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Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 36146-BG

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND INTERNATIONAL FINANCE CORPORATION COUNTRY PARTNERSHIP STRATEGY FOR THE REPUBLIC OF BULGARIA FOR THE PERIOD FY07-FY09 May 16,2006

South Central Europe Country Unit Europe and Central Asia Region InternationalFinance Corporation Southern Europe and Central Asia Department

This document has restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization.


The date of the last Country Assistance Strategy Report was May 31,2002. CURRENCY EQUIVALENTS (Exchange Rate as of March 30,2006) Currency Unit = Bulgarian Lev (BGN) US$= 1.616920 BGN

GOVERNMENT’S FISCAL YEAR: (January 1 -December 31) WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AAA APL BGN BNB CAE CAS CBA CEEC CEM CFAA CPAR CPS DPL EBRD EC ECA EIB EU EU-8 EU-15 EU-25 FDI FIAS FSAP GDI GDFI GDP GEF GNI HD HIV/AIDS IBRD IFA IFC

Analytical and Advisory Activity Adaptable Program Loan Bulgarian Lev BulgarianNational Bank Country Assistance Evaluation Country Assistance Strategy Currency Board Arrangement Central and Eastern European Countries Country Economic Memorandum Country Financial Accountability Assessment Country Procurement Assessment Report Country Partnership Strategy Development Policy Loan European Bank for Reconstructionand Development European Commission Europe and Central Asia European Investment Bank European Union EU Member States as of May 1, 2004, excluding Malta and Cyprus EU Member States prior to May 1,2004 EU Member States as of May 1,2004 Foreign direct investment Foreign Investment Advisory Service Financial Sector Assessment Program Gross Domestic Investment Gross Domestic Fixed Investment Gross Domestic Product Global Environment Facility Gross National Income Human Development Human Immunodeficiency Virus/Acquired Immunodeficiency Syndrome International Bank for Reconstruction and Development Institutional Fiduciary Assessment International Finance Corporation

Vice President: Country Director: Task Team Leader:

IBRD Shigeo Katsu Anand K. Seth Oscar de Bruyn Kops

IF1 ILO IMF JIM JPR MDG M&E MIC MIGA MoF MTHS NEK NGO NSP NSRF OP OED PAL PBA PEIR PFPR PIU PPP PPS QAG R&D SBA SEE SDR SME TA TTFSE UK UNDP USAID USD WBI

Internationalfinancial institution InternationalLabor Organization InternationalMonetary Fund Joint Inclusion Memorandum Joint Portfolio Review Millennium Development Goals Monitoring and evaluation Middle Income Country Multilateral Investment Guarantee Agency Ministry o f Finance Multi-Topic Household Survey National Electricity Company Non-governmental organization National Strategic Plan National Strategic Reference Framework Operational Program Operations Evaluation Department Programmatic Adjustment Loan Programmatic Based Approach Public Expenditure and InstitutionalReview Public Finance Policy Review Project Implementation Unit Public Private Partnership Purchasing Power Standard Quality Assurance Group Research and Development Stand-By Arrangement South Eastern Europe Special Drawing Rights Small and medium enterprises Technical assistance Trade & Transport Facilitation for SE Europe United Kingdom United Nations Development Program United States Agency for International Development United States dollar World Bank Institute

Acting Vice President, Operations: Director: Task Leader:

IFC Declan Duff Shahbaz Mavaddat Gjergi Konda


BULGARIA COUNTRY PARTNERSHIP STRATEGY CONTENTS

.......................................................................................... I. Introduction ........................................................................................................................... ......................................................... ..................................... I1. Country Context ........... Executive Summary

A . Political Developments........................................................................................................ B. Economic Developments..................................................................................................... C. Developments in Poverty Reduction, Gender and MDGs ...................................................

i 1

1 1 2 5

........................................................

.

I11 Government Priorities and Development Challenges 8 . . . Government Priorities .......................................................................................................... 8 A. 8 B. Key Challenges for Successful EU Integration ................................................................... (i) Raising productivity and employment for sustaining high private sector led growth ....11 (ii)Improving governance and strengthening institutions.................................................... 13 (iii) Strengthening fiscal sustainability and absorption o f EU funds..................................... 16 (iv) Poverty reduction and social inclusion ........................................................................... 19

............................................. V . Proposed World Bank-Bulgaria Partnership. FY2007-2009........................................... .

19

A. B. C. D. E. F. G. H. I.

22 22 23 24 25 26 29 31 32 34

I V Past World Bank Group Assistance and Lessons Learned

.

Rationale for Future Partnership........................................................................................ Implications o f Client Survey Feedback for the CPS ........................................................ Strategic Priorities for the CPS .......................................................................................... Outline of Initial Bank Program ........................................................................................ Bank Support for Strategic Priorities................................................................................. Lending Principles ............................................................................................................. IFC and M I G A Support for the CPS ................................................................................. Partnerships ....................................................................................................................... CPS Results Monitoring ....................................................................................................

..........................................................................

V I Creditworthiness and Risk Management

34


BOXES Box 1: Bulgaria - Who are the Poor? .............................................................................................. Box 2: Bulgaria’s Progress Toward the MDGs............................................................................... Box 3: National Strategic Reference Framework 2007-20 13 ....................................................... Box 4: Corruption has reduced but remains a concern..................................................................

6 7 ..9 15

FIGURES Figure 1: Bulgaria: Stability and Growth ........................................................................................ 3 Figure 2: Bulgaria and CEEC: Progress in Structural Reforms, 1999-2004 ................................... 4 Figure 3: Selected Governance Indicators for Bulgaria and EU-8, 2004 ...................................... 14 .. Figure 4: External oebt Composition ............................................................................................ 35

TABLES Table 1: Summary o f EU Financial Support for Bulgaria, 2007-2009 ......................................... 18 Table 2: Proposed Bank Lending and AAA Program, FY07-09 ................................................... 26 27 Table 3: CPS Strategic Priorities and Bank Lending & AAA Instruments ................................... Table 4: Policy Performance Indicators for Bank Lending Engagement ...................................... 30 Table 5: Partnerships in Addressing Bulgaria’s Development Challenges .................................. .33 Table 6: IBRD Exposure Indicators for Bulgaria, 2002-2009....................................................... 35

ANNEXES Annex 1 Annex A2 Annex B2 Annex B3 Annex B4 Annex B5 Annex B6 Annex B7 Annex B8 Annex C

Results Matrix Bulgaria at a glance Selected Indicators o f Bank Portfolio Performance and Management Bank Group Program Summary IFC and M I G A Program Summary o f Non-lending Services Social Indicators Key Economic Indicators Key Exposure Indicators Status o f Bank Group Operations (Operations Portfolio) Statement o f IFC’s Weld and Disbursed Portfolio CAS Completion Report


Executive Summary (i) This three-year Country Partnership Strategy builds on Bulgaria’s considerable achievements over the last eight years which have brought it to the threshold o f EU accession. Following a difficult transition which culminated in a severe financial and social crisis in 1996-97, Bulgaria established macroeconomic stability and accelerated structural reforms. Fiscal discipline was introduced and debt brought well within Maastricht criteria. Most non-infrastructure enterprises and virtually all banks have been privatized or liquidated, trade and prices were liberalized, and the investment climate improved. As a result, growth has accelerated to about 5 percent per year during 2000-05, inflation slowed to single digits, unemployment declined to 10.7 percent in 2005 from 18 percent in 2000, and poverty levels dropped during the period. The private sector share in the economy at 75 percent o f GDP i s now in line with the share in the eight EU new member states (EU-8). Building on these major achievements, Bulgaria completed formal negotiations on EU membership in April 2005 and i s expected to realize i t s goal o f EU membership on January 1,2007, following a final go-ahead by the European Commission in mid-2006. (ii) At the same time, key challenges remain for Bulgaria’s successful integration with the EU. Bulgaria’s per capita income, at PPS in 2003, was 31 and 56 percent o f the average level o f EU-25 and the EU-8 countries respectively. To narrow this large income gap, Bulgaria will need to improve efficiency o f the economy and set it on a higher growth path leading to sustained improvements in living standards. Bulgaria also faces an investment gap in both human and physical infrastructure capital as a result o f years o f relatively low investment which i s only now catching up. To accelerate convergence with the EU, Bulgaria faces four major challenges. First, and foremost, to push ahead with reforms to promote productivity and employment for sustained high private sector led growth. T h i s i s particularly pressing for Bulgaria as it has the worst demographic conditions in Europe and its employment rate i s well below EU average. Second, to strengthen institutional capacity and public finance management for improved service delivery, fiscal sustainability and effective absorption o f EU grant fimds which could reach about 3.7 percent o f GDP in 2007-09 if managed well. Third, to address poverty and social exclusion aimed at wider participation in growth. And fourth, to maintain macroeconomic stability and manage risks related to the widening current account deficit and the rapid increase in private sector credit as the foundation for continued strong economic growth. (iii) The CPS seeks to help Bulgaria meet these challenges and facilitate Bulgaria’s economic and social integration with the EU. The Government has requested that the Bank continue to stay involved in Bulgaria with a full-service, yet focused, assistance program over the coming years o f EU accession and integration. In line with the directions o f Government’s medium t e r m program, and building on Bulgaria’s development priorities and the Bank’s comparative advantage in Bulgaria, the CPS will support three overall priorities: (i) productivity and employment - implementation o f unfinished structural reforms and investments to strengthen productivity and employment in support o f private sector led growth along the lines o f the EU Lisbon agenda; (ii) fiscal sustainability and absorption of EU funds - capacity building for improved public expenditure management, investment planning, and development o f project pipelines eligible for EU funds, coupled with development o f effective mechanisms to combine


ii

Executive Summary

EU, local and IF1 financing; and (iii)social inclusion - policies and investments to reduce regional imbalances and improve social inclusion for poverty reduction. (iv) Within this broader strategic framework, the consultations with Government resulted in a focused set o f priorities f o r initial Bank involvement. The strategic consultations o n the Bank’s future involvement provided a strong preference for initial Bank involvement in addressing the unfinished reform agenda in health, education and social protection, and in implementing fiscally sustainable investment programs in roads, municipal infrastructure, social inclusion and regional development, coupled with an effective absorption o f EU funds.

(v) I n line with Bulgaria’s achievements, the Bank will adjust its business model in future country assistance and move towards a partnership model with greater flexibility. The new business model will involve (i) a more flexible approach to defining lending and nonlending activities within the broad CPS strategic priorities, with an agreed assistance program for FY07 and an indicative program for FY08-09 to be revisited by an annual consultation process with Government; (ii) lending up to an agreed ceiling based o n continued sound macroeconomic performance and prudent country risk assessment and IBRD exposure management, including a move greater choice in lending instruments and the share o f fast disbursing operations; and (iii) towards programmatic approaches in lending coupled with gradual alignment o f Bank procedures with country systems while ensuring compliance with prudent Bank fiduciary standards. (vi) The proposed lending program up to US300 million per year would involve three operations per year based on a series o f Development Policy Loans @PLs) and programmatic investment loans in support of the above priority areas. A series o f three programmatic DPLs o f about US$lSO million each would focus on advancing the unfinished reforms in health, education, and social protection, in support o f growth, employment, fiscal sustainability and social inclusion. The DPLs would be Complemented by up to two investment operations per year to help with implementation o f prioritized investment programs and absorption o f EU b d s in roads and municipal infrastructure, social inclusion, and regional development. They would build on sound medium-term sector expenditure frameworks. (vii) The AAA program agreed with the Government would be front loaded to provide analytical support and advice in core policy areas and underpin the design o f lending operations. The CPS includes upfront core AAA on strengthening the investment climate for private sector growth and employment, and a second phase Public Finance Policy Review. A poverty/living standards assessment would update the Bank’s earlier poverty work in Bulgaria and support the D P L series. A report on the implementation o f the structural reform agenda is foreseen as follow-up to the recent CEM. These activities are complemented by TA in selected policy areas - energy sector reform and regional development. Finally, fiduciary and safeguards work will facilitate the move towards a program-based lending approach in the roads sector, while a fiduciary (CFANCPAR) update will underpin the D P L series.

(viii) I F C and M I G A will support Bulgaria’s EU integration agenda. IFC’s strategic objective will be to help Bulgaria improve i t s competitiveness through supporting domestic companies and attracting foreign private investors in the country, with focus on (i) the financial


Executive Summaw

iii

sector where IFC i s gradually shifting i t s focus to the non-bank financial sector; (ii) the corporate sector where it will continue to support the rehabilitation and modernization o f post-privatized companies and promote foreign investments to foster technology transfer for productivity gains; and (iii) infrastructure where it will support public-private partnerships and catalyze FDI. The Bank and IFC will collaborate in developing a joint program in financing water and waste water investment needs in selected municipalities. MIGA i s open for opportunities to support foreign investors through the provision o f political risk guarantees, also on a sub-sovereign level.

The proposed strategy faces a number o f risks. The main risk would be a possible (ix) slow down in the reform agenda following EU accession which in turn could trigger a slowdown in growth. This risk i s mitigated by the external discipline provided by the EU accession and integration agenda. The risks to macroeconomic stability, particularly from the widening current account deficit and external developments in interest rates, oil prices and FDI flows, are reduced by the government’s strong record o f sound macroeconomic and fiscal management and the surveillance roles played by the I M F and the EU’s Stability and Growth Pact upon Bulgaria’s EU accession. Board members may wish to discuss the following aspects: 0

0

Does the CPS adequately respond to the needs o f Bulgaria, balancing flexibility and client responsiveness with a strategic framework to guide and focus the program?

A r e the suggested principles for Bank lending engagement appropriate?


BULGARIA COUNTRY PARTNERSHIP STRATEGY F Y 2007-2009

I. Introduction 1. This three-year Country Partnership Strategy for Bulgaria (FYO7-09) will cover the period when the country i s expected to join the EU. The CPS builds on Bulgaria’s considerable achievements over the last eight years and proposes a Bank program in support o f Bulgaria’s integration and convergence with the EU. I t follows completion o f the previous CAS which covered the period FY02-05,’ and which included the completion o f the PAL series in support o f Bulgaria’s broad structural reform agenda. The CPS would evolve the Bank’s relationship with Bulgaria towards a flexible arrangement within a three year strategic framework, also drawing on the Bank’s agenda for well-performing Middle Income Countries (MICs). The proposed Bank involvement draws on a number o f strategic consultations with the Government which requested a renewed partnership with the Bank - including a lending program up to US$300 million per year - focused on a limited set o f priorities for initial Bank involvement: (i)the unfinished reform agenda in the human development area, and (ii) implementation o f fiscally sustainable investment programs in infrastructure, social inclusion and regional development to help absorb the considerable EU grant funds which accompany Bulgaria’s EU accession. It builds on the lessons from the previous CAS and the Bank’s involvement in the EU-8 new members states.

11. Country Context A.

Political Developments

2. EU accession on January 1,2007, i s the central focus of the Government. Bulgaria signed i t s EU accession treaty in April 2005, following completion o f the formal negotiation process. Since then, the European Commission has tracked Bulgaria’s progress on a few key outstanding areas. The EU monitoring report o f last October highlighted shortcomings in justice and organized crime, fraud and corruption, and the preparation o f administrative structures for channeling EU funds, which would need to be resolved by the time a final monitoring report i s prepared in May this year to keep accession in 2007 on track. If readiness i s judged insufficient, a “safeguard clause” in the treaty may be invoked to delay membership by a year.* In the meantime, the ratification process o f the accession treaty by EU member states has been underway to permit Bulgaria’s timely accession. Government in the meantime has been singularly focused on meeting i t s commitments in the remaining areas o f EU concern.

3. The new three-party coalition government has a large majority, but i t s stability will be tested by the forthcoming Presidential elections. The coalition government i s made up o f the three largest parties to emerge from the elections last June and has a comfortable two-thirds

/ FY06 was treated as an interim year between the previous CAS and the CPS to allow preparation of the CPS in consultation with the new government which took office in August 2005 following the June 2005 general elections. * / Approval o f the “safeguard clause” would require a unanimous vote among EU members.


2

Bulgaria: Country Partnership Strategy

majority in Parliament. It i s led by the center-left Bulgarian Socialist Party (BSP) which emerged with most of the votes, and i s further made up o f the two partners in the previous coalition government - the centrist Simeon I1National Movement (NMS2) and the mainly ethnic Turkish Movement for Rights and Freedoms (MW). The program o f the new government centered on EU accession shows a high degree o f continuity from the previous government, with a focus on economic growth and stability. I t supports a continued conservative fiscal policy and maintenance o f the currency board which links the local currency to the Euro. The forthcoming Presidential elections in November may complicate the relations in the coalition with an SNM2 candidate possibly running against the incumbent socialist President. A possible delay in EU membership may also test the strength and resolve o f the coalition. While such developments may affect the pace o f reform, the risk o f major deviations from the current reform path i s reduced by Bulgaria’s EU accession agenda and the strong record o f reform established in the last eight years.

B.

Economic Developments

4. Over the last eight years, Bulgaria has made impressive progress towards long-term stability and sustained growth. Following a difficult transition which culminated in a severe crisis in 1996-97, macroeconomic stability was reestablished and has been maintained by prudent fiscal policies and strict discipline in incomes policy anchored in the Currency Board Arrangement (CBA) adopted in 1997. Fiscal consolidation reduced the overall fiscal deficit from 15.2 percent o f GDP in 1996 to a balanced budget in 2003 and generated a fiscal surplus in 2004 (1.7 percent o f GDP) and 2005 (2.3 percent). The external and public debt to GDP ratios declined from nearly 100 and 107 percent o f GDP respectively in 1997, to about 68 and 32 percent respectively in 2005. As a result o f these policies and deep structural reforms, average growth reached the levels o f the eight EU New Member States (NMS-8) at about 5 percent per year in 2000-05. (estimated at 5.5 percent in 2005) and inflation has declined to single digits from hyperinflation levels (estimated at 5.0 percent in 2005). Unemployment also declined from 18 percent in 2000 to 10.7 percent by end-2005, but masks a continued low labor market participation rate.

5. A broad structural reform agenda has contributed to solid economic performance. The severity o f the 1996-97 crisis and the prospect o f EU accession changed the political economy in the direction o f reforms. Between 1998 and 2002, most o f the non-infrastructure enterprises and banks were privatized or liquidated, trade and prices were liberalized, energy reforms made important progress, and the first steps were taken in regulatory reform to improve the investment climate. As a result, growth i s led by the private sector which now accounts for 75 percent o f Gross Domestic Product (GDP) with an equal share o f total employment. Integration with external markets expanded with trade in goods and services increasing relative to GDP from 94 percent in 1998 to almost 140 percent in 2005. Foreign direct investment (FDI) flows increased during the period, but remained broadly constant as a share o f total investment. Investor confidence improved over time - both domestically and externally. Bulgaria’s longterm foreign currency debt was upgraded to an investment grade rating in the summer o f 2004.


3

Bulgaria: Country Partnership Strategy

Figure 1: Bulgaria: Stability and Growth CPI Inflation (% change, annual average)

Fiscal Balance (% o f GDP)

1100 4

900

-1

700

-6

500 300

-11

100

-16

-100 rl

-2 1

120

100 110

External Debt and D e b t Service (% o f GDP)

30

70 50 -

20 15

80

-10 -20 -30 a,

n 20

g c)

10

80

Investment

25

25

90

1

30

-40; 15

5

-50'

-60

10

0

-70

5

-External +External

-80

Debt Debt Service (RHS) GDI % of GDP -GDFI

R e a l GDP (% change) 24 20 16 12 8 4 0 -4 -8 -16 -12

24 20 16 12 8 54 0 -4 -8 -12 -16

Source: World Bank staff estimates based on data from

1

ml

(l989=1)

C u r r e n t Account Deficit and net FDI (% o f GDP)

l6 12 8 4 0 -4

-8

OFDl

SI, BNB, MOF (GFS200Z),and NEA.

6. Despite the positive developments over the last eight years, important gaps in reforms and performance remain relative to the EU New Members States. Despite a well diversified trade partnership and a liberal trade regime which provide Bulgarian producers with


4

Bulgaria: Country Partnership Strategy

easy access to global markets, its economy has yet to benefit more fully from its integration with the EU and external markets. Bulgaria’s export capacity remains limited compared to the EU-8 countries. Competitiveness remains mostly limited to unskilled labor-intensive and energyintensive activities. This can be explained by the remaining gaps in structural reforms in Bulgaria relative to the EU-8 as shown in Figure 2 below for two phases o f the reform agenda.

Figure 2: Bulgaria and CEEC: Progress in Structural Reforms, 1999-2004 Initial Phase of Reforms EBRD Index

Second Phase of Reforms 5 R D Index

Slovak Rep.

Caech Republic

Poland

Hungaly

Lithmnia

Poland

Latvia

jlovak RepuMi

Hungary

Estonia

Estonia

Latvia

Caech Rep

Croatia

Slovenia

Bulgaria

Croatia

Lithuania

Romania

Slovenia

Bulgaria

Romania

3.6

3.8

4

4.2

42

0

1

2

3

4

Source: EBRD Transition Indicators; Indicators for the initial phase o f reforms are calculated as unweighted averages o f

indicators for small-scale privatization; price liberalization; trade and foreign exchange system. Indicators for the second phase of reforms are calculated as unweighted averages o f indicators for large-scale privatization; governance and enterprise restructuring; competition policy; banking reform and interest rate liberalization; securities markets and non-bank financial institutions; infrastructure reform.

Economic growth i s expected to remain strong. Based on continued growth o f 7. domestic demand and a recovery in exports, GDP i s estimated to have grown by 5.5 percent in 2005. During 2006-08, growth i s expected to remain strong and stay in the 5.5 to 6 percent range per year (see Annex B6 for the medium-term macroeconomic fiamework). So far economic growth has been supported by high private consumption and to lesser extent by intensified investment activity. Over the medium-term, private consumption growth i s forecast to slow down, while investments in the real sector and FDI flows are expected to remain high and the trade balance expected to improve due to the forthcoming EU accession.

8. The widening current account deficit remains a serious concern and poses a considerable macroeconomic risk. The deficit has been rapidly increasing in the past few years, reaching an estimated 11.8 percent o f GDP in 2005. The Government has responded by tightening the fiscal stance and by taking measures to control the growth o f credit to the private sector. The fiscal surplus was over two percent o f GDP in 2005, and i s expected to rise to about three percent o f GDP in 2006 to help control the current account deficit. Over the medium-term, fiscal surpluses are projected to continue. The impact o f these measures has been limited though. Further restructuring and consolidation o f the budget will also be required to accommodate the forthcoming flows o f EU grant funds which are estimated to have a net fiscal


Bulgaria: Country Partnership Strategy

5

impact o f about two percent o f GDP during 2007-093. The fiscal stance will also need to remain sufficiently flexible to respond to possible external shocks (also see the section on creditworthiness and risk management below). So far the current account deficits have been largely covered by FDI inflows, which are projected to remain high given the expected EU accession. However, sustaining high foreign inflows will require continued improvements in the business climate, including the needed reforms in the judiciary.

9. T o meet the criteria for entering the euro zone, Bulgaria would also need to further curtail inflation. Inflation i s projected to pick up to about 7 percent in 2006 as a result o f increases in excise taxes, impact o f floods last year and this year on agricultural prices, and possible impact o f further o i l price increases, but to decline in the following years. 10. The IMF has completed the second review o f the Stand-By Arrangement (SBA) in early April 2006. A precautionary 25-months SBA with access o f SDRlOO million was approved b y the IMF Board on August 6, 2004, and the first review was completed on M a y 18, 2005. The SBA-supported program seeks to reduce Bulgaria’s increased external vulnerability and to achieve sustainable high growth through: (i) continued tight fiscal policy and measures to reduce bank liquidity in order to reduce excess demand in the short run; and (ii)structural reforms to boost output and export capacity in the medium-term. The current arrangement may be extended beyond September 2006 to support satisfactory program implementation in light o f Bulgaria’s continued high external vulnerability. Once Bulgaria joins the EU, its participation in the EU’s Stability and Growth Pact (SGP),4 with related multilateral surveillance, would help to sustain Bulgaria’s prudent macroeconomic policies.

C.

Developments in Poverty Reduction, Gender and MDGs

11, Continued growth since the 1996-97 economic crisis has led to improvements in living standards generally, although deep pockets of poverty persist. Per capita income has increased f i o m US$1,200 in 1997 to US$2,740 in 2004 (GNI, Atlas method). Nevertheless, per capita GDP, at PPS in 2003, was just over 30 percent o f EU average which makes continued growth and convergence o f living standards towards EU standards a core policy goal. As incomes in Bulgaria have risen, poverty has fallen. Poverty, measured at two-thirds o f average per capita consumption in 1997, fell by two-thirds between 1997 and 2001. The depth and severity o f poverty also improved. Although there are no comparable surveys for the period after 2001, a more recent study that used econometric techniques to estimate comparable numbers showed that poverty had fallen from 24 percent in 2001 to 21.9 percent in 2003. T h i s study showed that the decline was mostly on account o f improvements in rural areas, where poverty / The impact o f EU grant flows on the country i s estimated at 3.7 percent o f GDP during 2007-09. The net fiscal impact estimated at about two percent o f GDP during 2007-09 also takes into account Bulgaria contributions to EU budget, and co/pre-financing requirements o f EU financed investments. / The main objective o f the Stability and Growth Pact (SGP) i s to enforce discipline in the Euro-zone as a means to support price stability and sustainable growth. Budgetary discipline i s gauged with respect to two criteria: a general government deficit-to-GDP ratio below three percent, and a debt-to-GDP ratio below 60 percent. Functioning of the SGP rests on two pillars: multilateral surveillance and corrective mechanisms, As regards surveillance, EU member states are required to prepare a Convergence Program and update it annually. The European Commission (EC) prepares an assessment o f such convergence programs on the basis o f which the Council o f the EU issues an opinion. As regards corrective mechanisms, the Excessive Deficit Procedure identifies and forces corrections o f excessive deficits, defined under non-exceptional circumstances as a deficit over three percent o f GDP.


6

Bulgaria: Country Partnership Strategy

continues to be higher than in urban areas. At the same time, inequality in urban areas increased. The study showed that extreme poverty i s low at 4.8 percent o f households, while food poverty (a proxy for malnutrition) i s virtually non-existent. As poverty has fallen, the nature o f poverty has evolved with poverty increasingly concentrated among vulnerable groups. Analysis o f the 2003 data establishes that the poverty profile in Bulgaria has come to resemble poverty patterns in other CEE countries more closely - key determinants o f household welfare and poverty are household size, number o f children, education or occupation o f the head o f household, gender, ethnicity and location (see Box 1).

-

Box 1: Bulgaria Who are the Poor?

The poor are more likely to be found outside Sofia. T h e poverty rate in rural areas was estimated at 29.1 percent in 2003, compared to 18.7 percent in urban areas. Welfare differences by location, however, become sharper when Sofia city i s compared to other - urban or rural - areas. Even taking into account the differences in characteristics (such as education, family size, etc.) between rural and urban households, the per capita consumption o f households living outside Sofia i s 10 to 25 percent lower than that for households living in the capital city. People living in large households with two or more children are more likely to be poor. Only a fifth o f the population lives in households with five or more members, but they account for about 41 percent o f the poor. People living in households with two or more children account for over a third o f the poor. A strong correlate of poverty is ethnicity. Roma. households account for about 6 percent o f the population according to the survey, but for over a fifth o f the poor. Per capita consumption in a Roma household i s only half o f the consumption o f a similar non-Roma household. Human capital is a strong policy lever for reducing poverty. Over two-thirds o f the poor consist o f people living in households where the head has less than high-school education. Per capita consumption i s 30-35 percent higher in households where the head has completed high school or technical education and 45 percent higher when the head has completed university studies (relative to a household where the head has only completed primary education). Private entrepreneurs and employed individuals are relatively protected from paver@. The poverty rate is significantly lower in households headed by employers, self-employed or employees, while the risk o f poverty i s twice as high in households headed by the unemployed and inactive (other than pensioners) compared to the rest J f the population. Poverty is not gender neutral. The risk o f poverty i s slightly higher in households headed by women, usually jingle parent households. When differences in education, location and other characteristics are taken into %ccount,per capita consumption in these households is 10 percent lower than in those headed by men.

iurce: Bulgaria MTHS data, 2003.

12. While Bulgarian men and women have equal legal status, individual and family rights, and protection under the law, a gender gap persists in the labor market and participation in political life and decision making, while serious imbalances continue among Roma women and girls. Equal rights o f men and women are guaranteed by the Constitution and reinforced by the recent adoption o f the Law on Protection against Discrimination and o f special provisions for non-discrimination and equal labor opportunities in the Labor Code. In education, female participation rates are higher at basic and tertiary level and lower at secondary level. However, women benefit less than men fkom professional education and life-long learning opportunities. In the labor market, despite legal safeguards women earn less, are concentrated in low paid sectors and under-represented in managerial positions. The wage gap for comparable positions i s comparable with EU member states. Roma women and


7

Bulgaria: Country Partnership Strategy

girls experience particular hurdles despite the increasing efforts to increase Roma women's limited participation in the labor market and economic and social l i f e in general and to curb the early drop-out by Roma girls from the education system.

13. Bulgaria i s on track to meet the Millennium Development Goals (MDGs). After 2000, improvements are more pronounced in school enrollments and smaller with respect to

It i s important that improvements include gains among the most health indicators. disadvantaged: gaps in access to health care and education appear to be narrowing. But gaps in Bulgarian attendance rates in primary and secondary education remain among the highest in the ECA region. As with education, financial constraints (formal and informal out-of-pocket costs) and differences in quality o f services accessed are in part responsible for lower health outcomes among poor and disadvantaged groups. Minorities, Roma in particular, are more likely to fall through the cracks o f the education and health systems with their lower access compounded by social exclusion. Such disparities, unless addressed, will increase differences in future welfare and result in lower poverty reduction. --

___

.____

____

_ _ _ I _

Government Objectives Eradicate extreme poverty

percent o f population below US$2.15 per day percent of population below US$2.76 per day"'

Achieve universal education

-

percent net enrollment rate primary school percent net enrollment rate lower secondary school percent net enrollment rate secondary school

-

Improve maternal health

Maternal mortality ratio per 100,000 live births Combat HIV/AIDS, malaria and other diseases 0

Tuberculosis incidence (new cases per 100,000) Polio immunization rate (percent of children under two years o f age)

Reduce infant mortality D

________ -_______

Box 2: Bulgaria's Progress Toward the MDGs

Infant mortality rate per 1000 live births

Ensure emironmental rustainability * GDP per unit o f energy use (PPP US$ per kg o f oil

Baseline Data

Update on Status

2005 Target

2015 Target

7.9 (2001)

n.a.

3.2

1.5

12.8 (2001)

6.4 (2005)

98.5 (2001-02)

99.7 (2004-05)

97-98

100

83.1(200 1-02)

84.2 (2004-05)

86-90

100

68.3 (2001-02)

77.3 (2004-05)

73-75

90

19.1 (2001)

10.0 (2004)

18

16

48 (2001)

42.4 (2004)

40

26

94.4 (2000)

94.1 (2004)

98

100

14.4 (2001)

11.6 (2004)

13

9

568 ( 1997)

n.a.

653

75 1

equivalent)

'Due to lack of data, figure for 2005 is based on assumed growth elasticity of poverty o f 1.5. See para. 38. %!KELE?>E!!

sE!!&ic@ln5t@te&wo!!LBF~

uNKEL-____-------__

_ _ _ _


8

Bulgaria: Country Partnership Strategy

111. Government Priorities and Development Challenges A.

Government Priorities

14. EU membership in 2007 and successful EU integration and convergence for improved prosperity are the key priorities o f the new Government as laid out in its political program and the National Strategic Reference Framework for 2007-2013.5 I t s vision for Bulgaria b y 2013 i s a country with a high living standard, based on sustainable socio-economic growth in the process o f full integration in the EU. Accordingly, it has called itself “Government o f EU Integration, Economic Growth and Social Responsibility”. In the economic sphere, the Government seeks to promote sustainable economic growth in the range o f 5.5 to 6 percent per year and reduce unemployment permanently below 10 percent, based on improvements in productivity and competitiveness through increased investment, innovation and exports, while maintaining a stable macroeconomic framework with prudent public finances and fiscal sustainability. I t i s committed to maintaining the currency board until Bulgaria joins the Euro zone and envisages continued cooperation with the international financial institutions, including the World Bank. The strategic priorities laid out in the draft National Strategic Reference Framework (NSRF) for 2007-20 13, focus on increased competitiveness o f the economy, development o f human capital, improvement o f basic infrastructure, sustainable and balanced regional development, development o f m a l areas and agriculture, and protection o f the environment. Based on these priorities, the Government is preparing six Operational Programs (OPs) and two National Strategic Plans in these priority areas to facilitate future access to EU f h d s (see B o x 3 for an overview o f these OPs and NSPs, and para 32 for details o n EU funds).

B.

Key Challenges for Successful EU Integration

15. Bulgaria’s immediate challenge i s to meet the remaining EU requirements to enable membership in January 2007. As noted, Bulgaria will have to demonstrate significant progress over the coming months in a few key reform areas to receive a positive assessment o f the EU before it makes a final decision on Bulgaria’s readiness for EU membership or consider invoking the accession treaty’s safeguard clause which could delay membership by a year. The key areas highlighted by the EU monitoring report o f October, 2005 include: (i)foremost, accelerated further strengthening o f judicial reform to ensure a transparent, honest and eficient judiciary; (ii) the institutional capacity for programming, monitoring and control o f EU structural funds; and (iii)improving the readiness o f the agriculture sector, including the structures for channeling o f EU funds for agriculture, the integrated administration and control system (IACS), and veterinary control systems. While Bulgaria has made progress in these last two areas, reform o f the judiciary i s likely to remain a significant hurdle.

/ In accordance with EU guidelines, the National Strategic Reference Framework replaces the previous National Development Plan as the strategic document for programming EU funds for 2007-20 13.


Bulgaria: Country Partnership Strategy

9

Box 3: National Strategic Reference Framework 2007-2013Directions of Operational Programs and National Strategic Plans in Priority Areas a/

Improving Competitiveness of the Bulgarian Economy: The main goal i s development o f a dynamic economy which i s competitive in European and international markets. The main priorities are development o f a knowledge based economy and innovation potential, development o f a favorable business environment, increased productivity and financial access by SMEs, and strengthening Bulgaria’s external market position. Human Resources Development: The objective i s to enhance the quality o f life through employment, access to high quality education and lifelong learning, and social inclusion by (i)creation o f more and better jobs through enhancement o f labor force adaptability, mobility and competitiveness; (ii)access to education and training, improving i t s quality, and strengthening links between communities and education, and (iii)social integration and employment through development o f the social economy. Transport: The program aims to achieve balanced and sustainable development o f the national and urban transport systems o f national, trans-border and European importance. The program aims at the full integration o f the national transport system into the EU transport network, as well as at improving the quality and safety o f transport services. Environment: The main goal i s improvement o f the quality o f l i f e and favorable environment and protection o f the rich natural inheritance through sustainable environmental management. The strategic objectives o f the program are: (i)protection and improvement o f the condition o f water resources; (ii)improvement o f waste management and soil protection; (iii)improvement o f air quality and reduction o f noise pollution, and (iv) conservation o f biodiversity and protection o f nature. Regional Development: The strategic goal o f the program i s to enhance the quality o f the living and working environment with better access and opportunities for increased regional competitiveness and sustainable development. The two program objectives are: (i) developing sustainable and dynamic urban centres connected with their less urbanized hinterlands, thus enhancing their opportunities for prosperity and development, and (ii) mobilizing institutional and financial resources for implementation o f regional development policies and programs. Agricultural and Rural Development: The strategic objectives are: (i) development o f a competitive agriculture and forestry sector with focus on innovations in the food-processing sector; (ii) conservation o f natural resources and protection o f the environment in rural areas; and (iii)employment promotion and improvement o f the quality o f life in rural areas. Administrative capacity: T h i s horizontal Operational Program aims at building a strong, effective and modern mblic administration, capable o f meeting the high expectations o f Bulgarian citizens, the business sector and the EU in terms of enhanced service delivery and high professional ethics, and efficient and effective use o f EU funds. a/ Based on draft Operational Programs and National Strategic Plans prepared in the context o f the draft National Strategic Reference Framework, 2007-2013. OPs cover competitiveness, human resource development, transport, environment, regional development, and administrative capacity. NSPs cover agriculture and rural development, and fisheries (under preparation).

16. Despite a good growth record over recent years, Bulgaria’s income gap with the EU remains large. Bulgaria’s per capita income, at PPS in 2003, was 31 and 56 percent of the average level o f EU-25 and the eight EU new member states (NMS-8), respectively. Given Bulgaria’s large income gap with the EU, improving the efficiency o f the economy and setting it on a higher growth path will be required to ensure that forthcoming EU accession will rapidly narrow the gap and result in sustained improvements in living standards.

17. The recent experience o f the EU-8 new member states provides important lessons for Bulgaria. First, the importance o f setting clear priorities and undertaking as much reform as possible before accession. Policies and reforms should be anchored in a clear long-term vision and strategic national development plan for the country. Securing macroeconomic stability, stimulating the investment climate, strengthening human capital, and enhancing labor market flexibility, are core prerequisites for high and sustainable growth rates. Second, an efficient and technically competent public administration i s essential to manage rigorous and properly sequenced reforms and ensure effective delivery o f public services. Third, the need for


10

Bulgaria: Country Partnership Strategy

ambitious public finance reform before accession to rationalize expenditures, focus on economic growth and create space for absorption o f EU finances. There are difficult trade-offs between the need for fiscal restraint and meeting demographic challenges, and additional investments needed especially in infrastructure and the environment. Fourth, in tandem with public finance reform, a special focus on effective absorption o f EU funds will require capacity building at both central and local levels for preparation and implementation o f needed project pipelines, based on prioritized sector investment programs within a sustainable medium-term expenditure framework. Fifth, greater effort i s needed to address early on the issues o f poverty, social exclusion and regional disparities, including the need for better targeted social policies to ensure wider participation in growth.

T o accelerate convergence and building on NMS-8 lessons, four major challenges 18. for Bulgaria emerge: 0

0

0

First, and foremost, to push ahead with the needed reforms to promote productivity and employment for sustainable high private sector led growth. These reforms are particularly pressing for Bulgaria, as it has the worst demographic conditions in Europe with a rapidly declining working age and graying population as a result o f a negative natural rate o f population growth (-0.7 percent per year) and out-migration (-0.1 percent per year). At the same time, Bulgaria’s employment rate (55.8 percent for population aged 15-64 years in 2004) i s well below the EU average and the EU’s Lisbon employment target o f 70 percent. Also, a large share o f the population i s in unproductive segments o f the economy or in areas where labor productivity i s largely stagnant agriculture in particular where productivity has fallen sharply. To grow, Bulgaria will need to get the young to start working earlier in productive jobs and to keep the older population working longer than i s currently the case. And Bulgaria needs to raise investment to upgrade i t s lagging capital stock following years of relatively low investment. Second, to strengthen institutional capacity and public finance management for improved service delivery, fiscal sustainability and effective absorption of EU funds. Over the last few years, Bulgaria has implemented a series o f reforms aimed at improving the functioning o f the public sector. The next stage o f public administration reform will need to focus on fully implementing the new legislative framework to strengthen delivery o f public services, promote transparency and accountability, and root out corruption. Public finance reform will need to address fiscal vulnerabilities in view o f Bulgaria’s difficult demographic situation, and prudently adjust fiscal policies and build capacity to make room for growth-oriented public investments and effective absorption o f EU funds estimated at about 3.7 percent o f annual GDP during 2007-09, in support o f long-term growth. Third, to address poverty and social exclusion to ensure wider participation in growth. As mentioned, Bulgaria continues to have a large income gap with the EU and despite overall poverty reduction deep pockets o f poverty persist. While the growth agenda i s expected to have a positive impact on poverty, accompanying initiatives to address regional disparities, increase employment and lift the living standards o f


11

Bulgaria: Country Partnership Strategy

vulnerable groups - Roma in particular agenda.

- will be needed to support the poverty reduction

And fourth, to address macroeconomic risks and vulnerabilities and maintain macroeconomic stability as the foundation for future growth. In the short run there are the pressures from the widening current account deficit and the rapid growth o f private sector credit. To date, these risks have been partly offset by prudent fiscal policies. Looking forward, the fiscal stance needs to remain sufficiently flexible to respond to possible external shocks.

(0

Raising productivity and employmentfor sustaining high private sector led growth

19. The business environment needs further deregulation to reduce the costs o f doing business in Bulgaria. While much progress has been made in recent years in reducing the cost o f doing business, the regulatory reform agenda i s far from complete. In 2005 more than half o f businesses report uncertainty over regulatory policies as a problem o f doing business in Bulgaria, and the regulatory framework continues to place businesses in Bulgaria at a disadvantage compared to their regional peers. The number o f procedures to open a business i s more numerous, and Bulgaria has the highest minimum capital requirements in Europe as share o f per capita income. Insolvency procedures have been simplified, but closing a business in Bulgaria remains more expensive than in other countries in the region. Contract enforcement i s overly complex - it takes 34 procedures to enforce a contract in Bulgaria, compared to 25 in Estonia, 21 in Hungary, and 16 in Ireland. Court inefficiencies magnify the problem. Enforcing a simple debt contract takes an average 440 days in Bulgaria, compared to 252 days in EU countries, 335 in Romania, and 174 in Germany. 20. Increasing labor market performance and employment will be critical for sustained growth and convergence to EU income levels. The current share o f long-term unemployed i s large (60 percent o f jobless are unemployed for more than a year) due to competency and skills mismatches and l o w employability, while the share o f informal employment remains high. K e y reducing the high payroll taxes to decrease disincentives to reforms in this area include: (i) employment creation - a significant cut o f social security contributions in 2006 from 29 percent to 23 percent o f the payroll already made these taxes compatible with the CEE countries; (ii) adopting policies for more flexible use o f fixed-tern contracts and working schedules; (iii) allowing more flexible terms for hiring and firing owing to fluctuations in production levels, performance and absenteeism; (iv) strengthening the link between wages and performance; (v) adjusting unemployment benefits to increase incentives to work; (vi) increasing labor force participation by allowing flexible use o f temporary and part-time contracts; and (vii) improving the effectiveness and increasing the net impact o f active labor market programs. 2 1. Upgrading education and skills for the knowledge economy. Bulgaria’s education system faces three major challenges. First, the quality and relevance o f skills i s inadequate for today’s labor market. According to recent international comparative assessments (PISA 2002 and TIMSS 2003), there i s a decline in Bulgarian secondary school students’ competencies and skills for the knowledge economy both in terms o f reading proficiency and mathematics and science achievement. This requires the establishment o f an effective national system for assessment and control o f the quality of education. Decentralization with accountability systems and teacher quality will be essential for improving school quality. Likewise, the quality and


12

Bulgaria: Country Partnership Strategv

relevance o f skills provided in higher education does not meet labor market needs. Improved information and quality assurance, stronger l i n k s with industry, and accountability systems to deliver results will be crucial. Second, completion o f upper secondary schools i s below NMS-8 countries and the EU Lisbon targets, and children from l o w income families, rural areas, and Roma in particular, have unacceptably l o w participation rates. Targeted interventions will be needed to include the hard-to-reach groups. At tertiary level, private provision and finance should play a larger role in raising participation. Third, more efficient resource use i s needed in view o f the continuing reduction in school-age population. Down-sizing school infrastructure and staffing to reallocate resources will require political will to adopt and implement the longterm Program for Development o f School Education (2006-201 5), strong communication and incentives. L o w student-teacher ratios and the large number o f small institutions pose similar challenges in higher education.

The poor state o f transport infrastructure i s a major bottleneck for trade 22. integration and competitiveness. Due to inadequate investment, the existing transport network i s in poor shape - an estimated 60 percent o f the road network i s in fair or poor condition and needs urgent rehabilitation and maintenance; railways are in a similar poor condition with l o w staff productivity and high track access charges; and port efficiency is low. Combined with an inefficient trade facilitation system, this results in high transport costs for Bulgarian exports and Bulgaria has imports and transit trade, and limits Bulgaria’s external competitiveness. committed to completing the upgrade o f i t s main road network to EU standards by 2014, and has also proposed a motonvay construction program that requires significant investment. EU funds for transport infrastructure estimated at €1.2 billion from 2007-13 (0.6 percent o f GDP per year) provide an opportunity, but will require development o f a prioritized road investment program that fits within government’s medium-term expenditure framework. In parallel, reform o f maritime ports i s needed with separation o f operational and commercial functions, privatization o f port services, and concessioning o f terminals to private operators. In addition, the sector needs improved trade facilitation at border crossings. Reform o f the energy sector has advanced, but energy efficiency remains weak and 23. sector restructuring and market opening need to be completed. Significant advances have been made in meeting sector EU accession needs, especially in sector legislation and regulation and in reducing price distortions. But sector restructuring and market opening have been delayed which may hinder Bulgaria’s integration into the European energy market and limits the benefits from regional market liberalization. The unfinished sector agenda includes: accelerating the liberalization o f both electricity and gas markets; completing the restructuring o f the National Electricity Company (NEK) to stimulate competition in the wholesale market; opening o f the natural gas market through restructuring o f Bulgargas; promoting energy efficiency in view o f Bulgaria’s high energy intensity which i s more than twice EU average; and promoting renewable energy sources in line with the EU directives which set a target o f renewable sources meeting 12 percent o f total energy consumption by 2010. 24. Agriculture remains largely underdeveloped with low productivity. In contrast to the NMS-8 countries, the share o f agriculture in employment rose f i o m 18.5 to 25.5 percent from 1990-2003. At the same time, agriculture’s share in GDP fell from 18 to 11 percent. As a result, sector productivity felI sharply. W h i l e past policies have successfully focused on market stabilization and liberalization, the supply response has been weak in view o f a fragmentation o f land ownership following the restitution process in the 1990s and lack o f investment in farming


Bulgaria: Country Partnership Strategy

13

activity and rural infrastructure. The two major challenges for the sector involve: (i) adopting an agricultural policy and institutional framework compatible with the EU’s Common Agricultural Policy (CAP); and (ii) the implementation o f policies and programs to enhance sector investment and competitiveness. The former will involve a trade-off between direct income support payments which reduce the incentives to restructure, consolidate and modernize, and the need to support productivity enhancing measures as the only sustainable path to raising agricultural income. These would include support for farm consolidation, productivity-enhancing farm investments, and diversification to off-farm activities. (ii)

Improving governance and strengthening institutions

25. Bulgaria’s institutional development and implementation capacity will be central to growth prospects but need to catch up with EU standards. The importance o f institutions and governance to growth and economic development has long been recognized. The process o f EU accession has contributed markedly to the institutional framework in Bulgaria. Yet in 2004, selected governance indicators for Bulgaria were lower than for the EU-8 (see Figure 3). The agenda involves further strengthening o f public administration capacity, improving the quality o f service delivery, reducing corruption, strengthening accountability and transparency, and, importantly, increasing the efficiency and effectiveness o f the judicial system. Together with the

need for judicial reform, corruption remains a concern despite adoption o f legislative acts, strategies and action plans to address the problem (see Box 4). Improved capacity in both central and local levels also will be critical for effective absorption o f the post-accession EU funds.

26. Moving towards a transparent, honest and efficient judiciary i s one of the key requirements for improving the business environment and meeting EU accession requirements. Despite progress over the last years, judicial reform remains one o f the serious challenges in improving Bulgaria’s institutional framework and i t s readiness for EU membership. Prevailing public perception is that magistrates are subject to undue influence from parties and their attorneys, other magistrates, and government officials. Enforcement o f civil judgments continues to be a major issue. As mentioned, procedures for contract enforcement are significantly more complex than other countries. Efficiency o f Bulgarian courts is low, and business perceives courts as slow. There i s limited use o f out o f court settlement, no specialized commercial courts, and extensive opportunities for debtors to appeal and delay the process. Finally, the complexity and efficiency o f the penal structures has been highlighted by the EU as one o f the major shortcomings in the judicial system. Key reforms and actions focus o n implementation o f already enacted changes, particularly in the areas o f anti-corruption, improving court organization, and reducing court delays; significant improvements in the functioning o f courts; speeding up resolution o f commercial disputes; adoption o f a new Penal Procedural Code; and establishment o f specialized administrative courts.


14

Bulgaria: Country Partnership Strategy ~~~~~~~

~

~

~~~

~-

Figure 3: Selected Governance Indicators for Bulgaria and EU-8,2004

I

27. While there have been significant reforms in Bulgaria's fiduciary systems, implementation continues to lag in key areas. The Bank's diagnostic work, such as the Country Financial Accountability Assessment (CFAA), Country Procurement Assessment Report (CPAR) and Public Expenditure and Institutional Review (PEIR), has shown considerable progress in Bulgaria's fiduciary environment but also pointed at remaining weaknesses and risk (with CPAR 2004 rating procurement as a high risk and C F A A rating financial management as average risk). The C F A A highlighted strong features in several aspects o f the Public Financial Management (PFM) environment, such as a well functioning automated treasury system, sound public internal financial control framework, and independent external audit. Moreover, Bulgaria has developed a sound legal framework for public procurement and has made progress in the implementation o f the CPAR action plan. Notwithstanding this progress, the Government will need to continue the reform process by deepening civil service reforms, strengthening accountability o f the administrative judiciary system, strengthening management o f capital expenditures and program budgeting, and implementation o f procurement reforms beyond the regulatory framework. The EU and the Bank will continue to support the government through further analytical work and TA for strengthening financial management and procurement practices in the public sector. The Bank will carry out a country fiduciary update in FY07 to meet the policy requirement for adequate knowledge o f country PFM systems to support


15

Bulgaria: Country Partnership Strategy

new development policy lending. In the context o f new investment loans, the Bank will focus o n fiduciary safeguards and capacity building o f implementing institutions, in addition to project specific controls which are designed to minimize fiduciary risk in Bank funded projects. Box 4: Corruption has reduced but remains a concern ~~~~

~~

~

~~

Surveys and assessments by national and international organizations confirm that corruption remains a cause for concern in Bulgaria and affects many aspects o f society. The EU has highlighted corruption as one o f the key problem areas as Bulgaria prepares for EU accession in 2007. There has been a positive trend as far as administrative corruption i s concerned, although recent surveys show a slight deterioration between 2004-05. Transparency International’s 2005 corruption perception index ranks Bulgaria in 55” place among 159 countries. T I had shown steady improvements for Bulgaria between 1998-2002 with a leveling o f f thereafter. The EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS) on the other hand shows a marked decline in corruption as a problem o f doing business in Bulgaria from 2002-05, even though the so-called bribe tax (bribes as a share o f sales) remains comparatively high (see below). As main areas for unofficial payments by firms, BEEPS shows obtaining government contracts, obtaining business licenses and permits, dealing with customs, and dealing with the courts.

Corruption as a Problem Doing Business: YOfirms indicating corruption as a problem o f doing business I

60%d 50% 40% 30% 20% 10% 0%

,

Bul

SEE

ECA

Bribe Tax: Bribes as a share of annual sales 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

2002 2006

B ul

SEE

ECA

While the European Commission’s 2005 Comprehensive monitoring report (CMR) on Bulgaria identified an overall improvement in administrative corruption, it highlighted Bulgaria’s weak enforcement record with very limited results in the investigation and prosecution o f high level corruption cases. Public works contracting, including the health sector, was cited as particularly vulnerable to corruption. The EU acknowledges the considerable administrative efforts by the Government in implementing its National Strategy for Combating Corruption combined with an updated action plan implemented by the Commission for the Coordination o f the Fight Against Corruption, but notes that its capacity remains weak and action plan implementation delayed. The 2006 Corruption Assessment Report prepared by Bulgaria’s Center for the Study o f Democracy (CSD) attributes the observed increase in corruption transactions in 2005 following the gradual decline during 1998-2004 to the impact o f the electoral cycle. The report shows that Bulgarian public perceptions o f corruption are widespread and reflect a low level o f trust in state institutions. After low incomes and unemployment, corruption is the third ranked concern in 2005. With a reduction in administrative corruption, political corruption - state capture and politically connected business - is gaining attention as it shifts from privatization and illegal trafficking to the spheres o f public procurement, concessions and the use o f EU funds. The report argues that the potential o f ‘‘soft” measures against corruption (e.g. awareness campaigns, training civil servants, codes o f ethics) i s being exhausted and that more effective political and institutional mechanisms need to be put in place. The government has responded by developing and implementing its anti-corruption strategy and related action plans, moving towards a merit-based and depoliticized civil service, introducing legal provisions for conflict o f interest, asset declarations, and freedom o f information regulations, and starting reform o f the judiciary, including improved accountability and more transparent and merit-based appointment o f judges. More recently, Parliament adopted a new Penal Procedural Code, and the Council o f Ministers approved an amendment o f the Law on Judiciary to introduce mandatory competition in the appointment o f magistrates. With the legislative and institutional foundations for anti-corruption mostly in place, implementation and enforcement i s now the main challenge.


16

Bulgaria: Country Partnership StrategV

28. With regard to corporate financial reporting, Bulgaria has worked towards meeting compliance with EU standards. The Bank’s Accounting and Auditing Report on the Observance o f Standards and Codes (ROSC) o f end-2002 concluded that Bulgaria’s legislation i s largely in line with the EU acquis communautaire, but that shortcomings remain in implementation and enforcement o f the acquis, International Financial Reporting Standards, and International Standards on Auditing. Since then, Bulgarian stakeholders have worked o n enhancing implementation which has been challenging given the significant changes to the acquis following Europe’s response to recent accounting scandals. In support o f this effort, the Bank provided TA to the National Accounting Council in developing a comprehensive Country Action Plan following the ROSC, and has continued to provide assistance through a regional TA program.

(iii) Strengtheningfwcal sustainability and absorption of EUfunds 29. With about 40 percent of the economy’s resources in the public sector, improving the efficiency and effectiveness of public expenditures i s central to Bulgaria’s growth prospects. In addition, Bulgaria has a unique opportunity in putting forthcoming EU funds, estimated at an average 3.7 percent o f annual GDP during 2007-09, to best use in support o f long-term growth. To make room for growth-oriented public investments and effective absorption o f EU funds, and contain spending in the face o f a difficult demographic situation, Bulgaria will need to contain and improve efficiency o f spending on the health care system, pensions, and the social assistance system. Reform in these areas should be driven by improving the quality o f services while increasing the efficiency o f expenditures and their fiscal sustainability. In addition, effective absorption o f EU funds will require urgent development o f project pipelines to meet the high investment needs based on prioritized investment programs in key sectors (transport, municipal services, and environment). T h i s will need to be accompanied by capacity building at central and local levels. 30. The health sector needs cost containment for financial sustainability, while at the same time improved quality and access. Eight years after introduction o f the mandatory health insurance system, health outcomes are beginning to reverse from the negative trends in the 1990s. Yet the reforms remain unfinished, and Bulgaria’s demographic and epidemiological profile will generate additional pressures on health spending. The two most significant problems slow progress in improving efficiency and cost containment while at the same time are: (i) securing quality care; and (ii)inequality in access due to lack o f alternatives for those who cannot pay for services. Financial sustainability o f the system i s threatened by a combination o f poor monitoring o f the payment system for inpatient care, the oversized hospital infrastructure, and high pharmaceutical spending. The focus o f care will need to shift from hospitalization and curative care towards prevention and outpatient care. Pharmaceutical spending needs to be contained through regulation in prices and volumes. And consolidation in hospitals will require the implementation o f the hospital restructuring strategy developed in 2002. The EU as part o f i t s recent monitoring report has also raised concerns about access to the system, and equity considerations will have to be part o f any discussion o n restoring financial balance to the system.

The challenges of the social security system. Despite substantial reforms since 1999 31. when Bulgaria moved to a three-pillar pension system, i t s social security system i s not aligned with the adverse demographic trends. As a result, payroll taxes are high and provide incentives for informal work as well as under-reporting o f income, both o f which lead to even higher


Bulgaria: Country Partnership StrategV

17

dependency ratios. The public pension pillar has needed budget transfers in the order o f three percent o f GDP in recent years. This i s exacerbated by the rise in disability pensions which has been prone to abuse and has further deteriorated dependency ratios. The dual challenges o f the pension system involve: (i) reducing payroll taxes to boost employment while improving the system’s financial sustainability; and (ii)reconciling wide-spread non-compliance with longterm negative welfare considerations o f exclusion. The reform path has been to contain financial imbalances by increasing retirement ages and tightening the criteria for access to the system. Additional reforms should include strict discipline in the use o f disability pensions and the collection o f contributions, increasing the link between benefits and contributions to the system by further reforms to the funded pension system. The pension system will need to have a basic pension to keep some segments o f the old age population out o f poverty. Given the financial and policy challenges involved, detailed work i s needed to assess the feasibility o f alternative reforms.

32. Effective absorption o f EU funds will require further public expenditure restructuring and capacity building. With k t u r e EU accession, the EU has committed about €4.6 billion o f EU grant funds to Bulgaria over the period 2007-09. The bulk o f these funds are expected to go to implementation o f the European common agricultural policy and environmental standards, upgrading o f roads and other infrastructure, and support human resource development (see Table I).The overall financial effect o f expected EU funds i s projected to be highly positive on Bulgaria, about 3.7 percent o f annual GDP o n average during 2007-2009 if the country takes all available funds. At the same time, however, Bulgaria’s fiscal position would deteriorate by about two percent o f GDP during the period, if the government absorbed all available funds and there was no restructuring o f the fiscal framework. Since the Government intends to keep public expenditures at their current level o f 40 percent o f GDP or below, fiscal adjustment equivalent to the projected impact o f EU funds (about two percentage points o f GDP) will be required. 33. At the same time, Bulgaria’s performance on absorption of EU pre-accession funds has been below potential and will require development o f needed capacity to prepare and implement high return investments which can support future growth and improve service delivery. There i s a long lead time in project preparation and the readiness for implementation o f some projects i s not very high, which leads to delays in contracting and subsequently in disbursement o f pre-accession funds. For example, under the ISPA instrument for transport and environment investment support only 25 percent had been contracted by the end o f 2005 while actual disbursement levels are substantially lower. At the same time, experience f i o m EU-8 countries indicates that, if effectively used, the EU funds can contribute to economic growth both in the short and long run. In the short run they will increase domestic demand. In the long run, ifinvested in the improvement o f the physical and human capital with high economic returns, they have the potential o f making an important contribution to economic growth through the supply side. But experience also shows that, if badly used, these resources may have only a short-term positive demand effect on the economy, and in the long term lead to real appreciation o f the local currency and reduced competitiveness, aid dependency, and undermine the efforts to improve governance. Effective use o f these funds therefore will require building the needed capacity for careful advance planning and development o f a pipeline o f high return projects in the areas eligible for EU funds.


18

Bulgaria: Country Partnership Strategy

Table 1: Summary of EU Financial Support for Bulgaria, 2007-2009

I

EU Support Measure

t

Purpose

Allocation* (€ mln)

Budgetary compensations aimed to avoid worsening o f the country’s fiscal stance

240

Cover accession-related expenditures, such as increased interpretation and translation needs.

nta

I

Administration

I

* Appropriations for commitments, in 2004 prices Source: Bulgaria Public Finance Policy Review, World Bank, Report No. 33992-86 34. Meeting the high investment needs in municipal infrastructure to align with EU environmental directives. The combined EU compliance cost for investments in water and waste water sector (€6.9 billion) and solid waste management (€0.5 billion) exceeds the projected medium-term financing possibilities o f the Government. These requirements therefore will need to be placed within a viable medium-term financing framework, based on prioritization o f investments and development o f public-private partnerships to attract private investments into the sector. EIF funds will be available to help meet the investment needs but will require preparation o f a pipeline o f projects and capacity to implement them. Current sector financing plans also make unrealistic assumptions about available municipal financing which is predicated o n overly optimistic increases in tariffs. And the ownership o f water utility companies will need to be clarified to entice private sector participation. T o move forward quickly in addressing the high sector investment needs will therefore require institutional and policy reforms to clarify the central responsibility for municipal infrastructure, strengthen local capacity to prepare and


Bulgaria: Country Partnership Strategy

19

implement projects, ensure sufficient resources at the local level to support investments, strengthen the newly formed water regulator to set and enforce service standards and tariffs, and development o f a functional public private partnership model for the sector.

(iv)

Poverty reduction and social inclusion

35. Addressing regional disparities will be an important component o f poverty reduction. The poverty rate in rural areas, where about 40 percent o f Bulgarians live, was 29.1 percent in 2003 compared to 18.7 percent in urban areas. Rural unemployment i s high (39 percent), with reliance o n subsistence farming and social programs and benefits. A survey o f rural areas showed employment as main concern, followed by poor conditions in road infrastructure, the high cost o f health services, marketing o f agricultural products, and access to credit. Infrastructure in rural villages i s poor, with ffequent interruptions in water and electricity supply and very limited access to sewerage and solid waste systems. Alongside the needed consolidation and efficiency improvement in the farming sector, non-farm sources o f income will be increasingly important in rural areas. Availability o f EU funds for regional development provides opportunities to generate non- farm employment and increase productivity in small and medium-sized farms. 36. Addressing the poverty and dependency cycle o f Roma. The Roma minority lives in deep poverty and social exclusion. Roma households which account for about 6 percent o f the population represent over a fifth o f the poor. Roma children drop out earlier and more often from the school system. Close to 16 percent o f Roma adults are illiterate; 6-10 percent o f Roma adults never attended school. Socio-economic conditions have made many Roma highly vulnerable to diseases such as tuberculosis. The Government has adopted the Framework Program for Integration o f Roma and the National Action Plan for the Decade o f Roma Inclusion, outlining the goals, targets and indicators which it i s committed to achieving and monitoring in 2005-2015. Fully funding the framework program and action plan remains a challenge. Key commitments are also undertaken in the Joint Inclusion Memorandum (JIM) with the EU signed in 2005, the National Employment Action Plan, and the National Plan for Reducing Poverty and Social Inclusion.

IV. Past World Bank Group Assistance and Lessons Learned 37. From 1990, the Bank has actively supported Bulgaria’s transition. During the 1990s, Bank support was focused on Bulgaria’s transition f i o m a highly centralized socialist state to building the foundations o f a market economy and a stable macroeconomic framework. This was only partly successful as witnessed by the severe 1996-97 economic crisis. From 1998 on, Bank support was associated with the structural and institutional reforms started by the postcrisis Government, which formed the basis for Bulgaria recent strong growth record. Bank focus initially moved to reform o f the financial and enterprise sector, agriculture, social security, and environmental protection, through a series o f sector adjustment loans accompanied by investment lending. The previous CAS which covered FY03-05 broadened Bank support to the reforms and the EU accession process through a series o f three multi-pillar PALStogether with a number o f investment projects and AAA. As o f today, total lending to Bulgaria amounts to US$2.1 billion equivalent, o f which 64 percent in adjustment lending.


20

Bulgaria: Country Partnership Strategy

38. Implementation o f the ambitious three-year PAL program has been successful, although an unfinished reform agenda remains. The three PALs for a total o f US$425 million during FY03-05 supported the Government’s comprehensive program, organized around five complementary and mutually reinforcing pillars: (i)sustaining structural reforms in the enterprise sector, with emphasis on infrastructure; (ii) establishing a market-friendly business environment; (iii) deepening the financial system; (iv) improving public sector governance; and (v) investing in human capital and strengthening social protection. By the end o f the program, two o f the three broader country outcomes to which the P A L program was expected to contribute had been surpassed and 28 o f the original 31 program triggers fulfilled. GDP growth averaged 5.2 percent during 2002-05 compared with the overall PAL country goal o f 4.5-5.0 percent, and unemployment at 10.7 percent by end-2005 was well below the Government’s goal o f 12-14 percent. The country goal to halve poverty during 2002-05 has been more elusive, though poverty certainly declined during the perioda6 The Government’s strong ownership o f the P A L agenda and its effective monitoring and evaluation capacity were key success factors. Despite the impressive progress on the overall PAL agenda, some o f the reforms in the human development area proved more challenging than originally foreseen - education and health care reform in particular - and have been highlighted by the Government as needing continued attention with Bank assistance. The lower unemployment rate also masks Bulgaria’s l o w labor force participation rate, which has become a core challenge to sustaining growth.

39. At the same time, fewer investment projects than had been foreseen in the CAS moved forward. The CAS program included a pipeline o f seven investment loans totaling US$300 million o f which just three were approved for a total o f US$llS.4 million (district heating, social investment and employment, and revenue administration reform). In addition, four GEFPCF grant investment projects were approved for a total o f US$17.0 million. The reasons for not pursuing the remaining IBRD projects included: (i) Government’s conservative debt management which restricted external borrowing for all investment projects while leaving fiscal space for a few politically important projects (e.g. Belene nuclear plant); (ii) complexity o f underlying sector reforms (forestry); and (iii) failure o f a precursor project (education APL2). Actual CAS lending amounted to US$543.4 million (73 percent o f the US$750 million CAS lending target), o f which 78 percent for the fast disbursing PALs. Performance o f the investment lending portfolio picked up following concerted 40. efforts to address key issues and accelerate implementation. Despite the Bank’s close portfolio monitoring efforts, on average one or two projects o f the total eight to ten investment projects in the portfolio during the CAS period was showing problems with implementation and/or achievement o f development objectives. A number o f projects showed considerable delays and the overall portfolio disbursement ratio fell to 9.7 percent in FY04. At the same time, other projects performed well and have had important impacts on institution building and reforms (e.g. revenue administration reform, trade and transport facilitation, child welfare reform, district heating). The semi-annual joint portfolio reviews (JPRs) with Government flagged project-specific as well as cross-cutting implementation issues, including slow and insufficient delegation o f decision making, and weak capacity and discontinuity in project / Comparable poverty data over the PAL period is not available, and different approximations give different results. An econometric study (Tesliuc 2004) finds that the fall in poverty between 2001-03 was a little more than two percentage points (from 24 percent to 2 1.9 percent), and thus the PAL goal not likely to have been met. But simulations using growth-poverty elasticities find that the target o f halving poverty may have been possible.


Bulgaria: Country Partnership Strategy

21

management and procurement. Subsequently, a focused review o f projects at risk led to specific recommendations for project restructuring and speeding up implementation. As a result o f close joint follow-up, most projects demonstrated improved performance and some even managed to catch up with earlier delays. Significantly, the average disbursement ratio nearly tripled in one year to reach 27.9 percent by end-FYOS.

41. The Government has generally valued the Bank’s AAA work and QAG’s assessment found the quality o f the CAS AAA program to be satisfactory. The AAA program was built around a set o f core policy pieces (Public Expenditure and Institutional Review, CEM, fiscal decentralization), diagnostic and fiduciary reports (FSAP, CPAR, CFAA, accounting & auditing ROSC) and a number o f high impact sectoral reports, policy notes and workshops (energy, rural development, water and waste water, roads and motor ways investments reviews, infrastructure strategy review). The Ministry o f Finance also appreciated the debt management TA provided by the Bank’s Treasury Department, which turned into a feebased arrangement in 2003. Q A G judged the program’s strategic relevance, internal quality, and likely impact as satisfactory. As areas for improvement it underlined the importance o f client ownership, integration across AAA activities, and dissemination and dialogue with non-official stakeholders to enhance overall impact. 42. IFC has been active in the corporate and financial sector. A s o f March 2006, IFC has 15 projects in i t s Bulgaria portfolio with total commitment o f US$267 million for i t s own account and an additional US$75 million syndicated with partner banks. Projects in the manufacturing and services sectors represent about 80 percent o f IFC’s country portfolio, with investments in a number o f key projects in electronics assembly, wood panel and board production, post-privatization restructuring o f a steel mill, two major glass processing plants, a retail start-up operation, and a first-class hotel. In the financial sector, I F C supported two specialized SME banks, established Bulgaria’s first micro-lending bank, supported country’s largest bank, and invested in a venture capital fund that also targets the S M E sector. To support the design o f a competitive wholesale energy market in Bulgaria, I F C provided technical assistance to the Ministry o f Economy and Energy and to the National Electricity Company (NEK). 43. MIGA’s outstanding guarantee portfolio in Bulgaria consists o f four contracts in the infrastructure sector and one contract in the manufacturing sector. As o f end-March 2006, MIGA’s gross exposure in Bulgaria i s US$391 million (7.0 percent o f the Agency’s gross exposure), while the exposure net o f reinsurance amounts to US$140 million (4.2 percent o f MIFA’s net exposure). About 83 percent o f MIGA’s net exposure in Bulgaria i s in the infkastructure sector and the balance in manufacturing. In the infrastructure sector, MIGA’s coverage includes the Maritza East 3 and the Maritza East 1 power plants. 44. A number o f lessons emerge from the implementation of the previous CAS, with implications for the design and implementation of the CPS. First, the Bank should move towards a partnership approach with a well-performing M I C client such as Bulgaria, with demand-orientation in design and delivery o f assistance and flexibility in adjusting the Bank’s program to the client’s needs. Second, the Bank should engage in new investment lending only if it has strong client demand and meets i t s expectations o f simpler designs, shorter preparation and implementation periods, enhanced flexibility, reduced reliance o n freestanding PIUs, and increased leverage o f other resources, including EU grant funds. Third, swift action i s needed to


Bulgaria: Country Partnership Strategy

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address portfolio implementation issues as they arise. This will require timely Government action and follow-up of problem areas, coupled with proactive project supervision on the Bank side to turn around and restructure poorly performing projects. Fourth, Bulgaria’s unfinished human development agenda remaining from the P A L series will need to be addressed to make up for delays and to support Bulgaria’s growth agenda and readiness for EU accession. Reforms in education, healthcare and labor markets are urgently needed to increase Bulgaria’s competitiveness and broaden participation in the country’s growth. Both political will and public attitude make these reforms now more feasible. A key outcome should be an increase in the labor force participation rate which remains l o w by international standards. Fifth, effective Government coordination and M&E systems are critical for successful implementation o f reforms and Bank support. The successful P A L coordination arrangements linked to a comprehensive M&E system implemented with strong client support, was one o f its key success factors. And sixth, political economy aspects need watching in the design and implementatian o f the overall CPS program and reforms supported by the Bank. The examples o f the failed privatization o f Bulgartabak (PAL2 conditionality) and stalled forestry reforms which underpinned the dropped forestry project come to mind.

V. A.

Proposed World Bank-Bulgaria Partnership, FY2007-2009

Rationale for Future Partnership

45. The new Government has requested a continued full-service, yet focused, assistance program with the Bank over the coming years o f EU accession and integration. In the consultations held with the Government last November and December, it has expressed a preference for a continued relationship with Bank involving both financial and non-financial assistance focused on helping Bulgaria achieve a successful integration with the EU. Among the various options discussed, ranging from a fee-based knowledge sharing relationship to a fullservice assistance program, i t s preference i s for the latter - including a lending program up to US$300 million per year. At the same time, it has requested the Bank’s initial lending focus for the coming years on selected priorities linked to the unfinished reforms in the Human Development (HD) sector and to infrastructure investment support, with a special focus on effective absorption o f EU funds. 46. The Government recognizes the Bank’s value added and comparative advantage vis-his Bulgaria’s other development partners, which also draws on the lessons from the EU-8 countries. Bulgaria has access to extensive external assistance both financial and nonfinancial. Foremost this includes support from the EU in the context o f accession, as well as the IMF, EBRD, EIB, UNDP and various active bilaterals (see para 65 for the focus o f various external partners in supporting Bulgaria’s development challenges). The Bank’s value added and comparative advantage i s seen in its expertise and assistance in three distinct areas: (i) design, capacity building and implementation support for structural and institutional reforms that promote growth and productivity, facilitate EU convergence and social inclusion, and cover design and areas not addressed by the EU such as health and education policies and reform; (ii) capacity building for public finance reform that strengthens effective and efficient public design and expenditure management in support o f growth and fiscal sustainability; and (iii) financial support for effective absorption o f EU funds based o n the Bank’s expertise in developing prioritized sector investment programs linked to sustainable medium-term sector

-


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expenditure pameworks, developing the needed Jinancing mechanisms for channeling and cojnancing of funds with EU and other IFIs, and preparation of project pipelines to absorb available funds. The Bank’s strengths are seen in developing systemic, rather than one-off, solutions, and in sharing lessons from global and EU/EU-8 experience. Recognition o f the Bank’s role in these areas builds on the implementation o f the PAL program, the institution building efforts in investment projects, and appreciation o f the Bank’s analytical and advisory work.

47. At the same time, the Bank i s adjusting its business model in Bulgaria to remain relevant in its current environment. Bulgaria today i s a different country from just four years ago at the start o f the last CAS. It has established a strong record o f reform and sustained growth, built o n prudent macroeconomic policies. Based on these achievements, Bulgaria is now o n the threshold o f EU accession. And it established investment grade status with access to capital markets. In this new environment, the Bank i s continued to be seen as relevant including a recognition that Bank financial products and instruments have evolved and remain competitive with Bulgaria’s alternative financing sources. The CPS aims to reflect these new

realities.

48. Accordingly, Bank support will move towards greater flexibility within a strategic framework that reflects Bulgaria’s priorities, also building on the Bank’s agenda f o r wellperforming MICs. The new partnership will provide greater flexibility than the previous CAS approach, and allow for adjustment in the Bank’s assistance program based on the evolving priorities o f the client. While responsive and flexible, Bank assistance will be anchored in a strategic framework that builds on Bulgaria’s development priorities and o n the Bank’s comparative advantage in Bulgaria. Accordingly, the evolution from the previous CAS to the new CPS will involve: (i) a more flexible approach to defining lending and non-lending activities within a set o f broad priorities for the CPS period with an agreed program for FY07 and an indicative program for FY08-09 to be revisited by an annual consultation process with Government7; (ii)lending flexibility up to a lending ceiling based on continued sound macroeconomic performance and country risk and within IBRD exposure limits, including a flexibility in the use o f lending instruments and share o f fast disbursing operations; and (iii) move towards programmatic approaches in investment lending coupled with gradual alignment o f Bank procedures with country systems while ensuring compliance with Bank fiduciary standards.

B.

Implications o f Client Survey Feedback for the CPS’

49. Most respondents o f the survey felt that the Bank should focus on economic growth and jobs, followed by infrastructure development, education, poverty reduction, and health sector issues. They ranked the Bank’s involvement in these areas higher than in EU integration, even though effective EU integration was viewed by stakeholders as Bulgaria’s overriding

development priority. The feedback points to a preference for the Bank’s involvement in basic

/ Annual consultations are proposed to take place by December each year to precede the Government’s budget formulation process for Bulgaria’s subsequent fiscal year (e.g. the December 2006 consultations would focus on Bank activities in Government FYO8 which coincides with calendar year 2008). * / The survey included a quantitative survey involving 300 responding stakeholders, in-depth interviews with 32 public officials experienced in working with the Bank, and four focus groups on major themes o f Bank involvement (economic reform, education, health and infrastructure).


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Bulgaria: County Partnership Strategy

development issues. At the same time, it was felt that the Bank should tailor its approach to Bulgaria’s EU integration needs. The Bank’s financial resources were seen as the Bank’s greatest value, followed by its policy and economic advice and ability to build implementation capacity. As weaknesses respondents cited the Bank’s perceived disregard o f country realities in proposing solutions and the bureaucratic nature o f operational policies and procedures. At the same time, impressions o f Bank effectiveness did not always match important areas highlighted for i t s fbture attention. The survey showed higher effectiveness gaps in areas such as health and education. These impressions may be linked to the well publicized past implementation problems o f investment projects in these areas - education in particular.

50. The qualitative survey respondents emphasized the importance of the Bank’s involvement beyond EU accession and identified a number of recommendations for enhancing the Bank’s relevance in the future. These included an enhanced partnership approach and dialogue that builds on Government priorities; Bank support in the priority areas o f education, healthcare, infrastructure investments, and strengthening o f institutional and administrative capacity; and a move to co-financing with the EU.

C.

Strategic Priorities f o r the C P S

51. I n line with Government’s overall objectives for the coming years, the strategic framework that i s proposed to guide the three-year CPS program i s focused on facilitating Bulgaria’s successful economic and social integration with the EU. In support o f this overarching objective and following the directions o f the Government’s medium-term program, the CPS directions are proposed to be guided by the following three main priorities:

(i) Productivity and employment: Implementation o f unfinished structural reforms and investments to strengthen productivity and employment in support o f strong private sector-led growth along the lines o f EU’s Lisbon agenda; (ii) Fiscal sustainability and absorption of EU funds: Capacity building for improved public expenditure management and investment planning to strengthen fiscal sustainability, sound public investment, and effective absorption o f EU funds; and

(iii)Social inclusion: Policies and investments to reduce regional imbalances and improve social inclusion for poverty reduction.

52. These priorities would help guide the selection of future Bank financial and nonfinancial activities. The annual consultations with Government as part o f the flexible CPS programming approach (also see para 48) would review current and planned activities in the context o f the strategic framework, modi@ them as needed, and define additional activities as appropriate. In the unlikely event that Bulgaria’s EU accession i s delayed by a year, the above strategic priorities are considered sufficiently robust to continue to guide the Bank’s activities over the coming three years. 53. Within this broader strategic framework, the consultations with Government resulted in a focused set of priorities for initial Bank engagement under the CPS. The strategic consultations o n the Bank’s future involvement provided clear guidance for initial Bank involvement in: (i) addressing the unfinished reform agenda remaining after the successful PAL program, (ii)developing a fiscally sustainable medium-term expenditure fiamework and


Bulgaria: Country Partnership Strategy

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prioritized investment programs for key sectors, in combination with (iii)a goal o f effective absorption o f EU funds. The key priority sectors proposed for the Bank’s immediate attention are health care, education and infrastructure. Specifically, Government seeks the Bank’s immediate help in addressing the remaining reforms in health, education and social protection, and in implementing a fiscally sustainable investment program in roads and municipal infrastructure focused on effective absorption o f EU funds, while remaining open to other ideas consistent with the above thematic priorities. These priorities draw on the Bank’s comprehensive diagnostic work undertaken in the context o f the recent C E M (policies for growth) and Public Finance Policy Review (PFPR), and provide continuity to the unfinished agenda o f the P A L program and the considerable recent analytical and advisory work undertaken in the infrastructure sector (roads, and waterlwaste water in particular).

D.

Outline of Initial Bank Program

54. The proposed lending program up to US%300million per year would involve 2-3 operations per year based on a series o f DPLs and programmatic investment loans in support o f the above priority areas. In line with Government’s priorities for Bank involvement, a series o f three programmatic DPLs o f about US$150 million each would focus on advancing the unfinished reforms in the HD sectors - health, education and social protection in particular, in support of growth, employment, fiscal sustainability and social inclusion. The Government has requested that the DPLs would be complemented by one to two investment operations per year to help with implementation o f prioritized investment programs and absorption o f EU funds in roads and municipal infrastructure, social inclusion, and regional development. These investment projects would be designed to incorporate lessons on investment lending from the previous CAS (see paras 44 and 62). They would build on sound medium-term sector expenditure frameworks, and, where feasible, be designed as full or partial programmatic based approaches (PBAs). 55. The AAA program would be front-loaded to provide analytical support and advice in core policy areas and underpin the design o f lending operations. The CPS has benefited greatly from the recently completed core AAA work, particularly the C E M and PFPR which have also helped inform the Government’s agenda for growth and fiscal adjustment in its preparation for EU accession. A number o f recent HD policy notes (health, education, social protection) will also facilitate preparation o f the DPLs. In addition, the proposed program includes upfront core AAA in FY07 on: (i)strengthening the investment climate for private a second phase PFPR to deepen the work on prioritized sector growth and employment; and (ii) medium-term expenditure frameworks for key sectors and absorption o f EU funds. A poverty/living standards assessment envisaged for FY08 would update the Bank’s earlier poverty work in Bulgaria and support the D P L series. A report on the implementation o f the structural reform agenda as follow-up to the recent C E M i s foreseen for FY08. These activities are complemented by TA in selected policy areas - energy sector reform and regional development (FY07). The latter would also precede a possible regional development project in FY09. Finally, fiduciary and safeguards work in FY06 will facilitate the move towards a FY07 PBA investment project in the roads sector, while a fiduciary ( C F M C P A R ) update in FY07 will underpin the D P L series. The proposed initial lending and AAA programs are shown in Annexes B3 and B4 respectively and are summarized below (Table 2).


Bulnaria: Country Partnership Strategy

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Table 2: Proposed Bank Lending and AAA Program, FYO7-09 a/

Road infrastructure ISIL

Municipal infrastructure SIL Social inclusion S I L

a/ the program is based on consultations with the government, but for FYO8-09 remains indicative and subject to annual review with government (see para 48).

E.

Bank Support for Strategic Priorities

56. The proposed CPS program i s balanced to support the three strategic priorities o f the CPS while facilitating the overall goal o f Bulgaria’s successful economic and social integration with the EU. Table 3 shows how the proposed Bank lending and AAA instruments support the three strategic priorities o f the CPS. As can be seen, many o f the instruments address more than one o f the strategic priorities. The DPL series would support aspects o f all three priority areas. At the same time, the Government has requested the Bank to focus i t s interventions in selected areas o f Bulgaria’s remaining development agenda where it values the Bank’s comparative advantage and expects to achieve complementarities with the Government’s own interventions and involvement o f other external partners. Accordingly, Bank support would not necessarily address all aspects o f Bulgaria’s remaining agenda. Examples o f areas where Bank assistance i s not foreseen at this stage are agriculture and judicial reform. At the same time, these areas remain central to the Government’s program and continue to receive support fiom other external partners (also see para 65 below which shows how various external partners support Bulgaria’s broader development agenda). Bank support for the three CPS strategic priorities i s summarized below.


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Bulgaria: Country Partnership Strategy

Table 3: CP! Strategic Priorities and Bank Lending & AAA Instruments

Strategic Priorities Productivity & Employment

Major Contributions

Bank Instruments

Lending: DPLs (FY07,08,09)

Roads Infrastructure S I L I& I1 (FY07,09: Trade & transport facilitation for SE Europe 2 SIL (FY07)

u:

Fiscal sustainability & absorption of EU funds

Investment climate review for private sector growth & employment (FY07) Public Finance Policy Review Phase 2 (FY07) Energy advisory TA (FY07-08) Lending: DPLs

Municipal Infrastructure SIL (FY08) Social Inclusion SIL(FYO8) Regional development SIL (FY09) & l J : PFPR Phase 2

Poverty Reduction & Social Inclusion Social Inclusion SIL Regional development AAA (FY07) & SIL (FY09) @: Povertylliving standards assessment lFYO8)

57.

Education reform for relevant skills Reform o f labor framework for increased labor market flexibility & employability Easing social contributions for business and increased labor force participation Improved roads investment planning& roads upgrading for better access to markets Improved border crossing systems & infrastructure for enhanced trade Reduce constraints to private firms’ investment, productivity & employment Public expenditure restructuringtowards growtk Advice for completing energy sector reforms

) ) )

Sustainable financing health system, hospital restructuring, efficiency pharmaceutical sector Education finance reform for efficiency & school consolidation Lower dependence from social assistance Development of sustainable medium-term expenditure frameworks & improved absorption EU funds Public expenditure restructuringfor efficiency & absorption EU funds Reform disability benefits for employability Improvedtargeting of risk groups Improved social service delivery Inclusion disadvantaged groups in line EU Joint Inclusion Memorandum (JIM) Reduce regional disparities Updated poverty profile for improved social policies

Productivity and employment: The three programmatic DPLs (FYO7-09) would some o f the needed contribute to the productivity and employment agenda by focusing on: (i) education reforms that would help to meet the skill needs o f the knowledge economy by improving the quality o f education outcomes and reducing dropout rates, and (ii) continuing the reform o f the labor framework, health system, and social protection system, aiming to increase labor force participation by lowering payroll taxes, reducing social assistance dependency, reforming disability benefits, and increasing formal employment through more flexible work arrangements and better incentives to participate in the formal economy. The focus on employment leads the DPLs to support the government’s reform efforts in primary and secondary school education and social protection, in particular reforms to (i) improve outcomes through assessment o f system performance, and improved evaluation o f teachers and schools; (ii) introduce a new financing and management model where money follows the pupil in a fiamework with decentralized management and accountability at the school level. Higher education reforms may be addressed later in the DPL series. (iii) create more flexible work


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Bulgaria: Country Partnership Strategy

arrangements through adjustments to the labor framework; (iv) restructure active labor market policies; and (v) ease the social contributions burden by lowering pension insurance contributions and restructuring benefits. These efforts are expected to contribute to increasing the employment rate from 56 percent in 2005 to 60 percent in 2009, and decreasing the share o f long term unemployment to total unemployment.

58. Both the two roads inpastructure projects (FY07 & FY09) and the second trade and transport facilitation for South East Europe (TTFSE2) project (FY07) will help alleviate transport bottlenecks to trade, identified as one o f the main constraints to growth. The roads projects would support the Government define a prioritized roads investment program within its medium-term expenditure framework, develop needed capacity in the Road Executive Agency in investment programming and implementation, and help finance rehabilitation o f secondary roads to facilitate regional development and access to markets. These efforts would contribute to improvements in road network condition in Class I1 and Class I11 roads. The TTFSE2 project would continue assistance under a successful first project in improving border crossing systems and infrastructure, which helps speed-up cross-border trade along the major trans-European transport corridors. Following the recent growth-oriented CEM, the proposed A M focused o n improving the investment climate for private sector growth and employment (FY07) would conduct an in-depth evaluation o f investment climate aspects at the firm-level and develop an agenda o f microeconomic reforms for private sector growth and employment generation. The proposed report on structural reforms monitoring and dissemination (FY08) will build on the recent C E M by monitoring the progress and outcomes o f the recommended structural reforms. The second phase public finance policy review (PFPR2, FY07) will build on the recently completed PFPR in addressing the needed restructuring o f public expenditures for growth. Finally, proposed A M on energy advisory services (FYO7-8) in support o f finishing the reforms in the sector support private sector development for growth. Fiscal sustainability and absorption of EU funds: The DPL series’ focus o n 59. improving the efficiency o f the health, education, pension and social assistance systems to support their financial sustainability and effectiveness would help to contain the growth o f expenditures in these areas in support o f Government efforts to maintain public expenditures at less than 40 percent o f GDP. Bulgaria’s severe demographic challenge makes efficient spending in these areas a priority to maintain fiscal stability. In health, the focus will be on improving financial sustainability o f the National Health Insurance Fund (NHIF), through reforms to the payment system, restructuring o f the hospital sector, and improved efficiency in the pharmaceutical sector. In education, the DPLs will support finance and governance reforms that would help improve both eficiency and quality o f education including fiscal measures to encourage school mergers and consolidation. T o improve efficiency o f social protection, the DPLs would contribute toward better targeting o f core risk groups and decreasing new recipients o f disability pensions due to general sickness. The proposed investment projects (roads I & II, municipal inpastructure, social inclusion and regional development) would all ensure that needed investments are undertaken within a sustainable medium-term expenditure framework, and focus on absorption o f EU funds by supporting preparation o f high priority investment programs and financing frameworks that would permit co-financing and coordination with EU funds and IFIs while building capacity at central and local levels for project preparation and implementation. The municipal inpastructure project will strengthen central and local institutions responsible for preparing projects that will be eligible for EU grant financing in


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support o f improved capacity for programming and committing EU funds. The Bank and IFC will jointly support the development o f the water sector to allow Bulgaria to meet i t s environmental commitments to the EU (also see para 63). In addition, AAA on PFPR2 (FY07) will continue the work started in the first PFPR focused on the needed public expenditure restructuring for growth and absorption o f EU funds, and on advancing implementation o f program/performance budgeting systems across Government.

Poverty Reduction and Social Inclusion: The DPLs would support policies that 60. promote further poverty reduction and social inclusion, by granting the poor, Roma in particular, equitable access to basic social services and supporting their insertion into the labor force, and increasing labor participation o f youth, older unemployed and disabled. In the health sector, the DPLs would support improved access to quality health services by helping curb unregulated payments in the sector. In social assistance, the DPLs would help improve targeting on core risk groups and continue the reform in child protection through further improvements in service delivery. The policies promoted by the DPLs would be supported by the proposed social inclusion project (FYO8) which helps to address the needs o f Bulgaria’s most vulnerable groups (Roma, people with disabilities, institutionalized children, vulnerable j o b seekers), in support o f meeting the goals o f the Joint Inclusion Memorandum (JIM) signed with the EU. The proposed regional development project (FY09) would address regional imbalances by strengthening capacity to manage the programming and strategic allocation o f EU structural funds, integrate them into public expenditure management and the inter-governmental fiscal system, and capacity building at regional and local levels for project preparation and absorption o f EU funds. Both the DPLs and these investment projects would be underpinned by apoverty and living standards assessment (FYU8) which updates previous poverty work in Bulgaria and adds a regional dimension on living standards. These efforts are expected to contribute to reducing rural poverty and lowering the gap between urban and rural poverty.

F.

Lending Principles

61. Annual lending volumes will be determined in consultation with the Government and consistent with policy performance for Bank lending engagement and with prudent IBRD risWexposure management within the agreed envelope. W h i l e the most likely scenario would involve lending up to US$300 million per year during FY07-09, including DPLs which are expected to cover up to US$lSO million per year, annual lending volumes and instruments would be agreed with the Government in accordance with the CPS strategic framework and priorities, and consistent with conducive policies and prudent IBRD risMexposure management within the agreed lending envelope o f US$300 million per year. T o the extent the Government may seek higher levels o f fast disbursing lending operations (eg DPLs) than currently envisaged, the overall envelope would be reduced to ensure exposure remains within the levels commensurate with the most likely scenario above. This is further based o n the expectation that Bulgaria will continue to pursue sound macroeconomic policies and that macroeconomic risks do not worsen. Should macroeconomic performance deteriorate, which may be evidenced by an increase in external imbalances beyond current levels, increased inflation, continued appreciation o f the real effective exchange rate, less prudent fiscal policies, a deviation from Government’s sound debt management, or by downgrading o f creditworthiness ratings by commercial rating agencies, the lending program and composition would be revisited and revert to a lower level, which in the case o f a significant deterioration (i.e. a l o w case scenario) would comprise only


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Bulgaria: Country Partnership Strategy

investment projects. In the proposed lending program, the DPLs will require a sound macroeconomic framework. Sectoral lending in turn would be modulated by the need for a satisfactory sector policy framework and expenditure program. Accordingly, the lending program would be adjusted for significant adverse changes in the macroeconomic or sector policy environment. A set o f policy performance indicators shown below (Table 4) will provide a framework for judging the presence o f a suitable environment for Bank lending engagement. In the event o f significant changes in the proposed strategy, a CPS progress report would be prepared for discussion by the Board.

Table 4: Policy Performance Indicators for Bank Lending Engagement Policy performance indicators

Policy areas

Maintenance o f satisfactory macroeconomic performance

Evidenced inter alia by maintenance o f prudent fiscal policies, improved price stability, continued sound public debt management, and declining external imbalances. I n addition, after EU accession: 0 Satisfactory progress towards meeting the EU Growth and Stability Pact provisions and implementation o f Bulgaria’s EU Convergence Program based o n EU surveillance mechanisms. 0

62. Building on the lessons from the previous CAS, the choice and design o f lending operations will follow several principles. The Government has indicated a preference for future lending to involve a combination o f DPLs and investment operations which move toward programmatic based approaches (PBAs) and help absorb EU fbnds. More particularly for investment lending, the following principles would be applied for future Bank engagement: (i) finance priority activities within a sustainable medium-term fiscal/expenditure framework and based on prioritized investment programs; (ii)help set up financing mechanisms and build capacity that facilitate absorption o f EU funds and co-financing with IFIs where appropriate; (iii) provide systemic solutions with lasting impact on institutional capacity and development, rather than one-off interventions; (iv) avoid design complexity and limit implementation periods up to four years; (v) mainstream implementation arrangements within existing Government structures, while ensuring sound fiduciary safeguards for project implementation; and (vi) where feasible, move towards programmatic support based on gradual adoption o f country fiduciary and safeguards systems in accordance with EU standards while ensuring compliance with Bank fiduciary standards based on fiduciary assessments o f the sectors and institutions involved in such lending. The Bank i s preparing Country Financing Parameters for Bulgaria in consultation


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with the Government to ensure that Bulgaria can benefit from the enhanced flexibility offered by the Bank’s new expenditure policy.

G.

IFC and MIGA Support for the CPS

63. IFC’s strategic objective over the coming years i s to facilitate and support Bulgaria’s successful EU accession and integration, by improving i t s competitiveness through supporting domestic companies and attracting foreign private investors in the country. Through private sector development and increased competitiveness, IFC will help to reduce Bulgaria’s external trade and current account imbalances and cope with rising competition in euro zone markets. Priority areas for IFC include: 0

0

0

In thefinancial sector, IFC’s strategy aims at increasing efficiency and sustainability o f the sector through appropriate financial products and instruments. Such support will continue to remain consistent with policies pursued by the Government and the Bulgarian National Bank (BNB). IFC i s gradually shifting i t s focus to the non-bank financial sector. Securities markets, local bond market, and contractual saving institutions are still underdeveloped and significant opportunities exist to support fbture development in these areas. IFC will seek opportunities to introduce i t s guarantee, risk management and structured finance instruments. Given Bulgaria’s high energy intensity, energy efficiency products and renewable energy will be another area o f priority. To develop such a product, IFC will provide financing combined with technical assistance programs to selected banks. In addition, IFC will explore opportunities for TA to support improvement of financial infrastructure which i s critical to market discipline. In the corporate sector, IFC will continue to support the rehabilitation and modernization o f post-privatized companies in sectors where Bulgaria has a comparative advantage and/or export-oriented sectors. In addition, IFC will continue to play an important role in promoting foreign investments in the areas where the technology transfer through FDI i s a prerequisite for productivity gains. IFC will support possible sell offs o f locally owned industrial enterprises to European majors as well as help local companies in their international establishment. Support for local and international private investments in the health and education sectors will be another area where IFC expects to have an increasing role. In the infrastructure sector, IFC’s objectives are to be innovative, foster public private partnerships and catalyze FDI. IFC pays special attention to support infrastructure development in coordination with the Bank, EIB, EBRD and the Stability Pact. The Bank and IFC will collaborate closely in the infrastructure sector, particularly in developing a joint program in municipal infrastructure financing o f water and waste water sector needs in selected municipalities. IFCs’ Private Enterprise Partnership - Southeast Europe Infrastructure (PEP-SE Infrastructure), recently established in Sofia, would lead IFC’s involvement through i t s efforts to assist Government in attracting private investors and operators in infrastructure through PPP approaches.

64. M I G A i s open for opportunities to support foreign investors in line with Bulgaria’s EU integration agenda. A potential area where MIGA can play a role in close coordination with the Bank and IFC i s supporting projects on a sub-sovereign level.


32

H.

Bulgaria: Country Partnership Strategy

Partnerships

65. Bulgaria benefits from a broad range of assistance from i t s various external partners. Table 5 shows how Bulgaria’s external partners help address the country’s major development challenges outlined in Chapter 111. I t shows that each o f these priority areas i s supported by one or more partners, including areas not covered by the Bank’s CPS program (e.g. agriculture, public administration reform, judicial reform). I t also underscores the importance o f effective coordination among partner programs in areas such as transport and municipal infiastructure where the three IFIs are active. The Government has been leading such coordination efforts, but further efforts are needed to improve them for the purpose o f maximizing the effectiveness o f Bulgaria’s external assistance. The Bank will continue to play a lead role in facilitating such coordination efforts. The design o f Bank-financed investment projects will also facilitate coordination and possible co-financing with EU and others through the establishment o f sector expenditure frameworks and financing mechanisms which seek a sector-wide approach.

66. The EU i s Bulgaria’s main external partner with considerable grant financial assistance. Prior to accession, Bulgaria benefits from the E C pre-accession assistance mainly provided by three instruments: PHARE, for strengthening public administration and institutions, to help implement the acquis communautaire, and promoting economic and social cohesion; ISPA for support o f large infiastructure projects in transport and environment; and SAPARD for support o f agriculture and rural development. The total volume o f pre-accession assistance available to Bulgaria i s substantial around €545 million will be available in 2006 for preaccession programs. As mentioned, following accession Bulgaria has been allocated €4.6 billion for the period 2007-09 (see para 32 above).

-

67. The IMF has had active programs in Bulgaria throughout the transition, with a focus on prudent fiscal policy underpinning the currency board arrangement. The current IMF program ends in September 2006, but may be extended until 2007. In August 2004, the IMF Board approved the current 25-month precautionary SBA in an amount o f SDRlOO million. The Fund and the Bank have had very close working relations over the years with the Bank leading the dialogue on the structural aspects o f the reforms, recently in the context o f the PAL program, while collaborating closely with the Fund to ensure synergies with the macroeconomic and fiscal aspects o f the reforms. 68. EIB activities in Bulgaria will focus on support for the country’s long-term investment needs with particular emphasis on supporting and co-financing projects identified under the Cohesion and Structural Funds. Since 1991 EIB has financed about €1.2 billion in Bulgaria o f which about 60 percent went to the transport sector while the rest financed key infrastructure and industrial projects with a European dimension, as well as SMEs. After Bulgaria’s EU accession, EIB would continue to facilitate Bulgaria’s EU integration by supporting infiastructure and other investment, with particular emphasis on Trans-European Networks, environment and human capital sectors, as well as contribute to promoting the development o f SMEs. EIB is offering technical assistance for project preparation, through the JASPERS initiative, and i s ready to cofinance projects and programs identified under Cohesion and Structural Funds. I t will also consider financing non-sovereign projects.


33

Bulgaria: Country Partnership Strategv

Development Challenges

EU IEBRDl EIB

Bulgaria’s External Partners IFC I UNDP, I USAID1

I IMF I IBRD I

Other

* G=Germany; J=Japan; N=Netherlands; S=Switzerland; U=United Kingdom.

*

69. EBRD’s involvement in Bulgaria has increasingly focused on commercial, nongovernmental financing. As o f September 2005, EBRD had made cumulative commitments o f €1.1 billion. The new EBRD country strategy, approved end-2005, identified three priorities for the period 2006-07: (i) enterprise sector, including support for restructuring and recapitalization o f local private firms to increase competitiveness and prepare them for EU entry and compliance with EU regulations, and supporting foreign direct investment - particularly green-field; (ii) inpastructure, including municipal financing for urban transport, solid waste, and district heating, structured on a commercial basis and helping to build institutional capacity; water and wastewater sector, where it finances regional water companies with ISPA co-financing; and opportunities in railways and the road sector, and (iii) power and energy efficiency including support to the energy sector, energy efficiency and renewable energy resources, and improvements to the sector legal and regulatory framework.

70. The UNDP continues to be active in Bulgaria, while some o f the bilateral partners are starting to pull back in view of the forthcoming EU accession. UNDP’s 2006-2009 country program approved in June 2005 focuses on: (i)social inclusion and local economic development for poverty reduction; (ii)good governance for equitable local and regional development; and (iii) conserving energy and preserving the natural environment for sustainable development. The priority areas o f USAID’SGraduation Strategy 2003-2007 are rule o f law, economic development and increased prosperity, and local governance. UK support i s aimed at


34

Bulgaria: Country Partnership Strate&

justice and home affairs, regional economic development, pro-business environment, and public German bilateral administration capacity building - including structural funds access. cooperation focuses on promotion o f SMEs and assistance to the public administration. The priority areas for the Swiss cooperation program are: sustainable management o f natural resources, fair and effective social services, favorable framework for the private sector, and establishment o f efficient infrastructure. The Netherlands support i s focused on implementation o f the aquis and building administrative and institutional capacity. Japan’s areas o f emphasis are: development o f a market economy, environmental protection, agriculture, and development o f economic and social infrastructure. In addition, Bulgaria benefits from the Japan Policy and Human Resource Development (PHRD) technical assistance program and Japan Social Development Fund (JSDF) grants which complement Bank financed operations.

I. CPS Results Monitoring 71. The CPS results monitoring will build on the successful PAL monitoring in the previous CAS and track progress towards achieving outcomes influenced by Bank interventions agreed to be undertaken as part o f the CPS. Annex 1 shows a CPS results matrix based on agreed activities for initial Bank involvement. Results monitoring would be undertaken jointly with Government as part o f the annual consultation process for assessing progress o f the CPS and possible adjustments to the Bank program. These discussions would also provide inputs into updating the results matrix to reflect adjustments to the Bank program.

VI. Creditworthiness and Risk Management 72. Bulgaria’s active debt management has achieved a gradual reduction in the share of public debt to GDP by limiting new borrowing and early repayment o f more costly debt, while improving the currency and interest rate structure o f debt. Bulgaria reached the Maastricht public debt criterion already in 2002, and by end-2004 the public debt to GDP ratio had declined to 41 percent o f GDP and was estimated to have reduced to 32 percent by end2005. External public debt also declined from 77 percent o f GDP in 1999 to 33 percent o f GDP in 2004 and an estimated 25 percent in 2005. The considerable reduction in public external debt was accompanied by increased private sector borrowing (Figure 4). In line with its debt management strategy, the Government carried out a number o f early debt-buyback operations, including selected loans from the World Bank and IMF, and buyback o f the remaining Bulgarian Brady bonds. Bulgaria’s public debt management strategy further seeks to maintain a stable nominal amount o f debt, leading to further reductions o f public debt as a share o f GDP, while increasing the share o f domestic debt and improving currency composition o f debt with a shift from U S dollar toward Euro-denominated debt. The Government’s efforts in developing domestic debt markets will help to absorb considerable liquidity in the banking system, strengthen domestic capital markets, and provide investment alternatives for private pension funds and insurance companies.

Bulgaria’s creditworthiness has improved significantly over the last few years. 73, Thanks to the improved macroeconomic and structural policies, Bulgaria’s sovereign credit

rating was upgraded several times to investment grade over the period 2003-05. L o w sovereign bond spreads also indicate continued investor confidence.


35

Bulgaria: Country Partnership Strategy

Figure 4: External Debt Composition External Debt Composition by Maturity

hternal Debt Compmition (?hGDP)

I

90 90

70

80 70

80

60 50

70

40

60

30

5?

20

40

10

30

0 1999

2000

2001

2002

2003

2004

2005

.g 0

60 50 40

30 20 IO 0 1999

2000

2001

2002

2003

2004

2005

~ L o n g - t c m@81Shon-tem I

Source Bulgarian National Bank

In the absence o f substantial adverse shocks to the economy and if‘ current 74. structural and prudent macroeconomic policy i s maintained, medium-term external sustainability i s expected to remain reasonably assured and the external debt to GDP ratio relatively stable. However, the widening current account deficit and increasing consumption and investment fueled by the private sector credit boom pose vulnerabilities in the context o f Bulgaria’s currency board arrangement. Careful monitoring o f the situation i s thus warranted.

75. Under the proposed lending scenario, IBRD’s exposure to Bulgaria would increase but i s expected to remain manageable. Bank exposure to Bulgaria would increase from about US$1.4 billion in 2005 to about US$1.8 billion in 2009-10. This would represent a slight increase in Bulgaria’s share o f total IBRD portfolio from 1.3 percent in FY05 to 1.7 percent in FY09-10. IBRD’s share o f Bulgaria’s total external debt would stay in the 7-8 percent range, while IBRD debt service as share o f exports would fall to 0.7 percent by 2009 (Table 6). Both the preferred creditor exposure and IBRD’s debt service as share o f overall external public debt service would rise in view o f IBRD’s increased exposure combined with the projected continued decline o f Bulgaria’s external public debt relative to GDP as a result o f Government’s prudent debt management. As part o f active debt management, Bulgaria recently pre-paid some o f i t s outstanding commitments to IBRD and the IMF, which explains the increased exposure indicators in 2006. Government’s decision to continue borrowing from IBRD i s based on its assessment o f the merits o f a continued engagement with the Bank in addressing i t s remaining challenges o f EU integration and convergence. Table 6: IBRD Exposure Indicators for Bulgaria, 2002-2009”

* based on calendar years. ** lower ratios in 2004-05 reflect Bulgaria’s prepayment o f its remaining Brady bonds.


36

Bulgaria: Country Partnership Strategy

There are several risks to the successful implementation o f the strategy - the main one would be a slowdown in the reform agenda which in turn would trigger a slowdown in economic growth. As pointed out earlier, sustained high growth will require continued vigorous reforms in the business environment, human and physical capital investment, strengthening o f labor markets, and fiscal adjustment. Given Bulgaria’s difficult demographic conditions, sustaining these reforms will be critical for keeping up productivity improvements for enhanced growth. At the same time, the reforms now touch more sensitive areas which are meeting greater political and social resistance. The Bank program itself i s focused on some o f these more difficult areas, such as health and education reform which have lagged for insufficient public support. The pressure from the EU accession agenda will help to mitigate the risk o f delays in the key reform areas. In the now unlikely event o f a delay in Bulgaria’s EU accession, the risk o f policy slippage i s low, given continued pressure for Bulgaria to meet accession requirements. In terms o f the Bank program, the link to continued satisfactory progress on macroeconomic policies in case o f the D P L series and to progress on sectoral reforms in case o f both DPLs and investment lending would help to modulate the program to progress o n the needed policies. A proactive effort by the Government and the Bank to engage stakeholders on the costs and benefits o f the reforms would also mitigate the risk o f slippage.

76.

77.

Further, the reforms and growth will be subject to risks to macroeconomic stability. In the short run, risks to the country’s external debt position include increases in interest rates, continuing growth in o i l prices, and reduction in FDI flows. Macroeconomic management could be further complicated if there were greater capital flow volatility induced by the growing reliance on short-term capital flows. A reduction in domestic interest rates relative to comparable returns in the euro zone would magnify the risks o f such volatility. The widening external current account deficit remains a serious concern as stated earlier, and raises questions about the competitiveness o f Bulgaria’s economy. Real effective exchange rate and unit labor cost dynamics suggest that competitiveness remains adequate for the time being. In the mediumterm, the intention towards joining the exchange rate mechanism ( E M - 2 ) and monetary integration with the EU after accession will raise additional challenges in piloting the economy towards full adoption o f the euro and maintaining it within the strict Maastricht criteria. The task will be complicated by the large structural differences, both real and financial, between Bulgaria and the other euro zone countries. These risks are mitigated by government’s strong record o f sound macroeconomic management since the 1996-97 crisis anchored in the currency board and a prudent fiscal policy. The current Government has demonstrated its intent to maintaining the past policies in this regard. A continuation o f the IMF program, at least through the fall 2006 and possibly longer, would provide support for maintaining prudent macroeconomic policies. Once Bulgaria joins the EU, the EU’s Stability and Growth Pact (SGP) would help provide further discipline in support o f macroeconomic stability and growth (para 10).


Q\ 0 0 CJ

.5 Y

8

2 #

5

m

e,

m

0

4-

m

0 0 CJ

.5

U

#

i


c c c


CAS Annex A2 Page 1 o f 2

Bulgaria at a glance Europe & Central Bulgaria Asia

POVERTY and SOCIAL 2005 Population, mid-year (rnm/lmons) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billmons)

6/28/06

Lower-

middieincome

Develoomentdiamond*

7.7 3,450 26.7

473 3,300 1,557

2,442 1,690 4,116

-1.o -0.8

0.0 0.5

0.9 1.4

13 70 72 12

64 69 29

100 99 100 1Ot 99

91 97 102 103 101

50 71 32 I1 81 89 112 113 111

1985

1995

2004

2005

GDP (US$ bmllrons) Gross caMal formation/GDP Exports of goods and services/GDP Gross domestic savings/GDP Gross national savings/GDP

17 6 32 2 42 8 31 8 31 7

13.1 15.7 44.8 14.2 11.0

24.3 23.5 58.0 13.2 15.4

26.6 28.0 60.8 11.4 22.0

Current account balance/GDP Interest payments/GDP Total debffGDP Total debt service/exports Present value of debffGDP Present value of debtlexports

-0 8

-1.5 4.4 79.2 16.6

-5.8 2.2 64.4 15.1

-11.8

2004

2005

2005-09

29 38 69

5.7 6.5 13.0

5.5 5.8 7.2

5.9 6.7 11.2

1985

1995

2004

2005

Growth of capital and GDP (K)

10.8 29.9 18.6 59.3

9.3 30.4 18.9 60.3

30 .I

70.6 15.3 46.3

68.0 18.8 68.2

72.1 16.5 77.4

1985-95 1995-05

2004

2005

13.9 14.1

24.6 14.6

Average annual growth, 1999-05 Populabon (%) Labor force (%J

Most recent estimate (latest year available, 1999-05) Poverty' (% of populatlon below nationalpoverty /me) Urban population (% of total populatron) Life expectancy at birth (years) infant mortality (per 1,000 h e brtfhs) Child malnutntion (% of chrldren under 5) Access to an improved water souree (% of populahon) Literacy (% ofpopulatm age 15+) Gross primary enrollment (% of school-age populatronl Male Female

Life

-

GNI per capita

Gross primary enrollment

I

Access to improved water source Bulgaria Lower-middle-mncorne group

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

(average annual growth) GDP GDP per capita Exports Of goods and SeNiceS

1985-95 1995-05

-2 0 -1 2 -227

STRUCTURE of the ECONOMY (% of GDPJ Agriculture Industry Manufacturing Services Household final consumption expenditure General gov't final consumption expenditure Imports of goods and services

(average annual growth) Agriculture Industry Manufacturing Services Household final consumption expenditure General gov't final consumption expenditure Gross capital formation Imports of goods and services

11.9 62.8

32.7

25.3 51.6 16.6 43.2

-4.2 -4.0 -2.6

2.6 2.5 6.4 1.9

-3.5 -5.0 -10.7 -26.1

3.4 3.4 16.9 11.8

Economic ratios' Trade

.L

Indebtedness -Bulgaria Lower-middle-income group

20

10

0

00

01

-Exports

02

03

04

05

-.Ollmpo!tts

Note: 2005 data are preliminary estimates. Group data are to 2004.

* The diamonds show four key indicators in the country (in bold) compared with its incomegroup average. If data are missing, the diamond will be incomplete.


CAS Annex A2 Page 2 o f 2

Bulaar ia PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

1985

1995

2004

2005

62.1 62.8

6.2 4.8

5.0 3.8

38.9 -3.3 -5.2

41.2 5.6 1.7

42.1 7.1 2.3

1985

1995

2004

2005

10,688 2,125 1,791 11,199 545 2.217 4,532

4,967 1,360 690 800 5,319 123 1,816 1,001

9,541 2,992 8,030 5,027 12,911

10,212 3,465 9,354 5,216 13,636

3,985

4,175

135 53 257

117 116 101

140 130 108

175 163 107

1985

1995

2004

2005

11,760 11,872 -112

6,738 6,636 102

13,852 16,657 -2,805

15,996 20,585 -4,589

Net income Net current transfers

-101 74

-432 132

291 1,098

312 1,144

Current account balance

-139

-198

-1,416

-3,133

Financing items (net) Changes in net reserves

562 -423

676 -479

2,029 -613

3,655 -522

0.002

1,545 0.067

9,238 1.575

8,535 1.574

1985

1995

2004

2005

10,379 444 0

15,661 1,498 0

1,140 31 0

2,456 121 0

22 38 -98 90 0

0 127 1,070 0 0

193 15 0 15 31 -16

150 204 80 124 41 83

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplusldeficit TRADE

(US$ milhons) Total exports (fob) Consumer goods Commodity 2 Manufactures Total imports (ciD Food Fuel and energy Capital goods

Export price index (2000=700) Import price index (2000=100) Terms of trade (2000=700) BALANCE of PAYMENTS (US$ millions) Exports of goods and services Imports of goods and services Resource balance

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$) EXTERNAL DEBT and RESOURCE FLOWS

(US$ mlons) Total debt outstanding and disbursed IBRD IDA

0.2

55.2

Total debt service IBRD IDA

Compositton of net resource flows Offiual grants Official creditors Pnvate creditors Foreign direct investment (net inflows) Portfolio equity (net inflows) World Bank program Commitments Disbursements Pnncipal repayments Net flows Interest payments Net transfers Development Economics

Inflatbn (%) 12

0 0 0

io 8

e

4 2 1

01

00

02

GDP deflator

05

M

03

‘IOI-CPI

Export and Import levels (US$ rnlll.) 16,oW T 14,000 12,000 10,000 8,000 6,WO 4,000 2,000 0

00

89

01

02

M

03

05

rn Imports

Exports

Current account balance to GDP (“A) 99

00

01

02

0

03

04

05

-2 -4 4 8 -10 -12

Composltlon of 2004 debt (US$ rnlll.)

F: 7,955

-

A IBRD B IDA C IMF

D Other multilateral ~

E -Bilateral F - Private G -Short-term

6/28/06


Annex 62 Page 1 of 1

-

CAS Annex 8 2 Bulgaria Selected Indicators* of Bank Portfolio Performance and Management As of 5/8/2006

indicator Portfolio Assessment Number of Projects Under Implementation a Average Implementation Period (years) Percent of Problem Projects by Number a* Percent of Problem Projects by Amount Percent of Projects at Risk by Number Percent of Projects at Risk by Amount a, Disbursement Ratio (%) e Portfolio Management CPPR during the year (yedno) Supervision Resources (total US$) Average Supervision (US$/project) Memorandum item Proj Eva1 by OED by Number Proj Eva1 by OED by Amt (US$ millions) % of OED Projects Rated U or HU by Number % of OED Projects Rated U or HU by Amt

a. b. c. d. e.

2003

2004

2005

2006

10 1.8 20.0 26.0 20.0 26.0 15.2

9 2.2 11.1 7.8 11.1 7.8 9.7

10 2.9 20.0 9.5 20.0 9.5 27.9

8 3.6 25.0 15.8 25.0 15.8 29.4

Yes 755.0 75.5

Yes 706.0 78.4

Yes 515.0 51.5

n/a 620.0 77.5

Since FY 80 Last Five FYs 25 10 1,637.2 740.9 20.0 10.0 3.7 1.6

As shown in the Annual Report on Portfolio Performance (except for current FY). Average age of projects in the Bank's country portfolio. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). As defined under the Portfolio Improvement Program. 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.


-

Annex 83 Page 1 of 2

-

CAS Annex 8 3 IBRDADA Program Summary Bulgaria As of 5/8/2006

Proposed IBRDADA Base-Case Lending Program a Strategic Rewards b (HIMA)

Implementationb Risks (HIMIL)

150.0 100.0 50.0 300.0

H M M

H L L

DPL 2 Municipal Infrastructure SIL Social Inclusion SIL Sub Total

150.0 100.0 50.0 300.0

H M M

H M M

DPL 3 Road Infrastructure II SIL Regional Development SIL Sub Total

150.0 100.0 50.0 300.0

H M M

H L M

TOTAL

900.0

Fiscal year

Pmj ID

2007

DPL 1 Road Infrastructure 1 SIL Trade & Transport Facilitation for SE Europe II SIL Sub Total

2008

2009

US$(M)

a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L). Template created on 06/28/2006.


Annex B3 Page 2 of 2

CAS Annex B3 (IFC & MIGA) for Bulgaria

-

Bulgaria IFC Program, F Y 2003-2006 IFC approvals (US$m)

Sector (YO)

Finance & Insurance Industrial & Consum Nonmetallic Mineral Oil, Gas and Mining Primary Metals Wholesale and retail trade

Total Investment instrument(%) Loans Equity Quasi-Equity Other

Total

2003

2004

2005

2006

28.24 101.44

58.48

23.84

13

11

39 61

66 21

100

89 100

100

100

100

93 7

91 9

100

00

100

100

100

00

Guarantee Program M I G A OutstandingExposure (Gross Exposure, $ milllion) As of end o f fiscal year FYOl FY02 FY03 FY04 FY05

Sectoral Distribution Finance Infrastructure Mining Oil & Gas

Agribusiness/Manufacturing/Services~ourism

Transfer Restriction War & Civil Disturbance

Breach of Contract

1.6

21.2__________ 333.7 353.1__ 351.5

390.9

1.4 0.4

1.2 20.0

0.4 0.0

0.0 20.0

305.3 305.3 0.0

324.2 0.0

351.5 322.7 296.7 0.0

378.9 365.1

1.6

353.1 6.8% 131.6 4.0%

351.5 6.9% 131.0 4.2%

390.9 7.0% 139.6 4.2%

0.0

0.0 0.0 24.7

333.7

0.0%

21.2 0.4%

333.7 6.6%

MIGA Net Exposure in Country

1.6 0.1%

11.2 0.4%

125.1 3.9%

YOShare of MIGA's Net Exposure

28.8 0.0 296.7 365.1 0.0 0.0 0.0 0.0 26.1 _l.ll____ 25.9

1.2 20.0 0.0 0.0

% Share o f MIGA's Gross Exposure

MIGA's Gross Exposure in Country

28.9

1.2 0.0 0.0 0.0 0.4

MIGA's Risk Profile Expropriation

28.4 280.6

FY06 through 3/31/06

298.0 0.0 0.0 26.2

353.1 324.2

I _ _ I _

272.1

0.0


Annex 84 Page 1 of 1

-

-

CAS Annex B4 Summary of Nonlending Services Bulgaria Product

As of 5/8/2006

Completion FY

Cost (lJS$OOO)

Audience a

Objective

Recent completions Environment Sequencing Strategy Pension Reform Note Rural Development Assessment Roads Study CPAR Financing Options for the Water and Wastewater Sectors Private Sector Assessment TA Cities of Change TA

04 04 04 04 04 04

48.3 41.3 39.3 42.2 81.5 35.2

G/PD/B PD G/PD/B G/PD/B G/PD/B G

KG/PS KG/PS KG/PS KG/PS KG/PS KG/PS

04 04

83.9 65.8

G G/PD

KG/PS KG/PS

Greening M U (Hot Air PCF) Road Investment Financing Options TA Water Workshop TA

05 05 05

92 39.6 22.5

G G/PD G

KG/PS KG/PS KG/PS

CEM - Policies for Growth Public Finance Policy Review

06 06

315 280

G/D/B G

KG/PS KG/PS

Underway" Infrastructure Investment Review Institutional Fiduciary Assessment - Roads Safeguards Assessment

06 06 06

50 78 20

GIB GIB GIB

KG/PS KG/PS KG/PS

Planned ' I Investment Climate for Private Sector Growth & Employment Public Finance Policy Review II Regional Development Energy Sector TA Fiduciary Update Poverty/Living Standards Assessment Structural Reform Monitoring Energy Sector TA Energy Sector TA

07 07 07 07 07 08 08 08 09

200 196 75 50 50 225 200 50 50

G/PD G/D/PD G/PD G/PD G/B GIBIPD G/D/PD G/PD G/PD

KG/PS KG/PS KG/PD/PS KG/PS KG KG/PD/PS KGIPDIPS KG/PS KG/PS

a. Government (G), donor (D), Bank (B), public dissemination (PD). b. Knowledge generation (KG), public debate (PD), problem-solving (PS).

c. Costs shown for these tasks are estimates


Annex 85 Page 1 of 1

Bulgaria Social Indicators Same regionlincome group

Latest single year

POPULATION Total population, mid-year (millions) Growth rate (YOannual average for period) Urban population (% of population) Total fertility rate (births per woman)

1975-80

1985-90

1998-2004

8.9 0.3 61.2 2.1

8.7 -0.5 66.4 1.8

7.8 -1 .o 70.2 1.2

472.1 -0.1 63.6 1.6

2,430.3 1.o 48.6 2.1

3,290

1,580

2.5 3.5

POVERTY (% of population) National headcount index Urban headcount index Rural headcount index

12.8

INCOME GNI per capita (US$) Consumer price index (1995=100) Food price index (1995=100)

2

2,260 2 3

INCOMWCONSUMPTION DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highest quintile (YOof income or consumption) SOCIAL INDICATORS Public expenditure Health (YOof GDP) Education (% of GDP) Net primary school enrollment rate (% of age group) Total Male Female Access to an improved water source (% of population) Total Urban Rural Immunization rate (% of children ages 12-23 months) Measles DPT Child malnutrition (% under 5 years) Life expectancy at birth (years) Total Male Female Mortality Infant (per 1,000 live births) Under 5 (per 1,000 live births) Adult (15-59) Male (per 1,000 population) Female (per 1,000 population) Maternal (modeled, per 100,000 live births) Births attended by skilled health staff (YO)

Lowermiddleincome

Europe & Central Asia

2,740 4,254 3,456 31.9 6.7 38.9

5.2

4.4 3.5

4.2 4.4

86 86 86

90 91 90

89 89 88

100 100 100

100 100 100

91 98 80

81 93 70

98 98

99 99

96 96

92 90

86 88 11

71 68 74

72 68 75

72 69 76

68 64 73

70 68 72

20 24

15 19

12 17

29 36

33 42

190 99

217 97

239 103 32

317 136 61

192 123 111 86

Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year of age. World Development Indicators database, World Bank - 08/29/05


Annex B6 Page 1 of 2

-

Bulgaria Key Economic Indicators

Indicator National accounts (as O@/ o f GDP)

2001

Actual 2002 2003

Estimated 2005

2004

Projected 2007 2008

2006

2009

100 13

I00 12

100 12

100 11

100 9

100 10

100 9

100 9

Industry

30

29

30

30

30

29

28

28

Services

57

59

59

59

60

61

62

63

i00 8 27 65

Total Consumption Gross domestic fixed investment Government investment Private investment

87 18 4 14

87 18 3 15

88 19 3 16

87 21 4 17

89 24 5 19

86 26 4 22

83 28 6 22

82 29 7 22

109 29 5 23

~xports(GNFS)~ Imports (GNFS)

56 63

53 60

54 63

58 68

61 77

66 81

67 80

65 78

62 101

Gross domestic savings

13

13

12

13

11

14

17

18

-9

Gross national savings'

17

15

13

15

22

22

26

28

-2

13,599

15,568

19,939

24,300

26,648

28,804

3 1,465

34,113

37,154

1,720

1,790

2,120

2,760

3,450

3,630

3,890

4,240

4.9 4.4

4.5 5.6

5.7 6.4

5.5 4.8

5.6 6.3

5.9 6.1

6.0 5.8

6.1 -8.2

Real annual per capita growth rates (%, calculated from 2002 prices) 5.4 6.1 Gross domestic product at market prices 4.1 6.4 Total consumption 4.0 7.2 Private consumption

5.1 7.2 7.1

6.5 5.9 6.3

5.8 7.1 7.9

6.6 4.4 5 .O

6.6 4.0 7.1

6.7 5.5 5.6

6.8 18.4 23.4

Gross domestic product' Agriculture

Memorandum items Gross domestic product (US$million at current prices) GNI per capita (US$,Atlas method)

e!,

Real annual growth rates calculated from 2002 prices) Gross domestic product at market prices 4.1 Gross Domestic Income 4.5

Balance of Payments (US$ millions)

7,276 5,113

7,557 5,354

10,043 7,08 1

13,852 9,848

15,996 1I,740

19,08 1 13,987

20,93 1 15,258

22,138 15,999

23,097 16,511

8,604 6,693 - 1,328 498 -805

8,767 7,O 13 -1,210 547 -319

12,104 9,657 -2,062 696 - 1,022

16,657 13,491 -2,805 1,098 -1,416

20,585 17,139 -4,589 1,144 -3,133

23,421 19,265 -4,340 1,336 -3,700

25,195 20,781 -4,264 1,998 -3,3 14

26,735 22,07 1 -4,597 2,390 -3,508

37,672 3 2 3 17 -14,575 552 - 14,101

Net private foreign direct investment Long-term loans (net) Official Private Other capital (net, id.errors & ommissions)

803 -54 -152 97 500

876 354 -109 463 -183

2,070 633 73 560 -785

2,226 -196 127 -324 -1

1,99 1 -765 -396 -369 2,429

2,691 2,222 28 2,194 -283

2,748 1,663 -129 1,792 146

1,320

Change in reservesd

-444

-729

-896

-613

-522

-930

- 1,242

2,663 824 -254 1,077 1,215 -1,194

-9.8

-7.8

-10.3

-11.5

-17.2

-15.1

-13.6

-13.5

-39.2

10.6

9.4

28.5

11.0

11.8

14.3

15.9

10.1

5.4

17.7

6.4

27.4

13.3

10.0

13.1

8.8

9.8

7.7

~xp01-t~ (GNFS)~ Merchandise FOB Imports (GNFS)~ Merchandise FOB Resource balance Net current transfers Current account balance

Memorandum items Resource balance (% o f GDP) Real annual growth rates ( YR02 prices) Merchandise exports (FOB) Primary Manufactures Merchandise imports (CIF)

(Continued)

-365

330


Annex B6 Page 2 of 2

-

Bulgaria Key Economic Indicators (Continued)

Indicator

2001

Public finance (as % of GDP at market prices)e Current revenues Current expenditures Current account surplus (+) or deficit (-) Capital expenditure Foreign financing Overall surplus (+)/deficit (-) Monetary indicators M2/GDP Growth o f M2 (%) Private sector credit growth / total credit growth (%) Price indices (YROZ =loo) Merchandise export price index Merchandise import price index Merchandise terms o f trade index

Actual 2002 2003

2004

39.5 36.3 3.2 4.2 -0.3 -0.6

38.4 36.1 2.3 3.0 1.5 -0.6

40.0 37.4 2.6 2.6 0.0 -0.4

41.2 35.6 5.6 3.9 -1.6 1.7

41.7 25.8 88.0

42.9 11.7 117.0

48.0 19.6 119.6

81.6 75.5 108.0

83.0 77.2 107.5

7.4 6.7

5.8 3.8

Estimated 2005

2006

Projected 2007 2008

2009

42.1 35.0 7.1 4.6 -5.8 2.3

39.9 32.4 7.5 4.5 -0.7 2.9

41.3 33.6 17.6 6.3 -0.6 1.2

41.5 33.5 7.9 7.0 -0.8 0.9

51.7 19.5 121.1

54.7 15.9 104.1

60.4 22.8 157.3

61.2 10.8 308.0

61.4 8.7 470.8

35.4

84.5 82.6 102.3

97.5 94.9 102.8

93.4 91.1 102.5

111.9 113.7 98.4

105.3 112.8 93.4

100.3 109.1 91.9

98.2 149.3 65.8

2.3 2.3

6.4 4.8

5.0 3.8

7.2 5.3

4.1 3.5

3.4 2.8

3.3 3.0

I

Real exchange rate (US$/LCU)f Real interest rates Consumer price index (% change) GDP deflator (% change)

a. b. c. d. e. f.

GDP at factor cost "GNFS" denotes "goods and nonfactor services." Includes net unrequited transfers excluding official capital grants. Includes use o f IMF resources. Consolidated central government. "LCU" denotes "local currency units." A n increase in US$/LCU denotes appreciation.


Annex B7 Page 1 of 1

-

Bulgaria Key Exposure Indicators

Indicator

2000

Actual 2001 2002

Estimate 2004 2005

2003

Projected 2006 2007

2008

11202

10619

11245

13241

15549

17798

19355

20685

22390

Net disbursements (LJS%m)a

492

123

375

1960

2361

79

1495

1912

2005

Total debt service (TDS)

990

1306

1121

1248

2498

5301

1826

2038

1893

Total debt outstanding and disbursed (TDO) (US$m)'

(US$mY Debt and debt service indicators

(%I

153.0

139.9

134.2

112.9

102.0

99.7

88.9

85.9

85.2

TDO/GDP

88.9

78.1

72.2

66.4

64.4

67.4

67.8

66.4

66.3

TDSKGS

13.5

17.2

13.4

10.6

16.4

29.7

8.4

8.5

7.2

3.2

3.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

8.4

6.8

8.5

11.2

7.6

5.8

27.6

14.7

26.9

40.2

50.8

51.3

51.7

25.9

26.9

76.3

44.8

54.2

TDOKGS~

ConcessionaVTDO IBRD exposure indicators (%) IBRD DS/public DS Preferred creditor DS/public DS (%)' IBRD DSKGS

IBRD TDO (us$mld

1.o 824

1.1 844

0.9

0.8

0.8

0.9

1.8

0.7

0.7

958

1266

1498

1437

1342

1495

1711

O f which present value of guarantees (US$m) Share of IBRD portfolio (%)

1

1

1

1

1

1

1

1

2

IDA TDO (us$mld

0

0

0

0

0

0

0

0

0

IFC (US$m) Loans Equity and quasi-equity /c MIGA MIGA guarantees (US$m)

a. Includes public and publicly guaranteed debt, private nonguaranteed, use o f IMF credits and net shortterm 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 o f guarantees. e. Includes equity and quasi-equity types of both loan and equity instruments.


Annex 88 Page 2 of 2

Statement o f IFC’s Committed and Outstanding Portfolio

BULGARIA

As of March 3 1,2006 Institution

Approval Fiscal Year

Short Name

1999102 2001 2004 2001 2006 1994 20001 01 2002 03/04/2001 2004 1997 2004 20041 2005 20021 2005 2005

BAC Bank Bulbank Drujba A.D. EPlQ EPlQ NV Euromerchant FND Kronospan Group PFS Restr Procredit Bulg Schwarz Group Sofia Hilton Stomana Trakya Bulgaria Unionbank AD Melrose Facility

Total

LN

ET

QL+QE

CmtdIFC

CmtdIFC

CmtdIFC

All

Amounts in US Dollar Million LN ET QL+QE All

Cmtd- Out Bal- Out-IFC Out-IFC Part IFC

0 0 0

0 0 0 0 6.01 0 0 12.36 0 0 2.6 0 0 0 0

0 0 0 0 0 0 8.52 0 0 0 1.72 0 56.8 0 0

21.13

20.97

67.04

0 0 7.5 0 0

0 0 0 0 6.01 0 0 17.74 0 0 2.6 0 0 0 0

0 0 0 0 0 0 8.52 0 0 0 1.72 0 64.69 0 0

0 0 21.63 4.53 6.01 0 18.63 0 12.01 48.06 7.75 20.91 29.54 5.58 10

0 17.47 0 0 0 1.64 0 2.01 0 0 0 0

28.63

26.35

74.93

184.63

5 0 21.63 4.53 18.02 0 18.63 0 12.01 48.06 7.75 20.91 34.81 10.38 10

0 17.47 0 0 0 1.65 0 2.01 0 0

211.72

OutPart


Annex C Page 1 o f 46

BULGARIA CAS COMPLETION REPORT

Date of CAS: May 3 1,2002 Date of CAS Progress Report: NA Period Covered by CAS Completion Report: FY03-FY05 CAS Completion Report prepared by: Myla Taylor Williams, Country Program Coordinator Date of CAS Completion Report: April 24,2006


Annex C Page 2 o f 46 Bulgaria Timeline: Key Events Related to FYO3-NO5 CAS Implementation

Feb. 2000 Early 200 I June 2001 Feb. 2002 May 2002 June 2002 Oct. 2002 Nov. 2002 Dec. 2002 Feb. 2003 May 2003 June 2003 July 2003 Nov. 2003 Dec. 2003 Mar. 2004 May 2004 June 2004

July 2004 Aug. 2004 Sept. 2004 Oct. 2004

Dec. 2004 Feb. 2005 Mar. 2005 Apr. 2005 May 2005 June 2005 Aug. 2005 Sept. 2005 Oct. 2005 Nov. 2005

Accession negotiations opened Consultations on draft CAS Parliamentary elections; NMSS-led coalition formed SBA launched CAS finalized Board discussion o f FY03-FY05 CAS EU Regular Report declares Bulgaria a functioning market economy and confirms negotiations on 22 EU ucguis communuutuire chapters provisionally closed; Public Expenditure and Institutional Review disseminated Socialist candidate wins presidential run-off election Board approves Social Investment and Employment Promotion loan Board approves PAL I EU sets tentative accession date o f Jan. 1,2007 Board approves District Heating and Revenue Administration Reform loans Cabinet reshuffling EU Regular Report confirms negotiations on 26 ucquis chapters provisionally closed Government attributes poor IBRD portfolio performance to Bank procedures SBA completed; Bulgaria joins NATO; lSt phase Education APL cancelled EU8 accede to EU Board approves P A L 11; negotiations on all 3 1 ucquis chapters provisionally closed; S&P upgrades Bulgaria’s long-term foreign and local currency debt from speculative to investment grade; Council on Economic Policy excludes two IBRD investment loans under preparation from i t s list o f projects recommended to Council o f Ministers for financing by state borrowing Council o f Ministers excludes two IBRD investment loans under preparation from projects to be financed by state borrowing New SBA launched; Fitch upgrades Bulgaria’s long-term foreign and local currency debt from speculative to investment grade; high-level “Plovdiv Meeting” to define strategic directions for future Bank engagement Limited Portfolio Review by ECA Quality Unit consultant EU Regular Report confirms negotiations on 3 1 ucguis chapters provisionally closed Accession negotiations closed Prime Minister survives no-confidence vote PAL I1second tranche cancelled EU Accession Treaty signed Forestry loan dropped Board approves P A L I11 Board; Parliamentary elections; improved portfolio performance by end-FYO5 New government formed Draft Country Economic Memorandum and CPS discussion paper shared with government EU Comprehensive Monitoring Report warns o f possible one-year postponement o f accession High-level CPS workshop


Annex C Page 3 of 46 I.INTRODUCTION 1. The last Country Assistance Strategy (CAS) for Bulgaria was discussed by the World Bank’s Executive Directors in June 2002 and covered the period FYO3-FYO5. This CAS Completion Report evaluates the effectiveness of the Bank’s program in achieving its expected results as set out in the CAS and as further elaborated in the performance benchmark matrices of the series of three Programmatic Adjustment Loans which formed the core of the CAS program. The CAS Completion Report also identifies lessons learned, with implications for the forthcoming Country Partnership Strategy covering the period FY06-FY09. 2. This CAS Completion Report i s based on a review of the CAS, other documentation, and interviews. The documentation includes assessments of implementation of the CAS lending and non-lending programs, Joint Portfolio Review reports prepared during the CAS period, reports prepared by the Bank’s Quality Assurance Group and Operations Evaluation Department, and results from a World Bank Client Survey conducted in Bulgaria in May-June 2005. The last Country Assistance Evaluation covered 1991-2000, prior to the FY03-FY05 CAS. Interviews were held with government counterparts, other stakeholders, partners, and members of the Bank’s Bulgaria Country Team during the CAS implementation period. The discussion of progress toward country goals and CAS outcomes reflects the findings of the Bank’s recently completed Country Economic Memorandum, Public Finance Policy Review, and Education and Health Policy Notes, as well as the preliminary findings of the PAL I11ImplementationCompletion Report (ICR) team. A.

Political and EU Accession Context

3. Parliamentary elections in June 2001 resulted in the replacement of the UDF-led coalition with a new government coalition led by the National Movement of Simeon the Second (NMSS), and headed by Prime Minister and former King Simeon the Second SaxeCoburg Gotha. In addition to the N M S S , the coalition included the Turkish minority-based Movement for Rights and Freedom (MRF). With unmet promises of improved prosperity leading to voter dissatisfaction and skepticism, the socialist candidate, Georgi Parvanov, won the presidential run-off election in November 2002. In response to declining public support for the ruling coalition, there was a reshuffle in July 2003 at the Ministerial and Deputy Prime Ministerial level that resulted in changes in a number of the Bank’s key counterparts. Surviving a noconfidence vote held in February 2005, this political leadership remained in place for the duration of the CAS period. 4. When the FYO3-FYO5 CAS was prepared in 2002, EU accession enjoyed broad popular support in Bulgaria and was a central theme of the Government’s agenda. Accession negotiations had been under way since February 2000, as with Romania, Lithuania, Latvia, the Slovak Republic, and Malta.’ B.

Alignment of CAS and PAL Program with Country Goal

5. Soon after taking office in mid-2001, the coalition government issued its Executive Program of the Republic o f Bulgaria which set out a longer term strategic goal that remained in place for the duration of the CAS period: to move Bulgaria closer to EU accession by (i) sustaining economic growth through creation of an investment climate that promotes private

Six other EU candidate countries - the Czech Republic, Cyprus, Poland, Hungary, Slovenia and Estonia had begun accession negotiations in March 1998.


Annex C Page 4 o f 46 sector investment, restructuring, and productivity; and (ii) reducing poverty and creating employment through empowerment o f the population, especially the poor, to participate in economic growth.

6. This strategic goal for Bulgaria was very closely aligned with the CAS’s stated objectives and outcomes o f the CAS and its core instrument, a series of three Programmatic Adjustment Loans (PALs). (See Table 1.) The CAS’S stated overarching objectives were to: (i) reduce poverty and raise living standards; and (ii) support Bulgaria’s move towards EU accession. And the CAS’s stated outcomes were: (i) per capita national income growth; (ii)reduced poverty rate; (iii)reduced long-term unemployment; and (iv) reduced total unemployment. The Bank’s PALs, investment lending, and analytical and advisory ( A M ) work in support o f the CAS objectives and outcomes were organized around three themes consistent with Bulgaria’s longer term strategic goal:

(i) (ii) (iii)

promoting competitive private sector-led growth; strengtheningpublic administration and anti-corruption initiatives; and investing in human capital and strengthening social protection.

Table 1: Strategic Alignment of CAS and PALs with Country Goal

Government’s Long-Term Strategic Goal To move Bulgaria closer to EU accession by:

(i) Sustaining economic growth through creation o f an investment climate that promotes private sector investment, restructuring, and productivity (ii) Reducing poverty and creating employment through empowerment o f the population, especially the poor, to participate in economic growth

CAS Objectives

I

1

To support Bulgaria’s move towards EU accession To raise living standards

To reduce poverty

CAS Desired Outcomes

CAS and PAL Themes“

P A L Desired Outcomes

(i) Per capita national income growth

(i)Promoting competitive private sector-led growth; (ii) Strengthening public administration and anti-corruption initiatives

(i) Average annual GDP growth rates of 4.5 to 5.0 percent during 2002-2005

(i) Reduced poverty rate; (iii)Reducedtotal unemployment rate; (iv) Reduced longterm unemployment rate

(iii) Investing in human capital and strengthening social protection

(ii) Reduction of the poverty rate by 50 percent by 2005 compared to the rate in 200 1; (iii)Reduction o f the unemployment rate to 12 to 14 percent in 2005 compared to 17.5 percent in 200 1.

I

‘Reflects retrofittingo f third CAS theme a aggregation of first close alignment between CAS and PAL programs and design.

ree PAL themes (pi1 rs), to highlight


Annex C Page 5 o f 46

7. The series of three PALSwas designed to support the Government’s reform program aimed at the achievement of the following three outcomes aligned with the three CAS outcomes: average annual GDP growth rates o f 4.5 to 5.0 percent during 2002-2005; reduction o f the poverty rate by 50 percent by 2005 compared to the rate in 2001; and (iii) reduction o f the unemployment rate to 12 to 14 percent in 2005 compared to 17.5 percent in 2001.

(i) (ii)

8. Underpinning these outcomes was a multitude of outcomes specific to each of the five pillars under the PAL program and spanning the Government’s four-year time horizon. These outcomes were articulated in the Program Document and the Government’s Letter o f Development Policy for PAL I,and carried through the two subsequent PALS with some adjustments as the program proceeded.

11.

PROGRESS TOWARD COUNTRY GOAL AND CAS OUTCOMES

9. I n October 2002 (four months after the CAS was finalized), the European Commission (EC) concluded that Bulgaria had a functioning market economy but separated Bulgaria and Romania from the other ten candidate countries by putting them on a slower, unspecified timetable for accession. This contributed to a greater sense o f urgency for the Bulgarian Government to meet EU accession requirements, and served as an incentive for the Government to accelerate its pace o f implementing structural reforms and institutional capacity building. The Government’s goal of moving Bulgaria closer to EU accession by the time o f the 10. national elections in June 2005 was achieved. In May 2003 the EU set a tentative accession date o f January 2007 for Bulgaria and Romania. By mid-2004 Bulgaria had provisionally closed negotiations an the 3 1 chapters o f the EU acquis communautaire. In April 2005, as the CAS period was drawing to a close, Bulgaria signed the EU Accession Treaty. Notwithstanding this important milestone, more progress was still needed on a 11. number of fronts, such that in October 2005 the EU’s Comprehensive Monitoring Report concluded that accession might be postponed by one year. The shaded areas in Table 2 indicate those aspects o f the EU’s political and economic criteria, relevant to the CAS, that were cited in the EU’s annual reports as needing accelerated progress prior to accession. The reports also evaluated progress in areas covered by the acquis. Although Bulgaria had succeeded in closing negotiations on all 31 acquis chapters in June 2004, the EU’s October 2005 report flagged areas o f “serious concern” in need o f further progress prior to accession (e.g., EU funds absorption, anti-corruption initiatives, food safety). The report also noted that “Little progress has been made in improving labor market flexibility, which, together with a comprehensive reform o f the education system, would be crucial for dealing with skills mismatches and improving the adaptability o f the Bulgarian economy.”


Annex C Page 6 o f 46 Table 2: Areas o f Concern Flagged in EU Reports

I Political and economic criteria relevant I 2002 Regular I

2003 Regular

I 2004 Regular I

2005 Comprehensive

Judicial reform Bankruntcv Drocedures

Includingdecentralizationand EU funds absorption. Key: Shading indicates those areas cited in EU Reports as needing more progress.

a/

A.

Sustaining Economic Growth

12. During the CAS period, Bulgaria performed well against i t s objective of sustained economic growth. (See Table 3 and Figure 1.) When the CAS was designed, Bulgaria’s economy was performing reasonably well. Sound policies had maintained macroeconomic stability. Following Bulgaria’s economic and financial crisis in 1996-1997, a Currency Board Arrangement (CBA) was put in place, and the Central Bank could no longer exercise monetary or exchange rate policy. Macroeconomic adjustment could be achieved only through strict discipline in fiscal and incomes policy. By 2001 this cautious fiscal management had brought the external debt to GDP ratio down to 79 percent from 100 percent in 1997. But growth had slowed (from 5.4 percent in 2000 to 4.1 percent in 200 l ) , per capita income was about 28 percent o f the EU-25 average, and the current account deficit remained large, at 7.3 percent o f GDP in 2001. 13. During the CAS period, strict fiscal discipline induced by the CBA strengthened Bulgaria’s financial position. The fiscal deficit was maintained at 0.6 percent o f GDP in 2002 and was eliminated altogether in 2003, The fiscal balance was in surplus (1.7 percent of GDP) in 2004 and was estimated at 2.3 percent in 2005. This fiscal adjustment has been accompanied by reductions in tax rates and significant reductions in public debt. Bulgaria reached the Maastricht Treaty target o f a public debt to GDP ratio o f less than 60 percent in 2002, and the ratio estimated for 2005 i s 32.4 percent, less than half o f the 2001 ratio o f 69.9 percent. This stabilization contributed to lower inflation during the first several years o f the CAS period, averaging 4.1 percent during 2002-2003, down from 7.4 percent in 200 1.

I


Annex C

Page 7 o f 46

Table 3: Private Sector-Led Growth Indicators

Indicators:

2001

2002

2003

2004

Cuirent account balance to GDP (%) Public debt to GDP (%) Private sector to GDP

-7.3

-5.6

-9.2

69.9 70.0

56.2 70.0

5.9 20.1 6.0 9.4

(%)b’

FDI to GDP (Yo) Domestic investment growth (%) Export growth (fob, %)” Productivity (GDP per employee)

Estimated

Estimated Average

2005

2002-2005

-5.8

-1 1.8

-8.1

47.8 75.0

40.9 75.0

32.4 75.0

44.3 73.8

5.8 4.4

10.3 18.2

9.2 14.8

8.6 21.2

8.5 14.7

11.3 9.8

32.5 9.6

30.6 9.9

19.2 10.3

23.4 9.9

14. Bulgaria’s strengthened financial position has helped to stimulate accelerated economic growth. Bulgaria’s GDP growth rate has increased from i t s 2001 level o f 4.1 percent to an estimated 5.5 percent in 2005, with an estimated 2002-2005 annual average o f 5.2 percent. With annual growth rates exceeding the average o f the EU-25, Bulgaria’s per capita income has grown from about 28 percent o f the EU-25 average in 2001 to an estimated 3 1 percent in 2005. Per capita income (at purchasing power parity) has increased from US$6,483 in 2001 to US$8,007 in 2004, at an average rate o f 5.5 percent in real terms.

15. The private sector has led Bulgaria’s growth. It accounted for an estimated 75 percent o f GDP in 2005 compared with 70 percent in 20012, about the same as the average o f the EU New Member States (NMS), 75.6 percent. Private sector growth has been stimulated largely by private consumption, which has accounted for more than two-thirds o f GDP during the CAS period. By contrast, investment accounted for only about 20 percent of GDP, with domestic investment growth slowing by half during the CAS period. While consumption levels are high, savings rates are low relative to those o f CEEC3, in part due to per capita income differentials.

EBRD staff estimates published in the 2005 Transition Report. Central and Eastern European Countries (CEEC) are defined here to include Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia.


Annex C Page 8 o f 46

Figure 1: Bulgaria’s Stability and Growth CPI Inflation (% change, annual average)

Fiscal Balance (% o f GDP) 4

-1 -6 -11

-16 -21

110 100 120

External Debt and Debt Service (% o f GDP)

80 70 60 50

30

-- 20 -- 15 -- 10

90

-- 5

-

30 1

-- 25

Investment -10

25

-20 -30 a,

n 20

;

P

0

-403

5 15

-505 -60

10

-70

5

-80

-External Debt --S-External Debt Service (RHS) GDI % of GDP -GDFI

Current Account Deficit and net FDI (% o f GDP) 24 20 16 12 8 4 0 -4 -8 -12 -16

Source: World Bank staff estimates based on data from

3

(1989=1)

Real GDP (% change)

31, BNB, MOF (GFSZOOI),and NEA.

12 8 54 0 -4 -8


Annex C Page 9 of 46

16. Heavier consumer spending, higher international oil prices, and higher food prices following heavy floods in the spring of 2005 exerted inflationary pressure in the latter part of the CAS period. Inflation i s estimated to have increased to an average of 5.6 percent during 20042005 from 2.3 percent in 2003. 17. Foreign direct investment (FDI) flows have grown substantially during the CAS period, from 5.9 percent of GDP in 2001 to an estimated average of 8.5 percent during 20022005, in response to improved macroeconomic stability resulting from implementation of structural reforms. Cumulative FDI per capita has surpassed the US$500 mark and i s approaching the critical mass needed to help improve Bulgaria’s ability to compete in external markets. However, this i s s t i l l well below cumulative FDI per capita levels o f strong trade performers among the N M S - about US$3,700 in Hungary and nearly US$3,800 in the Czech Republic. 18. This gap vis-a-vis some N M S reflects the heavy concentration o f Bulgaria’s FDI in domestically oriented activities, due not only to the attractiveness to foreign investors of sectors that serve primarily the domestic market, but also to impediments to export-oriented investment. Such impediments include inadequate basic infrastructure, complex regulatory frameworks, and an institutional framework that i s not sufficiently reliable or rules-based. The costs of these inefficiencies in Bulgaria’s economy can be transferred to domestic consumers via higher prices, but not to consumers in external markets where there i s stronger competition. This phenomenon, combined with a growing share of the population in agriculture (25 percent in 2004) despite the sector’s declining share of GDP (1 1 percent in 2004), are reflected in Bulgaria’s flat productivity levels during the CAS period. 19. Bulgaria’s continued inefficiencies are reflected in not only its investment and productivity levels but also its current account balance during the CAS period. Through fiscal tightening the Government was able to bring the external current account deficit down from 7.3 percent in 2001 to 5.6 percent in 2002. But it widened in 2003 to 9.2 percent, due to a large interest rate differential with Western Europe and the resulting growth in credit. Fiscal tightening and measures to reduce growth in credit brought the external current account deficit down to 5.8 percent in 2004, but higher prices and volume of oil imports, together with the impact o f the floods, pushed it up to an estimated 11.8 percent of GDP in 2005. Bulgaria’s large FDI flows have been financing the current account deficit, and this i s projected to continue. These large external imbalances make Bulgaria vulnerable to external shocks and adjustments. Hence the current account deficit i s a serious concern and poses a considerable macroeconomicrisk.

B.

ReducingPoverty and Creating Employment Through Empowerment

20. Bulgaria’s sustained economic growth has in turn led to a significant drop in unemployment. According to the Employment Agency data (the basis for the Government’s reform program targets referenced in para. 7 above), the unemployment rate fell from 17.5 percent in 2001 to around 11 percent in 2005. Labor Force Survey data (used in Table 4 because annual figures are available) indicate somewhat lower unemployment rates for the same period, but they also show a significant decline in unemployment, The Government’s active labor market programs have also had an impact. 2 1.

Progress in lowering the share o f long-term unemployment and increasingthe labor force participation rate has been disappointing, however. (See Table 4.) Bulgaria’s labor force participationrate i s one o f the lowest in the region. This may partly reflect Bulgaria’s labor market

policy, which mandates large benefits (e.g., seniority premiums, regardless of relevance of skills to current job) for those with long-term, full-time employment contracts and does not allow for


Annex C Page 10 of 46 flexible hiring through the use o f temporary or part-time contracts. In addition, Bulgaria’s highly fragmented social assistance system o f more than 34 programs i s largely ineffective at alleviating p ~ v e r t y .Instead, ~ poverty alleviation in Bulgaria i s heavily dependent on pensions, which are not means-tested and therefore not an efficient or effective instrument for poverty a l l e ~ i a t i o n . ~

Table 4: Employment Indicators

Sources: Bulgaria Labor Force Survey, N S I ‘EmployedPopulation aged 15+ b’Unemployed looking for a job/(Employed + Unemployed looking for a job) “(Employed + Unemployed looking for a job)Population aged 15+ ‘Unemployed looking for a job for more than one year/Unemployed looking for a job

The lack o f comparable and timely data on poverty reduction makes it difficult to 22. assess progress against the poverty reduction outcome of the CAS. The Bank conducted a Poverty Assessment Update in 2002 based on 2001 data, which formed the Bank’s baseline for the CAS period. An JDF grant approved during the previous CAS period aimed to build the Government’s capacity in poverty monitoring. In late 2003 the Government conducted a survey using a methodology more aligned with that used by the EU’s EUROSTAT, and not comparable to the Bank’s 2002 Poverty Assessment Update. The Government’s next planned survey (2006), a Survey o f Incomes and Living Conditions, w i l l also lack comparability for methodological reasons. (EUROSTAT measures poverty in terms o f income, while the Bank does so in terms o f consumption.)

23. As a proxy for assessing progress against the CAS outcome o f poverty reduction, Bank staff simulated a poverty headcount index, with the 2001 poverty rate o f 12.8 percent shown in the CAS as a baseline. With average household consumption data available for all relevant years, the concept o f elasticity was used for poverty approximation. The degree to which poverty responds to growth i s captured in the notion o f rowth elasticity o f poverty which measures the change in poverty for a given change in growth. Given the experience with poverty and growth linkages in neighboring countries, there i s a strong possibility that Bulgaria’s growth elasticity o f poverty i s greater than 1.5.7 Therefore, although direct measurement o f poverty in 2005 i s not possible due to lack o f comparable data, it i s highly likely that the CAS outcome o f poverty reduction was achieved, with a reduction in the poverty headcount index by at least one-

F

Cornelia Tesliuc, Social Protectionand Poverty Reduction in Bulgaria- an Update, 2004 mimeo. World Bank, Bulgaria Country Economic Memorandum, 2005. 6 In general the growth elasticity of poverty would be negative, as growth and poverty tend to move in opposite directions. For example, if poverty elasticity o f growth i s 2, then a 1 percent increase in growth will lead to 2 percent reduction in poverty. During 1998-2003, according to the ECA Regional flagship report, “Growth, Poverty, and Inequality in ECA” (2005), average growth elasticity ofpoverty for South Eastern Europe (SEE) was estimated at 2.5. Assuming the SEE countries (including Romania and Serbia) are good proxy for Bulgaria with regard to poverty and growth linkages, it i s reasonable to expect that growth elasticity of poverty in Bulgaria would be at least 1.5.


Annex C Page 11 o f 4 6 half, to 6.4 percent living below the poverty line. (See Table 5.) A model based on growth elasticity o f poverty assumes that the degree o f inequality remains constant, independent o f growth. With total and long-term unemployment not increasing, and the labor force participation rate not decreasing (in fact, they are doing the opposite), it i s reasonable to assume that inequality i s not increasing, which lends further confidence in the elasticity model as a proxy for determining the poverty headcount index.8

Table 5: Poverty HeadcountIndex Simulation

Growth elasticity o f poverty = 1.O Growth elasticitv o f ~ o v e r t v= 1.5 Growth elasticity o f poverty = 2.0 Growth elasticity o f poverty = 2.5 Growth elasticity o f poverty = 3.0

I

10.0 9.1 8. I 7.2

I

10.0 8.7 7.5 6.4 5.4

I 1

8.9 7.2 5.8 4.6 3.5

I I

8.2 6.4 4.9 3.7 2.7

Projectedbased on the first 10 months data.

24.

While the Government's active labor market programs had a positive (albeit likely unsustainable) effect on employment creation, data trends indicate that Bulgaria's progress toward facilitation of broader participation in economic growth by improving the education system fell short of expectations during the CAS period. Recent trends in quality indicators show some deterioration, despite increased public spending per studentg The Trends in International Mathematics and Sciences Study (TIMSS) shows a decline between 1995 and 2003 in mathematics performance by Bulgarian eighth graders, in absolute terms as w e l l as relative t o the NMS. (See Figure 2.) Data also indicate that ethnic minority children, especially Roma, are overrepresented in schools o f lower quality due t o discrimination or geographic separation." There were positive trends, however, with respect to access during the CAS period. (See B o x 1.) Net enrollment rates in primary school education are impressive, having increased from 96 percent to near 100 percent. This increase was accompanied by a dramatic reduction in the primary school enrollment gap between rich and poor." Secondary net enrollment rates increased as well, but they s t i l l lag behind primary enrollment rates, especially at the upper level (grades 9-12 are at 77 percent). About 20 percent o f Bulgaria's 18-24 year-olds do not have more than a lower secondary (eighth grade) education. (See Table 6.) Particularly worrisome i s the stagnating f l o w o f students into Bulgaria's tertiary system at about 40 percent, l o w relative to the NMS, and with continued

8

In Bulgaria many young people are delaying having children and working, and are residing longer with their employed or pensioner parents. With improved targeting o f social assistance, it i s even less probable that Bulgarians fitting this profile would be below the poverty line. As in Hungary, it i s possible to have low foverty rate as well as labor force participation rate in Bulgaria. World Bank, Bulgaria Public Finance Policy Review: Leveraging EU Funds for Productivity and Growth, 2006. loWorld Bank, Bulgaria Education Policy Note, 2005. " World Bank, Growth, Poverty and Inequality in Eastern Europe and Former Soviet Union, 2004.


Annex C Page 12 o f 46 very low tertiary age enrollment among the poor (6 percent).12 If l e f t unaddressed, these trends do not augur well for the competitiveness o f Bulgaria’s labor force or for broader participation in Bulgaria’s future economic growth. 25. A review of selected health indicatorsshows a significant increase in the utilization of health care services when sick and a slow but steady improvement in both male and female life expectancy as well as the infant mortality rate during the CAS period, in line with the Government’s objective of broadened participation in Bulgaria’s economic growth. Health care utilization increased from 62 percent to 83 percent between 2001 and 2003.13 Female and male l i f e expectancy increased, respectively, from 74.6 and 67.6 years in 2000 to 75.4 and 68.4 years in 2004 (e~tirnate).’~Over the same period infant mortality steadily improved. (See Box 1.) Figure 2: Mathematics performance of Bulgarian eighth graders fell from above to below the N M S average 1995 D2003 -NMS (1995) ---NMS (2003)

560 540

520 500 480

460 440 420

m

‘5M

-a

m

I

Selected new member states

Source: World Bank, Bulgaria Education Policy Note, 2005 (based on data from TIMSS; NMS average computed only for countries that participated in both years).

Table 6: Net EnrollmentRates in the Educational System by Age Groups

98.4

101.2

102.3

102.2

101.6

Source: World Bank, Bulgaria Education Policy Note, 2005 (based on data from National Statistics

Institute),

Note: Net enrollment rates can exceed 100 percent due to incomplete age cohort data.

World Bank, Bulgaria Education Policy Note, 2005. Bank, Growth, Poverty and Inequality in Eastern Europe and Former Soviet Union, 2004. l4World Bank, Bulgaria Health Policy Note, 2005. I3World


Annex C Page 13 o f 46

26. On the other hand, a recent government study15 documents a rise in noncommunicable disease due to unhealthy lifestyles and a healthcare system with insufficient access to preventive and curative healthcare services. A household survey conducted in 2002 indicated that l o w income groups (especially Roma) cannot afford access to healthcare services, and estimated that about 12 percent o f households make informal or unregulated payments to providers. l6 .__ __

_______~_-_

Box 1: Bulgaria's Progress Toward the MDGs During CAS Implementation

Government Objectives

Eradicate extreme poverty percent o f population below US$2. I 5 per day percent o f population below US$2.76 per daya/ Achieve universal education percent net enrollment rate primary school percent net enrollment rate lower secondary school percent net enrollment rate secondary school Improve maternal health Maternal mortality ratio per 100,000 live births Combat HIPVAIDS, malaria and other diseases Tuberculosis incidence (new cases per 100,000) Polio immunization rate (percent o f children under two

-

-

_~

Baseline Data

Update on Status

2005 Target

2015 Target

7.9 (2001)

n.a.

3.2

1.5

12.8 (2001)

6.4 (2005)

98.5 (2001-02)

99.7 (2004-05)

97-98

100

83.1(2001-02)

84.2 (2004-05)

86-90

100

68.3 (2001-02)

77.3 (2004-05)

73-75

90

19.1 (2001)

10.02 (2004)

18

16

48 (200 1)

42.4 (2004)

40

26

94.4 (2000)

94.1 (2004)

98

100

Reduce infant mortality Infant mortality rate per 1000 14.4 (2001) 1 1.6 (2004) 13 live births Ensure environmental sustainability GDP per unit o f energy use 568 (1997) n.a. 653 (PPP US$ per kg o f oil equivalent) Due to lack o f data, figure for 2005 is based on assumed growth elasticity of poverty o f 1.5. See para. 23 and Table 5. Smrces: National Statistical Institute and World Bank; UNICEF. . __ -

'

I

9

75 1

__

"-.

III. CAS PROGRAM DESIGN A.

Instrument M i x and Linkages to CAS Outcomes

27. The CAS program was designed around two lending scenarios, a base (most likely) case and a low case, with 14 triggers to be met for Bulgaria to remain in the base case. These triggers focused on five areas o f performance:

l5Bulgaria Ministry o f Health, Report on the Health o f the Nation in the Dawn o f the 21" Century, August 2004. l6World Bank, Bulgaria Health Policy Note, 2005.

__


Annex C Page 14 o f 46 a satisfactory macroeconomic framework portfolio - a disbursement ratio o f not less than 20 percent and satisfactory performance ratings o f not less than 80 percent o f Bank-financed projects structural reforms and private sector development - satisfactory progress against specific benchmarks for privatizations, railways restructuring, and approvals o f company registration and construction permits; establishment o f a Unified Revenue Information System; completion o f hnctional reviews for civil servants in two ministries; and amendment o f the bankruptcy law social sustainability - satisfactory progress in several aspects o f pension reform and implementation o f winter energy subsidy programs fiduciary capacity building - completion o f the CFAA in FY03 and satisfactory progress in implementing the action plan set out in the FYOO CPAR.

28. The centerpiece o f the CAS base case program was a series of three Programmatic Adjustment Loans (PALs) totaling US$450 million equivalent, designed to support Bulgaria’s structural reform agenda and path to EU accession. The PALs supported the Government’s comprehensive program, organized around five complementary and mutually reinforcing pillars, each o f which was to contribute to achievement o f the country goal and the three CAS outcomes: sustaining structural reforms in the enterprise sector, with emphasis on restructuring o f the infrastructure sectors (energy, railway, telecommunications, and water); establishing a market-Ji.iendly business environment by focusing on entry and exit poIicies, regulatory costs, delivery o f public services, competition, and judicial reform; deepening thefinancial system by addressing the constraints to increased lending by the banking system and the development o f financial markets; improving public sector governance by implementing the anti-corruption strategy, strengthening local governments, and reforming public administration and thejudiciary; and investing in human capital and strengthening social protection by reforming the education, health, and pension systems and improving social assistance effectiveness.

29. I n addition to the base case triggers, the CAS spelled out several negative macroeconomic and structural developments that would trigger reconsideration of proceeding with PAL III.” There were also from nine to twelve triggers specific to each o f the

three PALs, reflected in their respective Program Documents.

30. A policy framework of triggers, Board conditions, and benchmarks organized around the five pillars was presented in the context of the first P A L and remained in place throughout the PAL series. As stated in the CAS, within this framework each P A L was to have i t s own strategic focus as well as continue support for policy measures in areas supported under the previous PAL(s). P A L Iwould advance structural, regulatory and institutional reform in the real l7 (i) A material deviation from the downward trend in total public debt to GDP ratios as projected in the CAS; (ii) a lack o f improvement in the spreads on Bulgaria’s sovereign borrowing vis-&vis countries with similar risk rating, or deterioration in its own risk rating; (iii) a material deviation from the improving trend in the fiscal balance projected in the Government’s medium-term program, reaching fiscal balance by 2005; (iv) a material slow-down in the present trend o f increasing SMEs’ share in total employment; and (v) inadequate progress in reducing arrears in tax payments, social insurance contributions, and energy bill payment as set out in the Government program.


Annex C Page 15 of 46 sectors key to reforms, including energy. PAL I1 would focus on reform in areas taking longer to prepare, such as public administration, the legal and judicial system, and anti-corruption measures. And PAL I11 would focus on labor market and social sector policies, including long-term sustainability o f the social protection system and restructuring of the health and education sectors.

3 1. The design of the PAL program was complex and multi-sectoral. Across the three-year program there were 31 triggers, and the number of benchmarks went from 173 in the PAL I Program Document up to 246 in the PAL I1 Program Document, and down slightly to 232 in the PAL I11Program Document.

32. The PAL program was complemented by a pipeline o f seven sector investment loans totaling US$300 million equivalent, balanced across the major sectors: energy, municipal services, education, employment promotion and investment in social capital, tax administration, forestry, and rural finance. These were supplemented by three GEF operations and one PCF instrument. With the social sectors not specifically addressed in the EU acquis communautaire, investment lending in these areas was informed more by the Bank’s global knowledge and its poverty reduction agenda. Ongoing loans in the portfolio also covered a broad range of sectors, including those not addressed by the CAS pipeline, such as health. 33. Adjustment lending accounted for 60 percent of total lending in the CAS program. During CAS discussions the Bulgarian authorities had requested a program consisting of PALs and little to no investment lending. However, Bank management set a ceiling of 60 percent for fastdisbursing loans in light of Bulgaria’s already high level o f indebtedness to the Bank, which would rise even further once the PALs began to disburse. During the CAS period, the ratio of rSRD debt service to public and publicly guaranteed debt service was projected to increase from 8.9 percent in 2002 to 1 1.9 percent and the Bank’s share of total debt disbursed and outstanding was projected to increase from 9.9 percent in 2002 to 11.O-11.8 percent. 34. The centerpiece of the non-lending program in the CAS was to be the Country Economic Memorandum focusing on the policy agenda for Bulgaria’s successful EU integration. This was delayed from FY04 delivery to FY06 (so after CAS period), and while the previous Government was disappointed not to receive it, it was well timed to launch dialogue with the new Government. A Public Expenditure and Institutional Review preceded the CAS period, although it was successfully disseminated in the fall of 2002. (See para. 114.) This was to be followed by a fiduciary report (Country Financial Accountability Assessment), technical assistance in energy and private sector development, and a combination of sector reports (environment, energy, and transport) and policy notes (pension, fiscal decentralization, and agriculture). The third year of the non-lending program (FY0.5) was fairly thin, but it was expected that this would be fleshed out later in the CAS period, once lending priorities for FY06 and beyond were better known. 35. While the CAS program instruments were not specifically designed to help Bulgaria fulfill acquis requirements per se, they were well aligned with the Bank’s institutional priorities and the CAS outcomes, and consistent with the CAS objective o f moving Bulgaria closer to EU accession. Attachment E shows these linkages. It also illustrates the extent to which instruments were concentrated more heavily on the CAS outcome of per capita national income growth, with fewer focused on the CAS outcomes of reduced poverty and unemployment. The Government and the Bank believed that sustained per capita income growth in itself would lead to reduced poverty and unemployment, and so all CAS outcomes would be realized if the CAS program were focused disproportionately on the growth outcome.


Annex C Page 16 o f 46 36. I n the event of an unsatisfactory macroeconomic framework, Bulgaria would be in the low case. The low case CAS program would be limited to investment loans in the areas o f community-based development, rural development, and poverty reduction, and not to exceed US$180 million equivalent during the three-year CAS period. Non-lending services would be limited to analytical work on poverty, social assistance, and energy and environment issues with significant impact on EU accession. The probability o f the low case was considered low in light of Bulgaria’s strong performance and commitment to reform.

B.

Gaps in CAS Program

37.

There were no gaps in the design of the wide-ranging CAS lending program, but the non-lending program proved to be incomplete, with the result that there were gaps in its linkages to the lending program. The number o f non-lending instruments in the program more than doubled relative to what was originally envisioned in the CAS (from 12 to 25). This was partly in response to client demand for advice in additional areas such as public debt and public utility regulatory frameworks, as well as grants to address problems faced by ethnic minorities (the Bank helped launch a multi-country initiative focused on the Roma a year after the CAS was prepared). And it was partly at the Bank’s initiative, to underpin planned and potential lending operations for rural development, roads, and infrastructure financing in the energy and water supply and sanitation sectors. The CAS program should have included a Poverty Assessment in 2005, to gauge progress against the CAS outcome of poverty reduction. (See paras. 22-23.) In hindsight the Bank’s non-lending program should also have addressed the issue o f capacity building for effective absorption o f pre- and post-accession EU grant funds, which would prove to be a critical issue later in the CAS period as well as for the forthcoming FY06-FY09 Country Partnership Strategy. In addition, the design as well as Government ownership of the education and health investment loans already in the portfolio during the CAS period (see paras. 121 and 128) would likely have been strengthened, had there been sector work prior to design o f those operations during the FY99-FYO1 CAS period, to analyze sector issues and recommend policy options. (The 2002 PEIR addressed education and health sector issues, but several years after the education and health investment loans had been designed and approved.)

C.

Monitoring and Evaluation

38. The system for monitoring and evaluation (M&E) progress toward the CAS outcomes was successful because it was embedded in the PAL program negotiated with the Government. The Performance Benchmark matrix for each PAL spelled out measurable benchmarks and the corresponding specific, expected outcomes. Unlike those in a CAS, PAL benchmarks and outcomes are legally negotiated and agreed with the Government, and so are more meaningful. This approach o f detailed, multi-sector benchmarks and outcomes has subsequently been used in the design of PAL programs in Romania and Croatia with good success. Progress toward achievement o f the Bulgaria CAS outcomes i s therefore measured to a good extent within the M&E framework of PALS I- 111. (See Attachment F.) 39. M&E was also successful because it was institutionalizedwithin the Government. The high-level Council for Structural Policy, later called the Council for Economic Policy, coordinated and managed implementation of the reforms supported by the PAL program. The Council was cochaired by the Deputy Prime Minister and Minister for Economy and was supported by an efficient secretariat with access across the Government at the ministerial level. Several other committees were formed to focus on specific components o f reform, and feedback mechanisms were established for tracking progress toward outcomes.


Annex C Page 17 of 46 40. Measurement of performance against one of the PAL program outcomes, poverty reduction, was hindered by the lack of timely poverty data comparable to the 2001 baseline data in the Bank’s 2002 Poverty Assessment Update. Poverty rates for 2003 were measured by the Poverty Monitoring Unit within the Ministry of Labor and Social Policy, using a new multitopic household survey. Capacity building of the Poverty Monitoring Unit was supported by an Institutional Development Fund (IDF) grant.” The 2003 survey results, which the Government chose not to publish for political reasons in the pre-election cycle, were not directly comparable to the Bank’s 2001 data. The Government now plans to conduct a survey in 2006, aligned with EUROSTAT’s income-based methodology. In the future, the Bank will need to conduct its own poverty assessments in view of methodological issues and political factors. IV.

CAS PROGRAM IMPLEMENTATION AND OUTCOMES

41. By the end o f the CAS period, the broad CAS outcomes of per capita national income growth, poverty reduction, and reduced total and long-term unemployment had all been achieved And as quantified in the Government’s program and the corresponding PAL program’s overall outcomes, the specified poverty reduction outcome was likely achieved, and the specified growth and unemployment outcomes were not only achieved but surpassed. (See Tables 3 and 4.) 42. The CAS outcomes are inter-related. Poverty i s reduced as unemployment declines and for both, sustained economic growth i s a strong driver. A Bank instrument aimed at sustained growth therefore has an impact on reduction of poverty and unemployment as well, and a Bank instrument aimed at reduced unemployment has an impact on poverty reduction. Because they are more distinct one from another, and at the same each contribute to the achievement of all three CAS outcomes, the three themes of the CAS and PAL programs - (i)promotion of competitive private sector-led growth, (ii)strengtheningof public administration and anti-corruption initiatives, and (iii)investment in human capital and strengthening social protection - are the framework for the following assessment of the impact of Bank instruments. See Attachment F for detailed assessment of progress against desired PAL program outcomes within this thematic framework. A.

Impact o f Bank Instruments

Theme I : Promoting Competitive Private Sector-Led Growth

43. Complemented by several investment loans and a sector adjustment ioan, the primary vehicle for the Bank’s supporting increased competitiveness and private sector-led growth was the cluster o f the first three pillars of the PAL program: Sustaining Structural . Reform (Pillar I), Establishing a Market-Friendly Business Environment (Pillar 2), and Deepening the Financial System (Pillar 3). Bulgaria’s successful implementation o f reforms in these areas supported by the PAL program contributed to the expansion of the private sector to an estimated 75 percent of GDP in 2005 compared to 70 percent in 2002. As a result, EBRD upgraded Bulgaria’s transition indicators for large-scale privatizations in 2004, infrastructure and banking reform in 2004, and competition policy in 2005. (See Table 7.) This progress i s also reflected in Bulgaria’s FDI inflows over the period, averaging US$1.6 billion a year between 2001 and 2004 (60 percent more than the PAL program’s target) and comparing favorably with those of N M S .

l8

Approved in FY02 in the amount of US$338,000.


Annex C Page 18 o f 46 Table 7: Bulgaria’s Improved EBRD Transition Indicators Enterprises LargeScale

Markets and Trade

Financial Institutions Banking

scale restructuri

ex-change system

interest rate liberalization

I I

Securities market & nonbank financial institutions

I

Infrast ructure Infrast ructure reform

44. The objectives of reforms supported by Pillar 1 were largely met. These objectives were to rationalize the role of the state through privatizations while mitigating associated environmental risks; improve efficiency in the energy, railway, and water sectors; prepare the energy sector for EU accession; and liberalize the telecommunications market. 45. The goal of privatization and restructuring of SOEs was successfully achieved under the PAL program. More than 80 percent o f the remaining SOEs in which the Government had majority control in 2002 were sold or liquidated, and most companies in which the Government had minority shares were also divested. These privatizations contributed to the increase in the private sector’s share o f GDP, from 70 percent to 75 percent during the CAS period. Bulgaria’s performance in large-scale privatization i s now on a par with the best performing transition countries. The main outstanding and unfinished agenda in the PAL program’s large noninfrastructure privatization i s Bulgartabak. As PAL I1was being prepared, it became clear that the privatization of Bulgartabak, originally envisioned as a PAL I1 Board condition, would be delayed due to changing market and domestic political conditions, This privatization was therefore shifted to a second-tranche condition, which made PAL I1 the only multi-tranche operation in the PAL series. In the end, Bulgartabak was not privatized, and the second tranche o f EUR 20 million was cancelled. The significance to the international markets of the Government’s privatizing Bulgartabak diminished over the course of the PAL program, in light o f significant progress in other privatizations as well as political factors affecting this particular sale, widely publicized in the pre-election period. (The Minister o f Agriculture was a member o f MRF, a minority party within the governing coalition, with Bulgaria’s tobacco growers forming part o f the party’s constituency.) As a compensating measure, the privatizationof BTC was added to the PAL 111Board conditions. 46. Bulgaria’s energy intensity (measured in terms of kg oil equivalent per € 2000 PPP) was reduced by 10 percent from 2001 to 2004, and while data are not yet available, a further reduction in 2005 i s likely. Several reform measures supported by the PAL program contributed to this outcome, including: (i)energy prices brought to cost recovery levels; (ii)an improved legal and regulatory framework through enactment o f a new Energy Act consistent with EU energy directives (informed by PPIAF on new gas distribution networks); (iii)upgrading of the institutional capacity of the State Energy Regulatory Commission (SERC); and (iv) spin-off o f electricity distribution and generation companies from the former monopoly electricity company (NEK). The PAL program supported significant private sector entry in the energy sector, through 100 percent privatization of electricity distribution with the sale o f all seven distribution companies and seven (compared to the target o f five) district heating companies. 47. The energy reforms supported by the PAL program were complemented by several investment operations, sector work, and technical assistance during the CAS period. PAL


Annex C Page 19 of 46 benchmarks were informed by the Bank’s Infrastructure and Energy Strategy Review (FY03). The IBRD-financed District Heating project aims to improve the quality of the Sofia and Pernik District Heating Companies’ service provision and financial viability, as well as to increase their energy efficiency and reduce pollution. Results thus far from this project show that more consumers are returning to the district heating services of both companies, financial viability i s increasing which has allowed the phase-out of operating subsidies, and heat consumption per apartment i s decreasing due to tariff increases and demand-side measures supported by the project. The roject builds on the successfully implemented district heating component of an earlier operation,” which financed the procurement and installation of heat meters in buildings in 15 district heating systems. In its Project Performance Assessment Review (PPAR), IEG rated the development impact of this component high in light of achieved pumping cost savings and water loss reduction.

48. Bulgaria i s undertaking a number of Bank-supported initiatives to help reduce the energy intensiveness of its economy and meet its obligations under the UN Framework Convention on Climate Change. A GEF Energy Efficiency Grant (informed by the Bank’s earlier National Energy Efficiency Study) aims to support a large increase in energy efficiency investments for reduced greenhouse gas emissions, through development of self-sustaining, market-based financing mechanism, an energy efficiency revolving fund that reduces investor risk, independent of public subsidies. Implementation i s still at an early stage. Complementing this GEF grant and the District Heating loan are three Prototype Carbon Fund Emission Reduction Purchase Agreements (ERPAs), to help Bulgaria meet i t s obligations under the Kyoto Protocol: one for a wood residue to energy project (for minimum of US$1.75 million) aimed at reducing dependence on imported coal through conversion to stockpiled wood, and two signed with the Sofia and Pernik District Heating Companies (for a total value of close to US3.0 million). These ERPAs were not planned at the time of the CAS. In addition, Bulgaria implemented a small Forestry Fuel Switch Pilot (approximately US$900,000 in Bank-administered PHRD grant funds) to test the installation, operation, and resulting carbon credits o f two fuel-efficient, low-polluting heating systems, switching from fossil to wood fuel in two municipal buildings. The project increased public awareness. As these various initiatives indicate, Bulgaria has been a leader within the region in making use of the Bank’s “green” instruments. PAL restructuring of the railway sector was successful. The Government’s targets for financial sustainability established for end-2005 had been met by end-2004: operating subsidies (excluding funds for investment) fell from 0.5 percent of GDP in 2000 to 0.2 percent; financial 49.

working ratios of the operating and infrastructure companies were close to 100 percent (not including government subsidies); and productivity increased by 12 percent. These outcomes were achieved through actions supported by the PAL program, including the establishment of a new railway operating company and a new railway infrastructure state enterprise, termination of lossmaking passenger services, and reduction of the railway labor force by 13 percent from end-2001 to end-2004.20

50. The telecommunications sector was successfully liberalized. Substantial progress was made toward the PAL benchmarks for increased digitalization of the transfer network, transit exchanges, and fixed subscribers, the target that 94 percent of households with telecom services have internet access was met, and telephone connection waiting time was reduced. These results were achieved through actions to liberalize the sector, consistent with EU requirements and

’’

The Water Companies Restructuring and Modernization loan, to which the district heating component was added when the loan was restructured in 1997 (see para. 51). Aithough less than the 20 percent envisioned at the outset o f the PAL program, as a trigger relating to railway reform was changed from focusing on labor force reduction to include improved financial performance through changes in tariff structure and other structural reforms.

*’


Annex C Page 20 of 46 supported by the PAL program, including establishment of the Communications Regulation Commission, enactment o f a new Telecommunications Law consistent with best practice and EU requirements, and privatization of BTC and elimination of its monopoly. The Bank’s technical assistance for telecommunications regulator capacity enhancement, together with a PHRD-funded assessment of Bulgaria’s telecommunications market and policy, helped to inform the sector reform agenda.

5 1. Efforts under the PAL program to modernize the water sector were less successful, in part owing to challenges in coordinating private sector entry with the flow o f EU grant funds to utilities which have concessions or management contracts. While the reduction in the water companies’ operating ratio did not likely meet the PAL program benchmark of 86 percent by end2005, it did decline to 88 percent in 2004 from 90 percent in 2002. Under the PAL program, the Government adopted a new Water Sector Strategy emphasizing public-private partnerships for the provision o f adequate water service for all citizens, wastewater treatment in line with EU directives, and rehabilitation and construction of water and sewerage networks. A new Water Regulatory Law was enacted in January 2005, supported by technical assistance from the PPIAF. PAL benchmarks in the area of water sector reform were informed by two pieces o f analytical work in FY04 (Financing the Water and Wastewater Sector and Environmental Sequencing Strategies for EU Accession) and preceded by the Bank’s Water Companies Restructuring and Modernization loan from an earlier CAS and which closed in December 2002. The loan financed primarily (i)water and sewerage investments aimed at improving water quality in urban areas, operating efficiency and cost recovery, and transparency in procurement; and (ii)institutional strengthening of Regional Water Companies (RWCs). The original project objectives were only partially achieved in terms o f scale, because nearly half of the US$98 million loan amount was cancelled due to Bulgaria’s financial crisis in 1996-1997, which reduced the RWCs’ willingness to take on sub-loans. 52. With respect to environmental mitigation, the Government has been implementing provisions of the EU Integrated Pollution Prevention and Control (IPPC) Directive and extending issuance of integrated permits. A new Environmental Protection Act, harmonized with EU requirements, was adopted. By end-2004, the Government had issued only 7 integrated environmental permits under the IPPC directive, against the program’s goal o f approximately 225 to cover all enterprises under the IPPC directive by end-2007. With applications pending for 90 more, the Government needs to move more swiftly if it i s to meet i t s end-2007 goal. Given i t s good track record in addressing privatization-related environmental issues, there i s a good chance the Government will be able to meet its goal.

53. Two environmental mitigation loans from the previous CAS program, aimed at promoting growth, were in the portfolio six to twelve months into this CAS period before they closed. The Environmental Remediation Pilot financed successful clean-up o f an environmentally hazardous industrial site, MDK Copper Smelter. Discharge of heavy metals and other pollutants was reduced, and a monitoring system was installed. The project has served as a model for addressing past environmental damage and liability in the context of privatization and laid the groundwork for the Environment and Privatization Support Loan (EPSAL). Under the EPSAL the Government established norms, good by regional standards, for dealing with environmental liability ensuing from privatizations. The privatization law was amended to clarify state liability for environmental damages. The loan supported the establishment of a framework for integrating environmental liabiliaties into privatization of three industrial SOEs. The Government subsequently applied this framework to complete the privatization of ten additional industrial SOEs. In addition, there was substantial progress in harmonizing with EU environmental requirements, An ongoing GEF Wetlands Restoration and Pollution Reduction project was approved just prior to the CAS period. It aims to support the adoption of sustainable natural


Annex C Page 21 o f 46 resource management practices by local communities and local authorities in a nature park area and a protected site area. The wetlands restoration component i s stalled (see para. lll), but the protected areas management component i s proceeding well, with management plans more than 50 percent completed, with the active participation o f local stakeholders and park administration. Project outcomes are to be achieved by project closing in 2008. 54. The objectives of Pillar 2 to reduce firm entry constraints and regulatory costs, improve the Government’s business service delivery, ensure competitive and functioning markets, and improve the efficiency of the insolvency regime were met, while the objective to promote flexibility in the labor market was partially met. Competition in the domestic market, which had been limited by an overly complex regulatory environment and inefficient contract enforcement, improved following regulatory and judicial reforms supported by the P A L program. The SME share o f employment increased to 56.7 percent in 2003 from 50.6 percent in 2000 and its share o f value added increased to 36.2 percent in 2003 from 29.5 percent in 2000. The Government streamlined regulatory regimes to reduce private sector transaction costs. Most centrally managed regulatory regimes for licensing, permission and registration were eliminated or modified. An Internet-based public register o f all current operative regulatory regimes was put in place for greater transparency and accessibility. A new Law on Administrative Regulation and Administrative Control on Economic Activities, the enactment o f which was a PAL benchmark, controls and codifies the principles needed to underpin introduction o f new regimes. This was a contributing factor in the substantial decline in the shares o f f i r m s indicating business licensing and permits and uncertainty o f regulatory policies and bribery as problems in doing business. (See Figure 3.)

Figure 3: Improved BEEPS Results on Business Climate Regulatory Policies as a Problem Doing Business (% o f firms indicating uncertainty about regulatory policies as a problem doing business) IOO%rl

Business Licenses as a Problem Doing Business (% o f f i r m s indicating business licensing and permits as a problem doing

business)

80%

40%

‘60%

30%

40%

20%

20%

10%

0%

Bul

EU8

SEE

2002 .B2005

0%

B ul

EU8

SEE

t#2002 .2006

Source: PAL 111 ICR Team (BEEPS, 2002 and 2005).

55. Enactment o f a new Law on the Bulstat Register (a P A L III trigger) enabled businesses to use the Bulstat number as the single-identification number for registration as well as tax and social security payments. This established a unified national register to help facilitate shifting the registration system from the courts to a non-judicial administrative process. The release o f judges from routine administrative procedures is reducing delays associated with the resolution o f commercial disputes. The Bank’s Private Sector Assessment (FY04) helped lay the groundwork for this reform. 56. Bulgaria’s efforts to promote competition and functioning markets were supported by the P A L program as well as the ongoing Registration and Cadastre loan, approved during the previous CAS. Under the P A L program, the Government upgraded the capacity o f i t s Commission for the Protection o f Competition through enactment o f amendments to the Law on


Annex C Page 22 o f 46

the Protection o f Competition (a P A L benchmark). Indicators o f progress include SMEs’ steadily increasing share o f employment (from 51.6 percent in 2001 to 56.7 percent in 2003) and value added (from 31.2 percent in 2001 to 36.2 percent in 2003), and a near doubling o f antitrust decisions during 2003-2004. The Registration and Cadastre loan supports the establishment o f a Cadastre Agency and a property registration unit within the Ministry o f Justice, to create a unified cadastre and property registration system that includes information technology, lot creation, digitalized mapping, survey, and adjudication. Although the loan was approved nearly five years ago, i t s impact to date has fallen far short o f expectations. (See para. 128.) Successful completion o f this project will be critical to the development o f a fkctioning land market in Bulgaria. 57. The PAL program supported amendments to the Commercial Code to improve the insolvency regime and accelerate resolution of insolvency cases. These changes included guaranteeing the rights and independence o f trustees, strengthened protection o f the rights o f private creditors, more stringent criteria for licensing and dismissal o f trustees, and strengthened monitoring and control by the Ministry o f Justice and the courts. Figure 4 shows that the Government was successful in accelerating the insolvency process and facilitating the exit o f nonviable enterprises. The P A L objective had already been achieved in 2004 in that the average time for resolving insolvency cases fell by six months between 2003 and 2004, close to that found in other advanced transition economies.

Cost of insoiency (K of estate)

Time of insolvency (years)

2003

2005

2003

2005

Source: PAL 111 ICR Team (Doing Business, 2004 and 2006).

58. The PAL program initially included as a PAL I11 trigger enactment o f amendments of the Labor Code to promote labor market flexibility. However, this was later downgraded and replaced with a benchmark that was met, calling for Government consultation with stakeholders on labor market rigidities such as inflexibility of working time and insufficient adaptability o f wages, and the elevation of a benchmark regarding business registration reform to a trigger. This change was

Figure 5: UnderemploymentDue to Labor Regulations “If you didn’t have any restrictions (ie., you didn’t have to seek permission, make severance payments, etc.), and you could increase the number o f regular full-time workers your firm currently employs, by how much would you increase your number of employees as a percent o f your existing workforce?” 2 6

But

Source: BEEPS, 2002 and 2005

ECA


Annex C Page 23 o f 46 made due to the political difficulties o f implementing labor market reforms in an election year and in light o f international comparisons indicating Bulgaria’s labor regulations were not overly restrictive. However, these comparisons did not take into account Bulgaria’s Currency Board Arrangement, low employment rate, and aging population, all o f which point to Bulgaria’s need to outperform other countries in labor market flexibility in order to be competitive. Furthermore, the BEEPS results indicate that a less restrictive labor code could have a significant impact on employment. (See Figure 5.) More limited enhancements to labor market flexibility were achieved than initially planned under the PAL program. These included enactment o f amendments to the Labor Code to strengthen anti-discrimination provisions,21amendments to the Health Act to reduce abuse o f sick leave provisions, and removal o f regulatory barriers to the private provision o f employment services. 59. The objectives of Pillar 3 to improve the legal framework for lending, complete banking reform, and develop the financial markets and regulatory framework for private pension funds were met. Building on progress prior to the P A L program, some 98 percent o f bank assets were privatized by the end o f the PAL program, leading to a well-capitalized, wellsupervised and profitable banking sector, and 100 percent o f Bulgaria’s insurance sector was also privatized. In addition, the legal framework has been strengthened against terrorist financing and money laundering, and to introduce global custodianship as well as more flexibility in the investment regime to facilitate the movement o f pension fund members among funds. As a result o f these actions, P A L outcomes were met or surpassed, with credit to the private sector increasing to an estimated 36.9 percent o f GDP in 2004 from 15 percent in 2001. Access to and cost o f financing as a problem in doing business are now comparable to those o f the EU8 (see Figure 6), and the EBRD considers Bulgaria’s banking legislation compliance with international standards very high (EBRD, 2005). Figure 6: Improved Access to Financing Access to financing as a problem doing business (% o f f i r m s indicating access to financing (collateral required or financing not available from banks) as a problem doing

business) I

Cost o f financing as a problem doing business (% o f f i r m s indicating cost o f financing (e.g., interest rates and charges) as a problem doing

business)

I.

60% 60%

40% 30% 20%

10%

0%

Bul

7

EUS

1

SEE

Source: PAL 111 ICR Team (BEEPS 2002 and 2005).

This policy was developed by Bulgaria’s National Council on Ethnic and Demographic Issues, with support from the IDF Grant for Integrationo f Ethnic Minorities.

21


Annex C Page 24 o f 46

60. With the cancellation of several planned Bank loans aimed at stimulating economic growth in rural areas, the one remaining Bank instrument with this objective was the Survey on Rural Development Needs. (See paras. 116, 123-124.) This had been envisioned as an Agriculture Sector Note when the CAS was prepared, but when the Rural Finance loan was replaced by a Rural Development loan, the scope o f the sector work was modified accordingly. The Survey served as a basis for Bulgaria’s “National Program for development o f Agriculture and the Rural Regions 2007-20 13,” a requirement for EU accession. Theme 2: Strengthening Public Administration and Anti-Corruption Initiatives 61. The primary CAS instruments aimed at strengthening Bulgaria’s public administration and anti-corruption initiatives were Pillar 4 o f the PAL program (Improving Public Sector Governance), the Revenue Administration Reform Loan, and the Trade and Transport Facilitation in South East Europe (TTFSE) loan. The Bank’s fiduciary AAA (the Country Financial Accountability Assessment and Country Procurement Assessment Report) were also intended to support these efforts. The Bank also provided technical assistance on to strengthen the Government’s capacity in debt management. (See Box 2.)

62. The objectives of Pillar 4 of the PAL program were wide-ranging, as public administration reform and anti-corruption efforts had not been previously tackled. By contrast, the structural reforms supported by Pillars 1-3 were building on those initiated under sector adjustment loans during the previous CAS period. Actions supported by the P A L program included Parliament’s approval o f amendments to the Civil Service Law, and the Government’s adoption o f a Public Administration Reform Strategy, launch o f fknctional reviews, introduction o f performance standards, improvement o f budget management systems, adoption o f a legal framework governing the accountability o f judges, and preparation and implementation o f an Anticorruption Strategy and Action Plan. Much o f the reform agenda for Pillar 4 was informed by studies funded by a PHRD grant, including a comparative analysis o f civil service pay and a proposal for a results-based compensation system. Box 2: Debt Management Technical Assistance Program and Use of IBRD Financial Products

In mid-2002 the Ministry of Finance requested technical assistance in public debt management from the Bank’s Treasury staff, to address Bulgaria’s high proportion of external debt coupled with currency and interest rate risk. A three-year Government Debt Management Strategy was approved by the Council o f Ministers in March 2003, and several months later Bulgaria signed a Master Derivatives Agreement“ (MDA) with the Bank. The MDA provided the contractual framework for a swap between the Bank and the Government to change the currency of Bulgaria’s net obligation on a VSL (Variable Spread Loan) o f $96 million, €?omUSD to EURO, in line with Bulgaria’s strategic objective to reduce its share o f USD-denominated debt. The swap took place in November 2003 and was the first IBRD currency swap under an MDA. In December 2003 the Bank’s Treasury staff entered into a fee-based technical assistance agreement with the Bulgarian authorities, with the fee paid by the Bulgarian National Bank (BNB) through the Bank’s Reserve Asset Management Program’s technical advisory program for international reserves management. The technical assistance has focused on public debt and cash management, with the objective o f strengthening the institutional capacity of the Bulgarian State Treasury, in particular its governance and decision-makingarrangements and the technical skills o f staff below the management level. During its technical assistance program with the Bank, Bulgaria has successfully implemented its debt management strategy and strengthened the organizational structure o f the Debt Management Office. Intensive staff training has taken place, both in Sofia and abroad, and the technical assistance program i s nearing completion,

“ Bulgaria was the second country to do so, after Tunisia.


Annex C Page 25 o f 46

63. Key desired outcomes of Theme 2 were achieved. These included implementation o f merit-based recruitment and pay, with 100 percent o f the civil service affected in some way; all new recruitment conducted through external recruitment processes in accordance with new requirements; civil service pay increases exceeding inflation to narrow the gap with the private sector; and introduction of a new public procurement framework aligned with EU requirements. Public administration reforms exceeded expectations and were implemented in a relatively short period o f time. There was progress in certain aspects o f governance as well. Anti-corruption public councils were established in 21 o f 28 regional administrations. There was a 213 percent increase in applications to government bodies for access to public information in 2003 compared to 2002. A standing commission was formed within the Supreme Judicial ‘Council to address corruption within the judiciary. Independent reviews indicate that issues of public governance have improved, but important challenges remain. This i s reflected in BEEPS results indicatingthat custom tax regulation and corruption have eased as problems in doing business, but Bulgaria still fares worse than the N M S in terms of corruption more generally. (See Figure 7.) Figure 7: Customs Regulations and Corruption in Doing Business Custom regulations as a problem doing business (% of f m s indicating custom regulations as a problem doing business) 40%

doing business) 60% 50%

30%

40%

20%

30% 20% 10% 0%

10% 0%

Corruption as a problem doing business (% of firms indicating corruption as a problem

Bul

EU8

SEE

2002 M2005

Bul

EU8

SEE

2002 M2006

Source: PAL I11 ICR Team (BEEPS 2002 and 2005).

64. Pillar 4 of the PAL program was complemented by the Revenue Administration Reform investment loan and informed by the Bank’s report on Issues in Intergovernmental Relations. The Revenue Administration Reform Project (RAW) i s financing the establishment o f a sustainable public revenue collection system that facilitates private sector development and complies with EU accession requirements. I t aims to (i)maximize the level of taxpayer voluntary compliance, (ii)promote effectiveness and efficiency - thereby enabling tax rate reductions that would stimulate economic growth, (iii) establish a professional workforce at the National Revenue Agency established by Parliament in 2002, (iv) reduce the potential for corruption, (v) improve equity in system administration, and (vi) reduce the taxpayer’s compliance burden. To date, indicators show significant improvements in revenue collection and compliance rates, with some efficiency and effectiveness gains due to the separation o f central and municipal revenue collection functions and transfer of responsibility for local revenue collection to municipalities. These gains are reflected in tax rate cuts introduced in 2005. The National Revenue Agency began operations on January 1, 2006, so its longer term impact i s not yet known, but thus far the loan i s meeting its objectives, and implementation i s proceeding well despite its inherent institution building challenges. 65. The TTFSE loan was prepared during the previous CAS and remained in the portfolio for all of this CAS period and closed on September 30,2005. The loan was part of a regional program that was a collaborative effort among Bulgaria and other countries in South East Europe, and the EU, with financing by the Bank and the U S Government aimed at reducing non-


Annex C Page 26 o f 46 .

tariff costs to trade and transport and smuggling and corruption at border crossings. Performance against outcomes was impressive, with border trade volume significantly increased, as are tariff revenue collections, while the cost o f collection has declined. In light o f this successful experience, the Government has requested a sequel operation which i s expected to feature in the new CPS.

66. A Bank study on Issues in Intergovernmental Relations on fiscal decentralizationwas completed early in the CAS period to inform the subsequent RARP as well as the public expenditure management component o f Pillar 4 in the P A L program. Country Financial Accountability Assessment and Country Procurement Assessment Report (the latter not included in the CAS program) informed Pillar 4 policy actions as well. Theme 3: Investing in Human Capital and Strengthening Social Protection

67.

The primary CAS instruments aimed at investing in human capital and strengthening social protection were Pillar 5 of the P A L program and the Social Investment and Employment Promotion loan. These were supplemented by the Pension Reform Note, the IDF Grant for Integration o f Ethnic Minorities, the JSDF Grant for Child Development in Disadvantaged Communities, and the Poverty Assessment Dissemination and Disclosure Pilot. In addition, there were loans for Education Modernization, Health Sector Reform, and Child Welfare Reform plus an IDF Grant for Poverty Monitoring, Evaluation, and Policy Design (see paras. 22 and 40) in the portfolio, approved during the previous CAS.

68. With some of these instruments successful and others less so, the objectives o f Theme 3 were partially achieved. Pillar 5 supported reforms in each o f the social sectors. I t s objectives were to (i)improve the governance, efficiency, quality, and equity o f the education system; (ii) improve the governance, financial sustainability, quality o f service delivery, access to the health care system; (iii)improve the administration and targeting o f disability benefits and empower the disabled to integrate into society; (iv) ensure successful implementation o f pension reform; (v) improve the effectiveness o f social assistance programs; and (vi) reduce institutionalization o f children through community-based initiatives. A PHRD grant financed technical assistance in the areas addressed by Pillar 5. 69. I n the education sector, the main achievement of the P A L program was the implementation of reforms to improve equity. These included the strengthening o f policies to increase opportunities for children from poor families and ethnic minorities, integration o f disadvantaged groups (particularly Roma children) into primary and secondary education, and integration o f children with special needs into mainstream schools. Building on efforts under earlier PALSto increase incentives for Figure 8: Workers’ Education as a Problem Doing Business school attendance for children from poor families, the Government further Percent of firms indicating skills and education o f strengthened social benefits, including available workers as a problem doing business provision o f free textbooks to all primary school children, introducing school feeding in primary schools, and providing transportation to enable children from remote rural areas to attend school. The monthly child benefit was made allowance w ECA conditional on school attendance by eligible school-age children starting Source BEEPS 2002 and 2005 from the school year 2002-03. As a

I


Annex C Page 27 o f 46 result, school non-attendance rates for among 7-18 year olds from the poorest quintile fell by 20 percentage points between 2001 and 2003. (MTHS, 2003) But while the gap between poor and non-poor enrollment has narrowed, especially at the primary school level, it remains significant at the secondary and tertiary levels, with gaps of 38.7 and 3 1.9 percentage points, respectivelf. In addition, education sector actions supported by the PAL program were not sufficiently robust to address the governance, efficiency, and quality of the educational system, particularly at the tertiary level. (See Table 6 and Figure 8.) Quality outcomes were not in terms of improved curricula but increased public expenditure on education as a percentage of GDP to align with that of OECD countries, not taking account of Bulgaria’s shrinking school-age cohort or fiscal constraints stemming from the CBA. And efficiency outcomes were in terms of higher studentteacher ratios rather than the overall budget system and cost structure of the education system, including administration and schools. The first o f a three-phase Education Modernization APL, designed under the 70. previous CAS but ongoing during the implementation of PAL I reforms, was very broad in scope. It aimed to enhance both quality and efficiency at the primary, secondary, and tertiary levels. Components included introduction of a new curriculum and student assessment system, new teaching approaches, and more efficient resource use. The scope of objectives proved to be too ambitious, given that (i) the Government’s implementationcapacity was severely compromised by high turnover both at the highest level in the Ministry of Education and in the Project Coordination Unit, and (ii)public and political support for education reform was not sufficiently developed. Two-thirds of the loan amount was cancelled when the loan closed in March 2004, the subsequent two APLs in the series were dropped, and the ICR as well as IEG’s ICR Review rated achievement of project outcomes as unsatisfactory. Some but not all desired outcomes in the health sector were achieved under the PAL 71, program. The Government increased the share of the Ministry of Health’s operating budget going to national public health programs, and health outcomes for life expectancy, infant mortality, polio immunization rates, and incidence of tuberculosis improved. (See Box 1.) The National Assembly enacted amendments to the Health Act allowing for earmarking of 1 percent of the tobacco excise tax to fund the national tobacco control program, and legislation to harmonize tobacco control and regulations with EU directives. The National Health Insurance Fund’s administrative costs were 3 percent of its total expenditures in 2004, in line with the PAL program goal, and a National Health Map was updated. As with the education sector, the PAL program’s health sector benchmarks (some o f which were in terms of developing a strategy, preparation of standards, and launching of ministry restructuring) did not go far enough to ensure achievement of objectives. There are s t i l l outstanding issues in the health sector that need to be addressed in order for Bulgaria to attain health care quality and efficiency of EU standards. The country i s far behind the EU in dealing with the ownership and management of hospitals, financial sustainability of its health insurance system in view of its growing arrears, managing demand for healthcare services, defining the role and development of private supplementary health insurance, and defining the role of social assistance in health care.

72. The Health Sector Reform loan, under implementation since the previous CAS, is financing investments and technical assistance aimed at improving access to quality health services and ensuring their financial and operational sustainability. Two-thirds of the loan proceeds are financing information technology and related training. Successful implementation i s dependent on the pace of the health sector reforms it i s designed to support. (See para. 128.) The new CPS includes development policy loans (DPLs) to support health sector reforms, which should improve the likelihood that this investment loan will achieve its objectives. 22

World Bank, Bulgaria Education Policy Note, 2005.


Annex C Page 28 of 46

73. Actions to improve targeting of disability benefits and promote social integration of the disabled were successfully implemented under the PAL program. Legislation was enacted to disallow disability benefits to those over retirement age and therefore eligible to receive pensions, and to establish a frameworks for improved disability needs assessments to facilitate integration into the labor force and society, as well as for fraud detection and accountability of medical practitioners. 74.

Reform measures supported by the PAL program to further develop a multi-pillar pension system were also successfully implemented. Legislation was enacted to establish a benefits indexation formula, including maximum and minimum benefits, as well as contribution rates with a timetable for changing the ratio of employer to employee contributions from 70:30 in 2005 to 5 0 5 0 in 2009. As a result, fiscal sustainability of the pension system has been strengthened, and there i s greater predictability for beneficiaries, contributors, and investors, although some concerns regarding long-term sustainability remain. PAL benchmarks were informed by the Policy Note on Bulgarian Pension Legislation(FY04).

75. Reforms supported by the PAL program to improve the coverage and targeting o f the Guaranteed Minimum Income (GMI) benefits, child allowances, and energy subsidies in view o f tariff increases resulted in positive trends, but further progress i s needed, especially in the targeting o f child allowances. GMI and energy subsidy coverage increased 2.7 and 2.5 times, respectively from 2001 to 2003. Over the same period, the share of funds channeled to the poorest quintile increased from 60 percent to 75 percent for GMI, and from 47 percent to 54 percent for energy subsidies. The share of child allowances going to the poorest quintile increased from 20 to 35 percent, while the share going to the richest two quintiles fell from 40 percent to 23 percent.

76. The PAL program also supported enactment and implementation of legislation to shift to family and community-based alternatives to institutional care of children. These changes are being implemented over several years, with desired outcomes defined for 2007. While there are improvements at the margin in terms of inter alia the number of institutions (3.5 percent drop from 2001 to 2003) and the number of institutionalized children (9.5 percent drop over the same period), it i s too early to assess the adequacy of progress. The Child Welfare loan (cofinanced by the EU PHARE program, the UK, and Japan) was in the previous CAS program and has complemented the PAL component addressing this issue, by financing inter alia capacity building in monitoring and evaluation, public awareness and training campaigns, daycare centers and other community-based services for children from families at risk, and services for street children. With a prolonged implementation period, it was in the portfolio during the FY03-FY05 CAS and i s due to close at the end of FY06. As of mid-2005 the project indicators were on track toward desired outcomes, in terms o f absolute as well as rate reduction in child institutionalization, with a dramatic increase in the number of children from high-risk communities benefiting from pre-school services. As with a number of other investment loans, insufficient implementingagency budget allocation for counterpart funding has been a major source of implementation delay. The loan was complemented by an associated Japan Social Development Fund (JSDF) grant which supported community-based child development programs in disadvantaged ethnic minority communities and, significantly, has triggered the introduction of an obligatory pre-school year for all six year-olds nationwide. 77. The Social Investment and Employment Promotion (SIEP) loan aims to improve the standard of living o f those locked in persistent “pockets� of poverty in Bulgaria: certain regions, the long-term unemployed, and specific ethnic minorities (Roma and Turkish, in particular). With two interventions, the project addresses their social exclusion, weak social capital, poor access to markets and basic services, low employment, and low income. These interventions are the (i) Community Infrastructure for Development Initiative, to finance


Annex C Page 29 of 46 development investments identified and managed by such communities themselves; and (ii) the Bulgarian Active Labor Market Initiative to facilitate employment creation for disadvantaged individuals in poor communities. Progress against development objectives and indicators thus far has been positive, but slower than planned. In the first three years of a planned five-year implementation period, less than one-half of the loan has been disbursed, mainly due to insufficient implementing agency budget allocation for counterpart funding under the Bulgarian National Budget framework. B.

Exogenous Factors

78. There were a number of exogenous factors that contributed to the achievement of the CAS outcomes, with the prospect of EU accession first and foremost among them. Bulgaria’s being on the EU accession track gave its political leaders the incentive as well as the justification for implementing difficult reforms needed to meet EU requirements. When in May 2003 the EU set a tentative accession date of January 1, 2007, this added momentum to the ongoing accession negotiations. Joining NATO in March 2004 further spurred this momentum, as the Government and the Bulgarian population considered NATO membership a precursor to EU membership. With this tangible external encouragement, the pace of implementation of reforms called for in the EU’s Regular Reports, in line with accession requirements, accelerated as reflected in the significant reforms achieved during the CAS period under Pillars 1-4 of the PAL program. By contrast, however, in those sectors not as specifically addressed by EU accession requirements, the pace of reform was slower (e.g., education and health under Pillar 5), as the lack of external pressure meant less political will and popular consensus. 79. Bulgaria’s momentum for reform was also due in part to coordinated external support, in particular from the Bank and IMF. Support for structural reforms in the two institutions’ respective PAL and SBA programs was designed to be mutually reinforcing and complementary. (See Attachment G.) Reform progress was most significant where Bulgaria’s three primary external partners - the EU, the IMF, and the Bank - were closely aligned in the policies and programs they supported. External support was also coordinated with IFIs (e.g., EBRD) and bilateral partners (e.g., USAID, DFID, and The Netherlands). (See Attachment H.)

80. A third important factor contributing to the achievement of the CAS outcomes was the legacy of Bulgaria’s financial crisis of 1996-1997. The CBA, in place since the crisis and until Bulgaria joins the Euro zone (likely sometime between July 1, 2009 and January 1, 2010), imposed a strong discipline on macroeconomic management, and this created a relatively stable macroeconomic environment in which to be implementing sectoral reforms. C.

Role of Partners

8 1. Development partners played an important role in CAS program implementation and achievement of the CAS outcomes of growth and reduction o f poverty and unemployment. They have actively supported the PAL program as well as individual investment operations, as summarized in Attachment H.

82. Japanese PHRD grants played a critical role by funding analytical work and technical assistance that helped build Government support for reforms. (See paras. 48,50,62, 68, and 124.) This was especially important for the reform program, because as a matter o f policy Bulgaria does not borrow for technical assistance. 83. Cooperation between the Bank and the IMF during the CAS period was strong. This cooperation was focused primarily on support of complementary structural and institutional


Annex C Page 30 of 46 reforms. A 24-month Stand-By Arrangement (SBA) in the amount o f SDR 240 million was approved by the IMF in February 2002 and extended to mid-March 2004 when it was successfully concluded. This was followed by a 25-month precautionary SBA in the amount of SDR 100 million, approved by the IMF in August 2004. The SBA programs have focused on medium-term fiscal challenges and structural reforms with significant macroeconomic, notably fiscal, implications. Attachment G shows the close complementarity between structural and institutional reforms supported by the PALSand those specified in the Government’s Memoranda of Economic Policies (including Supplementals) under the two SBAs. This coordination contributed significantly to the successful completion of the reform programs being supported by the Bank and the resulting achievement of the CAS outcomes.

84. The EU played an important role in the achievement of the CAS outcomes through its large pre-accession grant programs and its annual Regular Reports. Both the PHARE and ISPA programs contributedto the achievement of higher growth by supporting investments in basic infrastructure. Aimed at the modernization of agriculture and rural development, SAPARD funds helped address unemployment and poverty levels, both of which have been higher in rural areas. The EU’s continuous monitoring and public disclosure of conclusions in its Regular Reports kept the pressure on the Government to make further progress in meeting the political and economic criteria and acquis requirements for accession, including in areas directly relevant to the CAS. (See Table 2.)

85. Government-led partner coordination during the CAS period was a daunting task, given (i)the large amounts of pre-accession grant funds and other partner financing to be coordinated, and (ii)the Government’s constrained capacity to undertake it and lack o f a champion for such an initiative. In April 2002, shortly before the FY03-FY05 CAS was finalized, the first Government-led partner coordination meeting was held in Sofia, chaired by one of the Deputy Prime Ministers. At the meeting a new coordination mechanism was established with the aim of maximizing effective absorption of partner assistance, organized into four priority areas aligned with the Government’s priorities: (i)business climate; (ii)living standards improvement; (iii) governance and public administration; and (iv) infrastructure and natural resources management. Various working groups were established in each of these thematic areas, with each working group led by the relevant deputy minister and a development partner. Serving as secretariat, the Council of Ministers’ Directorate for European Integration and Relations with the I F I s established excellent working relationshipswith the partner community.

86. The Bank was one of the lead partners providingtechnical assistance to the Bulgarian Government to strengthen its partner coordination during the CAS period. With the Government’s introduction of a new coordination mechanism in 2002, the Bank took on the role of lead partner for four o f the Government’s working groups.23 The Bank also provided support and advice to the Partner Coordination Secretariat at the Council o f Ministers and continued its ongoing coordination with the EU, includingjoint meetings with the EC Delegation in Sofia, as well as with UNDP, to further enhance the coordination and integration of programs. 87. Implementation o f the Government-led coordination mechanism during its first year and a half was mixed. The mechanism itself was rather complicated, with many working groups but no binding administrative procedures to support it. It suffered from insufficient attention and ownership at senior levels, lack o f capacity at ministerial and central levels, and inadequate understanding and commitment at the level o f deputy ministers. As a result, the working groups

~

23 Poverty/Social Sectorhlinority IssuedAccessto Health Services, Education and Culture, Agriculture/Forestry, and Energy.


Annex C Page 3 1 of 46 did not make much progress. Despite this, information sharing and coordination among Bulgaria’s partners worked well.

88. Initial experience with the new Government-led partner coordination process prompted Government to look for ways to enhance the mechanism and to make it more effective. The Council of Ministers, jointly with UNDP, developed a Development Cooperation Information System database to facilitate Government in external assistance planning and coordination. The CEP adopted a decision which provides for updating the database on a regular basis. The working group arrangement continues to be in a state of flux. Successful Governmentled partner coordination will require more high level attention within the Government, to ensure that Bulgaria i s able to make the best use o f the EU grant funds. D.

Government’s’ Role

89.

The Government played a critical role in the successful achievement of the CAS outcomes. There were five key elements of the Government’s role in connection with the PAL program, which was closely linked to the CAS outcomes: (i) coordination, (ii)participation and consultation, (iii)implementation, (iv) monitoring, and (v) communication.

90. Perhaps the most successful aspect of the Government’s role in implementation of the PAL program was the effective mechanism it put in place to coordinate the comprehensive effort. During preparation of PAL I the Government gave the Council for Structural Policy, subsequently renamed the Council for Economic Policy (CEP), responsibility for coordination of the PAL program. I t was chaired by the Deputy Prime Minister and Minister of Economy and was under the decision-making body, the Council of Ministers. The CEP was comprised of high-level representation from the line ministries responsible for key structural reforms: the Deputy Prime Minister and Minister of Labor and Social Policy, the Deputy Prime Minister and Minister of Regional Development and Public Works, the Minister of Finance, four other Ministers, two Deputy Ministers, and the Executive Directors of the Privatization Agency and Foreign Investment Agency. Several committees were formed to focus on specific components of reform. An eightperson team in the Directorate for EU Integration and Relations with IFIs, under the Council of Ministers, served as i t s secretariat and provided continuity despite a reshuffling of the Cabinet in July 2003. The EU Directorate staff collected information for tracking progress against the benchmarks in the PAL matrix for weeks prior to each PAL mission, accompanied the Bank’s PAL mission teams to meetings with the line ministries, and ensured post-mission follow-up. 91. As the PAL program was being developed and implemented, the Government consulted with the private sector and ensured i t s participation in a public dialogue on the reform program. The Government consulted private sector organizations such as the Chamber of Commerce and Industry, the Industrial Association, and the Employers’ Association. It established several public/private discussion fora, including the Council on Economic Growth and the Tax Council.

92. With strong Government ownership and commitment to reform, implementation o f the PAL program was completed on a timely basis, with the exception of the Bulgartabak privatizationwhich was shifted from PAL Ito the trigger for PAL 11second tranche release. (See para. 105.) Borrower performance was rated highly satisfactory for PAL Iin the ICR as well as IEG’s ICR Review. In light o f the Government’s failure to privatize Bulgartabak or implement labor market reforms as envisioned at the outset of the PAL program, the IEG ICR Review downgraded the PAL I1 ICR rating of borrower performance from highly satisfactory to satisfactory, in line with IEG’s guidelines disallowing highly satisfactory ratings if all covenants and commitments are not fully met.


Annex C Page 32 of 46

93. The Government put in place a number of feedback mechanisms for timely tracking o f progress toward PAL outcomes. These mechanisms included the Administrative and

Regulatory Cost Survey (ARCS), the Living Standards Survey, and the Judicial System Survey. A joint EBRD/World Bank Enterprise Survey was also used. The Labor Standards Measurement Survey (LSMS) Unit in the National Statistical Institute and the Poverty Monitoring Unit in the Ministry of Labor and Social Policy monitored progress as well.

94. A second weak element of the Government’s role in the context o f the PAL program was its public communication effort. Believing that democratic elections ensured sufficient engagement with stakeholders, the Government did not give enough priority to communications strategies or public information campaigns in support of the reform program. The Bank made a strong effort to help build capacity in this regard, including with an IDF grant, but without a highlevel champion, the effort was not successful. Funding for such activities was not systematically included in line ministries’ budgets. The resulting lack of understanding of the reform program and the public’s expectations for a rapid increase in the standard of living, fueled by the prospect of EU accession, led to the electorate’s frustration and eventually a change of government, despite the impressive achievements under the PAL program. 95. While much of the achievement of CAS outcomes i s linked to the Government’s successful implementation o f the PAL program, Bulgaria would likely be better positioned for post-accession convergence, had the Government implemented more of the investment lending program with equal success. (See paras. 115-129 for discussion o f investment loan portfolio and pipeline issues. See also para. 140.) Implementation of a number of loans in the portfolio has been significantly delayed, in part due to weak capacity, high turnover, and insufficient counterpart funding reflecting a lack of ownership (in some instances, resistance to reforms), particularly of loans prepared with the previous government under the previous CAS. In addition, much of the CAS investment lending pipeline was dropped due to lack o f Government ownership. This partly reflects less of a sense of urgency and pressure on the Government to reform in areas not immediately relevant to accession and therefore where the EU was less directly engaged. By contrast, implementationof RARP, which was prepared during the CAS period and is well aligned with the EU agenda, i s proceedingwell. E.

Sustainability o f CAS Outcomes

96. With widespread political support for Bulgaria to continue i t s progress toward accession in January 2007, sustainability of the CAS outcomes i s likely. The prospect o f EU membership clearly motivated the NMSS-led Government, as well as the preceding and succeeding Governments, to stay the course with an accession-oriented reform agenda aimed at private sectorled growth, poverty reduction, and employment creation. Political support for successful EU integration after accession i s also likely, such that it i s expected that future governments will continue to stay the course with reforms post-accession. This political support i s partly based on the public’s perception that EU membership will bring economic stability and will therefore prevent another economic crisis. However, to the extent there are political risks to sustainability, more effective government communications on the reform program would help to mitigate them. 97.

I n addition, the CAS outcomes are likely to be sustainable because the structural and macroeconomic reforms implemented to achieve them were for the most part deep and systemic. They were generally effected through the enactment of legislation by Parliament (as opposed to Government decrees or ordinances), affer a painstaking review process by multi-party Parliamentary commissions, which makes the laws difficult to reverse or amend. The legislation was typically followed by regulations that were then implemented. As a result, the overall policy environment has changed, such that reversal i s unlikely. Bulgaria’s prudent macroeconomic


Annex C Page 33 of 46 management and the resulting stability also facilitates sustainability of the structural reforms that have led to achievement of the CAS outcomes. One exception, however, i s the Government’s Active Labor Market Program, which provides shorter-term oriented interventions to address the longer term challenge of increasing employment within an aging population with skills gaps vis-&vis the EU labor market in which Bulgaria will be competing more intensely post-accession.

98. A third factor contributing to the sustainability of CAS outcomes i s the institutionalization of an effective coordination and monitoring mechanism within the Government’s structure. Originally established by the previous government inter alia to carry out these functions during implementation of the PAL program, the Council for Economic Policy remains in place as an active tool of the Council of Ministers for coordinating and monitoring the current government’s program. 99. Fourth, Bulgaria’s partnership with the Bank during the next CPS period should contribute to the sustainability of CAS outcomes. Bank support in the areas of Bulgaria’s unfinished reform agenda (e.g., education, labor market, and health reform) can help sustain momentum for reforms aimed at EU accession and post-accession convergence with member states.

100. Finally, Bulgaria’s continued partnership with the Bank during the next CPS period should contribute to the sustainability of CAS outcomes. Bank support in the areas of Bulgaria’s unfinished reform agenda (e.g., education, labor market, and health reform) should help sustain momentum for reforms aimed at EU accession and post-accession convergence and competitiveness with member states.

V.

Bank Performance

10 1. The Bank’s overall performance in supporting the achievement o f the CAS outcomes and supporting CAS and PAL themes was satisfactory. I t s performancg with regard to promoting competitive private-sector led growth (Theme 1) and strengthening public administration and anti-corruption initiatives (Theme 2 ) was highly satisfactoly, while it was moderately unsatisfactory with regard to investing in human capital and strengthening social protection (Theme 3). A.

Quality

102. The design o f the PAL program was complex and multi-sectoral, with 31 triggers and 232 benchmarks and actions taken by many ministries and agencies across a wide range of sectors. However, the Bank team took into account a number of factors that mitigated the risks of this complexity, and in the end 28 of the 3 1 program triggers articulated at the outset of the PAL program were completely fulfilled. One factor was strong macroeconomic management throughout the program, in part due to continuation of the Currency Board Arrangement (CBA) in place since the financial crisis of 1996-1997. A second factor was strong government ownership of and commitment to the PAL-supported reforms, aligned with Bulgaria’s EU accession agenda. Third, the multi-sector PAL instrument was an effective vehicle for inter-ministerial coordination

of reforms within a coalition government. Fourth, there was strong complementarity between the PAL program and the IMF program. (See Attachment G.) This alignment among three of Bulgaria’s key development partners gave the PAL program added credibility and leverage. And fifth, specific outcomes for measuring progress toward overall program outcomes over the threeyear period were built into the policy framework.


Annex C Page 34 of 46 103. Following a series o f SECALs during the previous CAS period when the focus was on stabilization following the financial crisis, the flexibility afforded by the PAL instrument was better suited to bringing about structural reform across multiple sectors. The PAL program was informed by these predecessor sector reform operations, as well as by a number of Bank studies and reports (e.g., the FSAP, Poverty Assessment, Public Expenditure and Institutional Review, Issues in IntergovernmentalRelations, and three Poverty and Social Impact Analyses24).

104. Throughout the P A L program, the full Country Team was actively engaged - indeed, it was the P A L Team. Critical to the effort was the role played by the Country Office staff, in terms of substance based on their local knowledge as well as day-to-day coordination with Bulgarian counterparts. 105. The Bank’s performance in PAL I was rated highly satisfactory in the I C R and in IEG’s ICR Review, while both gave a rating of satisfactory to P A L II. One reason for the lower rating of PAL I1 was the way the Bank handled the condition related to the privatization of Bulgartabak. (See para. 92.) When the privatization met with political and market constraints during PAL I,it was shifted to PAL I1 which accordingly was split into two tranches to allow more time. The condition called for the privatization outcome, which i s subject to political and market forces beyond a government’s control, rather than the execution of an appropriate privatization process. And as noted earlier, the market significance of this particular privatization had significantly diminished over time, especially in relation to over-performance with other privatizations. The Bank should have taken these factors into account in the design of PAL 11. 106. There were three additional weaknesses in the Bank’s design and implementation of the PAL program, all of which relate to Theme 3, which accounts for this report’s moderately unsatisfactory rating of Bank performance. One was the lack of poverty monitoring data with which to gauge progress against the CAS and PAL outcome of poverty reduction. The Government’s shift to an EU-oriented methodology was not unexpected, and to ensure comparability with the Bank’s previous poverty data using i t s preferred consumption-based methodology, the CAS should have included a Poverty Assessment to be conducted at the end of the CAS and PAL periods.

107. A second weakness was the backloading to PAL III of politically difficult reforms in the social sectors (labor market in Pillar 2 and education and health in Pillar S), thereby putting them on a collision course with an election year and making them even less politically viable, In the end, the Bank did not define the benchmarks for education and health as rigorously as needed (see paras. 69 and 7 I), and compensating for the downgrading of the politically difficult Labor Code amendment trigger by upgrading an important, but less politically difficult action related to business environment, diminished the outcome o f Pillar 2. The social sector reforms would likely have been implemented more successfilly, had they been included more consistently throughout the PAL program, rather than held for PAL 111. Building support and consensus for them takes time, as does their implementation. It i s important to allow sufficient time a sustained effort for this during a government’s tenure. 108. The third weakness relates to the CAS more broadly, as well as to the P A L program. Increasing the labor force participation rate should have been made an explicit CAS and PAL outcome, to focus the reform effort more directly on Bulgaria’s exceptionally low labor force participation. This would have reinforced achievement o f Bulgaria’s goals of private sector-led

24 These analyses assessed the poverty and social impact of privatizationo f Bulgartabak on tobacco farmers, restructuringo f the railway sector, and energy pricing.


Annex C Page 35 of 46 growth and employment creation. A stud? conducted for the 2002 Poverty Assessment flagged low labor force participation as an issue, which was then highlighted in the PAL IProgram Document. But neither the CAS nor the PAL took this on as an explicit outcome and instead focused on reducing unemployment and long-term unemployment. Although total and long-term unemployment declined during the CAS period, this did not make a significant dent in Bulgaria’s low labor force participation rate which, notwithstandingan increase of 4.3 percentage points from 2002 to 2005, still remains very low at only slightly above one-half (52.7 percent). Experience has shown that growth alone i s not a sufficient antidote. Labor market reforms are needed as well.

109. There were no Quality at Entry Assessments of the three investment loans prepared during the CAS period. During CAS implementation the Social Investment and Employment loan (see para. 77) was rated satisfactory until late FY05, when the implementation progress rating was downgraded to moderately satisfactory due to insufficient implementing agency budget allocation for counterpart funding that halted project spending less than half-way through 2005 .26 The Revenue Administration Reform loan (see para. 64) has performed especially well, with highly satisfactory and satisfactory ratings. Nearly all procurement procedures have been completed. The District Heating project (see para. 47) has had satisfactory ratings since it became effective in 2003. The GEF Energy Efficiency project, approved three months before the end o f the CAS period, i s off to a promising start, with the Government having made its f i l l contribution of US$2 million in seed capital. Table 8: Ratings of Bank Performance in Sector Loans Closed During CAS Period Theme

Environment

Public Administration/ 4ntiZormption Yuman Capital 3evelopment

a

25

Due to ineffect

Project

Water Companies Restructuring and Modernization Environmental Remediation Pilot Environmental and Privatization support Adjustment Loan Trade and Transport Facilitation in South East Europe Education

Amount

Board Approval

Closing Date

US$98.0 million (of which US$46.8 million cancelled)

May 26, 1994

2002

Dec. 3 1,

Bank Performance Rating Satisfactory

US$16.0 million

May 12, 1998

Dec. 31, 2002

Highly satisfactory

US$50.0 million equivalent

Feb. 24, 2000

Dec. 3 1, 2003

Satisfactory

US$7.4 million equivalent

May 25, 2000

Sept. 30, 2005

Satisfactory

ICR

US$14.4 million

Sept. 5,

March

Unsatisfactorf

IEG ICR Review

Source

IEG PPAR

IEG ICR Review IEG ICR Review

p (three in three years).

Rutkowski, Jan, “Why i s Unemployment So High in Bulgaria?” (Draft Working Paper, 2002). Bulgaria’s fiscal year i s the calendar year.


Annex C Page 36 of 46

110. Eight investment loans in the portfolio, five of which have now closed, were prepared during the previous CAS. Three focused on the environment and related institutional reform, one focused on public administration and anti-corruption intiatives, and one on human capital development. Ratings of Bank performance shown in Table 8 above correlate with project impact, discussed in Section W.A. above. 111. Three investment loans prepared during the previous CAS are still under implementation. (See Table 9 below.) The Child Welfare Reform loan (see para. 76), nearly completed, has consistently been rated satisfactory. See para. 128 regarding implementationissues with the Health Sector Reform and Registrationand Cadastre loans. One GEF operation, Wetlands Restoration and Pollution Reduction, prepared during the previous CAS, i s still under implementation. (See para. 53.) During the first three years of implementation, disbursement was relatively slow due to cumbersome, centralized contract approval procedures and lack of consensus among stakeholders regardingthe wetlands restoration component. By the end of the CAS period, the project was rated moderately unsatisfactory on development objectives as well as implementationprogress grounds. An upcoming Midterm Review may lead to restructuring.

Theme Human Capital Development

Private Sector-Led

1 Growth

I

Project Health Sector Reform Child Welfare Reform Registration and Cadastre

I

Loan Amount US$63.3 million

Board Approval June 22, 2000

March 3 1,2007

Closing Date

US$8.0 million equivalent US$30.0 million equivalent

March 6,2001

June 30,2006

June 21,2001

March 1,2007

112. QAG’s Country AAA Assessment found the quality of the delivered Bulgaria AAA program to be satisfactory overall, and specifically in terms of strategic relevance, internal quality, likely impact, and Bank inputs and processes. QAG ‘assessed ten of 32 AAA tasks completed during FY02-FY04. Of these ten, it found eight to be satisfactory, one highly satisfactory, and one marginally satisfactory.

113. A number of AAA tasks were added to the program, many of them frontloaded in the first two years o f the CAS period, and were a timely, effective response to new opportunities. Technical assistance in debt management i s one such example. (See Box 2.) This was added to the program at the request of the Ministry of Finance early in the CAS period and was highly valued by the client, such that a fee-based arrangement was launched in late 2003. The Bank team was comprised of staff from i t s Treasury, Legal Finance and Accounting Loan Client and Financial Services units. This inter-disciplinary team carried out its work in cooperation with the IMF, as well as with the EU to ensure coherence with the ongoing PHARE programs and to help the Bulgarian authorities move towards standard EU practice. A number of infrastructure studies2’ were added to the program as well, several of which were done quickly at the request of the Government as it weighed investment needs and financing alternatives for the roads sector. An especially significant addition to the CAS program was the Bank’s technical advice and support in connection with the launch of the Decade of the Roma, which focused more attention on policy issues and dialogue related to social inclusion of Roma communities.

27 Road Investment Financing Options and Financing the Water and Wastewater Sector, both delivered in FY04.

,


Annex C Page 37 of 46 114. While the QAG AAA Assessment found that the Government had a high regard for the Bank’s analytical and advisory work, it also flagged a number of weaknesses: (i) inadequate attention to the reality of implementation issues in view o f capacity constraints, when making policy recommendations; (ii)a striking disparity between the sustained macroeconomic and infrastructure sector dialogue based on robust analytical work on the one hand, and a dearth of AAA to sustain dialogue in the health and education sectors on the other; and (iii)a tendency on the part of the Bank to gear its AAA work to macroeconomic issues while crowding out important sector work. In addition, QAG found that several pieces of AAA were supply-driven and therefore lacking in client ownership. A case in point was the CPAR, given that Bulgaria’s procurement reforms were entirely geared to compliance with EU standards. As a result, the Bank waived the CAS base case trigger calling for implementation of the action plan developed in the previous CPAR. QAG also cited a lack of integration among the three fiduciary reports completed during CAS implementation (the CPAR, CFAA, and PEIR). QAG’s rating of the AAA program’s coherence and integration was therefore marginally satisfactory. The QAG report also concluded that while the PEIR and Poverty Assessment2’ (both of which were delivered in FY02) were exceptions, for the most part dissemination beyond non-official stakeholders was a weakness in the AAA program, with the development impact of the Bank’s AAA therefore falling short of its potential. QAG therefore rated the AAA program’s dissemination unsatisfactory, and concluded that while this was understandable due to Bulgarian public officials’ top-down management approach and Bank budget constraints, it should be explicitly addressed in the delivery o f the AAA program of the next CAS. It should be noted, however, that the Survey on Rural Development Needs was successfully disseminated through a well received workshop and publication. B.

Dialogue and Portfolio Management

115. The Bank’s country dialogue during the CAS period was mixed. On the one hand, the Bank enjoyed a favorable reputation for its technical expertise and international knowledge, as evident from Client Survey Results (see paras. 135-138 and Attachment I) as well as stakeholder and counterpart interviews held by QAG, CAS Completion Report, and PAL I11 ICR missions. The QAG AAA Assessment rated dialogue as satisfactory. Policy dialogue on Themes 1 and 2, for which the Bank’s main counterpart was the Ministry of Finance, was substantive and fruitful. On the other hand, there were a number of areas in which the Bank’s dialogue was difficult, mainly where line ministries were the primary counterpart. As a result, one year into CAS implementation, the sector investment lending program was dropped, while the Bank’s PAL program and associated AAA were proceeding as planned and achieving objectives. 116. Dialogue over the CAS investment lending program was difficult. As noted earlier, the Government wanted a much higher share of adjustment lending than was acceptable to Bank management due to IBRD exposure considerations. In addition, for political reasons there was a lack of consensus within the Government, especially between the Ministry of Finance and the Ministry of Agriculture, regarding the Bank program in the agriculture and rural sectors. One month after the Board discussion of the CAS in mid-2002, the Minister of Agriculture asked that the Rural Finance loan be replaced with a Rural Development loan. The Bank agreed to this change and undertook a Rural Development Assessment to underpin the loan. Early in preparation, the Bank proposed several options, including an innovative sector-wide approach (SWAP) to facilitate the Government’s accessing SAPARD funds by financing the needed counterpart 28 Although the FY02 PEIR and FY02 Poverty Assessment were disseminatedvery effectively (including through the inclusion o f the Poverty Assessment in OPCPD’s Bankwide information disclosure pilot) several months after the FY03-FY05 CAS was launched, their impact i s not assessed in this report because they were in the previous CAS program and were prepared and delivered to the Government during the previous CAS period.


Annex C Page 38 of 46 funding. The Government opted for a SWAP with the possible inclusion of a component focused on building capacity of micro-finance institutions in rural areas. Preparation continued until mid2004, a turning point in the CAS program dialogue. (See para. 124.)

1 17. Early in the CAS period, portfolio performance was a cause of concern. Six portfolio reviews were conducted during FY03-FY05. Continuing the semi-annual Joint Portfolio Review (JPR) cycle o f the previous CAS period, a mid-year JPR was done in the fall of 2002, followed by a full JPR in the spring of 2003, and another mid-year JPR in the fall of 2003. Following an agreement to shift to quarterly portfolio monitoring, additional reviews were done in the spring and summer of 2004, and a limited portfolio review was completed in October 2004. The Mid-Year Joint Portfolio Review (JPR) in October 2002 concluded that while portfolio management had improved in some respects (e.g., better alignment of projects with Government priorities and strengthened coordination by the Council of Ministers’ Directorate for EU Integration and Relations with the IFIs as well as by the IF1 Department o f the Ministry of Finance), a number o f problems cited in the February 2002 JPR remained. These included slow decision-making processes resulting from coordination problems and, in some instances, insufficient buy-in and disconnect between policy oversight and implementation. The resulting delays were reflected in slow disbursements. The 2002 Mid-Year JPR Report recommended that the Bank and Government jointly establish an outcome-based monitoring mechanism and capacity to ,ensure alignment of current and planned projects with the Government’s reform program and the Bank’s CAS. The report’s findings were discussed with the Council of Ministers’ Directorate for EU Integration and Relations with the IFIs, with the Council for Structural Policy, and with the Council of Ministers. Project oversight was intensified, with monthly meetings by the Council of Ministers with Project ImplementationUnits (PIUS). 118. Despite efforts by the Bank and the Government to improve portfolio performance, the pace of project implementation slowed further. The JPR Report of March 2003 cited continuation o f the problems cited a year earlier, as well as issues with capacity and continuity in project management, budget planning to ensure sufficient allocations for counterpart funding of project implementation, and partner coordination on multi-partner projects. By end-FY03 the disbursement ratio had declined to 15.2 percent. (See Table IO.) Specific actions were agreed for improving implementationof individual projects, and plans were put in place to address the generic portfolio issues, including through the establishment of outcome-based monitoring systems at the project level. Table 10: Bulgaria’s Investment Loan Portfolio Indicators C CASPeriod

O f which problem

Commitments at risk (US$M) Of which problem

1 1 181.1

189.3

Ratio o f diskursements during the year;o o f the year (investment loans only). b’

9

,,,, the undisbursed balance o f the Bank’s portfolio at the beginning


Annex C Page 39 of 46 119. The Bank’s Mid-Year Portfolio Review of October 2003 called for the Government to address continued poor portfolio performance. The review found that the generic issues flagged in previous portfolio reviews continuedto persist, with the result that nearly all active projects were experiencing implementationdelays, some by as much as two years. At any given time during the CAS period, one or two of four projects2’, out of an investment portfolio of eight to ten investment projects, were showing problems with implementation and/or achievement of development objectives. As a result, one or both of the portfolio performance triggers for the CAS base case was not met during the first two of the three FYs of the CAS. (Bank management decided to waive these triggers in view of Bulgaria’s strong performance vis-a-vis the other 12 base case triggers, especially those for structural reforms supported by the PAL program.) I n December 2003, the Government responded that poor portfolio performance was 120. largely due to problems with the Bank’s procedures during preparation and implementation. They believed that (i)a number of investment loans were no longer in line with current government priorities due to long preparation periods and insufficient flexibility in investment project design compared with the PAL instrument (Le., benchmarks for successor PALSmay be changed prior to their approval at the Board, and procurement rules do not apply because funds are for budget support); and (ii)implementation periods were unrealistic, given the time required for Bank approval of procurement procedures and the time required for civil works. Actively working to reduce Bulgaria’s debt, the Government noted that implementation delays were costly due to the additional commitment fees. They also criticized the Bank’s PIU model for not building sustainable project management capacity and called for a review of the structure of Bank assistance to Bulgaria, including consideration of approaches involving budget support and implementation arrangements aimed at building sustainable capacity. While acknowledging some serious management errors on its part, the Government considered the objectives of the Education Modernization loan too ambitious and complex and called for its cancellation, and for pursuing the sector policy dialogue through the ongoing PAL program.

121. I n response to the Government’s observations, the Bank agreed to cancel the Education Modernization loan. The ICR and IEG’s ICR Review concurred in their unsatisfactory ratings of this project. While design and preparation were considered satisfactory, this was quickly overtaken by unsatisfactory supervision (infrequent supervision and frequent turnover in the Bank’s Team Leader), combined with lack of Government ownership, weak capacity, high turnover in project management, and ineffective oversight. After three and a half years of implementation, the loan was closed with two-thirds of the loan amount cancelled. (See para. 70.) 122. Also in response to the Government’s feedback, the Bank committed to some key actions to be jointly monitored and reviewed on a quarterly basis: (i)closely monitor potential problem projects in the portfolio, (ii)develop disbursement targets for March and June 2004 and monitor progress on a monthly basis, (iii)monitor turnaround times on procurement decisionmaking and approvals by both the Government and the Bank, (iv) include in the planned Country Procurement Assessment Review (CPAR) recommendations for enhancing procurement capacity in support of the Bank’s lending program, (v) reduce reliance on freestandingPIUs, and (vi) review proposals for future Bank-financed projects with simplified implementation, accelerated disbursement profiles (including through the use of SWAPS), and leverage of other resources, including EU grant funds.

29 Registration and Cadastre, Health Sector Reform, Education Modernization ( lstphase APL), and Wetlands Restoration and Pollution Reduction (GEF).


Annex C Page 40 of 46

123.

I t was about this time that the Government asked the Bank to convert the Community Services loan shown in the CAS to a Roads loan. Initial dialogue over this issue was complicated for several reasons. One was that Bank management wanted to retain PHRD grant eligibility (which i s limited to loans included in CAS programs), and so was prepared to reorient the loan to a Community (Secondary) Roads project aimed at rehabilitation and maintenance for low-income communities. The Government wanted to consider other options as well, including investment to enhance i t s motonvay network in anticipation of increased traffic associated with EU accession. Yet a Motonvays Study prepared by the Bank at the Government’s request concluded that traffic volume would not be high enough to generate a minimum satisfactory economic internal rate of return, and the Government challenged the underlying assumptions of the analysis. Soon after these issues came to light, the Bank proposed a SWAP for this operation as well. The Bank’s proposing fast-disbursing SWAP’S for both the Rural Development and Community Services loans was an effort to respond to the Government’s feedback in December 2003 that Bank-financed projects needed to be prepared and implemented more quickly, with greater flexibility and less complexity. Toward the end of the CAS period, the Bank prepared a Policy Note on Road Investment Financing Options (FYOS), which will inform Bank support in the roads sector under the new CPS.

124. Four loans were dropped from the pipeline in 2004. A second phase APL in the education sector was dropped in March, once the first phase loan was cancelled at the Government’s request due to poor performance. (See paras. 120-121.) The proposed Forestry loan with an accompanying GEF grant was fully prepared and negotiated, when it was dropped in May due to political constraints (stemming from vested interests) to institutional reforms supported by the proposed loan. Preparationof the Rural Development and Community Services loans was well advanced with support from PHRD grants when in June, without prior notice to the Bank, the Government decided not to approve state borrowing for either project. The loans were eventually dropped, and the unused portion (US$969,300) of the two associated approved PHRD grants (one of which was not yet signed) totaling US$1.34 million was never disbursed. The Government’s decision was the outcome of its making trade-offs, in light of debt management considerations, among state loans and guarantees for various public investment priorities, including these two Bank loans and funding of politically more important projects (e.g., Belene nuclear power project). In the end, two state guarantees were granted, one for construction of the Calafat Bridge to Romania and the other for the Belene nuclear plant. Political considerations underpinned this decision. By end-FY04 the disbursement ratio for Bulgaria had fallen to an all-time low of 9.7 percent. 125. With five partially prepared projects (four IBRD and one GEF) dropping out of the lending program, the Bank incurred U S $ l million in “drop costs.” In the end, the Government declined any investment lending after the first year of CAS implementation, only three investment loans were delivered (vs. seven planned), and actual investment commitments were only 39 percent (US$I 18.4 million) of the planned base case volume (US$300 million) and 22 percent of total actual lending. The resulting 78 percent share of adjustment lending exceeded the 60 percent ceiling Bank management had set due to exposure concerns during CAS discussions. However, Bulgaria’s active debt management program, particularly i t s buy-back of Brady bonds, strengthened Bulgaria’s IBRD exposure indicators, such that in retrospect a 78 percent share o f adjustment lending might have been more acceptable. (See Table 11.) At the same time that the investment lending pipeline was drying up one year into the CAS period, the investment portfolio continuedto be a cause for concern.


Annex C Page 41 of 46 Table 11: Bulgaria’s IBRD Exposure Indicators IBRD Debt ServicePublic & Publicly Guaranteed

I

2002

I

2003

I

2004

I

2005

126. I n August 2004 (ten months before national elections) a joint high-level meeting was held in Plovdiv to discuss Bulgaria’s future engagement with the Bank. A number of strategic directions emerged from the discussions: (i)while Bulgaria no longer has an external financing gap requiring Bank financing, Bank funds can play a usefbl role in debt management by substituting for more costly sources of financing; (ii)the Government will continue to value the Bank’s advice on the next generation o f reforms to accelerate growth and competitiveness, ensure a seamless entry into the EU, reduce poverty and regional disparities, and deepen reforms in key sectors such as education and health; (iii)the PAL instrument i s highly valued, but future reforms may be best supported through single-pillar DPLs; (iv) there i s a critical need to support capacity building to improve management of Bulgaria’s investment programs and improve absorption o f EU funds by harmonizing Bank support with Bulgaria’s increasingly EU-oriented procurement and financial management systems; (v) future investment loans need to focus on systemic solutions and as part of a unified budget, move towards programmatic budget support, with shorter implementation periods and cofinancing of SWAp’s by the Bank, EU, EBRD, and EIB; and (vi) Bank should collaborate with IFC and MIGA to facilitate public-private partnerships.

127. To address the persistent portfolio problems, the Bank hired a retired Bank staff member from the ECA Region’s Quality Unit to undertake a review of projects at risk of not achieving their development objectives by their closing dates. The review, conducted in September 2004, was to consider cancellation o f any project components that could not be completed within one year after closing dates. The resulting report presented several options for each project at risk. The first option in each instance was to close the loan as scheduled and cancel the undisbursed proceeds, while the alternative options involved closing date extensions and some changes in approach, in some instances through restructuring. When faced with the option of cancelling, however, the Government opted not to do so (perhaps in light of elections less than a year away) but to restructure the projects. Most of them subsequently demonstrated improved implementation performance and focus on achieving development objectives, and some even managed to make up for earlier delays. Through joint efforts and intensive monthly monitoring of disbursements and implementation on a project-by-project basis, the average disbursement ratio nearly tripled in one year to 27.9 percent in FY05. 128. Two of the projects at risk were the Health Sector Reform loan and the Registration and Cadastre loan. The Health Sector Reform loan had a slow start due to delays in health sector reforms and consequently was rated unsatisfactory in meeting its development objectives during i t s early years. Although a QAG Assessment found project quality at entry satisfactory, the pace of sector reform slowed considerably, particularly in the area of hospital restructuring. The loan was restructured at the end of the CAS period to strengthen complementarity with health sector reforms under PAL I11 by increasing financing of investments in hospital reform and the information system of the National Health Insurance Fund (NHIF). The Registration and Cadastre loan was problematic from the start more than four years ago and suffered from significant implementation


Annex C Page 42 of 46 delays. A threat of suspension was lifted shortly before the time of this writing, after the new Government implemented actions that had been outstanding for several years and which would allow more rapid coverage of the country with the cadastre map and property register. In retrospect, the Bank should have issued a threat to suspend much earlier. In unsatisfactory status for nearly two years, this project i s now being restructured. Although a QAG Assessment found i t s quality at entry to be satisfactory, it appears that the project design, which requires cooperation among three ministries and several agencies, was too ambitious for the available administrative capacity and, as it turned out, not supported by the Government that had been elected just four days before the loan was approved by the Bank’s Board. 129. I n sum, the Bank’s country dialogue met with varied results, The results were better on issues relating to structural reforms and analytical work for which the Ministry of Finance was the primary counterpart. The Bank’s dialogue on issues where the line ministries were the main counterpart was more problematic, as evidenced by the erosion of the sector investment lending pipeline after the first year of CAS implementation. This disparity was due to fractious coalition dynamics within the Government, weaker capacity in a number o f line ministries, and despite energetic efforts by the Bank to strengthen the dialogue in mid-2004, the effect of the looming June 2005 elections. C.

CAS Consultation Process

130. I t was expected that the CAS would be completed shortly after the June 2001 elections. It was to serve as a roadmap for the Bank’s engagement with the new government over the next three fiscal years. The previous CAS had covered FY99-FYO1. 131. I n early 2001 members o f the Bank’s Country Team held CAS consultations through a series of nine “town meetings” across Bulgaria at which a draft o f the CAS was discussed. In all, there were more than 500 participants from local administrations, NGOs, the private sector, business associations, civic groups, and the Bulgaria offices of development partners. Discussions were also held with the European Commission in Brussels, to coordinate assistance to be provided in support of Bulgaria’s progress toward full compliance with the requirements of the acquis communautaire. To broaden the consultation process further, the draft CAS was posted on the Bank’s Bulgaria website. This generated a good deal o f interest, as more than 2,500 individuals and organizations visited the Bulgaria CAS website.

132. Feedback during CAS consultations showed broad consensus with the Bank on needs and how to address them. Priority areas identified were decentralization, municipal finance, unemployment, HIV/AIDS, social safety net, SME development, rural development, water quality, earthquake preparedness, and restructuring of the coal, district heating, and railway sectors. However, stakeholders generally did not share the Bank’s views on needed reforms in the education and health sectors for cost effectiveness. They also did not share the Bank’s view that having supported a policy tkamework for efficient investment in the transport and water sectors, the Bank should leave financing of such investments to EBRD and EIB, consistent with their institutional mandates. 133. The Bank made some revisions to the CAS to take account of the public consultations, and the revised draft was the basis for high-level discussions with the newly formed Government. There was basic agreement between the Bank and the Government on the country’s priorities. There was also agreement on the Bank’s comparative advantage in support for urgent reform measures and public sector programs aimed at private sector development and improved social service delivery. This support would take the form o f the PAL program in the FY03-FY05 CAS.


Annex C Page 43 of 46

134. For a number of reasons, it was another year before the next CAS went to the Board. First, it took the newly formed, somewhat fractious coalition Government some months to organize itself and engage with its partners. Second, given the urgency of the EU agenda, the Government was focusing initially on its relationship with the EU and EC. Third, following the successful completion of a Stand-By Arrangement by the previous Government in June 2001, the new Minister of Finance was keen to build on Bulgaria’s progress since the financial crisis o f 19961997 and so focused on developing the next SBA program with the IMF. The Bank collaborated with the Government and the IMF in these discussions, which led to complementarity between the SBA and CAS programs (specifically the PAL program) and the structural reforms they supported. (See Attachment G.) The next SBA began in February 2002, and finalization of the next CAS followed several months thereafter. But in hindsight, launching CAS preparation and consultations prior to the June 2001 elections was probably premature and may have weakened the new Government’s ownership of the CAS program.

D.

Client Survey

135. A Client Survey was conducted in June 2005 as input to the preparation of the CPS. The exercise consisted of a quantitative survey of stakeholders, to which there were 300 respondents (84 percent response rate), and in-depth interviews with 32 public officials experienced in working with the Bank and four focus groups on major themes o f Bank involvement (economic reform, education, health, and infrastructure). Respondents to the quantitative survey included high-level government officials, Parliamentarians, local government officials, multilateral and bilateral development partners, private sector organizations, NGOs, the media, academia, think-tanks, trade unions, the judiciary, and employees in ministries, departments, and agencies. (See Attachment I.) 136. Most respondents to the quantitative survey felt that the Bank should focus on economic growth and jobs, followed by infrastructure development, education, poverty reduction, and health sector issues. They ranked the Bank’s involvement in these areas higher than in EU integration, even though effective EU integration was viewed by stakeholders as Bulgaria’s top development priority The feedback appears to prefer the Bank’s involvement in basic development areas, rather than EU integration per se. At the same time, it was felt that the Bank should adjust its policies with the EU integration needs of the country. Interestingly, the Bank’s financial resources were seen as the Bank’s greatest value, followed by i t s policy and economic advice, and ability to build implementation capacity. Disregard for country realities and bureaucratic operational policies and procedures were cited as the Bank’s greatest weaknesses.

.

137. At the same time, perceptions of Bank effectiveness were not always aligned with perceived priorities for future Bank involvement. The survey showed wider “impact gaps” in areas such as strengtheningthe health and education sectors. These impressions may be linked to the fairly well publicized implementation problems of the Bank-financed investment projects in these sectors. While respondents ranked poverty reduction very high as a development priority, the rating o f the Bank’s positive impact on poverty reduction was quite low. The lack of timely and comparable poverty data may be a factor in this perception. Similarly, while stakeholders identified greater transparency in governance and strengthening of the judicial system as critical to EU integration, they did not see much positive impact in these areas on the part of the Bank. This implies that if the Government wants the Bank’s assistance in these areas, more effective dissemination and communication could play an important role in increasing development impact. This i s in line with the findings o f the QAG Country AAA Assessment.

138. The qualitative survey respondents stressed the importance of the Bank’s involvement beyond EU accession and identified a number o f recommendations for


Annex C Page 44 o f 46 enhancing the Bank’s relevance in the future. These included: (i)a client relationship characterized by more partnership and dialogue that takes into account the views o f the Government, including on the need to address the social costs of structural reforms; (ii)Bank support in the priority areas of education, healthcare, infrastructure investments, and strengthening of institutional and administrative capacity; and (iii) joint EU/Bank financing.

VI. A.

CONCLUSIONS

Role of CAS in Progress Toward Country Goal

139. The additionality of the CAS program i s an important consideration in assessing its impact on the achievement of Bulgaria’s goal o f moving closer to EU accession by sustaining economic growth, reducing poverty, and creating employment. One could argue that the Government would have undertaken many o f the IBRD-supported reforms and investments in any event, because they were aligned with Bulgaria’s EU accession agenda and because IBRD financing was not that important with the upgrading o f Bulgaria’s risk rating and the Government’s resulting enhanced access to capital markets. However, the consensus among consulted stakeholders, including government counterparts, on this question was that the Bank lent credibility to Bulgaria’s reform program and therefore played a direct role in the risk rating upgrade, and the PAL program in particular provided useful external pressure for politically difficult reforms, as well as an effective framework for mobilizing support and coordinating and monitoring implementation of multi-sector reform for EU accession across a coalition government. The CAS program also provided support for reforms in areas the specifics of which were not covered by the EU acquis, such as public administration, education, health, and labor market reform. W h i l e the Bank’s international experience in public administration reform was highly appreciated by the client, the Bank’s support in the latter three areas was not sufficiently effective. This underscores the linkage between pressure from the EU and government commitment to reform. Where EU ’ attention was relatively low, the Government’s appetite for reform was generally low as well. 140. With so much accomplished with Bank support through the PALS and AAA, one could ask whether the sector investment lending program envisioned in the CAS but for the most part subsequently dropped, was actually necessary. If the Rural Development Project were now underway, more pre-accession grant funds would have been channeled to low-income areas than has been the case to date. Education sector reforms for enhanced labor market competitiveness, a major priority in the new CPS, would be more advanced, had the education SILs been implemented. The IBRD and GEF Forestry operations would have increased the contribution of the forestry sector to Bulgaria’s GDP while enhancing sustainability through improved conservation in forest management. Overall, however, implementation o f the FY03-FY05 CAS likely served to accelerate the pace of reform implementation and Bulgaria’s associated progress toward EU accession. B.

Lessons Learned and Implicationsfor New CPS

141. A number o f lessons emerge from the Bank’s experience during implementationo f the last CAS, with implications for both design and implementation o f the next CAS. 142. First, the Bank should ensure a partnership-oriented relationship with Bulgaria, given that it i s a well-performing M I C with an investment grade credit rating and therefore access to alternative sources o f financing. The Bank has already signaled this change by calling the next CAS a Country Partnership Strategy. Partnership will call for the Bank’s working to find ways to deliver requested services in a timely manner. In keeping with the need for responsiveness to client demand, the Bank should engage in new investment lending only if it has strong client


Annex C Page 45 o f 46 demand - at the highest levels within the Government and with a high-level “champion” in the relevant line ministry - and meets the client’s expectations for design focus, shortened preparation and implementation time, management by line ministry staff, and use o f country systems. Care will need to be taken in addressing the fiduciary aspects o f any SWAPSto ensure that they do not result in the very delays that they are intended to avoid. It will also be important to prepare a Bulgaria CPS Progress Report in FY08 or FY09 to facilitate needed adjustments to the Bank’s partnership program in light o f changing circumstances.

143. Second, timely monitoring mechanisms with time series comparability need to be included in a CPS program to ensure rigorous measurement of progress toward CPS outcomes at the end o f the CPS period. T h i s will also apply to a future series of DPL operations. Methodology, timing, and responsibility should be explicitly agreed between the Government and the Bank at the beginning of the CPS program, since a good deal o f lead-time for preparation i s required. 144. Third, successful implementation of a multi-sector reform program requires an effective, sustained, coordination mechanism with a high-level champion in the Government. This will be important to carry forward from the PAL program to a DPL program focused on education and health, to ensure coordination with those two ministries as well as other agencies and stakeholders. 145.

Fourth, swifter action i s needed to address implementation issues with the existing investment loan portfolio as they arise. One o f the reasons for the success o f the PAL program was that accommodation for adjustment over time was built into its design from the outset. When project implementation runs into problems, the Bank team should be more proactive earlier. In addition to the restructuring option, teams should seriously consider issuing a threat to suspend disbursements if a loan has been in unsatisfactory status for more than 9-12 months. Portfolio performance triggers are not appropriate in a well-performing MIC CPS, and although there i s no indication this was the case with Bulgaria, could potentially create incentives for Bank staff to inflate project supervision ratings.

146. Fifth, several “do’s and don’t’s’’ have emerged regarding the architecture o f a programmatic development policy matrix: (i)by backloading Bulgaria’s human development agenda within the PAL program, the Bank and the Government postponed much needed reforms, the delay of which has cost Bulgaria time in terms o f i t s readiness for successful EU integration; (ii)if offsetting changes (“trades”) are made between triggers and benchmarks in light o f unforeseen realities as a DPL program evolves, the actions in play should be o f comparable political “weight” within the same pillar, in order to ensure sustained reform momentum across the full reform agenda (accordingly, the new CPS will need to give high priority to development policy lending (DPL) instruments to support overdue education, health, and labor market reforms not adequately addressed in the PAL program); (iii)the sequencing of benchmarks should be designed with the borrower’s political economy in mind (e.g., there i s typically more scope for bolder reform earlier rather than later during a government’s tenure); (iv) a key outcome for the CPS and the DPL instrument should be an increase in the labor force participation rate; and (v) any benchmarks relating to privatization should not be defined in terms of transaction outcomes, but rather, execution o f an appropriate, transparent process - beyond which market forces, and not policybased loan benchmarks, should dictate. 147. Sixth, investment project design should be commensurate with government commitment, the enabling sectoral policy environment, and the administrative capacity o f the implementing unit, and every effort should be made to mainstream project implementation


Annex C Page 46 of 46 functions within line ministries and agencies. This should help to build sustainable capacity, urgently needed by Bulgaria in this critical pre- and post-accession period.

148. Seventh, the AAA program should be aligned with Government and CAS priorities and as experience and feedback from stakeholders and QAG have indicated, dissemination should be built into the design of the Bank’s AAA instruments. Indeed, dissemination should be considered a standard phase of AAA service delivery, much in the same way as preparation and supervision for lending instruments, and this will require budget planning at an early stage. And analytical and advisory services should be strategically sequenced, to inform lending. Programmatic AAA should be considered for the new CPS to keep the Bank’s advice focused, timely, and relevant. 149. And finally, the Bank’s support to Bulgaria during the new CPS period should emphasize the Bank’s role as “the Knowledge Bank” and draw on the experience of the EU8, the EU25, and Part I countries elsewhere. The last CAS and the Government Program it supported identified desired outcomes in terms of the evolution o f Bulgaria’s continued progress since Bulgaria’s financial crisis of 1996-1997. To ensure strategic relevance going forward, the Bank’s investment lending pipeline will need to focus on issues more specific to Bulgaria’s eventual EU integration and convergence. Some of the new CPS outcomes should therefore be defined in terms of Bulgaria’s relative performance vis-a-vis that o f other countries. The Bank’s knowledge o f EU NMS experience has grown in recent years and according to the Client Survey i s perceived to be a significant share o f its value added, so the Bank i s well positioned to make a contribution in this regard.


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Annex C - Attachment C BULGARIA - Planned Analytical and Adviswy Services and Actual Deliveries CAS PLANS (May 31,2002)

FY 2003

Product Pension Reform Note Environmental Sequencing Study’ National Energy Efficiency Study Service and Fiscal Decentralization Note’ Country Financial Accountability Assessment

I

COMPLETION REPORT (April 24,2006)

Completed in FY04 Comdeted in FY04 Actual Actual Actual

Status

I

I

Completion advancedfiom FY04: IDF for Integration o f Ethnic Minorities Completion advanced9om FY05: Energy TA for EU Accession

I

I

Additional Actual Products: Infrastructure and Energy Strategy Review Telecom Regulator Capacity Enhancement TA PPIAF - New Gas DistributionNetworks Financial Sector Assessment Paper Follow-Up TA Public Debt TA Sofia Citv DeveloDment Stratem ROSC Accounting and Auditing Assessment Completed in FY06 Actual Replaced by FY03 Infrastructureand Energy Strategy Review See FY03 above

2004

I

CEM Update - Fiscal Impact o f EU Accession’ Private Sector Assessment TA Transport Strategy Paper

I IDF: Integrationo f Ethnic Minorities

I

I

I

Gender, Age and Ethnicity Assessment Agriculture Sector Note

2005

Energy TA for E U Accession

r

I

Additional Actual Products: Countrv Procurement Assessment ReDort Survey on Rural Development Needs Financing for Water and Wastewater Sector Motonvays Study TA Cities o f Chanee v JSDF: Child Development in Disadvantaged Communities Dropped Replaced by FY04 Rural Development Assessment See FY03 above

Additional Actual Products: Greening Assigned Amount Units (Hot Air) Study Road Investment Financing Options Policy Note -~ Water Workshop TA PPIAF: Establishment of Water Regulator ‘Product title changed to Environmental Sequencing Strategies for X.J Accession. Product title changed to Issues in Intergovernmental Relations. Product title changed to CEM - Policies for Growth. ~

I

I


Annex C - Attachment D

Projects from Earlier CAS’Sin FY03-FYOS Portfolio

IBRD

Pilot Water Companies Restructuring and Modernization Environmental and Privatization Support Adjustment Education Modernization APL I Trade and Transport Facilitation in South East Ongoing: Wetlands Restoration and Pollution Reduction

Amount

Approval Date

Closing Date

December 3 1,2002

s US$98.0 million, o f which US$46.8 million cancelled

May 26, 1994

US$50.0 million equivalent

February 24, 2000

US$l4.4 million equivalent, September 5,2000 o f which US$9.7 million e uivalent cancelled US$7.4 million equivalent May 25,2000

US$7.5 million

June 13,2002

December 3 1,2002

December 3 1,2003

---P March 3 1,2004

September 30, 2005

March 15,2008


Annex C - Attachment E

Instrument Linkages to CAS Outcomes and EU Accession Agenda CAS Outcomes

Per capita national income growth

Reduced poverty rate

Reduced total and longterm unemployment

EU Accession Agenda e Improve energy efficiency and promote use o f renewable energy resources e Accelerate restructuring and privatization o f SOEs e Simplify market entry procedures e Improve efficiency o f bankruptcy procedures e Increase efficiency o f railways and reduce subsidies e Liberalize telecommunications market e Mitigate environmental risks e Establish legislative framework for ensuring competition and functioning markets and financial sector e Reduce corruption e Improve efficiency, effectiveness, and transparency o f judicial system 0 Increase infrastructure investments for wastewater, water supply, and waste management e Improve efficiency and coverage o f social assistance programs e Social inclusion, including o f ethnic minorities

CAS Instruments e e e e

e 0

e e

e e e e e

P A L Program Pillar 1 P A L Program Pillar 2 P A L Program Pillar 3 P A L Program Pillar 4 Private Sector Assessment District Heating SIL Rural Finance SIL National Energy Efficiency Study Energy TA for EU Accession Transport Strategy Paper Environmental Sequencing Study Service and Fiscal Decentralization Note PublicPrivate Infrastructure Advisory Facility TA

P A L Program Pillar 5 Pension Reform Note e IDF for Integration o f Ethnic Minorities e JSDF for Child Development in Disadvantaged Communities e MunicipaVCommunity Social -Services S I L e P A L Program Pillar 5 e Education APL 2 e

e

Lisbon agenda: competitive, dynamic knowledge-based economy with more and better jobs Note: P A L Pillar 1: Sus lining structural reforms P A L Pillar 2: Establishing a market-friendly business environment P A L Pillar 3: Deepening the financial system P A L Pillar 4: Improving public sector governance P A L Pillar 5: Investing in human capital and strengthening social protection e


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Annex C - Attachment G Page 1 o f 2

Complementaritieso f PAL and SBA Programs PAL Program

REFORMS SUPPORTED BY:

Privatizationof Biochim Bank (PAL I) Privatizationof DZI (PAL I)

Stand-By Arrangement

Complete privatization of Biochim Bank (Feb. 2002 SBA) Issue a tender either to privatize the State Insurance Institute (DZI), or to transfer management of it to a strategic investor

Privatizationor liquidation o f agreed list of large SOEs (PAL II*/IIPrivatization I); or liquidation of 50% of remaining small SOEs (PAL 11); Privatization or liquidation of 80% of remaining small SOEs (PAL 111) *including Bulgartabac Energy Sector Restructuring: Enactment of amendments to Energy and Energy Efficiency Act (PAL I); Enactment o f energy legislation consistent with EU Electricity & Gas Directives (PAL 11) Implementation o f average price increase of 20% for household electricity prices in second half of 2002 and approval o f indicative timetable for their adjustment to cost-recovery levels (PAL I); Satisfactory implementation of the district heating component of the Energy Strategy approved by the Council of Ministers on May 11,2002 (PAL l/II/III Adoption ); o f additional regulations to support electricity market opening including pricing methodology for access to transmission, dispatch and other system services (PAL 11); Satisfactory implementation o f electricity tariff idjustment program (PAL II/III) Pillar IT: EsUblishlng a Mar Reducing Enhy Constraints and Regulatory Costs: Submissionto Parliament of a draft Law on 4dministrative Regulationand Administrative Control Jn Economic Activities (PAL I); Development by a #orking group of a plan for integrating the Bulstat, tax, ind social security registration of companies (PAL I); Znactment of the Law on Administrative Regulation and 4dministrative Control on Economic Activities (PAL I); Establishment of a comprehensive public registry of *egulatoryregimes (PAL 11); Introductionof one-stop :ompany registration at the Bulstat offices by integrating Zommercial Register with Bulstat Register (PAL 111)

?t-FriendlyBusiness Environment Submission to Parliament o f amendments to Companies Law, Civil Procedure Code, and any other legal instruments necessary to transfer business registrationto a nonjudicial administrative body and establish a unified national electronic register with limited judicial oversight and simplified administrative procedures (Aug. 2004 SBA)


Annex C - Attachment G Page 2 of 2

PAL Program Improving Business Service Delivery of Government OJ: Decision by Council of Ministers to establish National Revenue Agency (PAL I)Establishment ; of National Revenue Agency (PAL 11); Establishment of Unified Revenue Information System and Unified Corporate Information System (PAL 111)

Stand-By Arrangement 'a: Submit to Parliament draft law establishing unified revenue agency (Feb. 2002 SBA); Select I T system and Initiate pilot in town of Bourgas for National Revenue Agency (Feb. 2002 SBA); Parliamentary approval of agreed NRA procedural code (Aug. 2004 SBA); Acquisition of I T system for NRA (Aug. 2004 SBA)

Initiation of actions implementing Social Policy Strategy and Strategic Note on agreed Labor Market Reforms (PAL I); Development of a set of indicators on labor market flexibility and Active Labor Market Policy impact (PAL I); Submission to Parliament of agreed amendments to Labor Code (PAL 11); Enactment of amendments to Labor Code (PAL 111)

Adoption of decree that eliminates portability of seniority bonus and submission to Parliament of amendment to labor code that facilitates work outside regular hours (Aug. 2004 SBA)

Enactment of Bank Bankruptcy Law (PAL I)

Parliamentary adoption of Bank Bankruptcy Law (Feb. 2002 SBA)

Enactment o f Bank Bankruptcy Law (PAL I)

Parliamentary adoption of Bank Bankruptcy Law (Feb. 2002 SBA)

efficiency measures in the education system agreed with the Bank (PAL I); Implement agreed measures to improve efficiency of education resource use (PAL 11); Continue implementation of agreed measures to improve efficiencv of education resource use (PAL 111) Agreement among Ministry of Finance, Ministry of Health, and National Health Insurance Fund (NHIF) on long-term funding approach for hospital services (PAL I); Achievement of balanced operating budget for NHIF P A L 111

Finalize school and teacher redeployment plan and submit it to Council of Ministers (Feb. 2002 SBA)

Complete accreditation process for all hospitals for better targeting of NHIF spending (Feb. 2002 SBA)

Enactment of amendments to social insurance code setting out benefits indexation formula (including maximum and minimum benefits) and contribution rates (including timetable for establishing 50/50 split of employer/employee contributions and timetable for increasing second pillar contributions (PAL 111)

Adoption of law to base annual adjustment of pensions on 75% of increase in average CPI in previous year and 25% of increase in average insurable income in previous year (Aug. 2004 SBA)

lntroduce targeting o f child allowances (PAL I); Implementation of a plan to improve coverage and increase efficiency of social assistance programs (PAL [II)

Adopt a child allowance allocation system, limiting allowances to most needy families (Feb. 2002 SBA); Approval o f law authorizingNational Social Security Institute (NSSI) to have its own medical experts verifjdrecertify disability certifications (Aug. 2004 SBA)


Annex C - Attachment H

CAS Program Partnerships

Reforms Pillar 11: Establishing a MarketFriendly Business Environment

EBRD EC USAID

Pillar IV: Improving Public Sector Governance

EC DFID OECDEU USAID USAID

Pillar V: Investing in Human Capital and Strengthening Social Protection

Coll~botation Energy sector Energy sector Bankruptcy Business registration, labor market reform, commercial law Public administration reform, judicial reform

Public administrationreform Governance Governance Pensions, health, and education decentralization Child welfare Child -..._-welfare .. -_---

Collaboration

Switzerland EU

Child Welfare Reform

UK USAID

Social Investment and Employment Promotion Registration and Cadastre Wetlands Restoration and Pollution Reduction (GEF) Revenue Administration Reform

The Netherlands EU Austria EU

1 Water Companies Restructuring

I

The Netherlands

DFID EU EBRD

3istrict Heating

EBRD EU ~~

hade & Transport Facilitation in Southeast Europe 3nergy Efficiency

USAID USAID EU IMF Austria CIDA

Coordinated funding for reform activities Coordinated fimding for reform activities Closely coordinated parallel projects 2 JSDF grants support project subcomponents training TA provided within scope of JSDF Grant for Building Social Capital in Disadvantaged Communities US$2 million for project implementation PHARE finances one project component Financing of one sub-component Strong collaborationwith PHARE Program on capacity building o f National Revenue Agency (NRA) 2 Dutch grants, each EUR 2 million, directly supporting implementation of project activities Complementary support of human resource strategy development and implementation o f related project sub-component Coordinationand consultation, including during supervision Coordination and consultation, including during supervision Implements part o f project Consultancy support for procurement capacity building Consultant on private sector participation Quarterly coordination meetings; consultancy support Quarterly coordination meetings Quarterly coordination meetings Support for operation o f Energy Efficiency Fund Development of National Energy Efficiency Strategy


Annex C - Attachment I

Stakeholder Views on Bank’s Effectiveness

A quantitative survey was mailed to 357 stakeholders. Of the 300 respondents (84 percent), employees o f ministries, NGOs, and local government officials or staff accounted for 54 percent, while the private sector and the media accounted for another 23 percent. Bulgaria’s Priorities: Becoming an effective EU member was rated Bulgaria’s highest development priority, followed by reducing poverty, and improving Bulgaria’s investment climate and economic competitiveness. Priorities for World Bank Support: The top priorities for increased or continued Bank support were identified as economic growth and j o b creation, infrastructure, judicial reform, poverty reduction, education, health, and anti-corruption initiatives. World Bank’s Strengths and Weaknesses: Imposing solutions disregarding country realities and excessively bureaucratic operational policies and procedures were considered the Bank’s greatest weaknesses. On the other hand, the Bank received favorable ratings o f i t s effectiveness (particularly i t s technical competence and global knowledge), strategy recommendations, working relationships, and partner collaboration.

I Statement I The Bank i s effective in Bulgaria.

*

Strategies recommended by the Bank are sustainable. Overall Ilike to workhteract with Bank staff. The Bank collaborates with other partners, e.g., EU. 1 = very unfavorable, 10 = very favorable.

I I

Level of Agreement (Mean)* 6.34 6.59 7.29 6.83

I I

“Impact Gap:” Respondents said that in most areas the degree o f the Bank’s perceived impact in a given area was correlated with the area’s perceived relative importance. In seven areas, however, there was a pronounced gap (>1 .O), with the Bank’s impact lagging behind importance in each instance.

1 =not at all, 10 = very. Defined as difference between mean of ratings o f “Importance o f Bank Involvement” and mean o f ratings o f “Positive Impact o f Bank Involvement.”

b’

The World Bank's Strategy in Bulgaria: 2007-2009  

The World Bank's Strategy in Bulgaria: 2007-2009

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