Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: ICR00001958

IMPLEMENTATION COMPLETION AND RESULTS REPORT

(LOAN NO 7829-MK, GRANT NO TF096329)

FOR

THE FIRST PROGRAMMATIC DEVELOPMENT POLICY LOAN

IN A TOTAL AMOUNT OF EUR 20.5 MILLION (US $30 MILLION EQUIVALENT)

TO

THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

JUNE 29 2011

Poverty Reduction and Economic Management (ECSP2) South East Europe country Unit (ECCU4) Europe and Central Asia (ECA)

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GOVERNMENT FISCAL YEAR January 1-December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of June 30, 2011) Currency Unit = Macedonian Denar (MKD)

US$1 = MKD 43.2 Weights and Measures: Metric system

ABBREVIATIONS AND ACRONYMS

BBP Basic Benefits Package CB Cash Benefits CCT Conditional Cash Transfers CEM Country Economic Memorandum CFAA Country Financial Accountability

Assessment CFAA Country Financial Accountability

Assessment CPAR Country Procurement Assessment Report CPS Country Partnership Strategy DIF Deposit Insurance Fund DPL Development Policy Loan DRG Diagnosis-Related Group EBF Extra Budgetary Fund EBRD European Bank for Reconstruction and

Development ECA Europe and Central Asia Region ECB European Central Bank ESW Economic and Sector Work FDI Foreign Direct Investment FSAP Financial Sector Assessment Program GDP Gross Domestic Product GoRM Government of the Republic of

Macedonia HBS Household Budget Survey HCI Health Care Institution HIF Health Insurance Fund IBRD International Bank for Reconstruction

and Development ICRR Implementation Completion and Results

Report IFC International Finance Corporation IMF International Monetary Fund

IPA Instrument for Pre-Accession ISA Insurance Supervision Agency LDP Letter of Development Policy LFS Labor Force Survey MLSP Ministry of Labor and Social Policy MOF Ministry of Finance MOH Ministry of Health MoU Memorandum of Understanding NATO North Atlantic Treaty Organization NBRM National Bank of the Republic of

Macedonia NPL Non-Performing Loan NTR Non-Tax Revenues OECD Organization for Economic Cooperation

and Development PBG Policy Based Guarantee PDIF Pension and Disability Insurance Fund PCL Precautionary Credit Line PDO Program Development Objective PER Public Expenditure Review PIT Personal Income Tax PRO Public Revenues Office SAO State Audit Office SIC Social Insurance Contribution Rate SP Social Protection SPIL Social Protection and Implementation

Loan SRA Special Revenue Accounts SWC Social Welfare Center TSA Treasury Single Account TA Technical Assistance TF Trust Fund VAT Value Added Tax

Vice President: Philippe H. Le Houerou, ECAVP

Country Director: Jane Armitage, ECCU4 Sector Director: Yvonne M. Tsikata, ECSPE

Sector Manager: Satu Kahkonen, ECSP2

Task Team Leaders: Evgenij Najdov/Marina Wes, ECSP2 ICRR Team Leader Evgenij Najdov, ECSP2

THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

FIRST PROGRAMMATIC DEVELOPMENT POLICY LOAN

(Loan No 7829-MK Grant No TF 096329)

CONTENTS

Data Sheet

A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring 1. Program Context, Development Objectives and Design ................................................ 1 2. Key Factors Affecting Implementation and Outcomes .................................................. 6 3. Assessment of Outcomes ................................................................................................ 7 4. Assessment of Risk to Development Outcome ............................................................. 17 5. Assessment of Bank and Borrower Performance ......................................................... 18 6. Lessons Learned............................................................................................................ 19 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners ............... 19 Annex 1: Bank Lending and Implementation Support/Supervision Processes ................ 21 Annex 2: Beneficiary Survey Results (if any) .................................................................. 22 Annex 3: Stakeholder Workshop Report and Results (if any) .......................................... 23 Annex 4: Summary of Borrower’s ICR and/or Comments on Draft ICR ........................ 24 Annex 5: Comments of Co financiers and Other Partners/Stakeholders .......................... 28 Annex 6: List of persons interviewed ............................................................................... 29 

MAP

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DATA SHEET

A. Basic Information First Programmatic Development Policy Loan 7289-MK

Country: FYR Macedonia Program Name: First Programmatic Development Policy Loan

Program ID: P116984. L/C/TF Number(s): IBRD-7829MK; TF096329

ICRR Date: June 30, 2011 ICR Type: Core ICR

Lending Instrument: DPL Borrower: The Former Yugoslav Republic of Macedonia

Original Total Commitment: EUR 20.5 Million Disbursed Amount: EUR 20.5 Million

Implementing Agency: Ministry of Finance

Co-financiers and Other External Partners: Co-financed (EUR 7 million) by the Netherlands Trust Fund with the Bank acting as administrator.

B. Key Dates

First Programmatic Development Policy Loan 7289-MK

Process Date Process Original Date Revised/Actual Date(s)

Concept Review: September 17, 2009 Effectiveness: April 1, 2010 April 1, 2010

Appraisal: October 14, 2009 Restructuring(s): NA NA

Approval: December 15, 2009 Mid-term Review: NA NA

Closing: December 31, 2010 December 31, 2010

C. Ratings Summary1

C.1 Performance Rating by ICR Outcome: Satisfactory Risk to Development Outcome: Moderate Bank Performance: Satisfactory Borrower Performance: Satisfactory

1 All ratings given by the ICR should use a six-point rating scale (Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, or Highly Unsatisfactory), except for the rating of Risk to Development Outcome that use a four-point scale (Negligible to Low, Moderate, Significant, High).

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C.2 Detailed ratings of Bank and Borrower Performance (by ICR)

First Programmatic Development Policy Loan 7289-MK

Bank Ratings Borrower Ratings

Quality at Entry: Satisfactory Government: Satisfactory

Quality of Supervision: Satisfactory Implementation Agency/Agencies: Satisfactory

Overall Bank Performance: Satisfactory Overall Borrower Performance: Satisfactory

C.3 Quality at Entry and Implementation Performance Indicators

First Programmatic Development Policy Loan 7289-MK

Implementation Performance Indicators QAG Assessments (if any) Rating

Potential Prob. Program at any time (Yes/No):

No Quality at Entry (QEA):

Problem Program at any time(Yes/No): No Quality of Supervision (QSA):

DO rating before Closing/Inactive status:

Implementation Performance QAG Assessments (if any)

Potential Prob. Program at any time (Yes/No):

No Quality at Entry (QEA):

Problem Program at any time(Yes/No): No Quality of Supervision (QSA):

DO rating before Closing/Inactive status: Satisfactory

D. Sector and Theme Codes

First Programmatic Development Policy Loan 7289-MK

Sector Name code and % of Bank Financing Sector name Code Original Actual Central Government Administration BC 33 33 Other Social Services JB 33 33 Comp Pension/Unemployment BE 17 17 Health JA 17 17 Theme name Public Expenditure Financial Management and Procurement 27 33 33 Social Safety Nets 54 17 17 Tax Policy and Administration 28 17 17 Health System Performance 67 17 17 Other Economic Management 24 16 16

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E. Bank Staff

Positions At ICR At Approval

Vice President: Philippe H Le Houerou Philippe H Le Houerou

Country Director: Jane Armitage Jane Armitage

Sector Director: Yvonne M. Tsikata Luca Barbone

Sector Manager: Satu Kahkonen Bernard Funck

TTL: Evgenij Najdov Evgenij Najdov/Marina Wes

ICRR Team Leader: Evgenij Najdov

ICRR Primary Author Sudhir Chitale

F. Results Framework Analysis Program Development Objective: The First Development Policy Loan (DPL1) was envisaged as the first of a two-loan series , designed to achieve the following three objectives: (i) ensure the budget supports macroeconomic stability by improving public expenditure outcomes; (ii) ensure adequate support to vulnerable groups by reforming the social safety net and improving its administration; and (iii) ensure systemic risks in the banking sector are identified timely and corrective action is undertaken by strengthening the resilience of the sector. During the preparation of the second operation, DPL2, the authorities requested a Policy Based Guarantee (PBG) rather than a loan (see Section 2.4 for a discussion of the reasons). In line with the Bank’s policies on DPL lending and guarantees, the DPL series was terminated after DPL1 (April 2011), and the DPL2 was converted to a stand-alone PBG operation, with largely the same policy matrix as originally envisaged under the DPL2. Since the DPL series was terminated, as per Bank guidelines, this Implementation Completion and Results Report (ICRR) was prepared for the DPL1. The progress towards the specific development objectives measured by the results indicators and benchmarks set in the Program Document (PD) for the DPL1 is presented below. Wherever needed, the results matrix recognizes that since the DPL1 was the first of a two-operation series, many of the results indicators were set to be met only after completion of reforms implemented under the combined program envisaged for DPL1 and DPL2 (now PBG).

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

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1. Program Context, Development Objectives and Design

1.1 Context at Appraisal

The First Programmatic Development Policy Loan (DPL1) was requested by the Government when the international economic crisis brought to a halt the acceleration of economic activity in the former Yugoslav Republic (FYR) of Macedonia in the second half of 2008. As the crisis spread through the region, FYR Macedonia faced a sharp fall in the demand for and prices of its main exports and a fall in FDI flows. Consequently, following growth rates of close to 6 percent in 2007 and the first three quarters of 2008, real GDP fell by 0.9 percent in 2009. In 2009, exports dropped sharply by nearly 11 percent, industrial production dropped by 8 percent, FDI declined by nearly 70 percent from US$ 600 million to US$ 186 million, business confidence fell2, financing conditions became tighter and labor market performance deteriorated. Fiscal accounts were also adversely affected. Tax revenues fell sharply by nearly 2 percentage points of GDP over 2008-2010. Finally, there was great uncertainty about the intensity of the crisis and how long it would last.

Strong reforms and prudent macroeconomic policies in years prior to the crisis provided some buffers against the immediate impact of the crisis. Still, policies had to be adjusted considerably. Furthermore, any effort to address the macroeconomic crisis had to go hand in hand with policies to protect the poor. Poverty was persistent and did not decline significantly even during the high growth period before the crisis3. Moreover, although on a declining trend, unemployment was high at 34 percent of the labor force in 2008. Most of the jobs created during the robust growth phase prior to the crisis were low paid jobs or unpaid family work and did not contribute to poverty reduction. As a result, FYR Macedonia was experiencing a growing number of working poor.

The authorities proactively responded to the crisis to stem the fall in output. In response to a collapse in exports, industrial production, FDI, and the general decline in business confidence, the Government carried out a sizable fiscal stimulus in late 2008 and in early 2009. In addition, a moratorium on tax and interest liabilities was introduced to help businesses facing liquidity shortages, customs duties were reduced and a multiyear infrastructure program was announced. However, by April 2009, it was becoming evident that tax revenue outturns were lower than projected earlier. In response, the Government cut expenditures to match the projected shortfall in tax revenues of almost 3.2 percent of GDP. It introduced two supplementary budgets in April and October 2009. These measures helped preserved the fiscal deficit target of 2.8 percent of GDP in 2009. The expenditure restructuring was achieved by: lowering spending on less productive capital investments, lowering goods and services spending, and a freeze on public sector wages and employment. At the same time, the Government was careful to maintain allocations for the well targeted social transfers to protect the poor and reduce social insurance 2 The assessment of the current situation by businesses began to decline rapidly in early 2009 and by November 2009 it fell to -18.4, compared to the high of 12 in August 2008. The assessment fell further to -19.2 by March 2010, before beginning to recover. 3 Regional experience indicates that poverty responds to growth but generally with a lag. Furthermore, this coincided with the 2008 surge in world oil and food prices which off-set the impact of higher employment and wages.

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contributions to help employment and competitiveness. This fiscal strategy was continued in the 2010 budget which targeted a fiscal deficit of 2.5 percent of GDP. Despite the increase in fiscal deficits to 2.8 and 2.5 percent of GDP in 2009 and 2010, respectively, from less than 1 percent in 2008, and small surpluses before that, FYR Macedonia still had one of the lowest fiscal deficits in Europe and Central Asia (ECA). As per the most recent debt sustainability analysis which envisages a gradual reduction in the deficit level over the medium-term to around 1 percent of GDP, FYR Macedonia’s fiscal deficit remains in line with sustainable long-term solvency indicators and available financing.

As a result of the prudent regulation and supervision in the period before the crisis, FYR Macedonia entered the crisis with a resilient banking sector. The capital adequacy ratio was high, non performing assets were falling4 and were adequately provisioned, and the liquidity across the sector was high. The commercial banks were largely financed by domestic deposits and as a result, an abrupt credit crunch was avoided. Hence the focus of Government polices was on creating a responsive crisis resolution framework rather than specific measures to manage the financial sector.

The Bank was well placed to quickly assist the Government in responding to the crisis through the DPL1. First, the Bank had already worked closely with the Government through a series of three budget support operations over 2005-2008; the Programmatic Development Policy Loans (PDPL 1, 2 and 3) for a total of US$ 85 million5. In addition the Bank was also engaged in implementing a Conditional Cash Transfer (CCT) Loan and a Social Protection Implementation Loan (SPIL), both of which supported the reform of the social safety net. Second, the Bank had carried out considerable analytical work (including a Country Economic Memorandum, Public Expenditure Review, Poverty Assessment, a set of Labor Market Policy Notes, Financial Sector Assessment Program Report etc.) which informed the next phase of reforms pursued by the government in addressing the crisis. Drawing on this work, the Bank was well-placed to quickly prepare a policy note in 2009, which specifically analyzed the crisis and outlined reform priorities. These formed the basis of the program supported by the DPL1.

The DPL1 was approved in December 2009 on the basis of prior actions implemented during the course of 2009. The Loan Agreement with the Bank was signed in March 2010. The operation was declared effective and the Euro 20.5 million loan amount was withdrawn in a single tranche on April 20, 2010. The Bank’s operation was co-financed by a Euro 7 million grant provided by the Government of Netherlands. The Administration Agreement between the Bank and the Donor was signed in December 2009 followed by the signing of the Grant Agreement between the Bank and FYR Macedonia in March 2010 and disbursement of the funds in April 2010.

As mentioned before, the DPL1 was envisaged as the first of the two development policy lending operations which were to be executed sequentially in 2009 and 2010. The operation was designed: (i) to help the Government maintain a sound macroeconomic and fiscal framework, while implementing measures to improve public expenditure outcomes and to improve competitiveness; (ii) to cushion the impact of the crisis on the poor and vulnerable; and (iii) to 4 Non-performing loans were 6.5 percent of all loans by the third quarter of 2008 down from 7.5 percent at the end of 2007 and historically the lowest level registered. 5 Prior to the PDPL series the Bank had supported the Government’s reform program in the Public sector through the Public Sector Management Adjustment Credit and Loan (PSMAC and PSMAL).

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strengthen the resilience of the financial sector. It focused on three policy areas and contained six prior actions and six benchmarks. However, since it was the first of a two operation series, many of the results indicators in the Program Document (PD) were set to be met only after completion of the entire program (including reforms to be implemented under DPL2). However, during the preparation of the DPL2, the authorities requested a Policy Based Guarantee (PBG) rather than a loan. In line with the Bank’s policies on DPL lending and guarantees, the DPL series was terminated after DPL1 (April 2011), and DPL2 was converted to a stand-alone PBG operation, with largely the same policy matrix as originally envisaged under the DPL2. Since the DPL series was terminated, as per Bank guidelines this ICRR was prepared for the DPL1.

The DPL series of loans is an important component of the Banks Country Partnership Strategy (CPS) and was identified in the March 2009 CPS Progress Report. The DPL1 operation contributed to the following CPS outcomes: (i) labor market: increasing flexibility of labor market outcomes and decreasing the tax wedge; (ii) health: improving the efficiency and transparency of Health Insurance Fund Operations; and (iii) social protection: improving administration and targeting of cash benefits and strengthen the pension system.

The Bank maintains a close working relationship with the IMF resulting in largely shared views on the economic situation. The IMF provided an assessment letter to the Bank6 endorsing the Government’s macroeconomic policies, which was attached to the Program Document of the Operation. Since then, on the grounds of the country’s sound macroeconomic fundamentals (including a moderate fiscal stance and adequate monetary policy), limited balance of payments needs and generally favorable economic prospects; the IMF Board approved a Euro 475.6 million Precautionary Line of Credit (PCL) in January 2011. The PCL was originally approved as an insurance mechanism in case of an “unexpected balance of payment shock”. Since then, however, the Government decided that the 2011 budget deficit is best financed by external resources to avoid crowding out domestic credit to the private sector; however, the authorities also faced constraints accessing the capital markets7. Consequently in early 2011, the Government withdrew Euro 220 million from the Euro 475.6 million available under the PCL.

The Bank has maintained a robust dialogue with the donor community on issues related to the DPL. The Bank team benefitted from regular consultation with the IMF, the USAID and the European Commission (EC). Finally, the DPL1 was co-financed by the Dutch Government. In addition to the budget support, the Dutch also provided technical assistance (TA) funds to finance analytical work, including in the health and financial sectors.

1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved):

The Government’s program supported by the DPL1 had three development objectives. The measures implemented to achieve these and the performance indicators, as presented in the PD and in the legal documents, were grouped under three “pillars” as indicated below:

6 The letter was attached to the PD. 7 Financial turmoil in selected Eurozone countries kept borrowing costs high and access limited. In addition, the declaration of early elections for June 5, 2011, prevented the authorities from incurring new debt.

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Pillar 1

The budget supports macroeconomic stability. This was to be achieved by implementing an overall fiscal policy stance supportive of macroeconomic stability as well as by implementing measures to improve public expenditure outcomes. The key performance indicators for this PDO were:

Government approval of the draft budget for 2010 with a target budget deficit of 2.5 percent of GDP.

Implement first stage of tax reform by reducing social insurance contributions from 32.5 percent of gross wage in 2008 to 28.4 percent in 2009.

Government approval of draft amendments to the Law on Health Insurance to establish a treasury function for the public health sector within the Health Insurance Fund.

Freeze nominal wage and employment for the employees funded from the central government budget, at least throughout 2009.

Pillar 2

Ensure adequate support to vulnerable groups and improve administration of social safety system. This was to be achieved by reforming the social safety net and improving its administration. The key performance indicators for this PDO were:

Levels of spending for social protection maintained at the level set forth by the original 2009 budget in all its subsequent supplementary budgets adopted for this year.

Enact new Law on Social Protection to establish a framework to improve the regulation of cash benefits, to streamline the procedures for the administration of social safety net programs and enable further harmonization of the said programs and to enable rapid response to crisis.

Pillar 3

Systemic risks are identified timely and corrective action is undertaken. This was to be achieved by strengthening the resilience of the financial sector. The key performance indicator for this PDO was:

Endorsement of an MOU on crisis preparedness outlining key responsibilities and coordination mechanisms is obtained from all stakeholders.

1.3 Revised PDOs and Key Indicators There were no revisions. 1.4 Original Policy Areas Supported by the Program (as approved) The policy areas supported by the DPL1 were grouped into three “pillars” as shown below. Each of these policy areas contained measures which constituted prior actions for DPL1 as per legal documents as well as benchmarks to measure progress of the reform program. Since DPL1 was a one tranche operation, from a strictly legal point of view, all prior actions were met before the

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loan was submitted to the Board (see Table 1). In addition, as indicated in Table 1, all the benchmarks for DPL1 set in the PD have also been met. As originally designed, the DPL1 was the first of two lending operations. Hence the measures implemented under the DPL1 were the first cut of a program that continued to be implemented and forms a basis for the Policy Based Guarantee (PBG) operation currently under preparation. The impact of the measures implemented under the DPL1 and their follow up is discussed in Section 3.2, on “achievement of program development objectives”.

Table 1: Policy Areas, Prior Actions and Benchmarks Supported by the DPL1 Policy Areas supported

by DL1 Prior Actions as per the Program

Document Benchmarks as per the Program

Document Pillar 1 Implement budgetary policies to support macroeconomic stability by improving public expenditure outcomes.

Approve a draft budget for 2010 with a deficit of 2.5 percent of GDP. (Met) Implement the first stage of payroll tax reform by reducing the social insurance contributions from 32.5 percent of GDP in 2008 to 28.4 percent of GDP in 2009. (Met) Approve draft amendments to the Health Insurance Law which establish a treasury function for the public health sector within the Health Insurance Fund. (Met) Freeze nominal wages and employment for employees funded from the Central Government Budget throughout 2009. (Met)

Implement the 2009 Budget in line with the deficit target stipulated in the second supplementary budget. (Met) Establish Inter-Ministerial committee on public administration. (Met) Initiate analysis of the impact of labor taxation reforms on the sustainability of the pension system. (Met) Amend Pension and Disability Insurance Law to improve the current sustainability of the PAYG system (reduce indexation coefficient from 50:50 CPI: Wages; to 50:20 in 2009). (Met) Initiate an analysis of the impact of labor taxation reforms on the sustainability of the health system. (Met)

Pillar 2 Ensure adequate support to vulnerable groups by reforming the social safety net and improving its administration.

Maintain levels of spending for social protection at levels set forth in the original 2009 budget in all its subsequent Supplementary Budgets adopted during 2009. (Met) Enact a new law on social protection to establish a framework to improve the regulation of cash benefits, streamline the procedures for the administration of social safety net programs and enable further harmonization of the said programs to enable rapid response to crisis. (Met)

Pillar 3 Enable timely identification of systemic risks and undertake corrective action by strengthening the resilience of the financial sector.

Obtain an endorsement from all stakeholders of a MOU on crisis preparedness, outlining key responsibilities and coordination mechanisms. (Met)

Source: DPL1, Program Document.

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1.5 Revised Policy Areas: Not applicable 1.6 Other significant changes: Not applicable

2. Key Factors Affecting Implementation and Outcomes

2.1 Program Performance:

The full amount of the DPL1 (Euro 20.5 million) was disbursed in a single tranche on April 20, 2010. The Dutch Government co-financing of Euro 7 million was also disbursed in a single tranche at the same time.

The program supported by the DPL1(see Table 1 above) contained six prior actions and six benchmarks focusing on three policy areas. It was implemented timely and effectively reflecting the Government’s commitment to the program as well as the Bank’s ability to rapidly respond to the request of the client by providing sound policy advice and financing as well as leveraging support from other donors. All actions under the program were implemented as initially envisaged.

2.2 Major Factors Affecting Implementation:

There were four factors which contributed to the successful implementation of the operation. First, the Government was committed to the program. The authorities had a clear long term vision for development building on sound macroeconomic fundamentals and ambitious reform. Furthermore, the main development objectives were largely shared across party lines. The Government also had a consultation process with labor, representatives of the business sector and other important stakeholders. Second, the program (the prior actions) was based on extensive analytical work which was discussed and agreed upon with the Government. This included the CEM, the PER, the Poverty Assessment, the Financial Sector Assessment Program (FSAP), and most importantly a policy note prepared specifically to define an appropriate policy response to the crisis. In addition, valuable support was provided by the Dutch technical assistance TF, especially in the health and financial sectors. Third, the operation was well designed taking into account lessons learnt from the earlier PDPL series. The operation set clear and achievable objectives focusing on only six prior actions and six benchmarks. Fourth, FYR Macedonia was fortunate that the global crisis receded during 2010 and 2011. This resulted in restoration of growth (albeit low) and improvement in export performance and current account deficit, which precluded implementation of further harsher fiscal measures.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization:

The Monitoring and Evaluation (M&E) systems in FYR Macedonia are evolving. In general, while individual ministries and institutions have made progress in developing their M&E systems, they tend to operate in silos. Therefore, The Government still has some way to go

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before it can have a coherent system of integrating the data and messages from individual agencies for overall policy formulation and implementation. The implementation experience shows that it was relatively straightforward to monitor macroeconomic outcomes, budgetary allocations and outturns, the pension system developments and the developments in the financial sector, where the National Bank of Republic of Macedonia (NBRM) has the capability to track developments. While basic information on the effectiveness of policies in the health sector and the social safety net can be extracted from the household budget survey (HBS), the quality of monitoring the performance indicators in these sectors need to improve further. The overwhelming focus of these agencies is on formulating and spending budgets rather than on tracking outcomes; a shortcoming that the DPL1 attempted to address. The Government has some way to go before the authorities can generate policy-oriented indicators, such as tracking out of pocket payments going to vulnerable segments of the population (a results indicator set for the overall DPL program). Similarly, while much progress has been made (supported by a Bank project) in developing databases of the social cash benefit recipients and establishing network between the Social Welfare Centers and the Ministry, it will take some time until it is able to track cash benefits going to vulnerable sections of the population and the processing time; both outcome indicators for the overall DPL program.

2.4 Expected Next Phase/Follow-up Operation

The DPL1 was the first in a series of two operations designed to be sequentially disbursed in 2010 and 2011. The reform program defined in the PD continues to be pursued and the policy matrix for the DPL series largely forms the basis of the next operation. For the next operation, the Government requested a standalone Policy Based Guarantee (PBG) rather than a loan (DPL2) as originally envisaged. The PBG is considered a preferred instrument for the following reasons. First, although FYR Macedonia’s macroeconomic situation has stabilized and the financial system has weathered the crisis well, being a small country with some neighboring economies in severe financial difficulties, FYR Macedonia continues to face market access challenges. The 2009 Eurobond was issued at unfavorable terms and efforts to tap the bond market in 2010 were not successful. The use of an IBRD guarantee would help the Government of FYR Macedonia improve its access to international financial markets at lower cost and longer maturities. Second, given that access is an issue and FYR Macedonia’s financing needs are high, the PBG would allow FYR Macedonia to access larger amounts of financing than the alternative of US$ 30 million DPL. Third, the PBG presents an opportunity to expand the investor base on relatively favorable terms and is expected to have positive spillover effects for corporate borrowers.

3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation Rating: Satisfactory

The DPL1 had clear and relevant objectives -- to respond to the crisis by maintaining macroeconomic stability, protect the vulnerable from the inevitable expenditure cuts and strengthen the resilience of the financial sector. The design of the operation was simple; focusing on three reform areas linked to the Government’s ongoing reform program and

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contained six prior actions and six benchmarks. The DPL1 operation was quickly processed and was in the nature of a first cut of an ongoing reform program which continues to be pursued and now forms a basis of the PBG operation.

3.2 Achievement of Program Development Objectives: Macroeconomic framework. Maintaining a viable macroeconomic framework was one of the overall objectives of the Government’s program supported by the Bank. At the time of approval of the DPL1, the PD had evaluated and judged the macroeconomic framework to be appropriate and this view was endorsed in the assessment letter from the IMF. Since then, as a result of the fiscal and monetary policies followed by the Government, and improved external environment as the crisis receded, the macroeconomic situation has improved8. As indicated in Table 1, GDP grew by 0.7 percent in 20109 compared to a mild contraction in 2009 and is projected to grow by 3.5 percent in 2011. Exports grew by about 24.3 percent in 2010 resulting in a marked improvement in the current account. There was also some recovery in FDI flows which financed the current account deficit and restored the foreign exchange reserves to around five months of imports by end-2010. Recent debt sustainability analysis (undertaken as part of the preparation of the PBG in early 2011) indicates that the gross external debt of about 60 percent of GDP and Government debt of 24.8 percent of GDP in 2010, should be sustainable under most plausible economic scenarios.

Table 2: Selected Macroeconomic Indicators (2007-2011) 2007 2008 2009 2010 2011 Proj. National Accounts GDP ($ Billion) 8.1 9.8 9.3 9.1 10.2 Real GDP Growth (%) 6.1 5.0 -0.9 0.7 3.0 Fiscal Accounts (% of GDP) Revenues 32.7 33.1 31.4 31.1 33.0 Expenditures 32.1 34.0 34.0 33.5 35.5 Wages and Salaries 8.9 10.0 9.8 9.6 Social Expenditures (MKD Billion) 2.8 2.9 2.8 2.9 3.9 Fiscal Balance 0.6 -0.9 -2.7 -2.5 -2.5 Government Debt 24.0 20.7 23.9 24.8 26.2 External Accounts (% of GDP) Exports of Goods and Services 52.4 50.9 39.2 47.7 49.6 Imports of Goods and Services 70.8 76.2 60.8 66.5 69.0 Current Account Balance -7.4 -12.6 -6.5 -2.9 -4.6 FDI ($ million) 700 601 186 296 Official Reserves (Months of Imports) 5.1 3.7 5.4 5.0 4.5 External Debt Gross External Debt (% of GDP) 47.6 49.3 56.5 62.4 59.0 Debt Service (as % of Export of G&S) 16.4 7.2 10.1 10.0 9.0 Consumer Prices (Period Average) 2.3 8.3 -0.8 1.6 5.0 Source: Ministry of Finance, NBRM and State Statistics Office, World Bank staff for projections.

8 Government’s macroeconomic policies were endorsed by the IMF in their most recent Article IV consultation concluded in November 2010. 9 During 2010 there was a steady acceleration of growth from -1.7 percent, on an annual basis, in the first quarter of 2009 to 2.3 percent in the fourth quarter of 2009; resulting in growth of 0.7 percent for the year as a whole.

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As discussed below, the Government has largely succeeded in achieving most of these PDOs of the DPL1 in line with the results anticipated in the PD. However, achieving some of the expected results will depend on reforms currently ongoing and supported by the PBG (previously DPL2).

Pillar 1. Implement Budgetary Policies to Support Macroeconomic Stability through Improving Public Expenditure Outcomes. Rating: Satisfactory

The Government met the PDOs set for this pillar in the PD. Overall deficit targets have been met, as well as targets for limiting public sector wages and salaries and reducing social insurance contributions. As discussed in detail below, the measures in the context of the DPL1 are only a first cut of measures necessary for achieving longer-term financial sustainability. The financial situation of pension and health funds, although somewhat improved, continues to remain fragile and will require sustained policy measures and institutional reforms (including some planned under the PBG) to make these funds fully financially sustainable.

Maintain the 2010 budget deficit at 2.5 percent of GDP. Government’s challenge in responding to the crisis was to maintain the overall budget deficit at levels that would provide some support to the economy but remain in line with financing and solvency constraints, while at the same time, continuing with restructuring of expenditures to improve conditions in the labor market and protect critical social expenditures for vulnerable groups. The Government responded to the crisis by announcing a number of measures in late 2008 and early 2009. A sizable fiscal stimulus was undertaken in late 2008. In addition, measures were introduced to help firms facing liquidity problems due to liabilities towards the public sector, but also included reduction of customs duties and additional tax exemptions (including on corporate income tax). However, by April 2009, it was becoming evident that tax revenue outturns were lower than projected earlier. In response, the Government introduced two supplementary budgets in April and October 2009. The April and October supplementary budgets kept the fiscal deficit target at 2.8 percent of GDP in 2009 and restructured expenditures to match the projected shortfall in tax revenues of almost 3.2 percent of GDP. The expenditure restructuring was achieved by: decreasing spending on less productive capital investments, decreasing goods and services spending and a freeze on public sector wages and employment. In parallel the Government was careful to maintain allocations for the well performing social transfers to protect the poor and reduce social insurance contributions to help employment and competitiveness. This fiscal strategy continued in the 2010 budget, which targeted a fiscal deficit of 2.5 percent of GDP.

Results: As a result of the measures implemented above, as indicated in Table 2, the fiscal deficit was 2.7 percent of GDP in 2009, below the targeted deficit of 2.8 percent of GDP. Similarly, the 2010 fiscal deficit target of 2.5 percent of GDP was also met. The fiscal policies pursued by the authorities during this period allowed the central government to keep its debt low at 24.8 percent of GDP by end-2010 and below the DPL1 target of 29 percent of GDP. Despite the increase in fiscal deficits to 2.7 and 2.5 percent of GDP in 2009 and 2010, respectively, from less than 1 percent in 2008, and small surpluses before that, FYR Macedonia still had one of the lowest fiscal deficits in Europe and Central Asia (ECA). The most recent debt sustainability

10

analysis (performed as part of the preparation of the PBG operation in early 2011) indicates that FYR Macedonia’s fiscal deficit remains in line with sustainable long-term solvency indicators and available financing.

Freeze the nominal wages and employment in 2009. This was a difficult and an unpopular policy measure because the Government had to defer the third installment of a three year 10 percent p.a. increase in public sector salaries. In addition, the Government froze all new employment10, with the exception of new employment on the grounds of the implementation of the Ohrid Framework Agreement and the European integration processes.

Results. As a result of these measures, total wage and salaries11 were kept below the DPL1 benchmark of 10.5 percent of GDP in 2009 and 2010 (Table 2) and is estimated to have fallen to 9.8 percent of GDP by 2010. At the same time, other spending categories were also tightly controlled. Spending on goods and services was cut to 3.5 percent of GDP in 2010 (down from 4.6 percent in 2008), while capital expenditures were reduced to around 3.5 percent of GDP (down from 4.9 percent in 2008 but still close to the average for the period before).

Reduce social insurance contributions. Overall labor taxation in the form of social insurance contributions of 32.5 percent of gross wages for the average wage earner in 2008, while not excessive by regional standards, did act as a powerful disincentive for formal employment (especially for low-wage labor) and was one of the reasons behind the high unemployment rate (34 percent of the labor force) in 2008. The labor tax wedge was also slightly regressive since low-wage workers (earning less than 50 percent of the average wage) paid their social insurance contributions on 50 percent of the average wage rather than the actual wage. To address these issues, the Government introduced a comprehensive reform aimed to streamline wage payment, introduce greater transparency and reduce the labor costs.

Table 3: Social Insurance contributions as a Percentage of Gross Wage 2008 2009 2010 2011

Social Insurance Contributions (SIC) as a % of gross wage

32.5 28.4 27.0 27.0

o/w

Pension Insurance contribution 21.2 19.0 18.0 18.0

Health Insurance contribution 9.7 8.0 7.8 7.6

Unemployment Insurance contribution 1.6 1.4 1.2 1.2

Memorandum Item

Unemployment Rate (for age 15-64) 34.0 32.3 32.2

Source: Ministry of Finance

Results. As of January, 2009, total social insurance contribution (SICs) rates were reduced from 32.5 percent of the gross salary to 28.4 percent, a prior action for DPL1 (Table 3). Going ahead, the SICs were further reduced to 27 percent of the gross salary in 2010. Originally the Government had planned to reduce contributions to almost 22.5 percent in 2011. However in

10 These policies were implemented through a decree issued by the Government. 11 Refers to the wage bill of the General government and the public health sector.

11

view of the financial sustainability of the pension and health insurance funds, the SIC rates were maintained at 27 percent12 in 2011. In addition to the reduction in SIC contributions, the Government broadened the tax base by including fringe benefits, harmonizing income bases for social security, and moving from a net wage to a gross wage basis for calculating contributions. The reduction in social contributions is probably one of the reasons behind the relatively moderate impact of the crisis on the unemployment rate and is also expected to improve the competitiveness of the economy over the medium term.

Reaffirm the sustainability of the pension system. The 2008 PER concluded that although the pension system was generally financially sustainable as a result of reforms during the last decade (including measures supported by the SPIL), number of challenges remained. Moreover, some measures implemented prior to the crisis had further strained the affordability of the system. These included: (i) more generous indexation of pensions using the 50:50 ratio (Consumer Price Index (CPI): wages indexation) instead of 80:20; and (ii) additional ad-hoc increases of pensions. In addition, the labor market impact of the crisis as well as the reduction in the pension insurance contribution rate from 21.2 percent of the gross wages in 2008 to 18 percent in 2010, further adversely affected the financial sustainability of the Pension and Disability Insurance Fund (PDIF).

To ensure the fiscal sustainability of the pension system, the government introduced a number of measures over 2009 and 2010. First, after reviewing the financial sustainability of the pension system in light of the new environment, the government substantially slowed down the originally planned reduction in pension insurance contributions (see Para. 30). Second, the indexation formula was amended from 50:50 to 50:20 in 2009 to limit the impact of the change in the wage definition on pension growth. Third, valorization coefficients were revised in the pension determination formula for the wages received during the 2009-2011 period and fourth, eligibility criteria for survivor pensions were tightened generating expenditure savings.

Results. As a result of these measures, the sustainability of the pension system improved somewhat by end-2010: (i) the replacement rate in the pension system was reduced from a baseline of 55 percent in 2008 to 47.5 percent in 201013; and (ii) pension spending was maintained at less than 9 percent of GDP in 2010. These results are in line with the targets set in the PD.

Even with these reforms in place, the viability of the pension system needs to be strengthened further. While the labor market impact of the crisis was generally moderate, formal employment was hit in 2009 and has not fully recovered. The number of workers with paid pension contributions fell from 418,958 persons in 2008 to 407,887 in 2009. Since then, with the gradual recovery of the labor market the number of contributors has increased to 413,797 at the end of 2010. Drawing on the actuarial analysis and the analysis of the impact of the planned reduction in contribution rates carried out in the context of the DPL1, the government may need to formulate and introduce additional measures to safeguard the system. 12 This flexibility was anticipated and built in the design of the DPL series. The analysis and the discussions carried out by Bank staff contributed to the moderation of the planned reductions in the SIC. 13 More than half of the reduction, or about 3-4 percentage points can be attributed to the redefinition of wages in 2009 to include benefits. The rest, about 2-3 percentage points is a real reduction in pension benefits and will help the financial sustainability of the pension system.

12

Table 4: Financial Sustainability of the Pension System 2008 2009 2010 Pensions (MKD billion) 33.4 36.5 37.6 Pension (% of GDP) 8.1 8.9 8.9 Number of Formal Contributors 418,958 407,887 413,797 Replacement Rate 55.0 49.1 47.5 Source: Pension Fund (PDIF), Ministry of Finance and World Bank Staff calculations

Improving the sustainability of the health sector. Despite a number of reforms implemented prior to the onset of the crisis (including activities supported by the Dutch technical assistance TF on drugs policies and outputs-based financing), the long term sustainability of the health sector financing remains fragile and needs to be strengthened. Combined public and private health spending in FYR Macedonia in 2008 was around 6.5 percent of GDP, down from close to 9 percent in 2004. Access and quality of services remain important issues. Public opinion polls consistently rate health services as “poor or very poor”, while household budget surveys show that out-of-pocket payments for health care are significant and pose financial access barriers for poor households.

The impact of the crisis and the reductions in contribution rates in the context of the DPL1 reduced the financing available to the health sector and complicated an already difficult situation. The resulting financial stress could potentially have adverse impact on the quality of health services. In an effort to improve spending efficiency, the Government decided to introduce a treasury function for the public health sector within the Health Insurance Fund (HIF) and adopted the necessary legal framework as a prior action for DPL1. The hardware and software required for the treasury function were purchased under a Dutch Trust Fund (TF) for technical assistance. However, there were some concerns that a treasury function may undermine the autonomy of health institutions. The Bank helped facilitate the dialogue between key stakeholders to ensure that the concerns are adequately addressed resulting at the end in shared agreement on the functioning of the treasury. The system became fully functional on January 1, 2011. This measure improved the financial management and control in the health sector and alerts the authorities to budget over-commitment or overspending by the HIF and the Health Care Institutions (HCIs).

Results. The immediate impact of creating a treasury function was keeping the arrears in the public health sector (HIF and Health Care Institutions) to less than 0.3 percent of GDP in 2009 and 2010. This was an outcome indicator for the DPL1 and was met.

The gains achieved through improved financial management (introduction of the treasury function) while important, are necessarily of a limited, short-term nature. While the arrears were kept below 0.3 percent of GDP, further efforts would be required to ensure these are brought firmly under control and eliminated. A significant medium term impact would require bold reforms, including a reform of the Basic Benefits Package (BBP) that is being attempted in the context of the DPL2 (now PBG). Some progress towards the reform of the BBG has already been achieved. However, critical actions lie ahead and, given the political sensitivities, their success is by no means assured. First, a detailed actuarial analysis was carried out to cost out the current BBP. Second, the Government adopted a Memorandum on the revision of the BBP in November 2010. It recommends options for reform, including revision of the list of services to

13

be covered, change of co-payment policies as well as promotion of voluntary health insurance. Given the political sensitivity of these reforms, further background work and definition of these proposed reforms will be required. These activities should define concrete actions related to the BBP, including establishment of clear guidelines for inclusion of services in the BBP and are being supported by the PBG operation. Pillar 2: To Ensure Adequate Support to Vulnerable Groups. Rating: Satisfactory

Protect levels of spending for social protection. FYR Macedonia has a complex social safety net system that provides support to a large part of the country’s population. The safety net performs reasonably well by regional standards but suffers from both leakages and exclusion. In 2008, around 30 percent of social assistance benefits ended up in households in the highest three quintiles, with almost 7.6 percent going to households in the top quintile.

Results. As a prior action for the DPL1, social assistance transfers were protected from spending cuts necessitated by the crisis. Despite cutting expenditures by 9 percent in the April 2009 Supplementary Budget and a further 3 percent with the October budget revision, the budgetary allocation for social protection transfers was preserved at MKD 2.9 billion (Table 1). As a result, government spending on social financial assistance increased from 1.8 percent of Core Central Budget spending in the original 2009 Budget, to 2.0 percent in the final 2009 budget. In addition (as a part of the DPL1 program), the Parliament also approved a new Law on Social Protection which lays the basis for medium-term improvements of the functioning of the social protection system.

Beyond the DPL1, the Government has a strong agenda aimed to improve the administration of the social safety net and improve protection of the vulnerable, supported under the PBG (under preparation) and in close coordination with CCT/SPIL operations:

Prepare and enact by-laws that set the regulatory framework for the implementation of the new law on social protection (achieved).

Develop a unique registry of social cash benefit recipients (ongoing and at an advanced stage).

Create a policy unit which issues regular monthly reports on social protection (ongoing).

Implement an energy poverty program to mitigate the impact of the planned electricity price reforms on the poor (achieved).

Introduce a Conditional Cash transfer (CCT) program (ongoing).

These measures, when fully implemented, are likely to result in: (i) a higher percentage of cash benefits going to the poorest quintile (compared to 43 percent in 2008), and (ii) reduced processing time for social financial assistance (from a baseline of 30 days in 2008). These results indicators will be tracked in the follow up operation and during the supervision of the investment loans in the sector (CCT/SPIL).

14

Pillar 3: Enable the Timely Identification of Systemic Risks in the Financial Sector and Undertake Corrective Action by Strengthening the Resilience of the Financial sector. Rating: Satisfactory

FYR Macedonia’s banking system entered the period of the global crisis in a relatively healthy state. This is in part due to the prudent macroeconomic policies, improved financial sector regulation and supervision in the recent past and central bank’s earlier move to increase prudential requirements14. The Dutch TA trust fund contributed also to the improved supervision by financing the implementation of the Supervisory Development Plan (SDP) for the NBRM. There were, however, a number of issues which needed to be addressed going forward. In the context of the DPL1, the Government obtained an endorsement on a Memorandum of Understanding (MoU) among key stakeholders (Ministry of Finance (MoF) and NBRM) responsible for the resolution of systemic financial crises. The MoU facilitated the creation of a framework for information exchange, consultations on financial stability and crisis management among the MoF and the NBRM, including agreements on crisis communication strategy, the lead crisis manager and definition and monitoring of systemic risk. Following the MoU, the Government established a Committee on Financial Stability (CFS) at the higher policy level. This committee was originally envisaged in the MoU and is also in line with EU standards for monitoring macro-prudential vulnerabilities.

The MoU is only the first step towards efficient coordination, adequate crisis preparedness and contingency planning. Since the approval of the DPL1 the Government has implemented additional measures. These include: (i) the adoption of a new Law on Financial Institutions which regulates credit activities of non-bank financial institutions (NBFIs); (ii) facilitation of the start of the private credit bureau which, by strengthening information systems, is expected to reduce credit risks; and (iii) adoption of a new NBRM Law which increases accountability and independence standards to EU levels (supported under the PBG).

Table 5: Resilience indicators of the Financial System

2007 2008 2009 Q1.2010 Q2.2010 Q3.2010 Q4.2010 Capital Adequacy Ratio 17.0 16.2 16.4 16.8 16.5 16.4 16.1

Liquid Assets to total Assets 20.9 16.9 20.6 22.0 23.7 24.0 25.3

NPL to toal Loans 7.5 6.7 8.9 9.7 9.9 10.4 9.0

NPL net of Provision/Capital -5.0 -6.2 -0.6 1.1 1.2 3.7 -0.3

Foreign Exchange (FX) Denominated and FX Indexed loans to total Loans

54.7 57.0 58.5 58.9 58.6 58.0 58.8

Source: NBRM

Results. The agreement on the MoU and follow up actions taken by the Government has improved the quality of monitoring, crisis preparedness and resilience of the banking sector. The

14 The NBRM prudential measures included an increase in reserve requirements, risk weights for consumer loans, credit cards and overdrafts exposures, and in loan- loss provisioning requirements. In addition, NBRM required banks to improve matching of assets and liabilities across currency and maturity.

15

related results indicator-- financial stability indicators published regularly--has also been met. Further, according to financial stability indicators published by the NBRM (see Table 5), the banking system remains sound with comfortable capital adequacy ratio and high liquidity across the sector and improving NPLs. With the new Governor having taken the office recently, it is expected that the Financial Stability Committee will soon start formally functioning.

Table 6: DPL1 Results Matrix

2008 (Base Line

Value)

Original Target Value

Dec 31, 201015 16

Actual Value Achieved

Dec 31 201017

PDO 1: Budget supports macroeconomic stability by improving public expenditure outcomes (Pillar 1 ) Indicator 1: Government approval of the draft budget for 2010 with a target budget deficit of 2.5 percent of GDP. (Achieved) Budget Balance -0.9 -2.5 -2.5 Comment: Budgeted and actual deficits in 2010 were 2.5 percent of GDP. Indicator 2: Government debt maintained below 29 percent of GDP. (Achieved)Central Government Debt as a % of GDP 20.7 23.9 (in 2009) 24.8 Indicator 3: Replacement rate in pensions is reduced from a baseline of 55 percent in 2008. (Achieved) Replacement Rate 55.0 49.1 (in 2009) 47.5 Comment: More than half of this reduction over 2008- 2010, of about 3-4 percentage points can be attributed to the redefinition of wages to include benefits. The rest, about 2-3 percentage points is a real reduction in replacement rate (slower growth of pension benefits relative to wages) and will help the financial sustainability of the pension system. Indicator 4: Pension spending maintained at less than 9 percent of GDP in 2009 and 2010. (Achieved)Pension spending (Percent of GDP) 8.1 8.9 (in 2009) 8.9 Indicator 5: Increase in the number of formal workers with paid pension contributions from 418,958 in 2008. (Partially achieved) Number of formal workers with paid pension contributions.

418,958 407,887 (in 2009)

413,797

Comment: Although this result indicator was not achieved by the time DPL1 closed, the target was originally intended to be fully achieved only after the full implementation of DPL1 and DPL2 (now PBG) programs. Following the negative impact of the crisis in 2009, the labor market is improving and the number of pension contributors shows an increase over 2009-2010. We expect the target to be achieved by the time the PBG is implemented. Indicator 6: Reduce social insurance contributions from 32.5 percent of gross wage in 2008 to 28.4 percent in 2009. (Achieved) Social insurance contributions (percent of gross wage). 32.5 28.4 (in 2009) 27.0 Comment: The reduction in social insurance contributions rates was continued further in 2010 when the total contribution rates were reduced to 27 percent. Indicator 7: Maintaining arrears of the health sector at less than 0.3 percent of GDP. (Achieved) Arrears in public health sector (HIF and health care institutions) as percent of GDP

.04 0.2 (in 2009) 0.3

15 Target values and actual achieved values refer to December 31 2010, unless otherwise mentioned. 16 There were no revisions to the target values. 17 Target values and actual achieved values refer to December 31 2010, unless otherwise mentioned.

16

Indicator 8: Freeze nominal wage and employment for the employees funded from the central government budget, at least throughout 2009. (Achieved)Total wage bill (percent of GDP)18 8.9 10.0 (in 2009) 9.6 Comment: The wage bill was targeted to be kept below 10.5 percent of GDP in 2009. The freeze in the wage/employment helped the Government meet this target. The increase in 2009 was due to the decline in nominal GDP as well as the full impact of wage increases in 2008. The wage bill continues to be below 10 percent of GDP in 2010. PDO 2: Ensure adequate support to vulnerable groups and improve administration of social safety system by reforming the social safety nets. (Pillar 2) Indicator 1: Maintain the level of spending for social protection at the level set forth by the original 2009 budget in all its subsequent budgets. (Achieved)Social spending (MKD Billion) 2.9 (2009

Budget) 2.8 (2009 Actual)

2.9 (2010 Actual)

Comment: The Government responded to the crisis in 2009 by introducing supplementary budgets in April and October 2009, cutting back on the overall expenditures by 9 percent of GDP. In this environment, the expenditures on social protection were maintained at originally budgeted levels. The expenditures have also been maintained at MKD 2.9 billion in 2010. Indicator 2: Enact new law on social protection to improve the administration of social safety net programs. (Partially achieved) Processing time for social financial assistance. (Reduced from 30 days in 2008)

30

Percentage of cash benefits going to the poorest quintile. (Increased from 43 percent in 2008).

43

Comment: Achievement of these outcome indicators critically depends on reforms that envisaged to be supported under the DPL2 (now PBG). While the new Law on Social Protection enacted under DPL1 was a first step of the program; a reduction in the processing time for social financial assistance, and increase in the benefits going to the poorest quartile – the main outcome indicators for this policy action could only be achieved after setting up a unique database of social cash benefits and the network between the Ministry of Labor and Social Policy and the Social Works centers. These were to be implemented under DPL2 (now converted to PBG) and are therefore currently being formulated and implemented. PDO 3: Systemic risks are identified timely and corrective action is undertaken by strengthening the resilience of the financial sector. (Pillar 3) Indicator 1: Obtain endorsement for a MoU on crisis preparedness outlining key responsibilities and coordination mechanisms. (Achieved) Comments: The MoU was endorsed. Following the MOU, as indicated in the PD, a Committee on Financial Stability was established and the NBRM regularly publishes financial stability indicators. The government has also adopted a new Law on National Bank of Republic of Macedonia (NBRM) which increases the accountability and independence of the Central Bank.

3.3 Justification of Overall Outcome Rating:

Rating: Satisfactory

18 The wage bill refers to the general government gross wage bill and includes wage bills of the core Central Government, Municipalities and the public health sector personnel (most of the latter two are budgeted separately in the Core Central Government accounts under transfers).

17

The overall outcome of the operation was satisfactory on the basis of satisfactory rating of the relevance of the objectives, the design and implementation of the operation and achievement of the PDOs as discussed above. The DPL1 had clear and relevant objectives - to support the Government’s response to the crisis by maintaining macroeconomic stability, protect the vulnerable from the inevitable expenditure cuts and strengthen the resilience of the financial sector. The DPL1 operation was quickly processed and was in the nature of a first cut of an ongoing reform program which continues to be pursued and now forms a basis of the PBG operation.

3.4 Overarching Themes, Other Outcomes and Impacts (if any): Not applicable. 3.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops (optional for Core ICR, required for ILI, details in annexes): Not applicable.

4. Assessment of Risk to Development Outcome

Rating: Moderate

The operation succeeded in achieving the development outcomes that it set out to achieve, namely maintaining macroeconomic stability while restructuring public expenditure, protecting the vulnerable; and initiating institutional arrangements to improve the resilience of the financial system. These development outcomes could, however, be at risk from the continued uncertain external environment which could result in balance of payments problems and increasing difficulties in accessing financial markets. To mitigate this risk, the Government is likely to maintain prudent macro and fiscal policies. Moreover, the PBG from the Bank, currently under preparation, could act as insurance for increased market access problems. Furthermore, fully meeting the program objectives in some areas (social safety net, pensions, health) would require implementation of additional measures (including some that are supported by the PBG) as well as careful and continuous monitoring.

To strengthen the external position, the Government has also accessed IMF resources. On the grounds of country’s sound macroeconomic fundamentals (including a moderate fiscal stance and adequate monetary policy), limited balance of payments needs and generally favorable economic prospects, the IMF Board approved a Precautionary Line of Credit (PCL) in January 2011. The PCL was originally approved as an insurance mechanism in case of “unexpected balance of payment shock”; however, taking into consideration the Government decision to finance the 2011 budget deficit by external resources to avoid crowding out domestic credit to the private sector and given that the authorities faced constraints accessing the capital markets, in March 2011, the Government withdrew Euro 220 million from the Euro 475.6 million available under the PCL.

18

5. Assessment of Bank and Borrower Performance

5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry (i.e., performance through lending phase): Rating: Satisfactory

The Bank developed this operation using the solid knowledge and experience gained through working closely with the Government on the preceding series of budget support operations over 2005-2008 -- the Programmatic Development Policy Loans (PDPL 1, 2 and 3) and through extensive analytical work in areas covered by the operation. The CEM (2009), Poverty Assessment (2009) and the Public Expenditure Review (2008) contained analysis related to improving growth performance, labor markets and functioning of social safety nets. The 2008 FSAP (and the IMF work) provided specific recommendations to improve the resilience of the financial sector. Finally, as the crisis evolved, the Bank staff prepared a policy note to define response. Many of the suggestions from that note were incorporated in the reform program supported by the operation. In addition, the Bank performance benefited from the active ongoing engagement through the CCT and SPIL.

(b) Quality of Supervision (including M&E arrangements): Rating: Satisfactory

The Bank supervision of the operation was continuous. Since all DPL1 prior actions were completed before the operation was submitted to the Board, the implementation of the program was supervised in the context of preparation of the follow up operation (DPL2). It was helpful to have the TTL responsibility for formulating and supervising DPL1 located in the field, and working closely with the main counterpart – Ministry of Finance. Moreover it was also helpful that the TTL for the DLP1 operation was also the TTL for the follow up operation. This helped maintain continuity in the supervision of the DPL1 program. The Bank continued to provide advice on relevant policy issues, including under other Bank operations implemented in parallel (SPIL, CCT) as well the Dutch TA trust fund.

(c) Justification of Rating for Overall Bank Performance: Rating: Satisfactory

The overall Bank performance is judged to be satisfactory on the basis of satisfactory quality at entry and the satisfactory quality of supervision.

5.2 Borrower Performance (a) Government performance

19

The Government was quick to respond to the crisis and took difficult decisions. These included introducing supplementary budgets which slashed expenditures by nearly 8 percent of GDP, freezing wages and freezing employment. At the same time, the Government protected the vulnerable. There are three factors that helped the Government formulate and implement reforms: (i) the authorities had a clear long-term vision for reform that cuts across party lines; and (ii) the authorities involved various stakeholders (labor, the business community and other important stakeholders); and (iii) the Government was engaged with Bank, the IMF and other bilateral partners in carrying out analytical work and using it to design the reform program.

(b) Justification of Rating for Overall Borrower Performance: Rating: Satisfactory

For reasons noted above, overall borrower performance is rated satisfactory.

6. Lessons Learned

The DPL1 holds important lessons for Bank’s response to externally transmitted crisis in FYR Macedonia. These include:

Credits processed in response to crisis have to be processed quickly, and must help shape Government’s immediate response yet not lose sight of medium term objectives.

The experience under the DPL1 also indicates that the assistance the Bank can provide in designing Government’s response by analytical work and acting as an honest broker and facilitating the policy dialogue (i.e. on the health sector treasury) is just as important as the resources provided by the operation.

Having a Bank presence on the ground, and most of the Team on the ground with a previously established dialogue helped lay the basis for the design and relatively fast processing of this Operation.

Bank’s assistance in sharing of lessons from emergency response from other countries was also useful. In fact, the conversion of the DPL2 operation into a PBG benefitted from a similar experience in Serbia.

Close coordination with other projects (SPIL, CCT etc.) and donors helps improve the design of the operation and speed up its processing and leverage additional resources (Dutch co-financing and technical assistance grants).

7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners

Borrower comments:

The authorities sent comments responding to an earlier draft of the ICRR and outlining their views on the implementation of the DPL1 (see Annex 4). The Government agrees with our assessment of the operation and appreciates the continuous support provided by the World Bank. The Government acknowledges that the objectives of the program were met and that the policies supported under the DPL1 substantially contributed to maintaining the macroeconomic stability while protecting the vulnerable.

20

The Government comments also acknowledge the contribution by the Government of Netherlands through co-financing the operation as well as supporting a number of strategic activities through TA trust funds. Finally, the Government comments also contain a number of useful editorial suggestions, most of which have been taken on board in the current draft.

21

Annex 1: Bank Lending and Implementation Support/Supervision Processes

First Programmatic Development Policy Loan

(a) Task Team members

Name Title Unit Responsibility/ Specialty

Lending Evgenij Najdov Sr. Economist ECSP2 TTL Marina Wes Lead Economist ECSP2 TTL Sarosh Sattar Sr. Economist ECSP3 PSIA Rajna Cemerska Operations Officer ECH3 Health Sector Sarbani Chakraborty Sr. Health specialist EASHH Health Sector Mismake Galatis Program Assistant ECSP2 Administrative Support Martin Melecky Financial Economist ECSF2 Finance Aurora Ferrari Sr. Private Sector Development Specialist ECSF1 Finance Carl-Johan Lindgren Consultant Finance Snjezana Plevko Sr. Economist ECSH3 Social Protection / Pension Bojana Naceva Education specialist ECSH2 Social Protection Lewis Hawke Sr. Financial Management Specialist ECSC3 Financial Management Erika A. Jorgensen Economic Advisor ECSPE Overall Roumeen Islam Economic Advisor ECSPE Overall Nikolai Soubbotin Sr. Counsel LEGEM Legal Nicholay Chistyakov Sr. Finance Officer CTRFC Finance Jasminka Sopova Program Assistant ECCMK Administrative Support Supervision Evgenij Najdov Sr. Economist ECSP2 TTL Jasminka Sopova Program Assistant ECCMK Administrative Support

(b) Staff Time and Cost

Stage

Staff Time and Cost (Bank Budget Only) No. of Staff Weeks US$

(including travel and consultant costs)Lending

FY10 31 166,540 TOTAL: 31 166,540

Supervision/ICR 3 33,546

TOTAL 3 33,546

22

Annex 2: Beneficiary Survey Results (if any)

Not applicable.

23

Annex 3: Stakeholder Workshop Report and Results (if any)

Not applicable.

24

Annex 4: Summary of Borrower’s ICR and/or Comments on Draft ICR

25

26

27

28

Annex 5: Comments of Co financiers and Other Partners/Stakeholders

The DPL1 was co-financed by the Government of the Netherlands. A draft ICRR was sent to the Dutch Embassy in Skopje for comments and contributions. The Donor has broadly endorsed the assessment provided in the ICRR.

29

Annex 6: List of persons interviewed

Government of FYR Macedonia Ministry of Finance Ms. Suzana Peneva, State Advisor Ms. Lence Tagasovska, Head of Financial Systems Department Ms. Anita Popovska, Macroeconomics Department Mr. Nexhati Kurtishi, Macroeconomics Department Ms. Snezana Delevska, Macroeconomics Department Health Insurance Fund Ms. Maja Parnargieva Zmejkova, Director General Ms. Tatjana Lukanovska, Finance Director Ms. Maja Bogdanovska, Treasury Director National Bank of the Republic of Macedonia Ms. Milica Arnaudova, Head of Department for Financial Stability, Banking Regulation and Methodology Ms. Natasa Andreeva, Department for Financial Stability, Banking Regulation and Methodology Ministry of Labor and Social Policy Ms. Vesna Petkovic, Head of Sector for International Cooperation and Project Director for the Social Protection Implementation Loan Ms. Sofija Spasova, Head of Social Protection Sector Netherlands Embassy Mr. Blaze Kojcevski, Advisor Ms. Slobodanka Matakova, Advisor

Osogovske Mts.

Malesevske Mts.

Ni d

z e Mt n

.

Mt. KorabMt. Korab(2,753 m) (2,753 m)

SopotnicaSopotnica

PelinciPelinci

VratnicaVratnica

MedzitlijaMedzitlija

DrugovoDrugovo VraneshticaVraneshtica

TetovoTetovo

PetrovecPetrovec

TearceTearce

GostivarGostivar

DebarDebar MakedonskiMakedonskiBrodBrod

KavadarciKavadarci

GevgelijaGevgelija

KrivogashtaniKrivogashtani

BerovoBerovo

VinicaVinica

KratovoKratovo

KumanovoKumanovo

PrilepPrilep

StrumicaStrumica

ValandovoValandovo

OhridOhrid

StrugaStruga

ResenResen

BitolaBitola

VelesVeles

KrivaKrivaPalankaPalanka

SvetiSvetiNikoleNikole

Demir HisarDemir Hisar

ArachinovoArachinovo

BogdanciBogdanci

BogovinjeBogovinje

BosilovoBosilovo

BrvenicaBrvenica

Centar Centar ZupaZupa

ChaskaChaska

Chucher-Chucher-SandevoSandevo

Demir KapijaDemir KapijaDolneniDolneni

GradskoGradsko

IlindenIlinden

JegunovceJegunovce

KarbinciKarbinci

KoncheKonche

LipkovoLipkovo

LozovoLozovo

Makedonska Makedonska KamenicaKamenica

MogilaMogila

NegotinoNegotino

NovaciNovaci

NovoNovoSeloSelo

OslomejOslomejZajasZajas

PehcevoPehcevo

PlasnicaPlasnica

RankovceRankovce

SopisteSopiste

StaroStaroNagorichaneNagorichane

RosomanRosoman

StudenichaniStudenichani

VasilevoVasilevo

VevcaniVevcani

VrapchishteVrapchishte ZelenikovoZelenikovo

ZheinoZheino

ZrnovciZrnovci

KicevoKicevo

KrusevoKrusevo

RadovisRadovis

StipStip

DelcevoDelcevoProbistipProbistip

KocaniKocani

Star DojranStar Dojran(Dojran)(Dojran)

ObleshevoObleshevo(Cheshinovo)(Cheshinovo)

BelchishtaBelchishta(Debarca)(Debarca)

RostushaRostusha(Mavrovo &(Mavrovo &Rostusha)Rostusha)

SKOPJESKOPJE

Crna

Crni Drim

Vaarrddar

Bregain

ica

Sopotnica

Pelinci

Vratnica

Medzitlija

Drugovo Vraneshtica

Tetovo

Petrovec

Tearce

Gostivar

Debar MakedonskiBrod

Kavadarci

Gevgelija

Krivogashtani

Berovo

Vinica

Kratovo

Kumanovo

Prilep

Strumica

Valandovo

Ohrid

Struga

Resen

Bitola

Veles

KrivaPalanka

SvetiNikole

Demir Hisar

Arachinovo

Bogdanci

Bogovinje

Bosilovo

Brvenica

Centar Zupa

Chaska

Chucher-Sandevo

Demir KapijaDolneni

Gradsko

Ilinden

Jegunovce

Karbinci

Konche

Lipkovo

Lozovo

Makedonska Kamenica

Mogila

Negotino

Novaci

NovoSelo

OslomejZajas

Pehcevo

Plasnica

Rankovce

Sopiste

StaroNagorichane

Rosoman

Studenichani

Vasilevo

Vevcani

Vrapchishte Zelenikovo

Zheino

Zrnovci

Kicevo

Krusevo

Radovis

Stip

DelcevoProbistip

Kocani

Star Dojran(Dojran)

Obleshevo(Cheshinovo)

Belchishta(Debarca)

Rostusha(Mavrovo &Rostusha)

SKOPJE

B U L G A R I A

K O S O V OS E R B I A

G R E E C E

ALB

AN

IA

LakeOhrid

LakePrespa

LakeDojranCrna

Crni Drim

Vardar

Bregain

ica

To Pristina

To Nis

To Pernik

To Blagoevgrad

To Petrich

To Thessaloniki

To Kozáni

To Elbasan

To Korçë

Osogovske Mts.

Malesevske Mts.

Ni d

z e Mt n

.

Mt. Korab(2,753 m)

42°N

41°N

42°N

41°N

22°E

22°E 23°E

23°E

21°E

AERODROM

CENTAR

BUTEL

SARAJ

SUTOORIZARI

KARPOSH

KISELAVODA

GAZIBABA

GJORCEPETROV

CHAIR

THE CITY OF SKOPJE

SKOPJESKOPJESKOPJE

Skopje serves as theMunicipality Capital

for each of theseMunicipalities.

FYRMACEDONIA

FORMER YUGOSLAV REPUBLIC OFMACEDONIA

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 10 20

0 105 15 20 Miles

30 Kilometers

IBRD 33438R2

JULY 2009

SELECTED CITIES AND TOWNS

MUNICIPALITY CAPITALS*

NATIONAL CAPITAL

THE CITY OF SKOPJE

RIVERS

MAIN ROADS

RAILROADS

MUNICIPAL BOUNDARIES

INTERNATIONAL BOUNDARIES

*In most cases, the names of the municipalitiesare identical to their capitals. Where theydiffer, the municipality is shown in green italic.