transparency and

control over the pharmaceutical procurement with 30% reduction in reported informal payments [measured through HBS];

20% reduction in self-referral rate to specialist and hospital care [data from HIF system];

annual operating deficits of HCI’s reduced to < 3% [data from HIF system and provider reporting]

FY08: Baseline National

Health Accounts developed including estimates of informal payments

FY09: Benefits package revised to address (inter alia) incentives for patients to use primary care and limit self-referrals

FY8-10: Output-based payment systems adopted by HIF

Ongoing lending: HSMP (FY05), Planned lending: PDPL 2 and 3; (tentatively) E-Health project (FY10);Partners: WHO




institutions (HCIs); limited reliable data in the health sector

30% increase in patient satisfaction with health services by 2010 [special survey – base-line established in December, 2006]

FY8-10: Improved financial, clinical and management information systems under implementation

Improve effectiveness and efficiency of social protection system

Improved targeting and administration of cash benefits and social welfare services

Small and ineffective social protection system, burdened with legislative constraints and vacuums, mismatch between legislation and implementation, weak institutional capacities, inadequate management procedures and practices and weak monitoring capacities due to the lack of communication between the implementing institutions

Improved targeting and administration of cash benefits and social welfare services

Provide opportunities for development of earning skills and capacities and become self-reliant

FY08: design an enhanced and rationalized social safety net

FY09: implement an enhanced and rationalized social safety net

FY08: design Conditional cash benefit programs

FY09: Introduce Conditional cash benefit programs

Analytical Work and TA: Social Inclusion Assessment (FY09); Ongoing Lending: SPIL (FY04); Planned lending: Conditional Cash Transfer project (FY08)Partners: EU, USAID


Annex 2: FYR Macedonia’s CAS Completion Report, FY04-FY06

Date of CAS : September 9, 2003Date of Completion Report: February 2007Period Covered by the CAS: July 2003-June 2006

Prepared by: Andrew Kircher

A. CONTEXT OF THE CAS04

From Post-Conflict Country to EU Candidate

1. The former Yugoslav Republic of Macedonia (FYR Macedonia)’s progress from a post-conflict country to an EU candidate in the space of the 2004-2006 CAS has been impressive. When the CAS04 was approved in September 2003, fYR Macedonia was still recovering from the economic, political and social fallout of the 2001 conflict. Today in 2007, fYR Macedonia is enjoying EU candidate status, albeit without a clear date to start the negotiations, making it the third country to emerge from the former Yugoslavia to become a candidate, after Slovenia (already a member since 2004) and Croatia. On the political front, successive governments in fYR Macedonia have made considerable efforts to implement the Ohrid Framework Agreement, which provided the basis for resolving the 2001 ethnic conflict.

2. On the economic front, the Macedonian government has been pursuing an ambitious reform program and has successfully preserved macro-economic stability during the past few years, though its growth performance has not been stellar, especially by regional standards. Following the prolonged contraction of the early 1990s and stabilization in the mid-1990s, growth began to pick up in the period of 1998-2000, but was disrupted by the 2001 conflict. Growth averaged around 0.3 % in the period 2000-2002 and has accelerated to around 3.5% in the 2003-2005 period mostly driven by improved trade performance and modest pick-up in investment activity. This took a heavy toll on living standards as the unemployment rate (traditionally at very high levels), increased from around 30% in 2000 to 38% by 2002. Labor market data indicate that most of the growth has come from productivity gains as the unemployment rate remains at around 36.5% at end-2005.

3. The fiscal adjustment during this period was remarkable, with large imbalances of 2001-2002 of -6.3 and -5.6 percent of GDP respectively being reduced to 0.1 percent of GDP fiscal deficit in 2003, and surpluses of 0.7 percent and 0.3 percent of GDP in 2004 and 2005 respectively. The central budget deficit is expected to average 0.6 percent of GDP in 2006, ensuring that government spending and public debt continue on a downward path (as % of GDP). The prudent fiscal policy enabled a slight loosening of the monetary policy, resulting in declining interest rates16 and expanding credit to the private sector17 without compromising price

16 Lending rates have fallen from 19 and 18 percent in 2001 and 2002, respectively, to 11 percent in 2005. Recent reductions in benchmark National Bank rates have led to further reductions in lending rates in 2006.17 Credit growth to the private sector has risen from negligible levels in 2001 and 2002 to more than 20 percent in 2004 and 2005. This growth has continued in 2006.


and exchange rate stability. The increase in private transfers and the inflow of portfolio investments are signs of improving business confidence in the economy and have contributed to a significant improvement in the Balance of Payments in 2005. The current account deficit is at sustainable levels as reserves increased to a comfortable level of four months of imports. The country remains moderately indebted and the debt service burden of about 5 percent of GDP since 2003 remains modest. This success was reflected in the improvement in the credit rating of the country and subsequently by a four-fold oversubscription to the government’s first issue in December 2005 of a 10-year, €150 million Eurobond. The money was used to pre-pay London Club debt in January 2006.

MACEDONIA: Selected Economic Indicators2000 2001 2002 2003 2004 2005Act. Act. Act. Act. Act. Prel.

Real GDP growth, in % 4.5 -4.5 0.9 2.8 4.1 3.6 0.3 3.5GDP per capita, in current USD 1,770 1,689 1,877 2,259 2,604 2,797

Fiscal Indicators, in % of GDP Revenues 36.2 34.0 34.9 38.4 36.5 35.5 35.0 36.8 Expenditures 33.7 40.3 40.5 38.5 35.8 35.3 38.2 36.5 Deficit 2.5 -6.3 -5.6 -0.1 0.7 0.3 -3.1 0.3

Balance of Payments, in % of GDP Exports of G&S 45.6 40.7 36.0 36.5 38.8 43.6 40.8 39.6 Imports of G&S 63.5 56.6 57.8 55.0 60.5 62.5 59.3 59.3 Current Account Balance -2.0 -7.1 -9.4 -3.2 -7.7 -1.4 -6.2 -4.1

Debt Indicators, in % of GDP Total External Debt 43.2 43.5 43.3 39.6 37.9 39.1 43.3 38.8 o/w short-term 1.5 1.9 1.7 0.9 1.3 1.5 1.7 1.2 Total External Debt Service** 6.8 8.2 6.8 5.7 5.2 4.5 7.3 5.1

Total Public Debt 57.0 55.4 48.6 44.9 42.6 47.3 53.7 44.9

Average 00-02

Average 03-05

----------------------------------------------------------------------------------------------------------------

FYR Macedonia’s First IBRD-Only CAS

4. With an ethnically diverse population of 2 million, fYR Macedonia gained its independence under difficult circumstances. The breakup of Yugoslavia in 1991 and the conflicts that followed resulted in the loss of a large and protected market and key transport routes. This led to a period of economic decline with high inflation, large fiscal deficits, insider privatization and almost no foreign investment. The Government's stabilization program, initiated at the end of 1994 with the assistance of international donors including the World Bank and the International Monetary Fund (IMF), restored macroeconomic stability.


5. Since fYR Macedonia joined the World Bank in 1993, IDA and IBRD commitments to the country through 38 operations total approximately $780 million; since fYR Macedonia became a member of the IFC, the country has received commitments of over $93 million in IFC funds and more than $25 million in syndications. Bank financing has helped the government maintain macroeconomic stability, reform the enterprise sector and develop a sound financial sector, and provided investment support in key sectors including energy, roads, irrigation, community development, health, education, and others sectors. Around half of all lending has been on concessional IDA terms. But because of improved economic performance and creditworthiness, fYR Macedonia graduated fully from IDA in 2003.

6. During the three years of the World Bank’s Country Assistance Strategy (CAS) for fYR Macedonia during FY04-FY06 (hereafter referred to as CAS04), the country’s first IBRD-only CAS, the Bank moved to a high-case lending program in May 2004, based on the strong reform efforts by the Macedonian government. This is particularly noteworthy among the countries of the Western Balkans, where volume has been declining as IDA constraints have begun to apply and where the full transition to IBRD has proven to be difficult for creditworthiness reasons. In fact, fYR Macedonia’s strong performance has allowed the Bank to continue lending on full IBRD terms at a stable level over the past decade.

7. The CAS04 Completion Report concludes that the Bank’s assistance to fYR Macedonia through FY04-FY06 was Satisfactory. The report evaluates the impact and effectiveness of the Bank’s assistance, and the outcomes achieved, through the implementation of the CAS04. While the CAS04 was not prepared using a Results-Based methodology, this report attempts to retrofit a results-based framework to it as a basis for a new Country Partnership Strategy (CPS) covering FY07-FY10. The retrofitted CAS04 Results Matrix has been prepared as if it had been done when the CAS was originally prepared in FY04.

8. The CAS04 followed a Transitional Support Strategy (TSS) that was discussed by the Board in September 2001 and which covered FY02. The TSS had outlined a program of Bank assistance to support the post conflict priorities of the country as it emerged from an internal conflict in 2001. The TSS outlined a one year18 program of post-conflict Bank support primarily geared towards achieving four post-conflict priorities, namely (i) meeting balance of payments needs; (ii) reconstruction; (iii) strengthening social cohesion; and (iv) supporting decentralization.

9. The CAS04 presented an IBRD program of support for the period FY04-06, which sought to build on the markedly improved macroeconomic management and structural reform progress since the 2002 elections. The IBRD program focused on promoting the effective management of public resources, tackling corruption, creating the conditions for private sector led growth, and ensuring an effective safety net is in place for the most vulnerable Macedonians.

10. Although fYR Macedonia did not have a formal national development strategy at the time of the CAS04, the policy agenda of the government was clearly articulated in its political platform in the 2002 elections. The four pillars of the platform were (i) political and social

18 The effective period of the TSS was extended through FY03 following further program delays in FY02.


stability; (ii) poverty reduction; (iii) job creation; and (iv) tackling corruption. This program enjoyed broad support throughout the country.

11. The analysis of fYR Macedonia’s development challenges in the CAS04 were developed collaboratively by the Bank and the government, based on the overarching two-pronged framework provided by the Ohrid Agreement and the Stabilization and Association Agreement (SAA). The objectives of the CAS04 were drawn from this assessment, namely: (i) to promote the efficient management of public resources and tackle corruption; (ii) to promote the creation of jobs through sustainable private sector driven growth; and (iii) to promote social cohesion, build human capital, and protect the most vulnerable.

B. RETROFITTING THE RESULTS FRAMEWORK

Objective I: Promoting the efficient management of public resources and tackling corruption.

12. During the CAS04, the government strengthened the management of public resources and the fight against corruption. The Bank’s focus on this pillar was in large part an outcome of the Country Financial Accountability Assessment that looked at the design and implementation of the public financial management framework and evaluated the framework’s ability to ensure the proper use of the country’s own resources and those provided by the Bank and other donors. In particular, it recommended reform in the five Extra-Budgetary Funds (EBFs), including the Health Insurance Fund, the Pension and Disability Insurance Fund, the Agriculture Fund, the Road Fund, and the Employment Fund.

13. Program rating: Progress on public resource management and corruption is rated as Satisfactory. Outcomes have varied across the agenda.

14. Outcome 1: Public expenditure management has improved, but much remains to be done. The Bank’s support of the public sector management reform program came in three successive policy lending instruments, including the Public Sector Management Adjustment Credit (PSMAC), followed by the Public Sector Management Adjustment Loan (PSMALII) and the First Programmatic Development Policy Loan (PDPL). The latter loan is part of a three-year PDPL program aiming at supporting the country’s structural reform program to promote economic growth and job creation through improving the investment climate and strengthening the governance and efficiency of the public sectors. This program will continue to serve as the centerpiece of the Country Partnership Strategy 2007-2010 (hereafter referred to as CPS07).

15. As indicated before, a critical weakness identified in the CAS04 was the five EBFs, which together comprised some 40 percent of total government spending, and which operated outside of the central government budget and the treasury and with weak oversight and financial controls. The EBFs had been a major opportunity for corruption and misuse of public resources. Under the PSMAL II, four EBFs were brought under control and integrated into with the single treasury account, while the fifth one (the agricultural fund) was abolished. At the same time, the


PSMAL II supported several reforms in the government budgeting process. Hard budget ceilings were approved for individual line ministries, the government improved budget execution, and the parliament enacted new laws on internal audit, public procurement and civil servants. In particular, the PSMAL II gave a strong focus to improving governance – especially in the health sector where international tendering of pharmaceuticals allowed the government to make savings of over $10 million per year. PDPL1 continued to support further reforms in the management and governance of the health sector and its financing, and addressed some key reforms in fiscal decentralization. At the same time, and in close collaboration with other donors active at the local level, the Community Development Project has helped train more than 200 municipal finance officers from 84 municipalities and local branches of the finance ministry in financial management, budgeting and accounting, in support of the government’s decentralization program.

16. Outcome 2: The civil service and broader public sector employment structures have started their way on reform. In the CAS04, the uncontrolled growth of the public wage bill was found to be a major risk to fiscal sustainability in fYR Macedonia. In the context of the PSMAC, Parliament enacted a new Law on Civil Servants that included a uniform, rule-based and less compressed salary structure for all civil servants, uniform definitions of the types of positions in the civil service, competitive and transparent recruitment procedures, and establishment of an independent agency. After extensive consultations with the Bank, the IMF, and the government, actual implementation of the wage decompression provisions of this law were only enacted in April 2004, and its 24-month implementation schedule has just been concluded. The decompression followed a six-year period when civil servant pay was frozen. It is now serving as a catalyst for decompression in other areas of the public administration, including pay reform in education, the police and the judiciary, among others. PDPL1 then continued to support civil service reforms including further changes to the legislative framework and the development of comprehensive monitoring indicators and targets to ensure the sustained implementation of the reforms.

17. Outcome 3: The government has moved on regarding inappropriate public sector interventions in business but needs more action on business environment. Most State and Socially Owned Enterprises were privatized during the mid-1990s but the effort still left some large SOEs to be restructured or liquidated at the beginning of the CAS04 period. The Second Financial and Enterprise Sector Adjustment Loan (FESAL), which closed late 2004, successfully supported the government’s efforts in selling off or liquidating about 100 of these remaining SOEs, focusing on the largest loss-makers with substantial arrears to the government. Commercial bank lending increased as a percentage of GDP from 12-13 percent for 1998-2002 to around 24 percent of GDP by end-2005, while deposits increased from the equivalent of an average of 22 percent of GDP during that time to 33 percent in 2005. State ownership of the banking sector declined from an average of about 15 percent of total assets for 2000-2002 to about 9 percent in 2005. Bank lending to the private sector increased from 14 to 21 percent of GDP from 2001 to 2005.

18. Closures of SOEs caused a substantial increase in the number of unemployed. To tackle this, the government and the Bank developed and implemented the Social Support Project. The project facilitated labor restructuring through actions to reduce individual and community


impacts of worker dislocation while providing severance payment for redundant workers. It carried out active labor programs for about 35,000 unemployed workers in 43 communities providing 14,000 new jobs, and improved the delivery of social benefits by strengthening the Ministry of Labor and Social Policy with equipment and training of staff. 19. Public ownership is no longer a serious constraint to private sector performance in fYR Macedonia. In 2002, the government learned the lesson of the proper sequencing of privatization when the telecom privatization was carried out without a regulatory framework in place. The successful privatization of the Distribution part of ESM (the power utility company) in the spring of 2006 shows how the government’s strategy of putting in place the proper framework before privatization has paid off. With the ESM-Distribution privatization, the government now has the institutional, regulatory, and administrative framework that enables the electricity market to operate free from private market power and undue government interventions. To support this concept further, Business Environment Reform and Institutional Strengthening Project (BERIS) aims to help the government’s efforts to stimulate economic growth based on increased domestic and foreign investment by strengthening public sector capacity to improve selected areas of the business environment and increase competitiveness of the business sector. In particular, the BERIS will assist the government in implementing the European Partnership (EP) signed between the EC and the government in June 2004, by addressing many of the priority areas identified by the EP. The BERIS benefited from very close cooperation with USAID and EAR.

20. The first pillar of the PDPL program focuses on improving the investment climate through supporting structural reforms in the judiciary, labor market, financial intermediation and corporate governance, as well as on the regulatory environment for the private sector.

21. Outcome 4: Decentralization has proceeded with government commitment. Decentralization, which is an important element of the public sector reform pillar of the PDPL1, is a central tenet of the Ohrid Peace Agreement, which set out specific reforms and protections aimed at strengthening the rights of minority communities, especially ethnic Albanians, and mandates the phased decentralization of the responsibility of many government functions to the municipalities. In November 2004, a referendum aimed at blocking the country’s decentralization process was defeated at the polls. Because of its centrality to the Ohrid Agreement, decentralization has been supported by many donors and the Bank has worked carefully to ensure its support was complementary to those efforts, in particular in supporting fiscal decentralization.

22. In ESW, the Bank’s Urban Policy Note in 2004 highlighted the challenges of urban development in the decentralization context. On the lending side, Bank support for decentralization took the form of three different but similar projects that all produced satisfactory outcomes. First, the Community Development Project piloted small-scale community based initiatives in selected demonstration communities under an integrated development framework designed to respond to priority social needs and facilitate the transition from conflict to peace. Second, an accompanying Child/Youth Development Learning and Innovation Loan helped develop 25 Youth Centers in fYR Macedonia that served as inter-ethnic community gathering points. And third, a Community Development and Culture Project Learning and Innovation Loan facilitated community-based socioeconomic development by leveraging fYR Macedonia’s


cultural assets and raising awareness among municipal governments of the value of their heritage. In addition to these three projects, the Bank also supports decentralization through its Education Modernization Project, which provides required resources to the government to help implement the decentralization of education, and through the Irrigation Rehabilitation and Restructuring Project (closed in November 2006), which supported institutional reform to bring about a more bottom-up approach to stakeholder participation. PDPL1 included important policy measures to ensure proper fiscal decentralization arrangements to proceed with the first phase of the decentralization program.

23. Outcome 5: Transportation has improved and operations have been made more efficient. The CAS04 indicated that improvements in the transport sector were essential for regional integration and growth, and restructuring was necessary for compliance with EU directives. In the past few years, fYR Macedonia has made strides in this effort by improving the efficiency of its road and railway systems, an objective that was supported through the Transport Sector Project, which closed in late 2004. Before CAS04, the project underwent a major reallocation of funds from the railway IT system to railway infrastructure and to expanding pilot road maintenance. The project helped expand a key motorway to the Trans-European Network motorway standard, extended a pilot maintenance project to cover 110 kilometers of road, and provided technical assistance and training for staff at the Fund for National and Regional Roads. And even though the railways-related component of the project was reduced because of difficulties, the procurement of necessary equipment for Macedonian Railways provided good results. As a result of several studies of fYR Macedonia’s railways, there is now a consensus and commitment about the restructuring of fYR Macedonia Railways for which the new railway law approved in January 2005 provides the legal framework. The implementation of the chosen restructuring model, including labor retrenchment, is the objective of the Railways Reform Project approved in September 2005. It aims to improve the financial viability, productivity, and effectiveness of railway operations, which in fYR Macedonia are one of the largest money losers among public sector enterprises. The railways project stands out in the region because it is the first of its kind to address structural reform in the railways sector. Lastly, the Trade and Transport Facilitation in Southeast Europe Project, which closed in December 2005, achieved substantial reductions in truck waiting times at border crossings and inland clearance terminals; improved capacity of small and medium transport operators and freight forwarders through training programs; modernized border crossing processing, and enhanced capacity of border crossings through upgrading of facilities. All these activities contributed to enhanced customs performance and there also exists anecdotal evidence of reduced “petty” corruption at border crossings, in line with the objective of tackling corruption.

Objective 2: Promoting the creation of jobs through sustainable private sector driven growth.

24. FYR Macedonia’s transition from a post-conflict country to an EU candidate has not been accompanied by a drop in the country’s high unemployment rate. The first major piece of ESW to examine this trend was the Country Economic Memorandum – Tackling Unemployment, released in September 2003. It argued that as the authorities strive to solidify peace and stability, accelerate remaining structural reforms, and move policies and institutions


towards European norms, the problem of high unemployment cannot be ignored. Growth has been limited by low investment levels, and to remove this constraint, the study said the government should be focused on ways to improve education, create a supportive investment climate, and accelerate free trade as part of integration into European markets. Despite progress, fYR Macedonia has a long way to go in reducing corruption and improving the business environment for stronger private sector driven growth.

25. For its part, the International Finance Corporation (IFC) had a committed portfolio in summer 2006 of US$27 million and its outstanding portfolio was US$26 million. During FY04-06, IFC didn’t commit any new investments in fYR Macedonia. Still, IFC provided through its Southern Europe Enterprise Development (SEED) an intensive technical assistance program, aimed at improving the business enabling environment and competitiveness of SMEs. As of July 1, 2005 SEED was succeeded by Private Enterprise Partnership Southeast Europe (PEP SE) which is providing technical assistance and advisory services to help strengthen the development of the private sector and infrastructure of the Southeast Europe countries. PEP SE is currently focused on five technical assistance and advisory services programs - alternative dispute resolution, recycling linkages project, corporate governance, international and EU standards, and advisory services.

26. Meanwhile, the Bank’s Multilateral Investment Guarantee Agency (MIGA) undertook a series of short term technical assistance (TA) interventions since FY00, including support for the preparation of a new law for a Macedonian investment promotion agency and the establishment of the agency, MacInvest. After the establishment of MacInvest in the fall of 2004, the Austrian Development Agency (ADA) agreed to fund a longer term TA/capacity building project designed to operationalize the new agency and prepare for a larger, complementary European Agency for Reconstruction-funded TA program. The first phase of the project, implemented in FY05-06, provided the agency with a start-up strategy, a detailed analysis of the country’s competitiveness for foreign investment in several key sectors and training for its board and management. The second phase, focusing on further hands-on capacity building of the agency staff and the implementation of an investor tracking system, was implemented in FY06-07.

27. FYR Macedonia is also one of the beneficiary countries under MIGA’s European Investor Outreach Program for the Western Balkans (EIOP). Under the donor-funded EIOP pilot initiative, launched in summer 2004, MIGA supports a number of countries in the Western Balkan region in proactive investor outreach in the agribusiness and auto component sectors, focusing on the European business community. During Phase 2 of the EIOP, being implemented in the FY07-09 period, the program is expected to work closely with the new government to increase investor outreach efforts across a number of sectors.

28. Program rating: Progress on the jobs front and private sector driven growth is rated as Satisfactory given the challenges in fYR Macedonia but much more work needs to be done.

29. Outcome 1: Improve the business climate to allow private sector-led growth. With most of the regional conflicts being resolved, structural impediments are a key constraint to growth and employment. The Bank’s Doing Business 2006 report and the series of BEEPS surveys highlights slow and costly enforcement of contracts, restrictive bankruptcy procedures,


regulatory impediments and delays, and an inflexible labor market as particular concerns. FYR Macedonia, as with many countries in the region, also suffers from an opaque corporate governance structure. The government is committed to addressing these issues with Bank support through the First Programmatic Policy Development Loan (PDPL)-supported reform program, as well as capacity building and investments provided under the BERIS, the Real Estate and Land Registration Project, and the Legal and Judicial Implementation and Institutional Support Project approved in May, 2006. For its part, the TTFSE contributed to decreasing the economic distance to markets by reducing non-tariff barriers to trade. On a more longer-term footing, the country needs to upgrade the qualification of its labor force that significantly limits the growth prospects of the economy.

30. Meanwhile, the CAS04 end-FY06 target of two private sector projects in infrastructure has been met. In the energy sector, hydro-plants were given under concession to a private operator, and the construction of the Skopje Combined Heath and Power Plant is planned as a PPP and the electricity distribution network was recently privatized. In telecommunications, both GSM service providers are private. However, delays in the establishment of the regulatory framework in various sectors have prevented more dynamic private sector entry in infrastructure.

31. Outcome 2: The financial sector is more sound but problems remain. Before the CAS04 period, the government saw the need to reform the financial and enterprise sectors with the aim of speeding up private sector growth. The Bank supported that objective through the Second Financial and Enterprise Sector Adjustment Loan (FESAL), which helped provide the framework for faster private sector growth and job creation, supported by a healthier and more developed financial system. The project was designed and implemented in an environment of political turmoil and economic disruption caused by the Kosovo crisis of 1999. By the project’s end, fYR Macedonia had made substantial progress in enhancing the overall soundness of the financial system, particularly the banking sector. The largest of the loss-making enterprises that crowded out new private sector growth had been resolved while changes in the business environment have removed major obstacles for private sector entry and have contributed to strengthening of the creditors’ and shareholders’ rights. Still, a number of deficiencies and deep systemic problems in the judicial sector have undermined the success of the reforms in the financial and enterprise sectors.

32. A key part of creating the right business environment is proper financial reporting. In 2005, fYR Macedonia began to take part in “The Road to Europe - Program of Accounting Reform and Institutional Strengthening”(REPARIS) - a regional program aimed at creating a transparent policy environment and effective institutional framework for corporate reporting within South Central and South East Europe. REPARIS, developed by the Bank in close cooperation with the OECD, the European Commission and other partners, aims to train senior civil servants, financial sector regulators and accounting and auditing bodies in emerging issues and new trends in both EU and global requirements impacting the regulation of accounting and auditing in participating countries/entities.

33. Meanwhile, the Bank published a Report on the Observance of Standards and Codes (ROSC) Corporate Governance Country Assessment of fYR Macedonia in June 2005. It updated the 2001 corporate governance ROSC and assessed the corporate governance policy


framework, as well as enforcement and compliance practices. The report found that fYR Macedonia is in the final stages of an intense period of corporate governance reform with recent reforms resulting in a framework that has improved compliance with many OECD principles. But the ROSC also recommended several changes, including overhauling the disclosure framework and completion of the corporate governance code. Also, a Financial Sector Assessment in November 2003 found that fYR Macedonia’s financial system was very small and that the development showed the marks of the country’s first decade of independence. Nonetheless, the soundness of the banking system has been improving in recent years. The last three years saw a solid expansion of the financial sector activities in the country. Though still relatively shallow in international and regional comparisons, the entry of the few foreign banks created modest competitive pressure resulting in a reduction in commercial banks’ interest rates. The weighted lending rates fell from close to 18 percent in late 2002 to around 11 percent at the beginning of 2006, while further cuts are expected if current economic trends continue.

34. Outcome 3: Reform of the judicial system is a priority. The FESAL found that in order to achieve long-term dynamic private sector-led growth, a number of comprehensive reforms in the judicial sector, as well as more sophisticated reforms related to the investment climate, rule of law, and governance will be essential. The Bank supported the government’s efforts in this area first with a study on legal and judicial reform, which identified fYR Macedonia’s inefficient and ineffective system as a major constraint to the further development of a market economy, economic growth, and the expansion of the private and financial sectors. The study, Improving the Business Climate in fYR Macedonia: A Legal and Judicial Enforcement Assessment, released in June 2005, found that as a key component in fYR Macedonia’s investment climate, the ineffective legal and judicial system not only hinders the functioning of existing businesses, but it also creates obstacles to the definition and enforcement of creditor, contract and property rights. In May 2006, the Bank’s board approved the Legal and Judicial Implementation and Institutional Support Project to assist the government further in this area, which is in addition to key policy measures in judicial reform included in the PDPL. Its objective is to assist the Government of fYR Macedonia in enhancing government capacity and building institutions needed to systematically implement key laws and policies that are designed to improve the effectiveness and efficiency of the judicial system. Implementation of these laws and policies will help remove constraints on the legal and judicial system and improve the functioning of fYR Macedonia’s business environment.

35. Meanwhile, the IFC has been working since 2004 to support legislation reform through the Alternative Dispute Resolution (ADR) Program in fYR Macedonia. Remarkable progress in enabling the environment for mediation introduction and implementation has been made. With the Ministry of Justice being main partner, the law on Mediation was passed, as well as a by-law on the Training Program for Mediators. In addition, training for 60 mediators, 60 lawyers and 15 judges have been delivered, several round tables and one ADR Conference for promotion of usage of mediation has been organized, and an extensive and far-reaching PR campaign has been undertaken.

36. Outcome 4: Energy supplies are improving. The improvement of the performance of the energy sector is critical in improving and sustaining economic development in fYR Macedonia and the rest of South East Europe. The Bank supported the successful rehabilitation of the


country’s six major hydropower plants, which represent about 28 percent of fYR Macedonia’s generating capacity, through the provision of equipment and technical assistance and the carrying out of works. This progress, which was supported by the Power System Improvement Project, was exceptional given the severe social problems in the area in which most of the hydropower plants are located due to an influx of Kosovar refugees following civil disturbances. More capacity and generation were achieved than forecast, with the actual additional capacity of 49 Mw exceeding the project target of 31 Mw. And the improved efficiency has increased the number of hours per year that the plants are in operation and reduced the number of unplanned outages.

37. In July 2004, the Bank drafted proposals in the FYR Macedonia Energy Policy Paper, which examined fYR Macedonia’s progress in energy sector reform, particularly through the adoption of an Energy Law and establishment of an independent energy regulator. Now that the new energy law has been adopted in March 2006, a new medium term energy strategy will need to be drafted and the Bank has already been requested to assist under the CPS07. Meanwhile, a GEF energy efficiency project has been approved by the Board in December, 2006. In the area of renewable and environmentally friendly sources of energy, the government has implemented a GEF Mini-Hydro power project, which consists of five small hydropower plants, built on the water supply pipes of two towns. The concept is now being used and further developed by the government, which have identified additional 400 locations for construction of similar systems, attracting significant attention from private investors.

38. At the same time, fYR Macedonia and other SEE countries have acknowledged that solutions to regional energy issues require regional solutions. In December 2003, fYR Macedonia joined the other countries in SEE in signing the “Athens Memorandum,” which committed the countries to a regional approach to energy and to integration into the European Community Internal Energy Market. The needs for investment in the energy sector are more than the public sector can provide so reforms are needed to bring in the private sector to develop capacity. FYR Macedonia’s successful privatization of the ESM utility in the spring of 2006 shows how the government has made strides in opening up the sector to private funds. In January 2006, the Bank reinforced fYR Macedonia’s reforms with the ECSEE Adaptable Program Loan that supports fYR Macedonia’s participation in the Energy Community of South East Europe (ECSEE), by assisting in implementing its program for power market liberalization and regional power market accession, and providing investment support and technical assistance to the transmission company. In this way, it supports the CAS04, which highlighted the need for power sector investment and institutional development to support greater integration in the regional power market and to enhance security of power supply. 39. Outcome 5: The transport sector is crucial for successful regional integration. FYR Macedonia’s strategic location makes it a keystone for land transport between Turkey, Greece, Bulgaria and the rest of Europe. The CAS04 stressed that the efficient and effective operation of the roads and railways, as well as border crossings and the customs system, which link the Macedonian economy to the region, will become increasingly important to realizing the country’s growth potential. Since then, fYR Macedonia has improved the efficiency of its road and railway systems, an objective that was supported through the Transport Sector Project, which closed in late 2004. The implementation of the chosen restructuring model for the


railways, including labor retrenchment, is the objective of the new Bank-financed Railways Reform Project approved in September 2005.

40. On a regional level, fYR Macedonia takes part in the TTFSE, a regional program that aims to strengthen and modernize the customs administration and other border control agencies in the countries of the region, including Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Serbia and Montenegro, Romania and Moldova. The program, the result of a collaborative effort between the government, IDA, the EU, the US, and the Stability Pact, and some bilateral donors, seeks to reduce non-tariff costs to trade and transport, and to prevent smuggling and corruption at border crossings. Since the project became effective in 2001, fYR Macedonia has seen increases and exceeded its targets in the value of imports and revenue collected, significant reductions in truck border crossing waiting times, and enhanced transparency of customs transactions. These improvements came despite the interruption caused by the 2001 conflict that directly affected the transport, and consequently, trade activities in general. TTFSE1 closed on December 31, 2005, and preparation for a follow on project is underway.

41. Outcome 6: Support to SMEs must continue. Through several different programs, the IFC has supported Small and Medium Enterprise (SME) development in fYR Macedonia. A three-year project funded by Austria is focused on the secondary material recycling industry in fYR Macedonia and other Western Balkan countries. The project, managed by IFC, is focused on the financial, training, consulting, and market needs of every segment of the scrap metal, paper, plastic and glass value-chains. The objective is to promote SMEs, increase the competitiveness of the recycling sector, and improve the lives of thousands of families who make their primary income by collecting scrap materials.

42. Meanwhile, an IFC project funded by Switzerland aims to improve the internal corporate governance practices of Macedonian firms, thus making them more attractive to potential investors. On June 14, 2006, IFC assisted the Macedonian Stock Exchange to launch the newly drafted Corporate Governance Code which is expected to become effective at the beginning of 2007. IFC is also working with Macedonian companies in order to help them improve their corporate governance standards and plans to start working with banks as well. In addition, IFC will collaborate with universities to teach corporate governance to students, so that they can apply best standards in their future jobs. Also, an IFC project funded by Norway is focused on helping SMEs introduce EU and international standards. Macedonian companies are faced with challenges to meet international and EU technical requirements which must be satisfied if domestic products are to be exported to international and EU markets. In fYR Macedonia, where the economy is traditionally reliant on food production and related industries, IFC has implemented a comprehensive Hazard Analysis of Critical Control Points (HACCP) program. IFC has been working to help food-processing companies to implement HACCP and develop a local expertise able to undertake certification. An HACCP Information Center has been established at the Skopje Agricultural Faculty.

43. Outcome 7: Rural development has been limited. One major issue in fYR Macedonia’s rural development is irrigation, which is essential to establish the country’s potential in agriculture. The Irrigation Rehabilitation and Restructuring Project supported improvements by rehabilitating three deteriorated irrigation schemes, enhancing the transparency and efficiency


of the schemes by introducing participatory management, and reforming the country’s Water Management Organizations, to make them more financially sustainable. Although the Kosovo crisis of 1999 and the 2001 conflict in fYR Macedonia intervened to delay the project’s progress, and significant problems have been encountered during the last seven years, in 2004 the board approved a major restructuring of this project, and success is being achieved. The irrigation area in two project areas had surpassed pre-project level while it has achieved considerable improvement in the third area. Some 25,000 families are now benefiting from the irrigation schemes while 125 kilometers of primary canals have been repaired and 2,500 hectares of independent irrigation schemes have been rehabilitated. The reforms have delivered better quality irrigation services and a more efficient water distribution system. At the same time, the government has liquidated 12 Water Management Organizations (WMOs) and also eight other WMOs outside the project area to scale up the initiative taken under the project to the sector wide reform. This program received significant co-financing from the Dutch government.

44. Outcome 8: Uncertainty over land title acts as a brake on the private sector. In 2003 a Foreign Investment Advisory Service (FIAS) study indicated that problems with the purchase of and construction on real estate were rated as the most significant administrative barrier to investment in fYR Macedonia. The Bank has started its assistance in this field through the Real Estate Cadastre and Registration Project, which aims to help build an efficient and effective real estate cadastre and registration system, contributing to the development of efficient land and real estate markets. An effective system is critical to fYR Macedonia’s goal of integration with the European Union. It is too early to assess the project but based on progress made so far, especially in the Kumanovo pilot, it is likely that the project will achieve its objectives. The project has been complemented by the activities of the Swedish, Dutch, Japanese and Norwegian governments, through a well developed coordination mechanism. Land policy issues are still pivotal to private sector development. Recently completed ESW in agriculture and urban development have identified issues and solutions for better land use management in fYR Macedonia. CPS07 will continue on this agenda as well.

45. Outcome 9: Sustainable growth requires more effectively dealing with environmental challenges. FYR Macedonia faces significant environmental challenges, particularly in water resource management, issues that will get higher on the priority list once the country progresses on the EU accession process. The country has made progress in cooperating with Albania on conserving and protecting the natural resources and biodiversity of Lake Ohrid through a joint environmental management of the lake’s watershed. The cooperation was supported by the GEF’s Lake Ohrid Conservation Project, which sought to provide a transboundary, comprehensive approach to Lake Ohrid, combining restoration, conservation and protection of the lake with sustainable use of its natural resources. The approach was codified into a new transboundary treaty, “Agreement for the Protection and Sustainable Development of Lake Ohrid and its Watershed,” ratified by both countries in 2005. The project was the first GEF project of its kind in Southeastern Europe, and has been recognized internationally as a successful model of bilateral management of trans-boundary resources.

Objective 3: Promoting reconciliation, building human capital and protecting the most vulnerable.


46. The 2001 conflict disrupted the positive economic momentum that fYR Macedonia had enjoyed in the previous years. The effects of the conflict were felt on the country’s output, investment and export growth, while the budget and current account deficits remained high. Through the Ohrid Peace Agreement of 2001, the government set out specific reforms aimed at ensuring the rights of minority communities. Several years after Ohrid, fYR Macedonia is respected in the region for having come a long way since the days of conflict and for forging a multi-ethnic state that has progressed in reconciliation among its various groups. But to make the peace and cohesion last, fYR Macedonia must continue to implement the Ohrid principles and strive to promote reconciliation.

47. Meanwhile, fYR Macedonia is one of the leading countries that participate in the Decade of Roma Inclusion 2005-2015, a multi-country initiative supported by the Bank and other partners. The Macedonian government has positively responded to the initiative and has formed an inter-sectoral Country Working Group, under the auspices of the Minister of Labor and Social Affairs and with active involvement of Roma NGOs. The Country Working Group has developed a Decade Action Plan, which outlines the actions to be taken in the priority areas of education, health, housing and employment.

48. Program rating: Progress on reconciliation, building human capital and protecting the most vulnerable is rated as Satisfactory.

49. Outcome 1: The maintenance of social cohesion is improving. Bank support for social cohesion and community development took the form of three different but similar projects that all produced satisfactory outcomes and all were supported by grants from the Dutch government. First, the Community Development Project aimed to foster reconciliation among the people, reduce social tensions, and build local social capital. The project has made progress toward that goal by piloting small-scale community based initiatives in selected demonstration communities under an integrated development framework designed to respond to priority social needs and facilitate the transition from conflict to peace. Activities under the project have gained momentum, with performance reflected in project outcomes in completed and ongoing community investments in poor, conflict-affected and vulnerable groups, and in local government training projects. In addition to 118 completed community investment/small infrastructure projects, a total of 80 Social Services Micro-projects projects were developed and implemented. At the same time, the project successfully completed the second phase of local government training focusing on social service delivery that included 20 courses with 193 participants. However, the project was reviewed by IEG and rated Moderately Unsatisfactory because the ICR has not provided enough evidence to demonstrate satisfactory achievement of the project's stated objective.

50. Second, an accompanying Child/Youth Development Learning and Innovation Loan aimed to increase social cohesion through the social integration of adolescents and youth at risk (ages 15-24) from different socio-cultural backgrounds. In this, it helped the development of 25 Babylon Youth Centers in fYR Macedonia and attracting Albanian youth, who were initially under-represented in the centers. As of spring 2006, some 15,400 youth had benefited from the project’s centers. Meanwhile, several newly elected mayors from municipalities which are not yet covered by the project have requested technical assistance from the PMU to launch centers


with their own funding, citing them as one of the few public spaces of inter-ethnic and inter-cultural integration in the country.

51. Third, a Community Development and Culture Project Learning and Innovation Loan performed very well in facilitating community-based socioeconomic development by leveraging fYR Macedonia’s cultural assets. Handicraft projects are increasingly collaborating with private companies and tourism projects are expanding their promotion campaigns and international contacts, notably in the areas of rural and monastery tourism. The project has raised municipal government awareness of the value of their heritage with every project municipality having developed some form of information and promotion for its heritage. And local governments, NGOs, the Ministry of Culture and the Institute for Protection of Cultural Monuments are gaining experience and technical capacity through the project.

52. Outcome 2: The quality and relevance of education needs to be improved. The Bank’s Education Modernization Project has reported that progress on improving the quality of education in fYR Macedonia has been moderately satisfactory, with all of the building blocks that are needed to achieve the Bank’s development objectives being now in place. In particular, overall progress against the objective of learning at targeted schools through strengthening school level planning and management is good. As of December 2006, some 93 targeted schools have used or are using grants to carry out self-evaluations and development plans while all other primary and secondary schools are scheduled to take part in the program. Technical assistance for teacher training has arrived and is now active on the ground. Progress, meanwhile, on improving equity and efficiency for a decentralized education system has been slower. The building of capacity of the municipalities was deliberately delayed to ensure proper linkages to other donor-funded activities. It should be noted that the project benefited from extensive support and cooperation from the Dutch bilateral development agency.

53. Outcome 3: Health outcomes have improved. In April 2004, the ICR of the Bank’s Health Sector Transition Project found progress on financing of the health system had run into problems in the beginning but is now back on track. The project improved the health of the population by enhancing the quality of basic health services, with a 48 percent reduction in infant mortality (from 22.7 in 1995 to 11.8 in 2000); a 37 percent drop in maternal mortality, (from 21.8 in 1995 to 13.7 in 2000), and a 15 percent fall in tuberculosis incidence (from 40 in 1995 to 34.1 in 2001). It also supported an initial phase of policy reforms to increase cost effectiveness, fiscal sustainability and patient choice within the health system. The average length of stay in hospitals was decreased by 20 percent from 14.3 to 11.4 days, while the number of consultations per physician in outpatient care was increased by 18 percent.

54. The second health project, the Health Sector Management Project, set out to address the issue of cost-containment while improving quality and access. Although the project is still under implementation, it has helped fYR Macedonia to achieve some key results, including increasing the amount of collected contributions by 5 percent, as well as the number of contributors. Some 15 guidelines have been developed, according to international standards, and distributed, and the average length of stay in hospitals has fallen by 15 percent.

55. Outcome 4: The pension system has been reformed. Progress on the objective of improving the effectiveness and efficiency of the social protection system has been satisfactory.


In particular, the Bank has supported the government’s efforts to build a sound and fiscally sustainable pension system through the Social Protection Implementation Project. Bank assistance helped the development of the legal foundations of the new system and assisted in creating the conditions for its successful introduction, including completion of the legal and administrative framework for successful operations of the second pillar, a viable plan for financing the transition, and introducing long-term government bonds for investment of second pillar funds. This support led up to the January 2006 launch of the country’s second pillar of its pension system, along with a new individual contribution collection system. Meanwhile, the Ministry of Finance issued a long-term government bond in November 2005, and made a budgetary allocation for financing the pension reform transition in the 2006 budget.

56. Outcome 5: Measuring of Poverty is Improving. During the last three years, the State Statistics Office (SSO) made considerable progress in improved calculation and dissemination of poverty data. The data collection method was significantly improved, coverage of information was expanded to better understand non-income aspects of poverty (modules on access to health, education and social services were added to the HBS), regular poverty profile reports were expanded and are publicly available on the government’s website. The institutional capacity within the SSO for poverty monitoring is sound and not reliant on donor activities and there do not seem to be immediate challenges to continuing these activities though there is some concern that demands made by the EU accession process will reduce the SSO’s attention to this area. Earlier, the Bank teamed with the SSO of fYR Macedonia to produce the FYR Macedonia Poverty Assessment for 2002-2003 to improve understanding of the poverty situation in the country. Published in late 2005, the report provided a valuable opportunity and vehicle for estimating absolute poverty and more generally assessing living conditions of the population. It also identified some key remaining knowledge gaps in areas where a better understanding will be needed to provide further guidance on identifying policy actions to combat poverty in the country. During the course of the preparation of the report, the Bank team provided extensive assistance to the SSO staff on measurement of absolute poverty as well as a number of other social indicators (Laeken indicators etc.). The Bank team also prepared a 2004 update on the poverty numbers, with an emphasis on analyzing the poverty rates between Macedonians and other ethnic groups to get a better understanding of poverty challenges in relation to the Ohrid Peace Agreement. The Bank recently acquired micro-level datasets from the Labor Force Survey and will soon launch the preparation of a report investigating labor market developments, in particular trying to understand how high unemployment rates are maintained without a significant deterioration in living standards and poverty. Under the CPS07, it is foreseen that the Poverty Assessment will be updated annually on a more programmatic basis to provide more frequent data to inform the country program.

C. OVERALL BANK PERFORMANCE

57. Overall, the Bank’s performance is rated as Satisfactory. It is noteworthy that the CAS04 objectives and program were implemented according to the original design. This is in large part due to the government’s strategic decision to adhere to its commitments to international institutions such as the Bank in order for the benefits of reform to take root. The decentralization of the Bank’s portfolio and project management to the country office also contributed to this


success by allowing for increased supervision effort and intensified sectoral policy dialogue with the government.

58. In terms of lending, the Bank’s program in CAS04 was designed to support strong structural reform that would enable the achievement of the CAS outcomes in Tables 1, 2, and 3. The IBRD instruments were chosen in consideration of existing Bank support through the active portfolio (Annex A). The CAS04 outlined a highly selective program of investment and policy lending of up to US$165 million, complemented by a substantial body of diagnostic and fiduciary work. At the outset of the CAS04, fYR Macedonia was considered to be in the base case. But thanks to strong policy performance by the country, the program quickly moved into the strong reform/high case lending scenario for the entire CAS04 period, eventually committing slightly more than the full lending envelope of $165 million for the three-year period.

59. The last Joint Portfolio Performance Review (JPPR), finalized in March 2005, showed that the portfolio is in good shape, due to the efforts of the government during the past few years. (See Box 1). The disbursement ratio in FY05 of over 30 percent indicates strong progress with current operations. There are no immediate problems in the portfolio, although strengthened supervision and guidance is required for reform projects in areas with large vested interests, such as the health project, new railways reform project and the new legal and judicial project. The JPPR showed that the Bank’s lending program and analytic work were well aligned with key CAS objectives. This has produced significant benefits from the ongoing portfolio, including support for major reforms and institutional development programs in a number of high priority sectors. Several factors can be identified as contributing to the success of the portfolio, including close linkages between policy and investment operations, linkages between high quality analytic work and key policy reforms, and effective donor coordination on key reform issues. The JPPR said that in order to maintain this good performance and learn from the ongoing operations, it is important for projects to pay closer attention to monitoring and evaluation systems.

Box 1: Joint Portfolio Performance Review

In March 2005 the World Bank and the Government of fYR Macedonia conducted a Joint Portfolio Performance Review (JPPR). The JPPR indicates that the Bank-financed portfolio has undergone significant improvement since the previous portfolio review in November 2003. The percentage of projects “at risk” dropped from one-half of the portfolio to zero upon the completion of the JPPR. The success in monitoring the portfolio was due to good cooperation between the International Finance Department of the Ministry of Finance and the World Bank Country Office. The alignment of the lending program and analytical work with the CAS objectives was key to the success of the portfolio.Among the factors that contributed to this outcome, the JPPR emphasized the linkages between adjustment and investment operations, between high quality analytic work and key policy reforms, and effective donor coordination on key reform issues.

However, the JPPR recommendations focus on paying more attention to defining the linkages between results at the project outcomes and CAS-level goals, as well as demonstrating progress on institutional reforms and capacity building. The JPPR suggests that programmatic lending instruments should be used to link Bank financing more closely with government-led development strategies/ programs aligned with national goals. It also proposes a program on simplifying the Bank operational requirements and provides tools for implementing the changes.


60. In terms of donor coordination, it should be understood that there are substantial and competing priorities for development assistance in fYR Macedonia. Accordingly, the Bank’s country program relied heavily on development partners to take the lead in some sectors, in particular those in which the SAA agenda and the complementary EU CARDS program were focused. Similarly, as many other donors started to provide substantial technical assistance and training to build capacity at the local level in support of the decentralization agenda that implemented the Ohrid Framework Agreement, the Bank focused its program on reforms at the central level. As anticipated, this approach resulted in a more concentrated program and further emphasized reliance on the Bank’s partners.

61. Bank performance – Objective I – The Bank’s performance in supporting the promotion of the efficient management of public resources and tackling corruption is Satisfactory. Support of the public sector management reform program came from the Bank in the shape of the Public Sector Management Adjustment Loan (PSMALII) that supported five major areas of reform: budget formulation; budget execution; audit; procurement; and civil service. Its program also aimed at introducing these reforms in the health case sector in particular. The program built on the Public Sector Management Adjustment Credit (PSMAC) that had supported the initial stages of the reform strategy of the government in public sector management. And in September 2005, the Bank followed up the public sector reforms of the PSMAC and PSMAL II with the approval of the First Programmatic Development Policy Loan (PDPL1) to fYR Macedonia. While the PDPL program aims at supporting the country’s structural reform program to promote economic growth and job creation through improving the investment climate, and will continue to serve as the centerpiece of the CPS07, the second pillar continues to focus on further improving the governance and efficiency of the public sector, in particular in civil service reform, fiscal decentralization and the management of the health care sector.

62. Finally, the policy reform program was further supported by two investment projects to help the implementation of the reform effort by financing technical assistance, training and IT requirements: (i) the Social Protection Implementation Project targeted the management and administration of pensions and social benefits, to ensure proper implementation of the new pension system, and to ensure social benefits are reaching the poor and those in need, and (ii) the Health Sector Management Project that provides support to implement the comprehensive reforms in the health sector as agreed under PSMALII and PDPL. Meanwhile, (iii) the Trade and Transport Facilitation in Southeast Europe (TTFSE) project provided support to implement customs administration institutional reforms and improvement of the Integrated Customs Information System (ICIS) to enhance efficiency and speed up border crossing processing.

63. Bank performance – Objective II – The Bank’s performance in promoting job creation through sustainable private sector driven growth is Satisfactory. As outlined earlier, the Bank’s support for the business climate came in many forms in the CAS04 and many of the instruments are only now coming online in the latter phase of the CAS period. These include capacity building and investments provided under the Business Environment Reform and Institutional Strengthening Project (BERIS), the Real Estate and Land Registration Project, and the new legal and judicial investment loan. Also, the government is committed to addressing these issues with Bank support through the Programmatic Development Policy Loan (PDPL)-supported


reform program. On a more longer-term footing, the country needs to upgrade the qualification of its labor force that significantly limits the growth prospects of the economy.

64. Clearly, improving the business environment is an area where the Bank can do more in the CPS07 given the challenges that fYR Macedonia faces. In 2005, the EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS) showed that while corruption remains an important problem in fYR Macedonia, things have modestly improved in some areas in the last three years. Still, progress seems stagnant. And the Bank’s Doing Business 2006 report said fYR Macedonia ranked 81st in the global ranking of 155 nations on key business regulations and reforms, roughly the same position it had held in previous years.

65. Bank performance – Objective III – The Bank’s performance in supporting the promotion of reconciliation, building human capital, and protecting the most vulnerable is considered Satisfactory. The Kosovo crisis and the civil conflict of 2001 eroded social cohesion and elevated the importance of inter-ethnic relations in the ongoing political debate. The Bank contributed to the ongoing process of reconciliation through three similar and related projects – the Community Development Project, Child/Youth Development Learning and Innovation Loan, and the Community Development Culture Project Learning and Innovation Loan. Meanwhile, the objective of protecting the most vulnerable was greatly assisted through the government’s introduction of a new and fiscally sustainable pension system through the Social Protection Implementation Project. Also, a critical outcome of the CAS upon which the long-term reduction of poverty depends is improved capacity to understand and track the impacts of policy on poverty and progress towards achieving the MDGs. One way the Bank is helping is by building on the FYR Macedonia Poverty Assessment for 2002-2003 and adopting a more programmatic approach to analyzing poverty levels across the country’s range of ethnic groups and identifying where needs for support and intervention are greatest.

66. Lastly, a reflection of the World Bank’s performance and reputation in fYR Macedonia can be seen in a Base Line Survey of 1,200 Macedonians of different ethnicities that was undertaken by the Bank’s Skopje country office. The survey found that 69% of those surveyed have a favorable opinion about the Bank. Most of the people have more trust in the WB than in the public sector, private sector or NGOs (51% trust the WB, 42% trust the private sector, 40% - public sector and 38% - NGOs).


Box 2: Public Awareness of World Bank Activity

In the framework of the consultations for the preparation of the new CAS, the World Bank Office in Skopje undertook a Base Line Survey. A representative sample of the Base Line Survey was distributed to 12,000 people from all over fYR Macedonia (towns 74.4% and cities 25.6%). It covered a wide range of people with different ethnicities (Macedonians 66.2%, Albanians 22.5%, Turkish 3.8%, Roma 1.5%, Serbian 4.4.%, Vlach 1%); different education background (no primary education 2.6%, primary education 16.2%, secondary education 55.8%, university education 25.5%); different employment status and political association. The purpose of the survey was to find out to what extent the public was aware of World Bank activity in the country and where the Bank stands compared to other organizations such as the UN, IMF, EU and EBRD. Based on the survey, the Bank ranks third after the UN and EU (95% of the population have heard of the WB as compared to 98% who have heard of the UN and EU; 69% have a favorable opinion about the Bank as compared to 83% - UN and 74% - EU). Most of the people have more trust in the WB than in the public sector, private sector or NGOs (51% trust the WB, 42% trust the private sector, 40% - public sector and 38% - NGOs).

A. PUBLIC AWARENESS OF WORLD BANK ACTIVITY IN FYR MACEDONIA (given in frequency of answers out of a total of 1200 )

PUBLIC AWARENESS (FREQUENCY

OUT OF 1200)

PUBLIC AWARENESS, (IN %)

1. Most important areas in which opinion about the Bank scores High (Frequency above 400) i. Have you ever heard of the World Bank 1141 95.1

ii. What is the main source of information about the WB. - National TV

525 43.8

iii. What is your opinion of the WB. (very favourable – Don’t know, never heard of) - Somewhat favourable

502 41.8

iv. How much trust do you have in regard to the WB. (Trust fully – Don’t know). - Trust somewhat

466 38.8

2. Most important areas to Macedonians which score High (Frequency above 400)i.Which idea for your country’s future appeal to you most? (join world/world economy/West).– Join EU 615 51.3 ii. Which view do you agree on cooperation between fYR Macedonia and the WB. (join world economy and move closer to Europe/ make our economy grow/ neither/ both). – Make our economy grow 510 42.5 iii. What should be the priority of the Macedonian government in regard to economic development. (improve citizens’ well-being, combat corruption, EU accession, employment creation, denar stability, foreign trade expansion, private sector development, assisting the vulnerable) - Improve the well-being of citizens

412 34.3

D. LESSONS LEARNED FROM CAS04 – IMPLICATIONS FOR CPS07

67. The shift in focus in the Bank’ program over the 2003-2006 CAS period from public sector reform to private sector development issues was timely and appropriate, and should continue. Between 2002 and 2006, fYR Macedonia regained strong macro discipline and


transformed from a post-conflict country to an EU candidate. In response, the Bank shifted its program appropriately to deal more directly with economic growth constraints. This should continue in the next CPS.

68. The Bank needs to increase its focus on fYR Macedonia’s integration with the EU. EU accession is a top priority for fYR Macedonia, and the Bank needs to assist the country in meeting the accession criteria and the EU acquis, including on building the institutional capacity to effectively implement EU regulations.

69. The EU accession process has major implications on budget allocation and priorities. The Bank’s funding could serve as critical bridge financing to enable fYR Macedonia to access EU pre-accession funds. The new PER slated for delivery in FY07 should analyze and provide recommendations to the Macedonian government on the fiscal policy challenges the country faces in the run-up to EU accession.

70. Stronger economic growth and job creation must be achieved. In order to maintain popular support for the reform agenda, there is a need for fYR Macedonia to show that its successful macro economic discipline and structural reform initiatives do translate into stronger growth, job creation and improvement of living standards for all.

71. FYR Macedonia’s competitiveness needs attention and role of education reform needs to increase. If Macedonian companies are to compete in the regional and international markets, their competitiveness needs to improve. Such a stronger competitive edge also requires a better match between the quality of education in fYR Macedonia with the needs of the 21 st Century and the knowledge economy.

72. The multi year Policy Development Program has served the Bank’s program well. The ongoing three-year PDPL program helped in shift of policy priorities, has been well connected to a number of investment projects, and helped secure continuity and predictability in the reform program. It even helped in the transition period following the recent government change, as the already agreed upon PDPL policy framework and related conditionality, played an instrumental role in the continuation of specific reform efforts.

73. Decentralization is critical to ensuring the peace and reforms. Decentralization is a key part of the implementation of the Ohrid Peace Agreement. Key for its success will be that local communities are able to fully take part in the country’s development. The challenge for the CPS07 is to calibrate the Bank’s interventions carefully, through sector work and lending, to assist in urban development, including in the provision of public services at the municipal level. This will require close cooperation with many other donors already active at the local level, often better placed to finance and implement resource intensive community-based activities.


Box 3. The Ohrid Agreement & EU Candidate Status

The General Framework Agreement for Peace (the Ohrid Agreement) was signed in August, 2001 by the leaders of the four main political parties in fYR Macedonia at the time, representing ethnic Macedonians and ethnic Albanians. The document lists some basic principles of the Macedonian state and includes provisions on: the cessation of hostilities and the voluntary disarmament of ethnic Albanian armed groups; devolving centralized power to local administration; and reforming minority political and cultural rights. Among other things, the provisions create a “double majority” requirement in parliament (including a majority of representatives from minority populations) for passage of certain constitutional amendments and laws affecting minority rights.

The amendments to the Constitution required by the Ohrid Agreement were adopted by the Parliament in November, 2001 (almost two months later than anticipated). After considerable debate and delay the new Law on Local Self-Government was adopted by the Assembly in January, 2002. The Law assigns local governments responsibility for establishing and financing primary schools, providing social care for the disabled, and other social categories, and providing primary health care and health protection for persons without health insurance.

The Ohrid Agreement was preceded by the Stabilization and Association Agreement (SAA), which was signed in Luxembourg in April, 2001. SAA envisaged a step-by-step establishment of a free trade area within ten years after entry into force of the agreement, i.e. by June, 2011 at the latest.

SAA implementation was successfully finalized on November 9, 2005 when the European Commission recommended that fYR Macedonia be accepted as a candidate by the member states. On December 16, 2005 the EU Summit decided to grant fYR Macedonia EU Candidate Status. Negotiations for accession to the European Union will be opened once fYR Macedonia has reached a sufficient degree of compliance with the membership criteria.

FYR Macedonia has made significant efforts to align its legislation with EU rules particularly in the areas of the internal market and trade. However, much remains to be done to enable the country to cope with competitive pressure and market forces within the Union. In order to reach higher economic growth and competitiveness, the business climate must be improved and the country must become more attractive for domestic and foreign investors. The government of fYR Macedonia has to redouble its efforts to implement the judicial, economic, electoral and other reforms needed to realize their country’s full integration into Euro-Atlantic institutions.


TABLE 1: CAS03 OUTCOMES IN PROMOTING EFFICIENT MANAGEMENT OF PUBLIC FUNDS AND TACKLING CORRUPTION

CAS OUTCOMES THE BANK EXPECTED

TO INFLUENCE

INTERMEDIATE PROGRESS INDICATORS

RESULTS

PROMOTING EFFICIENT MANAGEMENT OF PUBLIC FUNDS & TACKLE CORRUPTION THROUGH:

Budget formulation;

Budget execution;

Improvement of procurement processes;

Strengthened civil service in public administration;

Strengthen the legal framework of internal & external auditing.

Hard budget ceilings for each of the first line budget entities were approved by the government in June 2003;

This was repeated with the budget approved by Parliament in 2004 and 2005;

Government consolidated all budgetary transactions in a single treasury account maintained at the National Bank of Macedonia;

Legislation has been enacted stipulating that contracts with public sector entities are legally invalid unless MOF registers them;

The new Law on Internal Audit was enacted by Parliament in September 2004;

The bill on State Audit Office was enacted by Parliament on March 26, 2004;

The new Law on Public Procurement was enacted by Parliament on March 26, 2004;

Parliament enacted the new Law on Civil Servants.

Approximately two-thirds of the resulting budget user’s submissions fell within their respective ceilings. As a result budget realism and budget discipline have continued to improve.

The government consolidated all budgetary transactions in a single treasury account maintained at the National Bank of Macedonia, resulting in significant improvements in budget execution. Sixteen district treasury offices now receive transaction details from their designated budget entities, code these transactions and send them to a centralized data base.

The government has also improved the management and financial oversight of extra budgetary funds. As a result, the Health Insurance Fund, pension, disability and road fund were transferred to the single treasury account completed on November 1, 2004.

A new internal audit oversight unit was established in the MOF. Eleven internal audit units have now been established and another four first-line budget users have full time internal auditors.

Standard bidding documents for works and equipment have been issued. The Public Procurement Bureau has established a procedure for obtaining information on public procurement from line ministries and has posted this information on the official website. A new procurement procedure based on international competitive bidding was adopted by the government for the pharmaceuticals procurement. As a result of the completion of the bid evaluation process, the tender achieved a savings of 17% (€ 8.57 mill.). New regulations governing the privatization of pharmacies have been put in place. This has been reinforced through the creation of new administrative units in key areas.


TABLE 2: CAS03 OUTCOMES IN PROMOTING THE CREATION OF JOBS THROUGH SUSTAINABLE PRIVATE SECTOR DRIVEN GROWTH

CAS OUTCOMES THE BANK

EXPECTED TO INFLUENCE

INTERMEDIATE PROGRESS INDICATORS RESULTS

IMPROVING THE FINANCIAL SECTOR AND SUPPORTING PRIVATE SECTOR GROWTH THROUGH: Overhaul of the

legal framework for the banking activity;

New Deposit Insurance Scheme;

Further upgrading of National Bank of Republic of Macedonia (NBRM);

Facilitating the enterprise formation and the FDI regime;

Strengthening the legal rights of creditors and shareholders;

Resolution of the assets of the Bank Rehabilitation Agency.

Parliament adopted a new Banking Law in July 2000;

A new Deposit Insurance Law was adopted in July 2000;

As of end-2003 four problem banks have been subject to enhanced monitoring;

As of January 1, 2002 a new two-tier payment system became fully operational and unblocked all corporate accounts;

A new company law was approved by Parliament in April 2004

In July 2000 Parliament adopted amendments to the bankruptcy Law and the existing law on Pledges;

In January 2003 the Parliament adopted a new integrated law for both movable and immovable collateral;

The government established a Self Regulatory Organization for chartered accountants and auditors;

The government adopted amendments to speed up asset recovery.

The new Banking Law (i) introduced definitions, allowable activities and prudential regulations for banks that are more in line with EU Banking Sector directives, International Accounting Standards (IAS) and Basle capital rules; (ii) strengthened bank corporate governance; and (iii) introduced efficient problem bank and bank failure resolution mechanisms.

The DIF (Deposit Insurance Fund) insures deposits of natural persons, including foreign currency denominated deposits held in commercial Banks and savings houses. As of March 2004 the reserve fund of DIF amounted to 3.20 percent of the deposit base.

As a result of large loss making enterprise resolution the government has formally resolved 32 enterprises that in 1999 had a total loss of 2.04 % of 1999 GDP.

The government support policy for the enterprise sector has been rationalized. Hence the government adopted a declining cap on public support for enterprises. In June 2003 the government met the targets for the reduction in fiscal cap (FESAL II targeted a reduction of 50% of 1999 levels of defined direct and indirect subsidies, expressed as a percentage of GDP).


TABLE 3: CAS03 IN PROMOTING RECONCILIATION, BUILDING HUMAN CAPITAL AND PROTECTING THE MOST VULNERABLE

CAS OUTCOMES THE BANK EXPECTED TO

INFLUENCE INTERMEDIATE

PROGRESS INDICATORS RESULTS

IMPROVED MAINTENANCE OF SOCIAL COHESION THROUGH:

Strengthening institutional capacity at central and local levels to address child and youth issues;

Facilitating the community-based socioeconomic development by leveraging the cultural assets.

25 youth centers were established and have become operational through the Child & Youth Development Project.

The affinity of Babylon Youth Centers participants for other ethnic groups has increased by 93%.

Providing training and technical assistance to the NGOs involved in the project.

Every pilot municipality has developed public awareness and information promotion for its heritage.

Newly elected mayors are interested in opening new youth centers that would be entirely funded through municipal finances. So far local communities have agreed to share the recurrent costs of youth centers (50% rental space).

Trainings have been conducted in 18 pilot municipalities where the project is being implemented. As a result for all these 18 municipalities separate Social Needs Assessments, Identifications of Local Cultural Heritage and Action Plans have been carried out. So far 134 Association grants and 112 Community Grants were approved in 7 regions. NGOs receiving grants have continued to grow their ability to design and implement strategies for generating income. Handicrafts projects are increasingly collaborating with private companies and tourism projects are expanding their promotion and international contracts, notably in the areas of rural and monastery tourism.


CAS CR ANNEXESAnnex A: FYR Macedonia: CAS Planned Lending Program and Actual Delivery

CAS Type : CASCAS Board Date: September 9, 2003CAS Lending Scenarios, FY04-06 ($Mil.): Base Case: $90.0m (see details below). Low Case: $20.0m

FY Project ($Mil.) Project Board Date ($Mil.)FY04 Education Access Improvement 5.0 Education Modernization 12/16/2003 5.00

Health & Social Protection* 15.0 Social Protection 05/13/2004 9.80 Administration PSMAL 2 05/13/2004 30.00 Health Sector Management 05/13/2004 10.00

Subtotal 20.00 Subtotal 54.80FY05 Land Registration 15.0 Reg. & Real Estate 03/15/2005 14.00

Financial Sector Development 15.0 Business Environment Reg. 06/21/2005 11.30 Subtotal 30.0 Subtotal 25.30

FY06 Judicial Reform 15.0 Legal & Judicial Implement. 05/30/2006 12.00 Electric Power Development 25.0 ECSEE APL #3 01/10/2006 25.00 Railways Reform 09/15/2005 19.38 PDPL 10/27/2005 30.00

Subtotal 40.0 Subtotal 86.38 Total 90.0 Total 166.48

Note 1: GEF projects not included above; Note 2: Actual lending in FYs may not add up to sum of actual project lending in the FY due to forwarding of projects to other FY.

ANNEX B: PLANNED NON-LENDING SERVICES AND ACTUAL DELIVERY

FY PLANNED NON-LENDING PROGRAM ACTUAL DELIVERY OF NON-LENDING ASSISTANCE

04 Country Financial Accountability Assessment (CFAA)

Country Economic Memorandum (CEM) Rural Human Capital TA Support for Post Conflict Transition

Actual (delivered FY04) Actual (delivered FY04) Actual (delivered FY04) Actual (delivered FY04)

05 Legal Judicial Diagnostic Poverty Assessment Urban Policy TA Social Services Delivery Study JPPR Energy Policy Paper

Actual (delivered FY05) Actual (delivered FY05) Actual (delivered FY05) Dropped Actual (delivered FY05) Actual (delivered FY05)

06 PEIR Update CPAR Update Social Development Update EU Competitiveness Competitiveness/ Innovation Note Financial Sector Governance TA Poverty Assessment

Actual ( to deliver in FY07) Actual ( to deliver in FY07) Dropped Actual (delivered FY07) Actual (delivered FY06) Actual (delivered FY06) Actual (delivered FY06)

Note: The deliverables marked in bold were planned in the previous CAS


ANNEX C: IFC- SEED TECHNICAL ASSISTANCE PROJECTS IN FYR MACEDONIA

Factoring Development Project: The main objective of the Project SEED was the introduction and development of factoring as a new financial instrument in the country. SEED has performed extensive research for the purposes of preparing a Factoring Market Feasibility Study by surveying all relevant stakeholders in this field: businesses, financial institutions, government, regulators and others. SEED has assessed the legal environment for initiating factoring operations in the country; tax and accounting treatment for factoring; commercial banks’ interest and capacity for introducing factoring as a new product along with the interest among companies in using this product. Two factoring roundtables were also conducted - one for banks and bank-like institutions and the other for businesses. Both of these workshops stirred a lot of interest within the public and private sector community.

Makstil Linkages Project: The focus of this Project was on developing the capacity of the Macedonian scrap metal recycling industry value chain by providing: training to the SME recyclers and Makstil (one of fYR Macedonia’s largest companies, also among the regional leaders in steel and rolled steel products manufacturing); access to finance to SMEs involved in the scrap collection and processing; technical assistance to the recycler’s association and needs assessment studies for the supplier network (primarily Roma collectors).

Tikves Linkages Project: The focus of this project was on the development of the grapes supply chain in the Tikves region by providing training to the grape farmers in vineyard management best practices as well as by providing technical assistance to Tikves (the largest winery in fYR Macedonia and one of the largest in the region) in design of its grape delivery logistics, assessment of its retrenchment policies, developing new SMEs and seminar in retrenchment management.

HACCP Certification Project: The main objective of this project was to help local food processing companies implement the HACCP certificate (Hazard Analysis of Critical Control Points), an internationally recognized food safety methodology that defines the framework for hazard identification and control. In a country like fYR Macedonia, where the economy is traditionally reliant on food production and related industries, HACCP remains as one of the most important vehicles for local food companies to place their products in European Union markets. SEED has implemented a comprehensive HACCP assistance strategy that included direct assistance to firms, building the capacities of service providers to offer the certification locally and working with the Macedonian government to establish a framework that will allow for easier and cheaper introduction of HACCP to local food companies.

Union of Private Chambers of Commerce (UCC) Capacity Building Project: The main objective of this Project was to enhance the sustainability of the newly created Union of private chambers and build its advocacy and service capacity in order to help its SME membership promote and advocate their collective interests including influencing the government’s decisions regarding creation of favorable legal framework where the SME sector can grow and prosper.

Agency for Entrepreneurship Promotion (APE) Technical Assistance Project: The main objective of this Project was capacity building of the national SME support agency in order to help improve the business enabling environment in the country and reduce the burdens to private sector growth and development. Some of the major accomplishments of the project were the preparation of the SME Country map and the assessment of the Agency’s strategic plan providing recommendations that set the path for its future operations and activities.


Capacity Building Program in fYR Macedonia: The Project was designed to support the growth and development of local Business Services Providers (BSPs), especially in areas where SEED needed expertise in upcoming projects and activities by focusing on improvement in knowledge/skills/experience base of both senior and junior consultants as well as the trainers from the consultant/trainer networks. The program also included mentoring and coaching of local consultants and pairing them up with their senior/more experienced colleagues in order to enable achievement of proficiency through learning-by-doing process. In addition, an Internship program with university graduates and students enrolled in last year was conducted, providing them with on-the-job training, either in SEED or in SEED client companies and partners.

ANNEX D: CAS 2003 OUTCOMES, INDICATORS AND BENCHMARKS

Long Term Goal

Short-term CAS Outcome

Intermediate Indicator

Base line

End FY06 Target

Results

Efficient and transparent management of public resources.

All EBFs fully integrated into the budget preparation and reporting systems and use the Single Treasury Account (STA).

Number of EBF’s integrated into the budget preparation and reporting systems and STA (or abolished).

1 5 Fully Achieved The CFAA proposed the abolishment of one of the funds (the

Agriculture Fund) and introduction of more stringent enhanced controls over the remaining four funds.

The authorities made considerable progress in this field. The Agricultural Fund was abolished during 2004. At the same time, the remaining funds were forbidden to incur debt and as of January 1, 2005 they all operate through the STA.

Currently, all revenues and expenditures of the EBFs (with the exception of some foreign financed expenditures of the Road Fund) are being processed through the STA.

The Ministry of Finance has precise and timely reporting on the balances of the accounts of the EBFs though still has limited influence over actual spending decisions of EBFs.

Namely, in order to allow for the specificities of the four EBFs, the Treasury does not execute the same level of controls over the transactions of the funds.

This is partly being overcome by the requirement for establishing the internal audit functions in the EBFs and further strengthening of financial controls (appointment of MoF representative with a veto power at the HIF Board).

Efficient and transparent management of public resources.

Adequate external audit coverage of budget users and EBFs to assure integrity of public finances.

Annual audit coverage of public accounts.

10 %

25% Fully achieved Since its establishment in 1999, the SAO has been expanding

the scope of its activities, thus preventing a direct comparison between the baseline indicator and the targeted one.

The Audit universe of the SAO in 2005 was 2,043 institutions compared to 1,740 in 2002.

However, the progress achieved in terms of improved audit coverage of public funds is notable.

In 2004, the SAO audited 113 institutions (5.5% of 2004 Audit universe) and prepared 190 Audit Reports compared to 85 institutions in 2002 (4.9% of 2002 Audit universe) with 99 Audit Reports.

The coverage in terms of public funds audited is significantly larger.

The 2004 Audit Reports covered 42% of the expenditures of narrowly defined Central Government (Ministries and first-line Budget users), 67% of the expenditures of the EBFs and 40% of the expenditures of the local government units.

Sustainable private sector

More efficient financial

Reduction in average loan spreads.

~9% 6-7% Fully achieved The last three years saw a solid expansion of the financial

sector activities in the country.


driven growth and reduced unemployment.

intermediation by the banking sector.

Though still relatively shallow in international and regional comparisons, the entry of the few foreign banks did create modest competitive pressure resulting in a reduction in commercial banks’ interest rates.

While exact comparison of interest rate spreads is not possible due to methodological breaks in calculation of weighted rates, indicative data show a reduction in the spread from 8.5 p.p. at end-2002 to around 6.5 p.p. at the beginning of 2006.

More importantly, this reduction was accompanied by a simultaneous overall reduction in the rates. The weighted lending rates fell from close to 18% p.a. in late-2002 to around 11% p.a. at the beginning of 2006.

Further rate cuts are expected if the current economic trends continue and the announced entry of few reputable foreign banks materializes.

Sustainable private sector driven growth and reduced unemployment

Increased Private sector participation in infrastructure.

No of private investments/partnerships in Roads, Railway, Energy.

0 2 Achieved The end-FY06 target of two private sector projects in

infrastructure has been met. In the energy sector, hydro-plants were given under

concession to a private operator; the construction of the Skopje CHPP is planned as a PPP and just recently the electricity distribution network was privatized.

In the telecommunications, both GSM service providers are private.

However, delays in the establishing of the regulatory framework in various sectors have prevented more dynamic private sector entry in infrastructure.

The adoption of the legal framework for introduction of competition in fixed-line phone services has been prolonged extensively and it seems that the regulatory bodies are not exercising sufficient pressures for earlier abolition of the monopoly in this sector.

The railways reform process has only recently begun, the ownership of the gas pipeline has been subject to court disputes for a prolonged period while the framework for giving the two airports under concessions remains unclear.

Reduced poverty and improved social cohesionHigher quality and credibility of data for poverty/MDG monitoring.

Legislative review completed and changes necessary for public access made.

Public access to agreed poverty monitoring datasets via World Wide Web (WWW).

No access

Public access

Achieved During the last three years, the State Statistics Office made

considerable progress in improved calculation and dissemination of poverty data.

The data collection method was significantly improved, regular poverty profile reports were expanded and are publicly available on the web-site of the SSM and in 2005, in a joint effort with the World Bank, the first ever absolute poverty figures for the country were published.

The SSO has given assurance that it will continue to improve its procedures and that it will include the absolute poverty calculations in its regular work plan.

However, less progress was made in the public access to actual micro-level datasets. A WB staff review of the legislation in 2003 revealed that there are no major obstacles to sharing individual level data for research purposes (provided all identifying characteristics are removed), the introduction of some new legislation may warrant a reassessment.


Annex 3: IFC in fYR Macedonia

I. FY04-06 IFC’s PROGRAM

To date, IFC has invested US$93 million in fYR Macedonia. As of December 2006, IFC’s committed portfolio was US$26.1 million and its outstanding portfolio was US$25.2 million. In the past, IFC financing include credit lines to Komercijalna Banka and Stopanska Banka and ProCredit Bank, two loans to a textiles company, Teteks, a loan to a pharmaceuticals company, Alkaloid, as well as financing a pre-privatization investment in Macedonian Telecommunications (now privatized).

What worked well?

During FY04-06, IFC was active in Advisory Services (IFC AS) operations. These operations have been in line with the priorities outlined in the CAS, focusing mainly on the SME sector and covering the areas of business enabling environment, access to finance, and value addition to firms (see Box 1). During the last two years, both the size and duration of IFC AS operations have increased to help strengthen the development of the private sector including in the infrastructure sector. Also, IFC has moved towards a more integrated approach combining FIAS’s activities with PEP SE activities (IFC’s advisory services facility operating in Southeast Europe). These advisory services have included the following:

Review of the administrative barriers to investment. This included a self-assessment exercise that was led by the Ministry of Economy and participation of the private sectors.

Survey of the administrative and regulatory costs reflected in the Doing Business 2005 report. The main economic obstacles for business operation and growth included economic and regulatory policy uncertainty, monopoly position and unfair competition, inadequate conflict resolution, and regulatory burden.

Administrative barriers implementation including: business registration reform; inputs on the Company Law; and preparation of the foundation for systemic regulatory reform to help reduce the cost and risk of doing business in fYR Macedonia.

Collaboration with the World Bank in designing the regulatory reform component of the Business Environment Reform and Institutional Strengthening project.

What didn’t work well?

During FY04-06, IFC made no direct investments in fYR Macedonia. The absence of IFC investment projects in the CAS period was the outcome of several unsuccessful attempts to generate investment business in the country. FYR Macedonia's business climate was not conducive to private investment, as reflected in the country's low Doing Business indicators, and particularly deterred FDI. At the same time, the mass privatization model that fYR Macedonia followed resulted in either widely dispersed ownership, where new owners adopted a rent-seeking mentality, lacked coherent development strategies, and in any case did not have funds to undertake investment projects, or in the control of privatized enterprises by interest groups of dubious reputation, that IFC could not do business with due to governance concerns. As a result, the opportunities in the real sector that IFC explored were ultimately dropped.


Similarly, IFC's attempts to approach the government with several infrastructure project concepts did not meet with the government's interest or support. Considering that IFC had already made investments in fYR Macedonia's two most prominent local banks prior to the CAS period, there was little opportunity to do more in the banking sector. IFC attempted to pursue a leasing project but it did not come to fruition.

However, IFC invested in four regional projects supporting countries in Southern Europe region, including in fYR Macedonia:

European Fund for Southeast Europe (EFSE), a collective debt investment vehicle that channels long-term resources for on-lending to micro-and-small businesses through banks, specialized microfinance institutions, and viable microfinance non-profit organizations;

Poteza Adriatic, a private equity fund that invests in equity and equity-related investments, through majority or significant minority stakes;

7L Capital, a private equity fund that makes equity and equity-related investments in companies, including in small and medium enterprises;

Mercator, a leading Slovenian retailer with operations in South Eastern Europe including in fYR Macedonia, which is expanding its hypermarket stores and supermarkets network.

Also, IFC is currently exploring several investment and advisory project possibilities, both in financial markets and real sector (SME, infrastructure, social sector).

II. FY07-09 IFC’S STRATEGIC PRIORITIES

IFC intends to focus on pillar 1 of the CPS enhancing fYR Macedonia’s competitiveness as a location for investment by:

Improving the business environment – reducing the costs and risks of doing business;

Enhancing competitiveness in strategic sectors of the economy and deepening the pool of domestic and foreign investors.

1. Improving Business Environment

According to 2006 Doing Business Report, fYR Macedonia’s overall “ease of doing business” ranking places it in the second tier of countries, number 92, significantly lagging behind Romania, Bulgaria, Serbia, and Montenegro in the region. With the exception of access to credit (ranking of 48), the rankings for all other indicators range from 72 to 127 with the poorest performance in customs, licensing, property registration and business exit. The World Economic Forum Competitiveness rankings also place fYR Macedonia in the bottom of the second tier worldwide and within South East Europe.

Therefore, in tandem with the Bank’s TA program, IFC will continue to play a strong role to improve the business environment in fYR Macedonia through its PEP-SE facility, focusing on:

Alternative Dispute Resolution (ADR) - mediation, as an alternative to formal court resolution of commercial disputes. Since 2004, IFC has been working to support legislation reform through the ADR Mediation Program in fYR Macedonia. Since then, a remarkable progress in enabling the environment for mediation introduction and


implementation has been made. With the Ministry of Justice being main partner, the law on Mediation was passed, as well as a by-law on the Training Program for Mediators. In addition, trainings for 60 mediators, 60 lawyers and 15 judges have been delivered, several round tables and one ADR Conference for promotion of usage of mediation has been organized, and extensive and far-reaching PR campaign has been undertaken. The next steps include establishment of a Pilot Mediation Center in cooperation with Skopje Primary courts, expansion of the public awareness campaign and continuation of the trainings for mediation practitioners and beneficiaries.

Recycling Linkages Project - development of the secondary material recycling industry in fYR Macedonia and the other countries in the Western Balkans. The project, managed by IFC, and focused on the financial, training, consulting, and market needs of every segment of the scrap metal, paper, plastic and glass value-chains. The objective is to promote Small and Medium Enterprise (SME) development in fYR Macedonia, increase the competitiveness of the recycling sector, and improve the lives of thousands of families who make their primary income by collecting scrap materials.

Corporate Governance - improve the internal corporate governance practices of the Macedonian firms, thus making them more attractive to potential investors. On June 14, 2006, IFC assisted the Macedonian Stock Exchange to launch the newly drafted Corporate Governance Code which is expected to become effective at the beginning of 2007. IFC is also working with Macedonian companies in order to help them improve their corporate governance standards and plans to start working with banks as well. In addition, IFC will collaborate with universities to teach corporate governance to students, so that they can apply best standards in their future jobs.

International and EU Standards - help Macedonian companies to meet international and EU technical requirements, which must be satisfied if domestic products are to be exported to international and EU markets. IFC has implemented a comprehensive Hazard Analysis of Critical Control Points (HACCP) program and has been working to help food-processing companies to implement HACCP and develop a local expertise able to undertake certification. HACCP Information Center has been established at the Skopje Agricultural Faculty.

Regulatory Reform - provide technical assistance on the guillotine review of the stock of business licensing and inspections regulations.

Industry competitiveness - value chain analyses for the agri-business, general manufacturing and services sectors starting with the agri-business. The goal of the regional value chain will be to assess the competitiveness of Bosnia and Herzegovina, fYR Macedonia, and Serbia in the context of CEFTA and the European Union, make recommendations for cross-cutting policy and regulatory reforms to enhance the competitiveness of the sector, and support firm-level technical assistance as well as investment activities of IFC and MIGA.

Sub-national Competitiveness - an integrated FIAS/PEP-SE program. The main elements of this project include:


o Better business regulation - focused on cleaning up the stock of licensing, inspections, and permit regulations as well as all administrative procedures affecting businesses on the municipal level.

o Simplification - in addition to reviewing the quality of regulations, the project will address specific administrative procedures for streamlining and simplification.

o Better service delivery - providing assistance in improving the quality of services provided to business. The primary mechanism for delivering services will be municipal one-stop shops. There will be a direct link with MIGA’s investment outreach and investment promotion capacity building on the sub-national level.

o Competitiveness indices – developing a system of rating the competitiveness of localities. This will draw on the experience of Peru, Romania and Vietnam where similar programs have been successfully implemented.

o Private investment and value addition to firms. This module will focus on capturing synergies with PEP-SE value addition to firms programs (e.g., standards, linkages) and MIGA programs to generate investment deals by identifying potential investors and providing information on specific localities.

2. Increasing Competitiveness

In the real sector, infrastructure, agribusiness, construction/real estate, retail and mining remain the top priority sectors for IFC. IFC is also well prepared to provide advice to the Macedonian government in its efforts to attract high quality FDIs in the privatization process of strategic sectors.

Infrastructure

IFC, jointly with the Bank and relevant authorities, will pursue opportunities to implement PPPs in the infrastructure sectors through PEP-SE Infrastructure or direct financing of private sector projects. IFC and the Bank will start preparing (in FY08) a joint policy note on concessions and public-private partnerships (PPPs) to help improve the environment for mobilizing private sector investments in infrastructure. Implementation of key recommendations of this analytical work would attract more private interest to invest in fYR’s Macedonia’s energy sector, and would enhance opportunities for IFC’s sequential involvement in helping structure and mobilize financing for pioneering infrastructure projects.

Working closely with the Bank, IFC will pursue investment opportunities in implementing PPPs in the gas distribution sector, depending on government’s progress with the privatization of the sector. However, opportunities in this sector remain limited given the outstanding issues on the ownership of the transmission pipe, small project scale (very few large towns justify such investments) and poor gas transmission infrastructure in the south. In addition, IFC will consider opportunities in financing mini- hydros in sizable packages.

In the Advisory Services, IFC will target a few things:

o Skopje municipality: Through its PEP-SE Infrastructure, IFC has already identified opportunities to advise local government for structuring PPP for a


concession for water and waste water services. Water and waste water sector needs significant restructuring (very high debt, overdue payables, etc, particularly for waste water). IFC can replicate its experience in other countries and more recently in Belgrade water project. However, the local government does not seem ready to move ahead in that direction.

o Transportation sector: (i) Skopje airport privatization: IFC has offered to the Macedonian government the privatization advisory services of PEP SE Infrastructure for the Privatization of Skopje Airport; (ii) In close coordination with the Bank IFC has been involved in discussions on structuring PPP for corridor 8 and corridor 10.

Corporate sector

SME and micro-enterprises is a significant segment of commercial activity and one of the largest contributions to employment in fYR Macedonia. Micro and small enterprises (MSEs) are estimated to account for around 90% of the total number of active enterprises in fYR Macedonia. Demand for micro-finance is driven by increasing self-employment and insufficient MSEs lending activity by local commercial banks. In the past, IFC has invested in ProCredit Bank, Skopje, representing a 19% ownership stake. IFC intends to continue supporting local banks with loans for on-lending to SMEs. In addition, IFC will directly support a few selected SME companies, which will help invert the tendency on credit risk perception without undermining but rather supporting a more disciplined lending culture in the banking sector.

IFC will work with regional private companies outside of fYR Macedonia to encourage their investments in fYR Macedonia. IFC expects to play an active role providing comfort to interested regional players coming from Turkey, Slovenia, Serbia, Bulgaria and Croatia as well as to international investors.

IFC will explore on capturing synergies with its PEP-SE value addition to firms programs (e.g., standards, linkages) to generate investment deals by identifying potential investors and providing information on specific localities.

Corporate Governance: IFC’s advisory services through PEP-SE has been working on the Corporate Governance code for listed companies on Macedonian Stock Exchange albeit small, in-company Corporate Governance consulting for SMEs, and public awareness campaign and capacity building to strengthen capacity of the business leaders, shareholders, regulators and other stakeholders on corporate governance issues.

Social Sector

In the education sector IFC’s strategy is to help strengthening private sector institutions with a strong track record of providing quality education. By providing long term financing, IFC would intend to demonstrate to other private education institutions and to the private sector in general, that capital is available for reputable institutions with high quality standards and professional management.

Financial sector

IFC will provide funding and TA to develop new products in the financial sector such as energy efficiency and support the development of housing, factoring and leasing. IFC


will continue to support commercial banks and micro-lending institutions with a focus on SMEs. IFC will also look for opportunities to facilitate banking sector consolidation through supporting the merger and acquisitions of the creditworthy institutions.

Box 1: IFC FY04-06 Advisory Services Projects in fYR Macedonia

Factoring Development Project - introducing and developing of factoring as a new financial instrument in the country. IFC has assessed the legal environment for initiating factoring operations in the country; tax and accounting treatment for factoring; commercial banks’ interest and capacity for introducing factoring as a new product along with the interest among companies in using this product.

Makstil Linkages Project - developing the capacity of the Macedonian scrap metal recycling industry value chain by providing: training to the SME recyclers and Makstil (one of fYR Macedonia’s largest companies, also among the regional leaders in steel and rolled steel products manufacturing); access to finance to SMEs involved in the scrap collection and processing; technical assistance to the recycler’s association (BMO) and need assessment studies for the supplier network (primarily Roma collectors).

Tikves Linkages Project: developing of the grapes supply chain in the Tikves region by providing training to the grape farmers in vineyard management best practices as well as by providing technical assistance to Tikves (the largest winery in fYR Macedonia and one of the largest in the region) in design of its grape delivery logistics, assessment of its retrenchment policies, developing new SMEs and seminar in retrenchment management

HACCP Certification Project - helping local food processing companies implement the Hazard Analysis of Critical Control Points (HACCP) certificate, an internationally recognized food safety methodology that defines the framework for hazard identification and control. In a country like fYR Macedonia, where the economy is traditionally reliant on food production and related industries, HACCP remains as one of the most important vehicles for local food companies to place their products in European Union markets.

Union of Private Chambers of Commerce (UCC) Capacity Building Project - enhancing the sustainability of the newly created Union of private chambers and building its advocacy and service capacity in order to help its SME membership promote and advocate their collective interests, including influencing the government’s decisions to create a favorable legal framework for SME sector.

Agency for Entrepreneurship Promotion (APE) Technical Assistance Project - capacity building of the SME Support Agency to help improve the business enabling environment in the country and reduce the burdens to private sector growth and development.

Capacity Building Program - supporting the growth and development of local Business Services Providers (BSPs) including mentoring and coaching of local consultants through a learning-by-doing process.

FYR MACEDONIAStatement of Committed and Outstanding Portfolio

As of 12/31/2006(in US Dollar Million)

Approval Fiscal Year

Institution Short Name

LNCmtd-

IFC

ET Cmtd-

IFC

QL+QE

Cmtd-IFC

AllCmtd-Part

LN Out Bal-IFC

ET Out-IFC

QL+QE

Out-IFC

AllOut-Part

1998 Macedonia Telcom 0.0 11.3 0.0 0.0 0.0 11.3 0.0 0.02003 ProCredit MCD 0.0 1.1 0.0 0.0 0.0 1.1 0.0 0.01999 SEAF Macedonia 0.0 0.5 0.0 0.0 0.0 0.0 0.0 0.01998/00/01/03 Stopanska Banka 0.0 10.5 0.0 0.0 0.0 10.3 0.0 0.01997/02 Teteks 2.6 0.0 0.0 0.0 2.5 0.0 0.0 0.0Total Portfolio: 2.6 23.5 0.0 0.0 2.5 22.7 0.0 0.0


Annex 4: MIGA Assistance Program and Guarantee Outstanding Exposure

Guarantees:

To date, MIGA has issued US$19.5 million in guarantee gross coverage in support of two projects in fYR Macedonia, one in the manufacturing sector and one in services. As of December 2006, MIGA has no outstanding contract of guarantee in fYR Macedonia.

Going forward, MIGA will be available to promote foreign direct investment into fYR Macedonia through the provision of political risk guarantees. The Agency will focus on priority areas aligned with the CPS. MIGA will consider supporting investments in the manufacturing, agribusiness and services sectors and will explore opportunities to use its Small Investment Program (SIP) to help promote small business development. MIGA will also be available to support projects in the financial sector and infrastructure.

MIGA expects to enhance its existing cooperation with the Slovene Export Corporation (SEC), the Slovene export credit agency, also by providing reinsurance. This will support the ability of SEC to promote investments of Slovene private companies in Southeast Europe, including in fYR Macedonia. Going forward, MIGA will seek similar opportunities to support the operations of national entities in the region.

Technical assistance:

MIGA’s technical assistance unit – merged into FIAS as of February 2007 – has undertaken a series of short term technical assistance interventions over the past several years, supporting the preparation of a new law for a Macedonian investment promotion agency and the establishment of the agency, MacInvest.

After the establishment of MacInvest in the fall of 2004, the Austrian Development Agency (ADA) agreed to fund a capacity building program designed to assist in the operational start-up of the agency and prepare it for a larger technical assistance project funded by the European Agency for Reconstruction. The first phase of the project involved the development of a business strategy, a detailed analysis of the country’s competitiveness for foreign investment in several key sectors and training for the agency’s staff, management and Board of Directors.

MIGA/FIAS has been in discussions with the new government concerning a possible follow-on technical assistance program, which would supplement the current EAR-funded activity which is scheduled to end in July 2007. In addition to further developing promotional capacity, this additional technical assistance should address the weaknesses in the current institutional framework for FDI promotion.

fYR Macedonia is also one of the seven beneficiary countries under the Invest in the Western Balkans Program (IIWB), formerly MIGA’s European Investor Outreach Program (EIOP). Under this donor-funded initiative, launched in 2004, MIGA/FIAS supports a number of countries in the Western Balkan region with regards to investor outreach and marketing, focusing on the European business community.


Guarantee ProgramMIGA Outstanding Exposure ($ million)As of end of fiscal year FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007

through 12/31/06Sectoral Distribution

Finance 0.0 0.0 0.0 0.0 0.0 0.0 0.0Infrastructure 0.0 0.0 0.0 0.0 0.0 0.0 0.0Mining 0.0 0.0 0.0 0.0 0.0 0.0 0.0Oil & Gas 0.0 0.0 0.0 0.0 0.0 0.0 0.0Agribusiness/Manufacturing/Services/Tourism 17.3 9.9 0.0 0.4 0.3 0.0 0.0

Total 17.3 9.9 0.0 0.4 0.3 0.0 0.0

MIGA's Risk ProfileTransfer Restriction 0.0 0.0 0.0 0.0 0.0 0.0 0.0Expropriation 0.0 0.0 0.0 0.0 0.0 0.0 0.0War & Civil Disturbance 17.3 9.9 0.0 0.0 0.0 0.0 0.0Breach of Contract 0.0 0.0 0.0 0.4 0.3 0.0 0.0

MIGA's Gross Exposure in Country 17.3 9.9 0.0 0.4 0.3 0.0 0.0% Share of MIGA's Gross Exposure 0.3% 0.2% 0.0% 0.01% 0.01% 0.0% 0.0%

MIGA Net Exposure in Country 17.3 9.9 0.0 0.3 0.3 0.0 0.0% Share of MIGA's Net Exposure 0.5% 0.3% 0.0% 0.01% 0.01% 0.0% 0.0%


Annex 5: CPS Consultations and Outreach

CONSULTATIONS AND OUTREACH

Extensive consultations underpinned the preparation of the CPS. Internally, the whole country team has been actively involved in the preparation of the strategy including IFC and MIGA members of the team. Early consultations begun in November 2005, when the members of the country team got together for two day retreat in fYR Macedonia and, jointly with the then Minister of Finance and Deputy PM for EU Integration, discussed the development priorities of the country and the general framework of the Country Partnership Strategy.

Consultations with the political opposition on the CPS program took place in the first half of 2006. With the parliamentary elections concluded in July 2006, these consultations were critical to ensure that the support program is focused on national priorities and has the support of all stakeholders. Despite the differences in party platforms during the election campaign, the consultations demonstrated wide consensus on the priorities related to economic growth and EU accession. Both the ruling and the opposition parties stressed on the importance of focusing the new program on economic development, creation of jobs and investment promotion.

In fYR Macedonia, the Country Office has embarked on focused consultations with stakeholders. The team started the consultation process by preparation and completion of a Client Survey in May 2006. Some 270 stakeholders from government, parliament, civil society, private sector, media and academic institutions responded to the questionnaire. The results clearly show overall endorsement of the priority areas of the Bank and its effectiveness in delivering the support. Draft CPS was presented through a separate section on the Country Office web site, which has been established to ensure wider participation of all stakeholders in the CPS preparation.

The Deputy Prime Minister for Economic Affairs formed a CPS government counterpart team to guide the preparation of the strategy. The Bank and the government teams conducted a review of Bank operations in fYR Macedonia, their effectiveness as well as the lessons drawn from the decade of Bank support. They reviewed government’s challenges and priorities as per the Work program presented in the Parliament in September 2006. The government team discussed and prioritized the draft CPS program as presented by the Bank. The list of programs and projects has been jointly finalized at the beginning of December. The government fully endorses the CPS program.

Four workshops were organized in different parts of the country (Tetovo, Kumanovo, Strumica and Bitola) for representatives of local governments, private sector and civil society organizations in the respective regions. The priorities identified by participants include: (i) organized marketing of the agricultural products and education of farmers; (ii) school renovations and organization of vocational trainings; (iii) improvement of road infrastructure; (iv) completion and equipment of the regional Health Care Centers; (v) gasification, investments in small hydro power plants and usage of the geothermal waters; (vi) support of the small and medium enterprises. The participants also stressed the importance of more direct support to local


government, increased support to urban and rural infrastructure, greater emphasis on job creation and strengthening of administrative capacities of local government.

Specific consultations were organized for donors for the CPS priorities and donor coordination. On October 4, 2006, a so called “Macedonia Coordination Day” was organized in Brussels between members of the country team and representatives of the European Commission. The purpose of the meeting was to present the draft goals and program of the CPS and to involve the Commission early on into the design, thereby coordinating Bank’s assistance with those of EU. Coordination efforts continued during the remaining of the CPS preparation period through meetings of the Bank’s management and teams with the other donors. All donors appreciated the role of the Bank in supporting the process of socioeconomic development in fYR Macedonia. They agreed on the importance of selectivity, complementarity and information sharing to avoid duplication of efforts and wasting financial resources.

The Country Office will continue to expand its outreach and communication to strengthen partnerships in the implementation of the new CPS. Communication tools include, but are not limited to the Country Office web site, visits of which expanded tremendously in the last year, Public Information Center (PIC) and Depository Libraries located at the Faculty of Economics, University of Skopje and at the South East European University in Tetovo. An agreement to establish affiliations with the Global Distance Learning Network (GDLN) was concluded between the Bank and the British Council. The Bank will also continue to support civil society activities through the small grant program as well as through direct involvement in project preparation and monitoring.

PARTNERSHIPS

In addition to building strong partnership with Macedonian stakeholders, the Bank has built effective partnerships with development partners and donor organizations active in fYR Macedonia, mainly through the country office. The European Commission (EC), Netherlands Embassy, USAID and UN are the Bank’s key multilateral partners in fYR Macedonia with shared responsibilities in donor coordination. As the pace of Macedonian integration with the European Union accelerated, the Bank has started to coordinate most of its activities with the European Commission both in fYR Macedonia and in Brussels and specific meetings for CPS preparations have been undertaken to ensure better alignment of the CPS with the acquis. The relations with the IMF have been very effective and strong in the area of public financing and structural reforms. The Bank also works closely with the Netherlands and Swedish authorities and has co-financed a number of projects and programs with them.


Annex 6: Donor Assistance to fYR Macedonia by Program

EU

EB

RD

EIB

US

AID

Net

herla

nds

Sw

eden

Aus

tria

Sw

itzer

land

Ger

man

y

UK

UN

DP

UN

ICE

F

WH

O

FAO

1. Economic growth, private sector development, business environment Banking X X X Finance X X X X SME X X X X X X X X X Investment promotion X X X X X Competitiveness X X X X Judicial reforms X X X X Property rights X X X 2. Public sector Reform, Governance, MacroeconomyPublic administration X X X X X X Governance X X X X X X X Decentralization X X X X X X X X Tax administration X X Macro support X Statistics X 3. Infrastructure/EnergyRoads X X X X Energy X X X X X X Railways Water X X X X X X X Tourism X X 4. Agriculture/Natural ResourcesAgriculture X X X X X X XEnvironment X X X X X X X X XForestry X 5. Human DevelopmentEducation X X X X X X Health X X X X Social protection/pensions X X X X


Annex 7: FYR Macedonia Country Financing Parameters

Date: April 7, 2005

The country financing parameters for the former Yugoslav Republic of Macedonia set out below have been approved by the Regional Vice President, Europe and Central Asia, and are being posted on the Bank’s internal website.

Item Parameter

Remarks / Explanation

Cost sharing. Limit on the proportion of individual project costs that the Bank may finance

Up to 100%

The Bank will still encourage cost sharing as a demonstration of ownership. While in some rare cases, Bank financing could be increased up to 100 percent, this increase may be differentiated by government level and sector. The actual cost sharing percentage would be determined during project preparation on a case-by-case basis. The experience so far indicates that the Bank’s financing share may be higher in the social sectors and lower in the infrastructure and energy sectors.

Recurrent cost financing. Any limits that would apply to the overall amount of recurrent expenditures that the Bank may finance

No country level limit

In determining Bank financing of recurrent costs in individual projects, the Bank would take into account sustainability issues at the sector and project level, including the sustainability of project outcomes, and implied future budgetary outlays. The Bank would also continue to monitor the country’s aggregate fiscal position and prospects, and its implications for recurrent cost financing.

Local cost financing. Are the requirements for Bank financing of local expenditures met, namely that: (i) financing requirements for the country’s development program would exceed the public sector’s own resources (e.g., from taxation and other revenues) and expected domestic borrowing; and (ii) the financing of foreign expenditures alone would not enable the Bank to assist in the financing of individual projects

Yes Under the new policy, foreign and local expenditures will be treated in the same way with regard to Bank financing. This approach should provide greater flexibility and reduce the administrative burden for project implementation. The Bank may finance local costs as required in individual projects.

Taxes and duties. Are there any taxes and duties that the Bank would not finance

None The Bank may finance taxes and duties as long as they are reasonable and non-discriminatory. As of December 2004, there are no taxes or duties that the Bank would not finance. At the project-level, the Bank would consider whether taxes and duties constitute an excessively high share of project costs. The proposed financing of taxes and duties will facilitate efficient project implementation.


Annex 8: FYR Macedonia’s Relations with the EU

Since 1991, successive Macedonian governments have placed the prospect of European integration at the top of their agendas. Integration in the EU has been the one of few subjects on which all political parties have reached a consensus. Since 2001, relations between fYR Macedonia and the European Union (EU) have been developing in the context of the Stabilization and Association process (SAp). The SAp is a framework in which a new contractual relationship (Stabilization and Association Agreements) and an assistance program (CARDS) help each country in the Western Balkans to progress, at its own pace towards EU membership.19

The idea of a SAp as a tool of anchoring the countries from the Western Balkans towards the EU was born at the Zagreb Summit in November 2000, after the Feira Council of June 2000 that addressed the future of the Balkans countries is in Europe.20 In Zagreb, the Western Balkan countries made a pledge to abide by the EU rules and conditionality, receiving in return the prospect for EU accession based on the Treaty of the European Union (TEU) and the Copenhagen criteria as well as on assistance program to promote and support this ambition.21

The countries of the Western Balkans also agreed that, when signed, the Stabilization and Association Agreements (SAAs) would be the principal means to begin preparing themselves for the demands that the prospect of accession to the EU entails.22 In addition, the countries agreed (once they meet the necessary rules and conditions) to receive financial assistance (CARDS). CARDS would focus on supporting necessary reforms and institution building to facilitate approximation with the EU. FYR Macedonia was the first of the countries of Western Balkans to sign the SAA in 2001.

Relations between the European Union and fYR Macedonia have evolved progressively over the years. On December 16, 2005, the European Council granted candidate country status to fYR Macedonia. The Council made this decision on the basis of the substantial progress made in completing the legislative framework related to the Ohrid Framework Agreement, as well as Macedonia's track record in implementing the Stabilization and Association Agreement. While no date to open actual negotiations is specified, the EU perspective is a very positive element in the reaching agreements across ethnic boundaries of the country, crucial against the backdrop of the Kosovo discussions.

19 European Community CARDS Programme - Albania Country Strategy Paper, 30 November 2001.20 The European Council in Feira confirmed that its objective remained fullest possible integration of the countries in the region into the political and economic mainstream of Europe through the SAp, political dialogue, liberalization of trade and cooperation in Justice and Home Affairs. http://www.euoparl.eu.int/summits/fei1_en.htm.21 The European Council in Copenhagen 1993 spelled out the Copenhagen criteria, by which candidate countries would be judged for accession on: (i) stability of institutions guaranteeing democracy, the rule of law, human rights and respect for and protection of minorities; (ii) existence of a functioning market economy, as well as capacity to cope with competitive pressure and market forces within the EU; and (iii) ability to take on obligations of membership, including adherence to the aims of political, economic and monetary union – i.e. the acquis communautaire. 22 Engineered similarly to the Europe Agreements that were signed between the EU and the 10 countries of Central and Eastern Europe at the beginning of 1990s, the SAAs focus on respect for democratic principles and integration of the countries of the region into the EU single market. They foresee the establishment of a free trade area with the EU and set out rights and obligations in areas such as competition and state aid rules, intellectual property and establishment, which will allow the economies of the region to begin to integrate with the EU. The conclusion of such Agreements represents the signatories’ commitment to complete over a transition period a formal association with the EU, tailored to the circumstances of each country but based on the implementation of the same core obligations.

http://www.euoparl.eu.int/summits/fei1_en.htm


On November 8, 2006 the European Commission (EC) published the first Progress Report of fYR Macedonia with regard to its preparation for EU membership, as part of the “Enlargement package” the EU prepares annually. The EC Progress Report outlines the progress fYR Macedonia made in adhering to the EU accession criteria (as outlined in the Analytical Report published by the EC on November 9, 2005 from October 1, 2005 until September 30, 2006. The Analytical report describes the situation in the country in relation to the EU accession criteria i.e. the progress fYR Macedonia made in adhering to this criteria.

Measuring the progress

EC measures the progress though all activities undertaken by the state to fulfill membership criteria: adoption of primary and secondary legislation and its implementation. The report is prepared based on the information available to the EC, contributed by the government and other partners. Findings are divided into three chapters: (i) political criteria, (ii) economic criteria and (iii) capacity to take over membership obligations.

Political criteria

Political criteria are divided into three sub-groups: a) Democracy and rule of law, b) Human and minority rights and c) Regional cooperation and international obligations.

Under Democracy and rule of law, the report describes the progress of the work of the parliament, government, judiciary and public administration, as well as the progress in the fight against corruption. A significant part is devoted to the electoral process, which is listed as one of the five key priorities for EU membership. The report states that changes in the electoral legislation were appropriate and enabled satisfactory elections, according to international standards. EC’s assessment is that the elections have passed in a generally peaceful atmosphere, with certain irregularities on the day of the elections. EC recommends putting maximum effort into adhering to international standards for the next elections. As for the post-election process and the formation of the new government, EC points at the need to decrease tensions between the ruling parties and the opposition, and especially the ethnic Albanian political parties (DUI-PDP). It is crucial for the economic stability that the government tries to reach consensus for the key reforms, especially for those related to the implementation of the Ohrid Framework Agreement and other areas that need two-thirds majority of votes in the Parliament (Badinter principle). It is also emphasized that the opposition should be constructive in its role. In order to achieve the desired political consensus, it is urgently needed that effective communication channels are established between the ruling parties and the opposition.

The report devotes special attention to judicial reforms. Establishing an independent and efficient judiciary is one of the five key priorities of the European partnership. The report positively assesses the 2005/2006 constitutional changes as pre-condition for establishment of independent judiciary, as well as adoption of laws related to the judiciary (Law on Courts, Law on Administrative Disputes, Misdemeanor Law, etc.). Certainly, the implementation of these laws will be the key. The EC stresses that fYR Macedonia makes significant progress in adopting the laws, but that the implementation often lags behind.

The Commission notes that there is a progress in public administration management through adoption of several laws from this area (e.g., the Law on access to information), as well as the


further implementation of the Civil Service Law. Of special importance is the Law on Police (also one of the key criteria of the European partnership), but the delay in its adoption has made the decentralization of the police impossible. The EC pays special attention to the implementation of this law, and stresses that an increased cooperation between the ruling parties and the opposition is needed to achieve it. The increased authority given to the Public Attorney is commended, with a caveat that strengthened cooperation with the Ministry of Internal Affairs is needed. A negative assessment is given to the massive replacements in the public administration following the elections, since this practice conflicts with the aim to depoliticize the public administration.

The report clearly states that, although there is progress, corruption is still widely spread in the society. The few sentences and fines (in the customs, judiciary and Public Revenue Office) are insufficient to diminish the problem, which means that more effort is needed to strengthen the institutions, increase transparency and implement laws.

In the area of Human and minority rights, a positive assessment is given to the strengthened freedom of expression law, the abolishment of the obligatory detention (through changes in the criminal procedures), and to the strengthened internal controls at the Ministry of Internal Affairs. The situation regarding minority rights has also improved: the number of persons employed in the public administration who belong to the ethnic minorities and the number of minority university students has increased. However, the report states that little progress has been made with regard to solving issues related to the Roma community an that the efforts for implementation of the National Strategy for Roma need to be intensified.

European Commission positively assesses the active participation of fYR Macedonia with regard to Regional cooperation (CEFTA, Stability Pact, etc.). The progress report commends the government for its constructive role during the Kosovo talks, as well as the progress the country made in developing the relations with the neighbors.

Economic criteria

The two economic criteria for membership are: existence of functional market economy and capacity to compete at the EU market. In the year covered by the report, fYR Macedonia made a great stride towards functional market economy. There is a general consensus on the basics of the economic policy, the macroeconomic situation is stable, and there is a moderate GDP growth. Specific progress has been made with shortening the time needed to register a company by introducing one-stop-shop system (another key priority of the European partnership). The government has continued with the privatization of the remaining few state owned enterprises. Areas still impeding full functioning of the market economy relate to disfunctioning rule of law and lack of legal certainty, insufficient guarantee over the security of tenure and disparities in the labor market. The Commission has positively assessed the development of the financial sector (which is still lagging behind compared to other candidate countries), the high level of trade interaction with the Union and the increased flexibility of the labor market. Areas where the progress is stale are: the implementation of the bankruptcy law, low level of investments, slow resolution of court cases and inefficiency in solving the problem of the indirect state aid (i.e. some companies do not pay taxes and social contributions).


Capacity to take over membership commitments

This chapter of the Progress Report describes the progress in approximation of the national legislation towards the European one, acquis communautaire, which is divided into 33 chapters. The progress is followed through the approximation of legislation, but also through the implementation of laws and capacities of the institutions to fulfill their commitments. The progress on the 33 chapters over the reporting period has been uneven. Significant progress has been made in some areas, such as customs, public procurement, business legislation, while other, such as intellectual property, telecommunications and state aid are lagging behind. In some areas, such as the agriculture and environment, although a progress has been made, the country is still behind. It is therefore of special importance to give greater priority to these areas.

The analysis of the progress on certain chapters leads to a conclusion that fYR Macedonia’s institutional capacity is quite uneven; most progress has been achieved in areas with stronger institutional capacity. Another key conclusion of the report is that the progress is significant when it comes to adopting primary and secondary legislation, but that the implementation often lags behind. The European Commission believes that enhanced efforts should be put into increasing the implementation capacity.

Conclusion

The Progress Report states that progress has been made during the previous 12 months with regard to the membership criteria. The focus of the reforms has been on realizing the key priorities of the European Partnership, fulfillment of the commitment of the Stabilization and Association Agreement (SAA) and addressing the problems identified in the analytical report of the Opinion for membership. Four out of five key criteria for EU Partnership have been fulfilled. The only area where progress has not been sufficient is the telecommunication sector. With regard to the political criteria, most of the positive marks were given to the initiated reforms in the judiciary and the parliamentary elections. Respect of minority rights remains at high level, while the decentralization process is developing satisfactorily. Further strengthening of the public administration is necessary to adapt the legislation and the institutions to acquis communautaire. FYR Macedonia continues to demonstrate macroeconomic stability and economic growth, but does not have a functioning market economy because of the insufficient legal certainty and rule of law. The progress on individual chapters of acquis communautaire is uneven; considerable legislation has been adopted, but the implementation pace is slow.

The most important conclusion of the Progress Report is that the progress that fYR Macedonia made so far is insufficient for the EC to propose start of membership negotiations. The start of negotiations will depend on the reforms that are going to be implemented in the forthcoming period and consequently will be reviewed in the 2007 Progress Report, expected in November 2007.


Annex 9: Governance Activities in World Bank Program

Sectors Governance Outcomes and Trends WBG Program to Address WeaknessesTransportation

- Poor governance structure with multiple government bodies that don’t communicate.

TTFSE II Project Preparation Steering Committee established to improve coordination

Customs/Border Crossings

- Potential for rent-seeking by border agency inspectors; Inefficient procedures hinder firms; - Border crossing times have fallen; Transparency has improved; Unofficial payments have declined dramatically.

Build on progress; further strengthening of transparency through EDI based trade and transport data harmonization and monitoring.

Roads - Institutional weaknesses, including the lack of transparency in road management responsibilities, result in increasing backlog in road maintenance- Poor financial oversight of toll collections results in an estimated “leakage” of Euros 7 million per year.

Support strengthening of road sector management and priority programming. Modernization of toll collection system will reduce opportunities for fraud and corruption.

Railways Institutional deficiencies constrain strengthening financial viability, productivity, and effectiveness of railway operations.

Railways Reform Project is working to establish separate accounting for its key functional areas and create appropriate regulatory and institutional environment for multiple operator market.

Business Licensing, Inspections, and Other Regulations

- Inefficient and non-transparent procedures, poor accountability and transparency of public institutions have resulted in significant barrier to business entry, operations and exit and considerable opportunity for rent-seeking;- The implementation of a “One-stop shop system” has significantly reduced opportunity for unofficial payments and discretionary and arbitrary decisions; - A “regulatory guillotine” is underway to eliminate those business regulations that are unnecessary or without a legal ground; the government has decided to introduce a regulatory impact assessment (RIA) system to ensure business friendly new regulations, a more transparent rule making process for new regulations, and increased accountability of relevant public sector entities; - Bankruptcy trustees had incentives to drag out cases.

Build on progress; further strengthening of transparency and monitoring;The BERIS and PDPL are supporting design and implementation of regulatory reform, including “regulatory guillotine” and RIA system as well as measures to improve business access to information and regulations;Supporting implementation of the new Bankruptcy Law in PDPL and Judicial Project..

Banking Governance

- Poor accountability of bank management and boards, and opacity of the ownership structure of certain banks reduce the ability of the banking supervisor to oversee the banking sector, including implementation of rigorous board member fit and proper rules; - The enforcement toolkit does not provide the supervisor with adequate and clear authorities to address board members, take important remedial actions, impose financial penalties, or enforce accurate financial statement and corporate

PDPL is supporting the gradual migration towards a more risk-based supervisory approach that would – inter alia - allow the NBRM to hold bank boards, controlling shareholders, and management increasingly responsible and accountable for the safe and sound operations of their banks.

In close coordination with the IMF, the Bank has provided technical and policy advice for the upgrade of the legal framework for


transparency; -The Banking Law and the NBRM law are being strengthened to – inter alia - better define and elevate the responsibility of bank boards and provide the supervisor with the necessary tools to harness market discipline as a key pillar in promoting and enforcing strong governance.

banking.

Insurance governance regulation

- There is practically no supervision of insurance companies. Poor governance structure of the existing regulator results in poor accountability and transparency of insurance companies, uncertainty about their financial solvency and, ultimately, weak protection of policyholders’ rights. - The government has recently decided to create an independent supervisory agency outside the Ministry of Finance

PDPL support for establishment and operations of an independent insurance supervisor and implementation of a plan to build supervisory capacity.The Bank has provided technical and policy advice for the upgrade of the legal, institutional and regulatory framework for insurance, including advice on governance arrangements for the new insurance supervisor.

Judicial System

- Inefficiency of the system creates incentives for corruption; Politicization in the selection and disciplining of judges.

Support major re-organization of the judiciary; strengthen administrative capacity.

Agriculture Lack of transparency and predictability of policy hinders progress; rent-seeking in agricultural inspections.

Creating capacity to design and monitor policy; Improving reporting systems and administrative structure for agricultural inspectors.

Health Poor governance structure in the Health Insurance Fund; Closed pharmaceutical market closely linked to political actors; Rampant conflicts of interest and poor financial controls; Unofficial payments for health care.

Restructure of HIF Board, change selection process and introduce Board training;Promote use of revised positive drug list, international competitive bidding;Introduce “four-eyes” principle, requiring both medical and economic input into key decisions;Introduce basic benefits package and address co-payment policy.

Education - Policy making not guided by data on achievement- Reports of unofficial payments for admission to higher education

Strengthening the demand side for governance by supporting school governance structures that include parent participation;Supporting comprehensive student assessment and testing.Strengthening transparency of testing and admission to tertiary education.

Energy Governance structure establishing separation of provision with regulation still emergent; result is poor payment discipline.

Policy based advice to strengthen payment discipline.

Land administration

Uncertainty of real property rights; Unofficial payments for official registrations or even to receive information are not unusual.

Projects in the real estate cadastre and in land administration to improve transparency in registration.

Municipal finance and management

Information on municipal performance (revenues and expenditures, including capital investments, and service delivery) not monitored by or for municipalities, contributing to lack of incentives for improved management, weak communications with constituents, lack of “downward accountability”.

Municipal Development (MD) project (FY09) to introduce good practices in performance monitoring on sustainable basis to promote better incentives and trust in local government, and permit benchmarking.

Communal services

Unclear and conflicting institutional framework discourages commercial orientation of CSEs and

MD project to support reforms in policy environment for CSEs to improve their


(municipal) enterprises(CSEs)

removes possible incentives for PPP; lack of arm’s-length regulation permits political interference by municipalities.

incentives for commercialized management and clarify regulatory relationship with municipalities, including possibly through changes in legislative framework for potential PPP


Annex 10: EU Partnership Priorities and World Bank Assistance

FYR Macedonia is a candidate for European Union membership since December 15, 2005, when the European Council decided to grant candidate status to the country in recognition of its achievements in the reform process. The decision was taken on the basis of the positive Opinion of the European Commission on the application of fYR Macedonia for EU membership, released on November 9, 2005. Opening of accession negotiations will be subject to the country’s further progress in meeting the membership criteria, as set by the Copenhagen European Council of 1993 (Copenhagen criteria):

- stability of institutions guaranteeing democracy, the rule of law, human rights and respect for and protection of minorities;- the existence of a functioning market economy, as well as the capacity to cope with competitive pressure and market forces within the

Union;- the ability to take on the obligations of membership, including adherence to the aims of political, economic and monetary union.

The Union’s capacity to absorb new members, while maintaining the momentum of European integration, is also an important consideration in the general interest of both the Union and the candidate countries.

As part of the Enlargement process and the Stabilization and Association process with the countries of the Western Balkans, the European Commission prepares, and the Council approves, European Partnerships with candidates and prospective candidates for EU membership. The latest European Partnership with fYR Macedonia was proposed by the European Commission on November 9, 2005 and approved by the Council in January 2006. The document identifies priorities which the country needs to address in preparing for the opening of EU membership negotiations.

The European Partnership is meant to help fYR Macedonia’s government to concentrate reform efforts and available resources where they are most needed (in the short to medium-term).

EC PRIORITIES

(as per COUNCIL DECISION on the Principles, Priorities and Conditions Contained in the European Partnership with fYR Macedonia,

SEC(2005) 1425}, presented by the Commission)

WORLD BANK AGENDA

TO ASSIST FYR MACEDONIA

IN THE EU INTEGRATION PROCESS

Medium-Term Priorities (to be accomplished within 3 to 4 years)POLITICAL CRITERIA

DEMOCRACY AND THE RULE OF LAWPublic administration

http://europa.eu.int/eur-lex/lex/LexUriServ/site/en/oj/2006/l_035/l_03520060207en00570072.pdf

http://ec.europa.eu/comm/enlargement/report_2005/pdf/package_v/com_562_final_en_opinion_fyrom.pdf


Further develop the capacity of the administration to implement the Stabilization and Association Agreement.

The overall assistance program of the World Bank, as well as the way Bank projects are developed, involve all interested stakeholders, including the civil society (NGOs, academia, media, etc.) starting from the earliest phases of the project identification all through the supervision of the implementation and closing of the projects. The Bank undertakes consultations in the preparation of strategies and programs, in order to gauge the views of all stakeholders on possible avenues of assistance.

Further promote the active participation of civil society, including the social partners, in decision-making processes.

Judicial system

Complete the implementation of the Strategy and Action Plan on Judicial Reform. Ensure the independence and efficiency of the judiciary.

Ongoing lending:

In conjunction with the PDPL Program, the Legal and Judicial Implementation and Institutional Support Project (LJIIS), (FY06) will strengthen the capacity of key institutions to implement selected reforms under the Judicial Reform Strategy. The objective of the LJIIS Project is to contribute to improving judicial efficiency and effectiveness and the business climate in fYR Macedonia by: (i) enhancing ministerial and judicial capacity to systemically implement the Government’s Judicial Reform Strategy and key laws; and (ii) improving judicial infrastructure. By strengthening the capacity of key institutions in the justice system, the Project will support the implementation of the proposed Law on the Judicial Council, the new Bankruptcy Law and the new legal framework for administrative disputes. The Project will support the implementation of the new Law on Courts by supporting the construction and rehabilitation of courthouses in fYR Macedonia. The Project will also help to strengthen the supply and analysis of statistical and other information for the management and functioning of the justice system. Planned lending:Given the long term nature of addressing these issues, a follow-on of this project is proposed in FY10. The scope and objectives of this operation will be determined in due course.

Reach tangible results in improving the functioning of the judiciary, increasing the rate of execution of civil cases.

Further develop the Training Academy for judges and prosecutors

Further develop the capacity of the judicial system to deal with organized and economic crime.

Provide adequate equipment and IT support to courts.

Anti corruption policy

http://www.worldbank.org.mk/external/default/main?pagePK=64027221&piPK=64027220&theSitePK=304473&menuPK=304507&Projectid=P089859


http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2005/10/14/000090341_20051014112029/Rendered/PDF/33494.pdf


Further implement the strategy for the fight against corruption and enhance awareness-raising initiatives in the administration and among the public at large. Ensure the effective implementation of measures and legislation adopted to fight corruption.

Planned lending:Through the DPL program and selected sector work (programmatic PERs and poverty assessments, as well as the CFA (FY07)), the Bank will continue to support the efficient and transparent use of public resources. Furthermore specific attention will be given to improve governance aspects in all sector interventions included in the strategy. For the CPS 2007-2010, the WBG will support building of quality institutional capacity to improve the transparency and regulatory capacity of governmental structures in all areas included in the strategy. The WBG will support fYR Macedonia in its efforts to (i) continue reducing the legal uncertainty and lack of confidence in the judicial system; (ii) apply proper public finance principles and governance standards at the municipal level, including to municipal public enterprises and utility companies; (iii) continue improving the use of public resources and performance monitoring in the provision of affordable and quality health services; and (iv) develop more targeted cash transfer systems and introduce incentives to encourage school enrollment and preventive health.

Develop a methodology and operate a system for collecting and sharing intelligence and for mutual access to databases.

Ohrid Framework Agreement

Complete the decentralization process and further implement the strategy on equitable representation of minorities in the public administration and public enterprises.

The Bank is not directly involved in the strategy on equitable representation of minorities in the public administration and public enterprises. However, a number of ongoing and planned Bank operations are facilitating the decentralization process:

Ongoing AAA:The World Bank’s Municipal Development Note (FY07) looks at municipal financial management, provision of communal services, urban planning and management of urban land use.

Ongoing lending:The decentralization process is assisted through the PDPLs (FY06-09)as well as through the Education Modernization Project (FY04-FY10), which seeks to establish sustainable institutional arrangements and capacities at central and local levels to run the education system effectively and efficiently.



Planned lending:The proposed Urban Development project (FY09) aims to support fYR Macedonia by addressing needed improvements in the performance of urban economies and the quality of urban governance, through components addressing sustainable municipal financing, municipal service delivery, urban planning and/or land management.

HUMAN RIGHTS AND THE PROTECTION OF MINORITIES

Further promote respect for human rights by law enforcement bodies and in detention centers and prisons. No immediate World Bank engagement.

ECONOMIC CRITERIA

Further improve the business environment. In particular, complete the registration of all land and real estate as well as the related strengthening of the cadastre. Ensure the enforcement of creditors’ rights within a transparent legal framework. Further improve conditions for investors.

The WBG will support the governments’ ambitious goals on accelerated growth and job creation through an integrated and multi faceted program. This will encompass both the demand for and the supply of labor in fYR Macedonia. Under this pillar, the WBG will aim to

(i) maintain macro economic stability, while ensuring proper integration of EU priorities into the budget - PDPL3, PER;

(ii) strengthen the investment climate, including regulatory reform and proper enforcement of contract and creditor rights - PDPL, BERIS, LJIIS, IFC, MIGA);

(iii) reduce the costs of capital - FSAP Update, PDPLs, REPARIS, IFC, MIGA);

(iv) improve enterprise sector’s competitiveness - PDPLs, Competitiveness/Technological Change/Higher Education project (FY08),

(v) improve agricultural competitiveness - Agricultural and Rural Development Cohesion project (FY07), Transport project (FY09);

(vi) establish a functioning land market and institutions - RECRP, Urban Development project (FY09), Land

Improve the quality of governance while maintaining sound public finances.

Take steps to integrate the informal sector into the formal economy, particularly in order to fully include employed persons into the social security system and to eliminate unfair competition from unregistered companies.

Promote structural change and the diversification of economic activities, with a view to better realising the country’s comparative advantages.

Pursue regional economic integration. Modernise transport and communication infrastructure. Extend the country’s trade integration with the region.


Management 2 project (FY10); (vii) invest selectively in energy and transport infrastructure

for growth - Railways Reform project (FY05), ECSEE APL3 (FY06), GEF Sustainable Energy project (FY07), National Energy Strategy (FY08), Energy Project (FY09) TTFSE II (FY07), Transport project (FY09);

(viii) remove rigidities in labor market regulations and reduce the labor tax wedge - PDPLs, CEM (FY08);

(ix) develop a productive and appropriately skilled labor force Education Modernization Project (FY04), Competitiveness/Technological Change/Tertiary Education project (FY08)

(x) MIGA will be available to provide political risk guarantees and will consider supporting investments in the manufacturing, agribusiness and services sectors and will explore opportunities to use its Small Investment Program (SIP) to help promote small business development.

Decrease the relatively high share of unproductive expenditure while increasing funding for education, infrastructure and research and development.

Modernize the educational system. Align the quality of the educational system with European standards. Modernize the curricula of secondary and university education. Step up efforts to create a modern vocational education and training system.

Increase administrative capacity with respect to tax collection and expenditure control. Increase internal control and audit standards.

ABILITY TO ASSUME THE OBLIGATIONS OF MEMBERSHIPFree movement of goods

Speed up efforts to become a full member of CEN and CENELEC and of the European Telecommunications Standards Institute (ETSI). Guarantee an appropriate staffing level at the Institute for Standardisation.

Ongoing lending:

Business Environment Reform and Institutional Strengthening project (BERIS), (FY05-FY10) will help to modernize the national metrology infrastructure; strengthen the capacity of MSTQ institutions to carry out their mandate in EU oriented environment; increase business sector awareness of the challenges and opportunities of competing in the EU market; and assist in drafting a development strategy, including reviewing the institutional and legislative framework, to bring the country closer to EU requirements.

In conjunction with the PDPL Program (FY06-09), BERIS will assist the country to strengthen its capacity to implement an EU compliant competition policy regime by (i) strengthening the capacity of the CPC and the State Aid unit and its commissioners to implement a competition policy regime in line with acquis communautaire; (ii)

Strengthen the administrative capacity needed for effective market surveillance.

Introduce mutual recognition clauses into the legislation.




strengthening the capacity of the Ministry of economy to design and implement industrial policy measures in line with EU requirements; (iii) increasing the public awareness of competition policy issues, including the functioning of state aid among relevant stakeholders; and (iv) providing training for relevant stakeholders in competition policy, the competition law and state aid regime.

Freedom of movement for workers

Develop sufficient administrative capacity to implement the Community rules on the co-ordination of social security schemes. No immediate World Bank engagement.

Right of establishment and freedom to provide services

Adopt legislation for the recognition of foreign professional qualifications and create administrative structures and procedures for this purpose. No immediate World Bank engagement.

Adopt a postal policy based on the Postal Directives, including the establishment of an independent national regulatory authority in the field of postal services

Company law

Ensure high standards in the audit profession. Ongoing TA:REPARIS aims to train senior civil servants, financial sector regulators and accounting and auditing bodies in emerging issues and new trends in both EU and global requirements impacting on the regulation of accounting and auditing in participating countries.

Ongoing lending:

Within the PDPL Program (FY06-09), the Bank assists the government in the adoption of a modern regulatory and institutional framework for the Audit profession. PDPL 1 (FY06) supported the adoption of the new Audit law, while PDPL 2 will support the establishment of the Institute of Certified Auditors. Further revisions to the Audit Law may be needed to align it with EU requirements.


http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/EXTECAREPARIS/0,,contentMDK:20737951~menuPK:1869794~pagePK:64168445~piPK:64168309~theSitePK:1869769,00.html


Competition

Further improve the enforcement record in the areas of anti-trust and State aid control.

Ongoing AAA :

Business Environment Reform and Institutional Strengthening project (BERIS), (FY05-FY10) will assist fYR Macedonia to strengthen its capacity to implement an EU compliant competition policy regime by (i) strengthening the capacity of the CPC and the State Aid unit and its commissioners to implement a competition policy regime in line with acquis communautaire; (ii) strengthening the capacity of the Ministry of economy to design and implement industrial policy measures in line with EU requirements; (iii) increasing the public awareness of competition policy issues, including the functioning of state aid among relevant stakeholders; and (iv) providing training for relevant stakeholders in competition policy, the competition law and state aid regime.

Information society and media

Transpose and implement the EU framework for the information society and media. No immediate World Bank engagement.

Adopt legislation on electronic commerce and conditional access services.

Continue the process of alignment with the European Convention on Transfrontier Television and the Television without Frontiers Directive.

Further strengthen the administrative capacity of the regulatory authorities.

Agriculture and rural development

Develop an overall strategy on rural development. Ongoing AAA:

Agriculture and EU Accession: Achieving fYR Macedonia’s Agricultural Potential (FY07)

Ongoing lending :

Upgrade the capacity of the agricultural administration and complete preparations for the enforcement and practical application of the management mechanisms of the Common Agricultural Policy, in



particular the Integrated Administration and Control System (IACS) and the Paying Agency. Ensure a functioning Land Parcel Identification System (LPIS).

The ongoing Real Estate Cadastre and Registration Project indirectly helps develop rural real estate markets by improving access to information and reducing transaction times. In coordination with the Agriculture and Rural Development Cohesion Project, an agriculture land management policy will be developed. The ongoing BERIS project strengthens the capacity of the Government to improve selected areas of the business environment in an EU-oriented context.

Planned lending :

The planned Agriculture and Rural Development Cohesion Project (FY07) will aim to improve the delivery of government assistance to the agriculture sector in a manner consistent with the European Union’s pre-accession requirements. Key outcome indicators would be: (a) improved MAFWE ability to disburse and track the use of rural development funds and to evaluate their impact on the agri-food sector; (b) EU IPARD funds are paid to farmers in an EU compliant manner; (c) timely delivery of EU compliant food safety certification to producers and agro-processors; (d) beneficiary participation in irrigation schemes; and (e) physical improvement of the water infrastructure for agriculture in project areas.

Transport (feeder roads) (FY09) project will result in key public infrastructure investments that reduce transportation costs and thus improve the supply chain and farmer and processor competitiveness.

Set up the vineyard register and make it operational.

Further align the legislation with the acquis regarding transmissible spongiform encephalopathies (TSE) and animal by-products, implement and control its enforcement and set up the necessary collection and treatment system.

Establish a properly staffed plant health authority and provide appropriate laboratory capacity to the phytosanitary services. Further align the phytosanitary legislation with the acquis.

Transport policy

Continue work towards complete alignment with the acquis in the area of road transport. Continue alignment with the railway acquis (first and second railway packages and interoperability).

Planned AAA:A Transport sector study (FY08) will inform the preparation of a National Transport Strategy. The study and the Strategy will then be seen as foundation for possible future work of the Bank in the sector (Roads Project). Regional Railways Study is currently underway that may inform a regional railway lending program.

Ongoing lending:

Railways Reform Project (FY06-FY10) – aims at improving the financial viability, productivity, and effectiveness of railway

Further implement the Memorandum of Understanding on the South East Europe Core Regional Transport Network.



operations, through labor rationalization, separation of infrastructure from operations, increasing accountability for performance of the separated entities, licensing independent operators, introducing competition in rail operations, and restructuring and rationalization of passenger services. The project contributes to closing the gap between the current situation and prescriptions under the acquis (first and second railway packages and interoperability).

Planned lending:

The TTFSE II (FY07), which will aim at enhancing regional trade and transport in Southeast Europe through optimizing the use of the Core Regional Transport Network, will be implemented in coordination with the work of the South East Europe Transport Observatory (SEETO), established with the MoU.

Transport sector project (feeder roads), planned for FY09 will focus on providing better access from the farms/local markets to the main transport corridors.

Energy

Continue the implementation of the requirements of the Energy Community Treaty.

Planned AAA:Assistance to the government in designing a comprehensive National Energy Strategy (FY08) that would determine the long-term energy needs of the country and actions necessary to achieve them.

Ongoing lending:The ECSEE APL3-fYR Macedonia Project (FY06) assists fYR Macedonia in preparing to participate effectively in the Energy Community of South East Europe (ECSEE).

Planned lending:The Sustainable Energy GEF Project (FY07) seeks to assist fYR Macedonia in developing indigenous (renewable) energy sources and improve energy efficiency by helping create an enabling framework, institutional capacity, and necessary financing mechanisms for increased investment in renewable energy sources and energy

Work towards alignment with the acquis concerning nuclear energy and strengthen administrative capacity in the sector.





efficiency.

A planned Energy Project (FY09) will provide investment support for high-priority energy infrastructure project(s) aimed at improving the efficiency of existing assets and meeting the growth in energy

Taxation

Fully align tax legislation with the acquis, including new legislation (for example the Energy Directive). IMF is providing a TA for harmonization of the basis for

calculating payroll contributions, administration of taxes (setting up of large tax payers office).

No immediate World Bank engagement.

Continue the reform of the tax administration and ensure its proper functioning.

Continue preparations to ensure interconnectivity with EU computerised systems.

Improve transparency and the exchange of information with EU Member States in order to facilitate the enforcement of measures preventing the avoidance or evasion of taxes. In this context, the exchange of information with EU Member States could be based on the OECD model agreement to exchange information.

Statistics

Define statistical regions that are compatible with the NUTS and launch the production of regional statistics.

Under the successive Poverty Assessment reports, the Bank works with the State Statistics Office (SSO) to increase its capacity for policy evaluation, improving its social and living standards statistics reporting practices and satisfy the social indicators reporting requirements of Eurostat.

Create a farm register on the basis of the agricultural census and address remaining gaps in agricultural statistics.

Further develop macro-economic statistics and social statistics.

http://www.worldbank.org.mk/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/MACEDONIAEXTN/0,,contentMDK:20721738~pagePK:141137~piPK:141127~theSitePK:304473,00.html


Develop reliable business statistics based on the statistical business register and the business census.

Social policy and employment

Continue alignment with EU legislation in the fields of occupational health and safety, labour law and anti-discrimination, and strengthen the corresponding administrative structures.

Planned AAA/studies:

The next Poverty Assessment report will focus on Labor Market developments which can provide input to the Employment Strategy.A Social Inclusion Assessment (FY09), will identify the main challenges fYR Macedonia faces in tackling poverty and social exclusion. The Social Inclusion Assessment will inform the preparation of a Joint Inclusion Memorandum (JIM). (As a candidate for EU membership, fYR Macedonia will be asked to prepare at the next stages of the EU integration process.)

Ongoing lending:

The PDPL Program (FY06-09): forthcoming PDPL operations may consider assisting the government in strengthening the capacity of the labor inspectorate.

Reinforce the Labour Inspectorate in terms of staff and equipment and enable it to apply effective and dissuasive sanctions.

Develop and implement a comprehensive employment strategy involving all relevant stakeholders with a view to subsequent participation in the European Employment Strategy, matched by appropriate capacity-building for analysis, implementation and assessment.

Enterprise and industrial policy

Define and implement an industrial strategy conducive to growth and innovation.

Planned AAA:In FY08, an update of the 2003 Financial Sector Assessment Program (FSAP) will assess progress made towards the completion of the financial sector reform agenda and inform the design of the new series of PDPLs to address remaining constraints to financial sector development.

Planned lending:PDPLs are expected to continue to support policy measures associated with financial sector development, and strengthening the governance of financial institutions, including the insurance sector.

Ongoing TA:REPARIS program and a TF funded by the Dutch and Austrian

Further develop support mechanisms for SMEs and improve access of SMEs to financial services.


http://www.worldbank.org.mk/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/MACEDONIAEXTN/0,,contentMDK:20721738~pagePK:141137~piPK:141127~theSitePK:304473,00.html


governments, the Bank will continue to support the implementation of the country action plan on corporate financial reporting that will align country’s regulatory with international standards and the relevant portions of the EU acquis communautaire.

Ongoing lending:The Business Environment Reform and Institutional Strengthening project (BERIS), (FY05-FY10) includes a component (Competition Policy Regime component) aimed at enhancing the competitiveness of the enterprise sector by fostering healthy market competition and thus stimulating the production of better quality products and services at lower prices. Sustainable Energy GEF Project will include support mechanisms for Macedonian SMEs that will participate in the investment activities Regional policy and co-ordination of structural instruments

Ensure a clear distribution of responsibilities and effective inter-ministerial co-ordination in order to develop a comprehensive and coherent regional development strategy. The Country Partnership Strategy (FY07-FY10) envisages

institutional development components in all projects to increase absorption capacity.Set up partnership structures ensuring close co-operation between

relevant stakeholders at national and regional levels. Involve socio-economic and other partners.





Ensure that the designated managing and paying authorities will progressively build up their capacity.

Design and implement national and regional development plans.

Enhance financial management and control procedures and set up proper monitoring and evaluation.

Set up a national agency for regional development.

Develop capacity for project preparation and management in accordance with the Structural and Cohesion Funds, both at central level and at NUTS III level.

Justice, freedom and security

Complete the implementation of the Integrated Border Management Strategy.

Planned lending:

The TTFSE II will be implemented in line with fYR Macedonia’s Integrated Border Management (IBM) Strategy and IBM Action Plan.

There is no involvement of the Bank in issues related to police and/or asylum policy.

Complete the implementation of the Action Plan for the reform of the police. Continue to upgrade equipment and enhance training. Further develop the human resources management system.

Further develop the integrated system for intelligence-led policing. Strengthen the special investigation capabilities to fight organised crime, including trafficking in human beings, arms and drugs.

Operate asylum procedures which are fully in line with international and European standards, including a reformed appeals system. Strengthen administrative capacity by adopting a strategic plan for the administrative structures as well as guidelines for processing asylum cases. Strengthen procedural management and support. Strengthen reception capacity and develop a central database for all aliens covering asylum, migration and visas.

Develop and implement a migration policy, including an active return policy, which is in line with EU standards and effective in the fight



against illegal migration and secondary migration movements.

Science and research

Start designing and applying an integrated research policy. Planned lending:

Competitiveness/Technological Change/Higher Education project (FY08) will contribute to sustainable economic growth and job creation by fostering the adoption of new technology for production of higher quality goods, especially for the export market, improve the link between research and development and the private sector, encourage improvement of managerial skills in the private sector and develop skills able to match the business sector’s emerging needs.

Strengthen research and technological development capacity in order to ensure successful participation in the Community Framework Programmes.

Environment

Integrate environmental protection requirements into other sectoral policies, in particular through the development of environmental impact assessments.

Planned lending:

Increase investments in environmental infrastructure, with particular emphasis on waste water collection and treatment, drinking water supply, tackling air pollution and waste management.

Consumer and health protection

Continue alignment with the acquis on safety-related measures. No immediate World Bank engagement.

Customs union

Fully align customs legislation and procedures with EU legislation and standards and fully implement these procedures on the whole territory

Planned lending:

TTFSE II (FY07) will be implemented in line with these priorities, in particular through the introduction of ICT applications.

Continue to strengthen the Customs Administration and ensure its proper functioning in order to reach EU standards. Complete the implementation of the 2004-2008 Strategic Plan.

Continue preparations to ensure interconnectivity with the computerised systems of the EU.



Foreign, security and defence policy

Ensure that the “EU Guiding Principles Concerning Arrangements between a State Party to the Rome Statute of the International Criminal Court and the United States Regarding the Conditions to Surrender of Persons to the Court”, adopted on 30 September 2002, are fully taken into account.

No immediate World Bank engagement.

Financial control

Develop and implement the principles of decentralized managerial accountability and functionally independent internal audit in accordance with the internationally accepted standards and EU best practice, following the EU’s Public Internal Financial Control (PIFC) model, through coherent legislation and adequate institutional capacity. Ensure that the process towards achieving this is led by the Ministry of Finance in a co-ordinating and harmonising role.

Planned AAA:Country Fiduciary Assessment(s) (FY07 and FY10) have an objective to assess the fiduciary risk related to fYR Macedonia’s budget environment, to further continue the Government’s commitment on Public Financial Management (PFM) reforms aimed at securing more efficient and effective use of public sector resources and help government to progress on procurement reforms to achieve alignment of fYR Macedonia’s procurement systems and practices with EU acquis communautaire and other internationally accepted standards.

Ongoing lending:

The PDPL Program (FY06-09) actively supports the government in establishing the necessary mechanisms for financial control in the health sector (strengthening the role of the Ministry of Finance on the Health Insurance Fund (HIF) Board, strengthening the capacity of the HIF Board, introducing independent Budget Officer in Health institutions etc.

Further strengthen the operational capacity and functional as well as financial independence of the State Audit Office.

Develop procedures and administrative capacity to ensure effective protection of the EC’s financial interests.



Annex 11: Standard CPS AnnexesMacedonia, FYR at a glance 1/25/07

Europe & LowerKey Development Indicators Macedonia, Central middle

FYR Asia income(2005)

Population, mid-year (millions) 2.0 473 2,475Surface area (thousand sq. km) 26 24,238 39,946Population growth (%) 0.2 0.1 1.0Urban population (% of total population) 69 64 50

GNI (Atlas method, US$ billions) 5.8 1,945 4,746GNI per capita (Atlas method, US$) 2,830 4,113 1,918GNI per capita (PPP, international $) 7,080 9,142 6,313

GDP growth (%) 3.8 6.0 6.9GDP per capita growth (%) 3.6 5.9 5.9

(most recent estimate, 2000–2005)

Poverty headcount ratio at $1 a day (PPP, %) <2 2 ..Poverty headcount ratio at $2 a day (PPP, %) <2 16 ..Life expectancy at birth (years) 74 69 70Infant mortality (per 1,000 live births) 13 28 33Child malnutrition (% of children under 5) .. 5 12

Adult literacy, male (% of ages 15 and older) 98 99 93Adult literacy, female (% of ages 15 and older) 94 96 85Gross primary enrollment, male (% of age group) 98 105 115Gross primary enrollment, female (% of age group) 98 102 113

Access to an improved water source (% of population) .. 92 82Access to improved sanitation facilities (% of population) .. 85 57

Net Aid Flows 1980 1990 2000 2005 a

(US$ millions)Net ODA and official aid .. 3 252 248Top 3 donors (in 2004): United States .. .. 37 53 Netherlands .. .. 21 28 Germany .. .. 7 18

Aid (% of GNI) .. 0.1 7.1 4.7Aid per capita (US$) .. 2 125 122

Long-Term Economic Trends

Consumer prices (annual % change) .. .. 5.8 0.5GDP implicit deflator (annual % change) .. 93.7 8.2 3.3

Exchange rate (annual average, local per US$) .. 0.1 65.9 49.3Terms of trade index (2000 = 100) .. 134 100 91

1980–90 1990–2000 2000–05

Population, mid-year (millions) 1.8 1.9 2.0 2.0 0.6 0.5 0.2GDP (US$ millions) .. 4,472 3,587 5,766 .. -0.8 1.9

Agriculture .. 8.5 12.0 12.9 .. 0.2 0.9Industry .. 44.5 33.7 29.3 .. -2.3 1.3 Manufacturing .. 35.7 20.7 18.4 .. -5.3 1.2Services .. 47.0 54.2 57.7 .. 0.5 2.2

Household final consumption expenditure .. 72.3 74.4 78.4 .. 0.1 2.4General gov't final consumption expenditure .. 19.0 18.2 19.0 .. -0.4 -2.0Gross capital formation .. 18.7 22.3 20.0 .. 3.6 2.2

Exports of goods and services .. 25.8 48.6 45.1 .. 4.2 -1.2Imports of goods and services .. 35.9 63.5 62.5 .. 7.5 -0.6Gross savings .. 9.3 23.2 20.1 .. .. ..

Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates. .. indicates data are not available.a. Aid data are for 2004.

Development Economics, Development Data Group (DECDG).

(average annual growth %)

(% of GDP)

10 5 0 5 10

0-4

10-14

20-24

30-34

40-44

50-54

60-64

70-74

percent

Age distribution, 2005

Male Female

0

10

20

30

40

50

60

1990 1995 2000 2004

Macedonia, FYR Europe & Central Asia

Under-5 mortality rate (per 1,000)

-10

-5

0

5

10

90 95 00 05

GDP GDP per capita

Growth of GDP and GDP per capita (%)


Macedonia, FYR

Balance of Payments and Trade 2000 2005

(US$ millions)Total merchandise exports (fob) 1,323 2,041Total merchandise imports (cif) 2,094 3,228Net trade in goods and services -642 -1,091

Workers' remittances and compensation of employees (receipts) 81 213

Current account balance -72 -81 as a % of GDP -2.0 -1.4

Reserves, including gold 700 1,325

Central Government Finance

(% of GDP)Revenue .. .. Tax revenue .. ..Expense .. ..

Technology and I nfrastructure 2000 2004Cash surplus/deficit .. ..

Paved roads (% of total) 63.8 ..Highest marginal tax rate (%) Fixed line and mobile phone Individual .. .. subscribers (per 1,000 people) 310 642 Corporate .. .. High technology exports

(% of manufactured exports) 1.2 1.3External Debt and Resource Flows

Environment(US$ millions)Total debt outstanding and disbursed 1,460 2,253 Agricultural land (% of land area) 49 49Total debt service 245 260 Forest area (% of land area, 2000 and 2005) 35.6 35.6HIPC and MDRI debt relief (expected; flow) – – Nationally protected areas (% of land area) .. 7.1

Total debt (% of GDP) 40.7 39.1 Freshwater resources per capita (cu. meters) .. 2,659Total debt service (% of exports) 13.9 9.4 Freshwater withdrawal (% of internal resources) .. ..

Foreign direct investment (net inflows) 175 97 CO2 emissions per capita (mt) 5.7 5.1Portfolio equity (net inflows) 0 52

GDP per unit of energy use (2000 PPP $ per kg of oil equivalent) .. ..

Energy use per capita (kg of oil equivalent) .. ..

World Bank Group portfolio 2000 2005

(US$ millions)

IBRD Total debt outstanding and disbursed 116 244 Disbursements 13 54 Principal repayments 3 11 Interest payments 7 7

IDA Total debt outstanding and disbursed 249 364 Disbursements 38 8

Private Sector Development 2000 2006 Total debt service 2 5

Time required to start a business (days) – 18 IFC (fiscal year)Cost to start a business (% of GNI per capita) – 7.4 Total disbursed and outstanding portfolio 65 28Time required to register property (days) – 98 of which IFC own account 40 28

Disbursements for IFC own account 8 1Ranked as a major constraint to business Portfolio sales, prepayments and (% of managers surveyed who agreed) repayments for IFC own account 0 5 Anti-competitive or informal practices .. 36.2 Cost of financing .. 36.1 MIGA

Gross exposure 19 0Stock market capitalization (% of GDP) 0.2 7.7 New guarantees 19 0Bank branches (per 100,000 people) .. ..

Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates. 1/25/07.. indicates data are not available. – indicates observation is not applicable.


0 25 50 75 100

Control of corruption

Rule of law

Regulatory quality

Political stability

Voice and accountability

Country's percentile rank (0-100)higher values imply better ratings

2005

2000

Governance indicators, 2000 and 2005

Source: Kaufmann-Kraay-Mastruzzi, World Bank

Short-term, 81 IBRD, 244

Other multilateral, 285

IMF, 62

IDA, 364

Private, 903

Bilateral, 288

Composition of total external debt, 2005

US$ millions


Millennium Development Goals Macedonia, FYR

With selected targets to achieve between 1990 and 2015(estimate closest to date shown, +/- 2 years)

Goal 1: halve the rates for $1 a day poverty and malnutrition 1990 1995 2000 2004 Poverty headcount ratio at $1 a day (PPP, % of population) .. .. <2 <2 Poverty headcount ratio at national poverty line (% of population) .. .. .. .. Share of income or consumption to the poorest qunitile (%) .. .. .. 6.1 Prevalence of malnutrition (% of children under 5) .. .. 6 ..

Goal 2: ensure that children are able to complete primary schooling Primary school enrollment (net, %) 94 .. 92 92 Primary completion rate (% of relevant age group) .. 97 99 96 Secondary school enrollment (gross, %) 56 .. 84 84 Youth literacy rate (% of people ages 15-24) .. .. .. 99

Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education (%) 99 .. 98 99 Women employed in the nonagricultural sector (% of nonagricultural employment) 38 39 42 42 Proportion of seats held by women in national parliament (%) .. 3 8 19

Goal 4: reduce under-5 mortality by two-thirds Under-5 mortality rate (per 1,000) 38 26 18 14 Infant mortality rate (per 1,000 live births) 33 23 16 13 Measles immunization (proportion of one-year olds immunized, %) .. 97 97 96

Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio (modeled estimate, per 100,000 live births) .. .. 23 .. Births attended by skilled health staff (% of total) .. .. 97 99

Goal 6: halt and begin to reverse the spread of HIV/AIDS and other major diseases Prevalence of HIV (% of population ages 15-49) .. .. .. 0.1 Contraceptive prevalence (% of women ages 15-49) .. .. .. .. Incidence of tuberculosis (per 100,000 people) 54 .. .. 30 Tuberculosis cases detected under DOTS (%) .. .. 54 73

Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source (% of population) .. .. .. .. Access to improved sanitation facilities (% of population) .. .. .. .. Forest area (% of total land area) .. .. 35.6 35.6 Nationally protected areas (% of total land area) .. .. .. 7.1 CO2 emissions (metric tons per capita) 8.2 5.4 5.7 5.1 GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent) .. .. .. ..

Goal 8: develop a global partnership for development Fixed line and mobile phone subscribers (per 1,000 people) 150 179 310 642 Internet users (per 1,000 people) 0 0 25 78 Personal computers (per 1,000 people) .. .. 36 69 Youth unemployment (% of total labor force ages 15-24) .. .. 59.9 65.7

Note: Figures in italics are for years other than those specified. .. indicates data are not available. 1/25/07


Macedonia, FYR

50

75

100

125

1998 2000 2002 2004

Primary net enrollment ratio

Ratio of girls to boys in primary &secondary education

Education indicators (%)

0

200

400

600

800

2000 2002 2004

Fixed + mobile subscribersInternet users

ICT indicators (per 1,000 people)

0

25

50

75

100

1990 1995 2000 2004

Macedonia, FYR Europe & Central Asia

Measles immunization (% of 1-year olds)


As Of Date 01/25/2007

Indicator 2004 2005 2006 2007Portfolio AssessmentNumber of Projects Under Implementation a 11 10 10 9Average Implementation Period (years) b 2.9 2.8 2.4 1.7Percent of Problem Projects by Number a, c 0.0 0.0 0.0 33.3Percent of Problem Projects by Amount a, c 0.0 0.0 0.0 36.1Percent of Projects at Risk by Number a, d 0.0 0.0 0.0 33.3Percent of Projects at Risk by Amount a, d 0.0 0.0 0.0 36.1Disbursement Ratio (%) e 35.0 35.0 24.0 7.9Portfolio ManagementCPPR during the year (yes/no)Supervision Resources (total US$)Average Supervision (US$/project)

Memorandum Item Since FY 80 Last Five FYsProj Eval by OED by Number 24 10Proj Eval by OED by Amt (US$ millions) 605.0 207.7% of OED Projects Rated U or HU by Number 17.4 11.1% of OED Projects Rated U or HU by Amt 3.5 3.2

a. As shown in the Annual Report on Portfolio Performance (except for current FY).b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only.* All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year.

Selected Indicators* of Bank Portfolio Performance and ManagementCAS Annex B2 -

Macedonia, fYRAs Of Date 02/27/2007

Proposed IBRD/IDA Base-Case Lending Program a

Fiscal year Proj ID US$(M) Strategic Rewards b (H/M/L)

Implementation b Risks (H/M/L)

2007 AG. EU ACQUIS 20.0

PDPL 2 30.0

TTFSE 2 20.0

Result 70.0

2008 Conditional Cash Transfers Project 25.0

MUNICIPAL DEVELOPMENT 0.0

TECHNOLOGIAL CHANGE & HIGHER EDUCATION 25.0

Result 50.0

Overall Result 120.0

CAS Annex B3 - IBRD/IDA Program Summary


Product Completion FYCost

(US$000) Audience a/ Objective b/

Recent completionsLegal and Judicial Diagnostic 2005 79 G/D/B KG/PSProgrammatic Poverty Assessment 2005 358 G/D/B/PD KG/PS/PDROSC on cosporate governance 2005 52 G KG/PSUrban/Municipal Development Study 2007 111 G/D/B KG/PSAgriculture and EU Accession 2007 103 G/D/B KG/PSProgrammatic Poverty Assessment 2007 103 G/B KG/PS

UnderwayCountry Fudiciary Assessment 2007 72 G/D/B KG/PSPEIR 2007 310 G/D/B KG/PSCompetitiveness Study 2007 110 G/D/B KG/PS

PlannedProgrammatic Poverty Assessment 08 G/D/B/PD KG/PD/PSCEM 08 G/D/B KG/PSNational Energy Strategy 08 G/D/B KG/PSTransport Sector Study 08 G/D/B/PD KG/PSFSAP Update 08 G/D/B KG/PSOther TBD

a/ Government (G), Donor (D), Bank (B), Public Dissemination (PD).b/ Knowledge Generation (KG), Public Debate (PD), Problem-Solving (PS).

FY 2007 - FY 2010As of date 15 January 2007

Annex B4 - Summary of IBRD Nonlending Services - fYR Macedonia


Macedonia, FYR - Key Economic Indicators

Actual Estimate ProjectedIndicator 2002 2003 2004 2005 2006 2007 2008 2009 2010

National accounts (as % of GDP)Gross domestic producta 100 100 100 100 100 100 100 100 100 Agriculture 12 13 13 13 13 13 12 12 12 Industry 30 31 29 29 29 29 29 29 30 Services 57 56 58 58 58 59 59 59 58

Total Consumption 100 97 99 97 97 98 98 97 97Gross domestic fixed investment 17 17 18 17 18 20 20 21 22 Government investment 4 4 3 4 3 3 3 3 3 Private investment 13 13 15 14 15 17 17 18 18

Exports (GNFS)b 38 38 40 45 48 49 49 49 50Imports (GNFS) 58 55 60 62 68 69 70 71 71

Gross domestic savings 0 3 1 3 3 2 2 3 3Gross national savingsc 13 18 15 20 22 20 20 20 20

Memorandum itemsGross domestic product 3791 4630 5368 5766 6217 6699 7216 7730 8278(US$ million at current prices)GNI per capita (US$, Atlas method) 1730 1990 2440 2830 3030 3180 3470 3740 3990

Real annual growth rates (%, calculated from 95 prices) Gross domestic product at market prices 0.9 2.8 4.1 3.8 3.2 4.5 5.0 5.0 5.0 Gross Domestic Income 1.0 1.0 3.8 4.6 3.1 4.5 5.0 5.1 5.0

Real annual per capita growth rates (%, calculated from 95 prices) Gross domestic product at market prices 0.6 2.6 3.9 3.6 3.0 4.4 4.9 4.9 4.9 Total consumption 5.4 -3.5 5.5 2.2 3.7 4.5 5.4 4.5 4.1 Private consumption 10.7 -1.8 6.7 3.3 3.5 5.6 6.2 4.4 4.2

Balance of Payments (US$ millions) Exports (GNFS)b 1365 1689 2080 2511 3000 3284 3540 3809 4098 Merchandise FOB 1112 1363 1672 2040 2400 2640 2843 3049 3293 Imports (GNFS)b 2192 2548 3247 3603 4209 4656 5072 5452 5847 Merchandise FOB 1916 2211 2785 3097 3612 4008 4378 4717 5067 Resource balance -826 -858 -1166 -1091 -1210 -1371 -1532 -1644 -1750 Net current transfers 498 741 791 1065 1240 1272 1350 1387 1439 Current account balance -358 -149 -415 -81 22 -213 -249 -306 -402

Net private foreign direct investment 78 96 156 97 380 184 432 276 345 Long-term loans (net) 8 59 35 136 -40 116 112 11 -14 Official -29 44 50 60 37 -28 35 20 31 Private 37 14 -15 76 -77 144 77 -10 -45 Other capital (net, incl. errors & ommissions) 141 45 243 263 30 25 54 96 143 Change in reservesd 131 -51 -19 -415 -392 -112 -349 -76 -72

Memorandum itemsResource balance (% of GDP) -21.8 -18.5 -21.7 -18.9 -19.5 -20.5 -21.2 -21.3 -21.1Real annual growth rates ( YR95 prices) Merchandise exports (FOB) -1.8 2.2 11.5 12.2 9.6 7.2 6.8 6.5 7.4 Primary 11.2 -11.5 -2.7 18.4 19.2 11.5 12.8 6.7 7.1 Manufactures -4.7 -1.2 19.1 17.6 5.0 5.0 3.5 6.4 7.5 Merchandise imports (CIF) 21.8 -5.2 11.2 -4.0 7.8 3.8 8.4 7.0 6.8

(Continued)


Macedonia, FYR - Key Economic Indicators(Continued)

Actual Estimate ProjectedIndicator 2002 2003 2004 2005 2006 2007 2008 2009 2010Indicator

Public finance (as % of GDP at market prices)e

Current revenues 34.7 38.1 36.3 34.0 33.9 32.2 32.0 32.2 32.2 Current expenditures 36.9 34.4 33.0 31.7 31.8 30.3 29.7 29.7 29.5 Current account surplus (+) or deficit (-) -2.2 3.8 3.3 2.3 2.1 1.9 2.3 2.5 2.7 Capital expenditure 3.6 4.1 3.1 3.6 2.9 3.4 3.6 3.8 4.0 Foreign financing 0.7 0.6 0.5 3.7 -4.0 -0.7 0.0 -0.4 -0.2

Monetary indicators M2/GDP 29.5 32.8 35.8 38.4 43.2 50.6 57.7 66.2 71.4 Growth of M2 (%) -11.8 14.7 15.3 14.9 19.8 26.3 22.8 22.9 15.6 Private sector credit growth / 8.8 73.8 111.2 1159.9 158.8 76.6 90.5 94.3 100.0 total credit growth (%)

Price indices( YR95 =100) Merchandise export price index 63.0 75.5 83.0 90.1 96.7 99.2 100.0 100.7 101.3 Merchandise import price index 82.0 100.0 114.3 131.1 133.2 145.4 146.6 147.6 148.5 Merchandise terms of trade index 76.8 75.5 72.6 68.8 72.6 68.2 68.2 68.2 68.2 Real exchange rate (US$/LCU)f 87.0 87.4 86.8 87.9 85.4 85.4 85.4 85.4 85.4

Real interest rates Consumer price index (% change) 1.8 1.2 -0.4 0.5 3.2 3.1 2.4 1.8 1.8 GDP deflator (% change) 3.4 0.3 1.3 3.3 3.4 3.1 2.6 2.0 2.0

a. GDP at factor costb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Consolidated central government.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.


Macedonia, FYR - Key Exposure Indicators

Actual Estimate ProjectedIndicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total debt outstanding and 1469 1671 1831 2034 2253 2389 2543 2791 3001disbursed (TDO) (US$m)a

Net disbursements (US$m)a -56 14 32 113 338 -35 106 118 26

Total debt service (TDS) 281 257 264 280 260 486 482 462 569(US$m)a

Debt and debt service indicators (%) TDO/XGSb 96.6 110.7 96.6 87.5 81.1 71.8 71.0 72.3 72.1 TDO/GDP 42.7 44.1 39.5 37.9 39.1 38.4 38.0 38.7 38.8 TDS/XGS 18.5 17.1 13.9 12.0 9.4 14.6 13.4 12.0 13.7 Concessional/TDO 22.9 24.7 27.5 27.6 .. .. .. .. ..

IBRD exposure indicators (%) IBRD DS/public DS 4.8 7.5 5.8 7.5 8.3 6.4 8.0 13.0 15.5 Preferred creditor DS/public 42.6 62.8 54.0 50.8 53.0 20.6 40.8 57.3 58.3 DS (%)c

IBRD DS/XGS 0.7 0.9 0.5 0.5 0.4 0.7 0.7 0.8 1.0 IBRD TDO (US$m)d 117 138 181 224 248 265 279 328 365 Of which present value of guarantees (US$m) Share of IBRD portfolio (%) 0 0 0 0 0 0 0 0 0 IDA TDO (US$m)d 254 293 358 388 362 384 359 355 349

IFC (US$m) Loans Equity and quasi-equity /c

MIGA MIGA guarantees (US$m)

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital.b. "XGS" denotes exports of goods and services, including workers' remittances.c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements.d. Includes present value of guarantees.e. Includes equity and quasi-equity types of both loan and equity instruments.


Closed Projects 28

IBRD/IDA *Total Disbursed (Active) 11.50

of which has been repaid 0.00

Total Disbursed (Closed) 638.40


Total Disbursed (Active + Closed) 649.90


Total Undisbursed (Active) 95.70

Total Undisbursed (Closed) 1.53

Total Undisbursed (Active + Closed) 97.23

Active Projects

Project ID Project Name Development Objectives

Implementation Progress Fiscal Year IBRD IDA GRANT Cancel. Undisb.

P079552 BUSINESS ENV REFORM & INST STRENGTHMS MS 2005 11.3 10.37408P082337 ECSEE APL #3 (FYR MACEDONIA)S S 2006 25 24.17632P066157 EDUC MOD S MS 2004 5 4.7P086670 HLT SEC MGT MS MS 2004 10 9.02144P089859 LEG/JUD IMPLMNT & INST SPPRT# # 2006 12.4 11.48306P083499 RAILWAYS REFORM S MU 2006 19.38 18.80113P083126 REG & REAL ESTATE (CRL)S S 2005 14 11.12023P074358 SOC PROT S S 2004 9.8 6.021311P089656 SUSTAINABLE ENERGY (GEF)# # 2007 5.85Overall Result 106.88 5.85 95.69757

Supervision Rating

Macedonia, former Yugoslav Republic

Last PSR

As Of Date 03/02/2007

CAS Annex B8 -

Operations Portfolio (IBRD/IDA and Grants)

Original Amount in US$ Millions


Annex 11

Macedonia, FYR Social IndicatorsLatest single year Same region/income group

Europe & Lower-

Central middle-1980-85 1990-95 1999-05 Asia income

POPULATION Total population, mid-year (millions) 2.0 2.0 2.0 472.9 2,474.7 Growth rate (% annual average for period) 0.8 0.6 0.3 0.0 1.0Urban population (% of population) 55.7 59.7 68.9 63.7 49.5Total fertility rate (births per woman) 2.5 2.0 1.7 1.6 2.2

POVERTY(% of population)National headcount index .. .. 20.5 .. .. Urban headcount index .. .. 19.5 .. .. Rural headcount index .. .. 21.8 .. ..

INCOMEGNI per capita (US$) .. 1,710 2,830 4,113 1,918Consumer price index (2000=100) .. 88 109 130 130Food price index (2000=100) .. .. .. .. ..

INCOME/CONSUMPTION DISTRIBUTIONGini index .. .. 0.4 .. ..Lowest quintile (% of income or consumption) .. .. 6.0 .. ..Highest quintile (% of income or consumption) .. .. .. .. ..

SOCIAL INDICATORSPublic expenditure Health (% of GDP) .. .. 5.6 .. .. Education (% of GNI) .. .. .. 4.4 4.3Net primary school enrollment rate(% of age group) Total .. 94 92 90 .. Male .. 95 92 91 .. Female .. 94 93 90 ..Access to an improved water source(% of population) Total .. .. 96 92 82 Urban .. .. 97 99 94 Rural .. .. 87 80 71Immunization rate(% of children ages 12-23 months) Measles .. 97 96 93 85 DPT .. 95 96 93 88Child malnutrition (% under 5 years) .. .. 6 5 12Life expectancy at birth(years) Total .. 72 74 69 70 Male .. 70 71 64 68 Female .. 74 76 73 73Mortality Infant (per 1,000 live births) 53 23 13 28 33 Under 5 (per 1,000) 69 25 14 34 42 Adult (15-59) Male (per 1,000 population) .. 147 145 316 184 Female (per 1,000 population) .. 100 84 134 117 Maternal (per 100,000 live births) .. .. 23 58 163Births attended by skilled health staff (%) .. .. 99 94 86

CAS Annex B5. This table was produced from the CMU LDB system. 03/01/07Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due tochange from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before oneyear of age or at any time before the survey.


Annex 11

Annex 12: Fund Relations Note

This Fund Relations Annex includes: (i) the February 5, 2007 statement of the IMF mission to Skopje, which includes an assessment of the macroeconomic outlook and the status of the IMF Second Review; and (ii) the August 11, 2006 Public Information Notice at the conclusion of the 2006 Article IV Consultation.

Statement of the IMF Staff Mission

An IMF mission headed by Mark Griffiths has visited Skopje January 25 – February 5, 2007 to discuss the Second Review under the Stand-By Arrangement.

The mission found that good progress has been made towards completing the review. The program’s macroeconomic targets for 2006 were met. The fiscal position remains strong, international reserves have increased, and interest rates are low. Preliminary official data estimate 2006 real GDP growth was broadly unchanged from 2005, but other indicators suggest that growth may well have been considerably higher.

The economic outlook for 2007 and the medium term is favorable. To secure macroeconomic stability, the 2007 budget that was approved by parliament in late December 2006 limits the fiscal deficit to 1 percent of GDP—slightly higher than the target for 2006. The additional resources will be used to finance important reforms, including harmonization of social security contributions, higher investment, the second pillar pension system, and lower tariffs and income taxes.

The mission welcomes the recent agreement with Paris Club creditors regarding debt prepayment. These prepayments are expected to be completed by end-April 2007. As a result, interest payments will decline, and medium-term debt sustainability will further improve.

In the view of the mission, it is crucial that the government adheres to its fiscal targets, and that fiscal risks stemming from problems in a few sectors of the economy—in particular, the health and energy sectors—are mitigated. Steps have been taken. However, the mission encouraged the authorities to develop a comprehensive action plan to restore the financial viability of the energy sector, in close collaboration with the World Bank.

The mission reached understandings on almost all elements of a draft letter of intent. A few issues still need to be discussed in greater detail, including: (i) clarification of the strategy for liberalization and reform of the telecommunications sector; (ii) next steps in harmonizing the bases of social security contributions and the personal income tax; (iii) improving tax collections, through integrating the social funds to collect social security contributions and, eventually, consolidating these reponsibilities within the public revenue office; and (iv) the new draft


Annex 11banking law. Provided sufficient progress is made in the coming weeks, an IMF Executive Board meeting to complete the Second Review could be held in March 2007.

Finally, the mission would like to thank the Macedonian authorities for their continued cooperation, and for their generous hospitality.

SkopjeFebruary 5, 2007


Annex 11

Public Information Notice (PIN) No.

FOR IMMEDIATE RELEASEAugust xx, 2006

IMF Concludes 2006 Article IV Consultation with the former Yugoslav Republic of Macedonia

On July 28, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the former Yugoslav Republic of Macedonia.23

Background

Economic performance has started to improve. After a decade of sluggish growth, in part the result of external shocks, growth has reached 4 percent for two years in a row. In 2005, growth was driven by strong exports. A broadly balanced fiscal position and the fixed exchange rate have kept inflation under control. The external position has strengthened, with gross reserves rising from €700 million at end-2004 to around €1,200 (more than 4 months of imports or 25 percent of GDP) by May 2006. The recorded current account deficit fell sharply to 1.3 percent of GDP in 2005 driven by increased private transfers, though these may also capture capital account transactions.

23 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the July 28, 2006 Executive Board discussion based on the staff report.

International Monetary Fund700 19th Street, NWWashington, D. C. 20431 USA


Annex 11The increase in reserves has allowed the central bank to cut interest rates. Bank credit has expanded, especially to households and in foreign currency, though from a low base and less rapidly than in the region’s other countries.

The overall fiscal position showed a small surplus in 2005. Last year’s 0.3 percent of GDP central government budget surplus was better than projected by 1 percent of GDP, reflecting continuing underperformance of ministries’ Special Revenue Accounts, restraint in public employment, and procurement delays. One-off revenue developments, including the unusually high telecom monopoly dividend and advancing VAT payments by importers, also contributed.

In 2006, growth is projected to remain at 4 percent, with higher domestic demand offsetting some decline in net exports. Inflation is expected to increase to 3 percent, driven by supply factors, including higher tobacco taxes and oil prices. The official current account deficit is projected to widen to 3 percent of GDP due to higher oil prices, lower interest rates stimulating imports, and some slowing in last year’s increase in private transfers.

Despite recent progress, structural weaknesses constrain the economy’s ability to increase employment and achieve more rapid output growth. Recorded unemployment in 2005 reached 35 percent, one of the highest in the region, as employment has barely increased since 1995. Levels of financial intermediation and the stock of foreign direct investment remain low. Macedonia ranked poorly in international comparisons of the business environment due to high costs of opening and closing a business, hiring and laying off workers, and enforcing contracts. Property rights are poorly defined with the land cadastre incomplete, the tax wedge on labor remains high, and telecommunications services are expensive. The government has amended the constitution and passed new laws to introduce comprehensive judicial reform, yet implementation has just started.

Executive Board Assessment

Executive Directors commended the Macedonian authorities for their sound macroeconomic policies which, after a decade of sluggish growth, have now started to deliver economic recovery. Inflation has remained under control, the current account deficit has narrowed, international reserves have increased, and the fiscal position is sound.

Directors noted that, despite these successes, considerable challenges lie ahead. These include raising living standards closer to European levels, reducing unemployment, and keeping the current account deficit under control. Directors stressed that the best way to meet these challenges would be by maintaining the country’s hard-won macroeconomic stability, and accelerating structural reforms.

Directors viewed the 0.6 percent of GDP fiscal deficit target as one of the anchors of macroeconomic stability. They cautioned that loosening the fiscal stance would be premature in view of uncertainties about the current account’s true size, medium-term fiscal challenges, and the limited institutional capacity in line ministries to spend additional funds efficiently. Rationalization of the public sector should be undertaken before spending increases are envisaged. Going forward, Directors also encouraged efforts to strengthen the fiscal revenue base and reduce nondiscretionary spending.


Annex 11Directors considered that the exchange rate peg is appropriate given the Macedonian economy’s size and openness, and its limited international financial market integration. The peg has kept inflation low, and, although there are structural weaknesses in the economy, price competitiveness and the level of the exchange rate seem broadly satisfactory. Directors considered it important to continue to strengthen the central bank’s policy instruments. They welcomed the central bank’s recent interest rate cuts, but with euro-area rates higher and the need to see the effects of the cuts on credit and the real economy, a pause now seems appropriate.

Directors stressed the importance of structural reforms for accelerating growth. Institutional reforms, ranging from judicial reform and improving public governance to market liberalization and privatization, will be essential to developing a functioning market economy. Reducing the very high unemployment rate should be a priority, and can be achieved through active labor market policies, reducing the tax wedge, and eliminating barriers to part-time employment. Financial market development is also needed, notably to lower intermediation costs, improve the credit culture, and enhance banking supervision. Such reforms would boost investment and employment, strengthen total factor productivity, and increase Macedonia’s attractiveness for foreign direct investment. Directors noted that although these tasks are immense, so too are the potential rewards, and they encouraged the authorities to implement these reforms expeditiously.

Macedonia’s provision of data to the Fund is broadly adequate for surveillance purposes. Directors nevertheless underscored the need for continued efforts to improve the quality and coverage of statistics, including in the area of fiscal transparency.

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.


Annex 11

Table 1. FYR Macedonia: Selected Economic Indicators, 2003-07

2003 2004 2005 2006 2007Prel. Proj. Proj.

(Percentage change)Real economy

Real GDP 2.8 4.1 4.0 4.0 4.0Consumer prices

period average 1.2 -0.3 0.5 2.9 2.0end of period 2.6 -2.0 1.8 ... ...

Real wages, period average 3.6 4.4 ... ... ...Unemployment rate (average) 36.7 37.2 37.3 ... ...

Government finances (In percent of GDP, unless otherwise indicated)

Central government balance 1/ -0.1 0.4 0.3 -0.6 -0.6Revenues (including grants) 38.4 36.5 35.8 33.8 34.5Expenditures 38.5 36.1 35.6 34.4 35.1

Central government debt 2/Gross 39.0 36.6 40.2 35.6 35.3Net 34.9 32.5 32.5 20.9 21.7

Money and credit

Broad money (M3, percent) 18.0 16.1 14.9 20.1 23.0Short-term lending rate (percent) 14.5 11.8 11.7 ... ...Interbank money market rate (percent) 6.8 8.3 9.2 ... ...

Balance of payments (In millions of Euro, unless otherwise indicated)

Exports 1,203 1,343 1,642 1,833 1,912Imports 1,953 2,237 2,496 2,847 3,001Trade balance -750 -894 -853 -1,015 -1,089Current account balance

excluding grants -227 -389 -114 -209 -290(in percent of GDP) -5.5 -9.0 -2.5 -4.2 -5.6

including grants -137 -334 -62 -151 -201(in percent of GDP) -3.4 -7.7 -1.3 -3.1 -3.9

Overall balance 14 -19 340 478 120Official gross reserves 710 717 1,123 1,602 1,699

(in months of following year's imports of goods and services) 3.3 2.9 4.1 5.5 5.6

External debt service ratio 3/ 24.2 14.7 13.0 25.8 20.3External debt to GDP ratio (percent) 4/ 37.7 40.2 47.1 45.7 46.3

Exchange rate

Real effective exchange rate (CPI-based) -0.1 -1.6 -3.3 ... ...

Sources: Data provided by the authorities, and IMF staff projections.

1/ In 2005, central government spent an additional 0.4 percent of GDP on the NBRM recapitalization.2/ In 2005 and 2006 the change in stock reflects a major debt management operation. Net debt is defined as

gross debt minus government’s deposits with the NBRM.3/ Debt service due, including IMF, as a percent of exports. For 2006, includes a major debt management

operation. Excludes rollover of trade credits.4/ Total external debt, including trade credit. For 2005, includes a Euro 150 million Eurobond issue.

former yugoslav republic of macedonia -...

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