Western Balkans and Europe 2020 - Supporting Convergence

and Growth

Jane Armitage, Country Director and Regional Coordinator for South East Europe

WORLD BANK

March 2011

Outline

Post-crisis macroeconomic framework Structural reforms for smart, sustainable, and

inclusive growth Competitiveness Governance and rule of law Social sectors

The World Bank’s engagement

2

Two years after the crisis started...

The legacy of the crisis continues though economies are slowly improving Growth collapsed but is recovering tentatively, especially through

growing export demand Private capital inflows fell sharply but very recently are beginning to

trend upwards and formerly unsustainable CADs have shrunk sharply Fiscal deficits spiked in most countries but have begun to moderate as

a result of a expenditure adjustments However, domestic demand remains weak and improvements in

employment and poverty reduction remain elusive

3

Growth rates declined sharply and GDP shrank in most countries but there is now a gradual return to growth…

4

The momentum of poverty reduction slowed considerably…

5

Fiscal consolidation needed for macro sustainability, but…

Ageing populations and increased longevity putting pressure on pension and health systems

Need for reformed social safety nets with improved targeting to alleviate budgetary pressures and reduce payroll tax disincentives for employment creation

Competitiveness requires greater access to higher education and improved quality at all levels

Major infrastructure improvements needed in environment of reduced private finance

6

I. Promoting Growth and Competitiveness

7

The Region is improving ranking on “Doing Business”, but key areas need attention…

Most difficult areas are construction licenses, property registration and contract enforcement

Reforms are not that difficult: FYR Macedonia climbed from being 94th in 2006 to 38th in 2011

8

Lack of infrastructure is a major bottleneck for businesses in the Western Balkans…

% of firms indicating transport is a major obstacle to doing business

% of indicating electricity is a major obstacle to doing business

Energy

9Source: Doing Business 2011

Lack of infrastructure cont’dIrrigation and Water Resources

Western Balkan countries have strong potential for agricultural production which is unrealized due largely to inadequate irrigation (most countries are net importers of food but could be net exporters with adequate irrigation)

Absence of River Basin Management Plans, inhibits balanced multi-purpose river use and leads to controversy (e.g. hydropower vs agriculture)

Major vulnerability to floods (e.g. Dec. 2010, 6 casualties) due to inadequate dike protection, lack of maintenance, no integrated planning, poor cost recovery

Going forward, climate change will continue to restrict areas that can produce rain- fed crops

Urban Water and Sanitation ServicesAlthough coverage is generally good in the Western Balkans, services are unreliable affecting growth in key high-potential and water intensive industries such as tourism and food processingWater and sanitation are generally publicly funded putting pressure on limited budgetary resources in many instancesLack of adequate policy framework – low tariffs, weak collection rates and non-revenue water-- inhibits private sector investment

10

Transport InfrastructureRoads: Total road network in the SEE countries covers over 100,000 kms of which core network is 6,000km Road quality remains poor despite investments in the SEETO ‘Core

Network’ All Western Balkan countries rank in the bottom half in a world economic forum

ranking of 139 countriesRail: Western Balkan countries are in the bottom half of rankings for quality of

rail infrastructure among 116 countries Serbia, Bosnia and Herzegovina, and Albania are among the bottom quarter

Port and inland waterways : The inland water transport network in SEE has been neglected for far too

long nearly no expenditure on Sava or Tisa since 1990

11

Better transport infrastructure is critical for Economic Development in the Western Balkans…

12

The small size of the Western Balkan countries, and their favorable location vis-à-vis the EU market, underline the importance of trade facilitation for growth and poverty reduction, but: Road infrastructure below European standards: raises costs of trade

Broader trade and logistics environment (transport services, border-crossings etc.) is also weaker than in EU-10 region

Overall objective for transport sector development is to reduce ‘economic distance’ to the main markets

A reduction in economic distance requires: improved physical infrastructure improvements in the institutional framework improved logistics multi-modal development strategy

Improving Transport: Priorities for Action

13

Address increasing demand for road transport through continued development of the SEETO core regional road network

Prioritize improved management of existing infrastructure through: better maintenance and establishment of professional management systems

Focus on enhancing logistic chains and clearance procedures to reduce delays to international transport

Revitalize the rail network through: rehabilitation of track to return line speeds to design speed, rolling stock rehabilitation rather than major upgrade in speed, further institutional reform.

Improve financing sustainability through: Efficiency improvements and increased cost recovery Effective partnership with the private sector Ensure environmental and social sustainability: Improve road safety Reducing disbenefits (air pollution, noise etc…) through appropriate pricing Include environmental social cost in determining mode choice

Energy use in the Western Balkans is massively inefficient and investment needs are huge…

SEE economies are characterized by high energy intensity and low energy efficiency: Conventional power generation structure, import dependent, and emerging

severe shortages; National market generally dominated by one state owned generator and is

subject to high losses (commercial and technical) Regulated tariffs cover costs but are generally low and insufficient to cover

cost of new investments Energy generation is dirty, heavily dependant on petroleum and coal

Meeting development and EU2020 goals will require Huge investments: 20-25 billion Euro over next 10 years Adoption of regional investment strategies Addition of new generation capacity and replacement of old plants Development of gas and renewable resources in conjunction with revamping

of tariffs structures 14

Energy (cont’d) Regional integration is critical for energy security but must overcome the

following challenge Lack of market price penetration to final consumers and no publicly available

and trusted “reference price” for electricity Close relationship between incumbent generator and incumbent supplier which

impedes open, competitive market Difference between regulated tariffs across countries are too low to allow market

based investments in generation Market participants, regulators, and authorities have little or no experience of

electricity market operation Perceived instability of energy policy constrains private involvement Strategic focus of Bank’s engagement in energy in the Western Balkans is Development of regional energy market (transmission, rehabilitation of

generation, dam-safety) Promotion of energy efficiency and renewable resources Improvement of energy supply and infrastructure (including new generation)

through PPP approaches Implementation of strategies for global and local environmental improvement

15

Western Balkan water and sanitation systems generate high water and financial losses…

16

Generally high water and sanitation coverage masks weaknesses aging infrastructure results in high physical lossesoutdated water pumps translate into high energy costs continuity of service dips as low as 8 hours per day in some countries wastewater treatment limited with negative externalities

Lack of operations & maintenance management & budgeting: accelerated depreciation of assets service disruptions

Utility financial performance is weak: high Non-Revenue Water & low collection rates overstaffing inability to attract private sector financing

Private sector participation low tariffs make concessions non-viable political interference undermines pricing weak regulatory oversight and enforcement

Water and Sanitation Sector: Priorities for Action

17

Update Water Sector Legislation and Regulations to align with EU Directives

Harmonize National Water and Sanitation Sector Strategies with EU Policies Link water supply distribution to water resource management goals Promote energy efficiency and water demand management

Initiate utility reform programs Consolidate utilities to achieve better economies of scale Institute utility performance contracts against realistic benchmarks Set performance standards for utilities Support utility staff training and certification programs

Devise subsidy programs that better target the poor: Wind down subsidies to poor performing utilities (perverse incentives) Target subsidies to the poor through social assistance programs Improve data collection and information systems: Empower regulatory oversight agencies to enforce reporting of sector data Standardize indicators and performance measurement Mainstream third-party verification of disclosed data

Despite tremendous potential, agricultural productivity is relatively low…

Agriculture represents 9-20% of GDP Half the population (and most of the poor) lives in rural areas Agriculture has enormous potential: abundant land and low-

cost labor, favorable climate, and proximity to EU Market Productivity is low: small farms, fragmented value chains,

poor logistics, inadequate infrastructure, and low skills Need for shift from subsistence producers to commercial farms Align policies to access

EU agriculture funds Prepare for climate change

18

Irrigation – Essential tool to generate income and jobs…

Agriculture is 12-25% of countries’ GDP and 20-50% of jobs -- given major un- and under-employment it is critical to maintain agricultural employment

Climatic conditions impose use of irrigation and drainage to produce marketable valuable crops (vegetables, fruits, grapes, oil seed crops, etc.) Climate will become drier and warmer limits rain-fed agriculture, expands need

for irrigation Investment needs in rural infrastructure amount to €5-6 billion. Most irrigation systems out of operation or vandalized, many drains not

maintained. Most countries now prioritize modern agriculture including irrigation and drainage; plus bulk water supply (reservoirs, groundwater).

World Bank focus in Agriculture/Rural Water: Institutional reform: (1) establish Water User Associations, (2) ensure market

access for agriculture products, (3) realistic water fee to be paid by farmers, (4) partnership with local govt.

O&M costs plus on-farm equipment to be paid by farmers, but “public good” investment in main reservoir, pump, piping, for the moment from national budget

Combine irrigation, drainage, water storage, in river basin management

19

Improving water use and mitigating impacts of climate change… Climate change has contributed to increasing frequency and severity of floods

throughout the Western Balkans Flood protection infrastructure is inadequate and poorly maintained Water management will be more critical over next 2 decades as Western Balkans

become subject to more intense but less frequent rainfall Households and businesses need protection from the high cost of flood damage Key emphases of World Bank strategy: Provision of affordable insurance against losses from flooding and other catastrophic

risks (Western Balkan Catastrophe Risk Insurance Fund) Early warning system, river flow forecasting, improve hydromet data system Localized emergency reconstruction and relief Better integrated planning of structural and non-structural measures, including

recreation of floodplains Securing the supply of bulk water, including dams and reservoirs bulk water canals,

pumping stations Support river basin management in line with EU Water Framework Directive,

including analysis of trade-offs between environment, hydropower, other uses

20

II Governance: Governments are by and large gradually becoming more

efficient, effective and transparent

21

EU Accession is Driving Clear Governance Improvements in the Western Balkans

Western Balkans have made clear progress in key governance indicators in recent years

But still lag the EU10 and Turkey in terms of governance quality

Rule of law and control of corruption are the weakest aspects of governance

Qualifying for decentralized management of IPA funds is a key driver of PFM reform

22

The rule of law has improved, but lags EU-10, Croatia, and Turkey

Rule of Law (WBI Indicators, 2009)

23

WBI Rule of Law (percentile rank)

Corruption in Courts is Down…

24

BEEPS 2005-2008: % of firms saying that bribes in dealing with the courts are frequent

Progress in government effectiveness is slow and uneven

Government effectiveness WBI Indicators, 2009

25

WBI Government Effectiveness (percentile rank)

The Western Balkans have seen a sharp drop in bribe incidence, but still fare worse than the EU-10

BEEPS 2005-2008: The % of firms reporting that bribes are frequent has dropped sharply

26

Public Financial Management and Procurement Systems are improving gradually, but reforms still needed…

PEFA assessments show that PFM systems are now more efficient, effective, and accountable

PFM reforms have improved budget planning, allocation, implementation and review

Procurement capacity is still weak and corruption is a concern

EU acquis and certification requirements for decentralized management of IPA funds (PIFC standards) are very strong incentives

27

III. Social Spending Challenging Balancing Act: Improving

Social Protection, Education and Health w/tight budgets

28

Social & Financial Sustainability

Pensions: Demographic => Fiscal Crisis

29

Population Structure in 2005 Population Structure in 2050

Aging population

(Doubling by 2050)

Shrinking Workforce

(Fewer contributors)

Rising PensionDeficits+ =

How Can Countries Prepare for the Demographic Crisis?

Raise retirement ages, particularly for women

Reduce early retirement exemptions

Index pensions to inflation only

Start preparing for elderly without pension rights

30

Social Safety Nets: Increasing Needs with Tighter Budgets

Dual challenge Higher unemployment + poverty => increasing needs. Tighter budgets given fiscal situation

Reform priorities: Focus limited spending on the most “needy” Shift away from “rights-based” benefits that largely go

to the non-poor (e.g., war veterans benefits in BiH, Croatia, Kosovo)

Strengthen targeting (adopting means-testing) Eliminate filters which cause disincentives to work and

exclude working poor

31

Education Sector Challenges

School rationalization: demographic shifts have left too many schools, with too many staff

Improve quality and increase participation in international standard testing

Increase access to poor and minorities (e.g.Roma) Skills mismatch with labor market needs For higher education: pursue sub-regional

approach to quality assurance, links to businesses, compliance with Bologna Process, and cost recovery

32

Health Sector Challenges and Reforms Challenges

Cost pressures due to structural trends (e.g. technology, pharmaceuticals)—plus high rate of exemptions exacerbate mismatch between benefits and revenues

Health Insurance Funds lack capacity to allocate resources efficiently Informal Out-of-Pocket expenditures are increasing (impact on poverty)

Reform priorities: enhance efficiency and equity in a fiscally constrained environment Define Benefits Package, using evidence-based decision making in

selecting interventions Link Payment to Performance Rationalize Infrastructure shifting resources to primary care Strengthen Institutional Capacity Tackle structural Cost Pressures (e.g. revising pharmaceutical pricing and

reimbursement policies)

33

World Bank Engagement In Western Balkans

34

The World Bank Group is Active in the Region

Over 20 years experience in the Western Balkans

Total Lending 1995-2010 US$7.3 billion

Pipeline of projects FY11-14 US$2.5 billion

Our work reinforces and supports the EU accession process

Significant country presence and sectoral knowledge

35

Total Lending 1995-2010 – US$ 7.3 billion

World Bank Lending to Western Balkans

36Does not include IFC lending

Pipeline of projects – FY 11-14 (US$ 2.5 billion)

World Bank Lending to Western Balkans

37Does not include IFC lending

Analytical and Advisory Assistance (AAA) AAA , including non-lending technical assistance (NLTA), is central to World

Bank program; AAA services to Western Balkans average USD 3-5 million annually;

US$46 million provided since FY2000;

38Does not include IFC AAA

Country Specific and Regional AAARecently Completed and Underway

ALBANIA: Country Governance and Anticorruption, Accountability for Better Governance, Public Expenditure and Financial Accountability, Social Protection TA, Country Economic Memorandum (CEM)

BOSNIA AND HERZEGOVINA: Pension Technical Assistance, Report on the Observance of Standards and Codes on Fiscal Transparency, Public Expenditure Review (PER)

KOSOVO: Country Economic Memorandum Follow up; Transport ; Comprehensive Water Sector Assessment; Environment Policy Note, Transport Sector Review

FYR MACEDONIA: Comprehensive Water Sector Assessment, Higher Education, Green Growth and Climate Change, Science/Technology TA, Labor TA, Energy Policy Note

MONTENEGRO: Public Expenditure and Institutional Review Follow up, Transport Sector Work, Public-Private Partnerships for Electricity

SERBIA: Pension TA, Innovation Promotion, Capital Markets, CEM, Education, Policy Notes on Growth

REGIONAL: REPARIS (The Road to Europe: Program of Accounting Reform and Institutional Strengthening); Programmatic Financial Sector Development; Study on Science, R&D and Innovation; Public Financial Management; Programmatic Poverty Assessment and Gender Monitoring; Labor market, Education Skills and Social (MILES), Energy Efficiency and Renewables.

39