Report No. 30714 Croatia Country Assistance Evaluation November 17, 2004 Operations Evaluation Department Document of the World Bank Contents Preface ................................................................................................................................. ... i Summary .......................................................................................................................... 111 . 1 Country Background Description .................................................................................................................... 1 Initial Conditions ........................................................................................................... 1 Economic and Social Challenges 1990-2002 ................................................................ 2 Macro Perspectives .................................................................................................. 2 Public Sector Expenditure and Debt ........................................................................ 3 Sustainable Growth .................................................................................................. 4 The Governance Challenge ...................................................................................... 4 Poverty and Social Issues ......................................................................................... 5 . 2 World Bank Products and Services Strategic and Policy Advice .......................................................................................... 6 Country Assistance Strategies ....................................................................................... 6 Implementation o f Strategies: Overview ...................................................................... 7 ESW: Overview ............................................................................................................ 8 Lending: Overview o f Project Quality ......................................................................... 8 Reconstruction Lending ................................................................................................ 9 Containing and Retargeting Public Expenditure to Reduce the Debt Burden...............9 Promoting Growth ....................................................................................................... 11 Improving Public Administration and the Judiciary ................................................... 12 Social Welfare and Poverty Reduction........................................................................ 13 Resource Mobilization and Aid Coordination............................................................. 14 . 3 Assessment o f the Development Impact o f the Bank Containing and Retargeting Public Expenditure to Reduce the Debt Burden............. 15 Promoting Growth ....................................................................................................... 17 Improving Public Administration and the Judiciary .................................................. 20 Poverty Alleviation and Unemployment ..................................................................... 21 Outcome o f the Country Assistance Program ........................................................... 22 Relevance ................................................................................................................ 22 EfJicacy ................................................................................................................... 22 Summary Rating o f the Outcome o f the Bank’s Assistance Strategy ...................... 22 Institutional Development Impact ............................................................................... 23 Sustainability ............................................................................................................... 23 Contents (cant.) . 4 Contributions to Outcomes World Bank Contributions .......................................................................................... 24 . . ........................................................................................ Client Country Contnbutlon 25 Aid Partner Contributions ........................................................................................... 25 Impact o f Exogenous Factors ...................................................................................... 26 . 5 Lessons and Recommendations Recommendations........................................................................................................ 27 Boxes in Text Box 2.1 : IFC and MIGA ......................................................................................... 13 Box 4.1 : Client Surveys .......................................................................................... 24 Box 4.2: EuropeanUnion Assistance ...................................................................... 26 Tables in Text Table 1.1: Croatia. Key Economic Indicators. 1994-2002....................................... 2 Table 2.1 : Proposed and Actual Lending (US$ millions) ....................................... 7 Table 2.2: IBRD Commitments by Sector ............................................................... 8 Table 2.3: Ratings on Closed Projects. FY99-FY03 ................................................ 8 Table 2.4: Active Projects ........................................................................................ 9 Table 3.1: Health Indicators ................................................................................... 16 Table 3.2: Financial Sector Performance ............................................................... 18 Table 3.3: Private Sector Share o f GDP ................................................................. 18 Annexes A. Statistical Annex ................................................................................................ 29 B. L i s t of People Interviewed................................................................................. 41 C. Management Action Record .............................................................................. 45 D. Guide o f OED’s Country Assistance Evaluation Methodology ........................ 47 E. Government Comments on the Draft CAE ........................................................ 51 Attachments 1. Croatia: Proposed and Actual Lending ............................................................. 53 2. Overview o f IFC Operations .............................................................................. 55 3. Clients Surveys: Methodology .......................................................................... 59 4. Chairman’s Summary (Committee on Development Effectiveness) ................. 61 Preface This evaluation provides an independent assessment o f the role o f World Bank assistance to Croatia during 1991-2003. The Country Assistance Evaluaton (CAE) examines whether: (a) the objectives o f Bank assistance were relevant; (b) the Bank’s assistance program was effectively designed and consistent with i t s objectives; and (c) the Bank’s program achieved i t s objectives and had a substantial impact o n the country’s development during this period. Examining these questions allows the C A E to draw lessons and recommendations for future Bank assistance. Annex D describes the methodological approach. The basis for the C A E consists o f OED project assessments, sectoral reviews, and interviews with past and present government officials, Croatian civil society, other donors, as well as Bank and IMF staff at headquarters and in Croatia. A l i s t o f those interviewed i s shown in Annex B. An OED mission visited Croatia in M a y 2003. Comments received from the Regional staff are reflected in the report. The report was also sent to the Croatian authorities, whose comments are in Annex E. The Country Assistance Evaluation was written by Michael L a v (Consultant). John Johnson, Csaba Feher (Consultant) provided support concerning pension reform, and R o y Jacobstein (Consultant) provided support in the health sector. This evaluation also benefited from comments o f two peer reviewers: M s . Poonam Gupta (OED) and Mr. Pedro Alba (MNA). Danuta Danilova provided research assistance. Tirsit Dinka and Janice Joshi provided administrative support. ... 111 Summary 1. Croatia gained independence in June 1991,but civil war and hostilities with neighboring countries together with the economic impact o f the break-up o f the former Socialist Federal Republic o f Yugoslavia caused per capita income to fall in 1993 to two-thirds o f its 1990 level. Starting in 1994 both the economic and political situation began to stabilize and a recovery began. The recovery was interrupted in 1999 when the fiscal deficit got out o f control, but subsequently resumed. By 2002 per capita income had regained i t s 1990 level. Underlying the recovery were the rebound and growth o f tourism, a high level o f worker remittances, private credit expansion, and public deficit spending. 2. Economic policymaking and the reform process have been uneven. O n the positive side, macroeconomic stabilization was achieved quickly, which facilitated the recovery. Trade was liberalized, financial sector reforms were very successful, and the environment for private sector development improved, albeit slowly. Some o f these reforms accelerated in 2000, when a new government improvedties with Westem Europe and firmly launched Croatia’s bid to join the European Union (EU). Since then the country also has joined the World Trade Organization (WTO). But, inefficient public spending in several areas- transport, health, social spending-has contributed to excessive public sector deficits with limited positive outcomes. Growth has been constrained by a corrupted privatization process, and many enterprises now failing were privatized with contracts allowing sale o f assets back to the state. The net result o f all this has been a rapid increase in the current account deficit and extemal debt, without commensurate improvements in growth and poverty reduction. A politicized and inexperienced public administration and an ineffective judicial system are also much in need o f reform. 3. Since 1993, the Bank has lent a total o f US$1,198 million to Croatia, for 23 operations, with initial emphasis on reconstruction, followed by public finance reform, growth, and public administration and judicial reform. Although the government r e h s e d permission throughout the 1990s to carry out some important economic and sector work (ESW) tasks such as public expenditure reviews and a poverty assessment, these have since been implemented, together with Country Economic Memoranda that detail clear reform priorities. 4. The reconstruction loans had successful outcomes. Operations to reform public finance have had mixed success. Although some reforms (such as pensions and health) started in the 199O’s, these were not wide-ranging, and public expenditures continued to grow with little retargeting. Since 2000, reforms have been deepened in pensions and health, and initiated in other areas, supported by Bank ESW and lending. Public expenditures, while s t i l l high, have since decreased as a percentage o f GDP. 5. Operations to help raise growth have also had mixed impact. The FY97 EFSAL privatization program was flawed, while financial sector reform was successful. The FY02 S A L reforms should have a positive impact on the labor market, and the new bankruptcy and company laws should help improve enterprise performance over time. 6. The impact of operations to strengthen public administration also has been limited. iv The S A L that has just closed helped improve some aspects o f budget management. The FIAS study o n administrative barriers provided a useful guide to action, but has only been partially implemented. Judicial reform i s moving slowly, and the Court and Bankruptcy Reform LIL has had only halting success, as has the more recent Cadastral Project. 7. Experience in Croatia emphasizes the importance o f Bank-Borrower agreement on reform. Although Bank actions are largely responsible for Bank performance, they are only one contributor to the outcome and institutional development impact o f the Bank’s assistance strategy. Outcomes are also determined by the Borrower’s performance and other factors. OED has rated as satisfactory the outcome o f only 65 percent o f loan commitments, below the average for the Europe and Central Asia (ECA) Region and the Bank as a whole. On the basis o f these ratings, the l o w impact o f ESW and slow progress by the government o n economic reforms, the overall outcome o f the Bank assistance program i s rated as unsatisfactory through FYOl. Subsequently, with accelerated reforms supported by Bank assistance including the SAL and more effective ESW, the overall outcome o f the Bank assistance program merits a rating o f satisfactory. 8. Sustainability i s rated as likely given Croatia’s determination to j o i n the EU and i t s conclusion o f the EU Stabilization and Association Agreement, as w e l l as OED’s evaluation o f likely sustainability in all i t s loan commitments. But to mitigate risks, the government will have to pursue i t s reform agenda vigorously. Institutional Development Impact (IDI) i s rated as modest for the first time period but substantial for the second. ID1 i s rated as substantial in only 28 percent o f loan commitments, well below E C A and Bank averages, but E S W has had an important impact in the later period. 9. The contrast in outcome ratings suggests that ambitious adjustment and assistance programs should not be pursued when governments are unconvinced o f the need for reform. With the Bank n o w playing an increasingly relevant role, and as agreement i s reached on priorities with the new government, elected in November 2003, the Bank should aim at assisting Croatia to: (i> Rationalize and retarget public expenditure to support reforms in health, education, and infrastructure and to contain debt; (ii) Foster private sector-led growth: first, by improving the environment for founding new enterprises and, second, by ensuring that privatization o f SOEs (or reprivatization o f failed enterprises that are reverting to government ownership) i s successful, in particular, by not favoring insider buyouts; and (iii) Improve the core functions o f government, public administration, and the judicial sector. Gregory K. Ingram Director-General Operations Evaluation 1 1. Country Background Description 1.1 Croatia i s a middle income country bordered by Bosnia-Herzegovina, Hungary, Serbia and Montenegro, and Slovenia. In 2002, the population o f 4.4 million had a per capita income o f US$4,640 (Atlas Methodology). Initial Conditions 1.2 Croatia declared independence from the former Socialist Federal Republic o f Yugoslavia (SFRY) in June 1991. I t faced the loss o f markets within former SFRY and the Council for Mutual Economic Assistance (CMEA), extensive destruction o f capital stock during the ensuing war, sharp declines in output, and severe inherited inflation coming o n top o f investment levels that had been falling since the early 1980s. Transport from the N o r t h and East to the South was disrupted as some rail lines and roads ran through Bosnia-Herzegovina. Advantages included a population with substantial technical skills, an inherited economic system which was far more market-oriented than those o f the planned economies o f Central Europe and the former USSR, a relatively liberal foreign trade regime with few quantitative restrictions (mainly in agriculture), l o w tariffs, and n o trading monopolies. The population o f 4.8 million at independence had a per capita income o f US$3,350. 1.3 After independence, hostilities erupted almost immediately, and turbulence continued until 1998. More than one-fourth o f Croatia’s territory had large Serb populations and was designated as U.N.Protected Areas (UNPAs) in January 1992, but hostilities with Serbia ensued during which Croatia lost the southern Kordun and Banija’ region and Eastern Slavonia. Croatia regained the Kordun and Banija region in 1995, while Eastern Slavonia was fully re-integrated into Croatia in 1998. On another front, hostilities also erupted within Bosnia-Herzegovina, among Serb, Croat, and Muslim populations during which Croatia lent support to the Croats. The Dayton Accords signed in 1995 ended hostilities, but international concerns about relations with Bosnia- Herzegovina, including border crossings, trade, and Croatia’s funding o f Bosnian Croats, were not addressed until 1997. 1.4 Franjo Tudjman was elected President by Parliament in 1990 and re-elected to five year terms in direct Presidential elections o f 1992 and 1997, as leader o f the Croatian Democratic Party (HDZ) which dominated politics. The war years were a very difficult period for Croatia. For a time, the country lost part o f its territory, i t suffered heavy casualties, had to deal with refugees and substantial economic damage. However, following the end o f hostilities in 1995, decision making was increasingly centralized in the Presidency, and there was a lack o f transparency in many government actions including privatization and public expenditures detailed elsewhere in this report. The ’The Kordun and Banija region has had a large Serbian population since Croatia was ruled by the Austro- Hungarian Empire which encouraged Serbs t o settle the region as a bulwark against the Ottoman Empire. 2 1998-99 economic recession led to some loss o f support for the government. Nonetheless, President Tudjman remained in power until his death in December 1999. 1.5 Since then, democratic processes have become more transparent. Croatia was governed from 2000 through 2003 by a multiparty coalition whose members were bound together by an outward orientation with the goal o f leading Croatia towards full EU membership. Croatia has signed an EU Stabilization and Association Agreement and the N A T O Membership Action Plan, and has become a member o f WTO, while signing free trade agreements with 30 countries. In the elections o f November 2003 the HDZ received a plurality and has formed a new government. I t s stated intention i s to pursue policies which would enable Croatia to j o i n the EU as quickly as possible. T o achieve this objective, the new govemment will need to carefully formulate a fiscally responsible program while pursuing a large number o f reforms. This will not be easy and will require political will, but the alternative would be all too costly for Croatia’s future. Economic and Social Challenges 1990-2002 Macro Perspectives 1.6 The initial challenge was stabilization to restore the basis for growth. From 1991 to 1993 inflation Table 1.1: Croatia, K e y Economic Indicators, 1994-2002 exceeded 200 percent I994 1995 I996 I997 I998 1999 2000 2001 2002 Real sector (percentage change) per year, real GDP Real GDP 5.9 6.8 5.9 6.8 2.5 -0.9 2.9 3.8 5.2 dropped by 28 percent Exports o f goods and services ... ... 9.8 7.6 3.9 0.7 12.0 9.5 3.0 and real wages by 64 Imports o f goods and services ._. . _ . 6.8 25.1 -4.9 -3.5 3.7 11.1 11.0 percent. The October Fixed investment ... . _ _ 37.6 23.3 2.5 -3.9 -3.8 9.7 10.1 Private consumption ... ... 0.4 12.9 -0.6 -2.9 4.2 4.6 6.6 1993 stabilization Average C P I Inflation 97.5 2.0 3.5 3.6 5.7 4.2 6.2 4.9 2.2 program was launched Gross real wages ... 34.0 12.3 21.0 12.6 10.2 7.0 3.9 6.0 after informal Unemployment rate ’ ... ... 10.0 9.9 11.4 13.6 16.1 15.8 14.4 (in percent o f GDP) consultations with the Exports o f goods and services 45.8 38.6 40.2 41.1 39.6 40.9 47.1 49.1 46.0 IMF and the World Imports o f goods and services 45.9 49.5 49.7 56.8 49.2 49.3 52.3 54.7 54.8 Bank. I t sharply General Government Overall balance 1.5 -1.4 -2.2 -3.1 -2.0 -8.2 -6.0 -6.8 -4.8 reduced inflation and Expenditures 44.1 48.9 51.9 51.3 53.8 57.0 53.2 51.5 50.0 restored growth. Debt Public debt’ 22.3 19.5 31.7 35.6 42.3 54.1 59.7 58.0 68.5 agreements were Extemal Accounts Current account balance 4.9 -7.5 -4.8 -12.5 -6.7 -7.0 -2.5 -3.7 -7.2 reached with creditors F D I (Net) 0.7 0.5 2.6 1.5 3.9 7.2 5.7 7.2 4.0 at the Paris Club in External Debt 20.7 20.2 26.7 37.1 44.8 50.1 60.0 57.9 68.1 1995 and at the Reserves (months ofimports) 2.4 2.5 2.8 2.7 3.2 3.7 4.4 4.4 4.4 ” ILO; ’ Includes central govemment domestic and extemal debt plus public guarantees (both London Club in 1996. financial and performance guarantees) During 1994-2002, Sources: C E M FY04 and IMF. GDP increased by The Stabilization and Association Agreement (SAA) covers trade liberalization, political dialogue, mutual right o f establishment o f firms, supply o f services, liberalization o f capital flows, movement o f workers and various forms o f cooperation. SAAs differ f r o m the Europe Agreements (EAs) in the political pre- conditions, legislation harmonization, and trade cooperation that have to be met prior t o starting negotiations o n the agreement, and S A A countries are only potential candidates for EU membership. In addition to Croatia, other S A A countries are Bosnia and Herzegovina, Federal Republic o f Yugoslavia, former Yugoslav Republic o f Macedonia, and Albania. See Croatia CEM (FY04). 3 4.3 percent per year, inflation averaged only 4 percent per year, and exports o f goods and services grew by 6 percent per year (see Table 1.1). Croatia i s now one o f the most open economies in Central Europe, and Croatia’s credit rating was established at investment grade in early 1997. 1.7 At the same time, the country faced major structural problems and made uneven progress towards their resolution over the period under review. They include inefficiencies in public spending, lack o f sustainable progress in privatization, resulting in GDP growth rates below potential, and rapidly increasing extemal debt, as well as govemance issues. The challenges faced by Croatia are presented immediately below. Chapter I1presents the Bank’s assistance to help Croatia address these challenges while the development impact o f the Bank’s assistance program i s discussed in Chapter 1 11 . Public Sector Expenditure and Debt 1.8 GDP growth, primarily based on a rebound o f tourism and large volumes o f workers remittances ,has been further stimulated by large public sector deficits which re-emerged in 1995 and increased through 1999, caused by large and ill-targeted public expenditure programs. The government elected in 2000 applied some fiscal restraint, and public expenditure declined from 57 percent o f GDP in 1999 to 50 percent in 2002 (still one o f the highest in the region), while the overall deficit declined from 8.2 percent o f GDP in 1999 to 4.8 percent in 2002. These budget deficits including bailouts and financing o f health and other funds, resulted in a large build-up o f debt. Public and publicly guaranteed external debt reached the equivalent o f 52 percent o f GDP by end-2003. Further reductions o f deficits are called for as well as pro-growth reforms discussed below, without which indebtednesswill continue to be a problem, and a barrier to EU accession. Also there was a large increase in total external debt between 2002 and 2003, from the equivalent o f 68 percent to above 80 percent o f GDP, but this increase was primarily o n account o f the private sector. 1.9 Public expenditure policy has faced numerous challenges. In highways, i t was to maintain the existing road network to good standards and limit new highway construction to economically justifiable roads, given the legitimate need for Croatia to secure some new transport routes within i t s territory. In railroads, it was to improve management and the enterprise’s financial position by trimming expenditures and non-essential activities and employment with a view to possible privatization. The challenge in education, where 30 percent o f the population has only 8 years or less o f schooling, and 1 percent are illiterate, was to reform an outdated cumculum and improve generally ineffective The teaching m e t h ~ d s . ~ challenge in health was to realign capacity from an excessive focus on secondary and tertiary health care to a stronger focus on primary health care, from which physicians could then direct patients to secondary facilities more efficiently. In pensions, the challenge was to modernize and reform an unsustainable pension system while ensuring adequate protection for the elderly. M a n y o f these challenges remain: among the most urgent ones are improving the efficiency o f spending in highways and health, and reducing railway subsidies. Data updated in accordance with the government’s comments (annex E). 4 Sustainable Growth 1.10 M o v i n g to a sustainable growth path requires a number o f reforms in the productive sectors. In industry, the challenge was to pursue privatization o f the State- owned enterprises (SOEs) and to create an environment in which both new private sector enterprises and privatized SOEs could grow. The challenge inJinanciaZ sector reform was to privatize the state-owned banks and allow for the growth o f private sector banks which were adequately capitalized, all within an effective regulatory system. In the agriculture sector, comprising privately-owned farms and Agrokombinats, the challenge was to improve land policies and build o n trade reforms to allow the competitive private sector to grow, while limiting bailouts and subsidies to the less competitive Agrokombinats. Apart from successful financial sector reform, here also much remains to be done. I nparticular, the privatization process lacked transparency and has been characterized by insider buyouts, stripping o f assets and illicit use o f company assets to collateralize and guarantee private mortgages. Since privatization arrangements frequently included buy-back clauses allowing workers who purchased shares to sell them back to the state, many failing privatized enterprises have reverted to public ownership. Many o f the large-scale state-owned enterprises which ought to have been privatized by now have not been. Finally, good corporate governance, crucial for sustainability, has been lacking although this has recently improved. 1.11 A more efficient economy would also benefit Croatia’s balance o f payments. Merchandise export growth has been lagging, and 20 percent o f foreign exchange receipts i s accounted for by FD14and workers remittances, and about 30 percent by tourism. While these inflows enabled foreign exchange reserves to increase to the equivalent o f 4.4 months o f imports at end 2002,5 the current account deficits, o n the order o f 7 percent o f GDP in 2002/03, remain too large. The Governance Challenge 1.12 Public administration and the judiciary required reforms for Croatia to become a well-governed democracy with a responsive market economy. Public administration has lacked the capacity to generate and implement policies and programs consistent with a market economy. The court system i s an important impediment to progress. There i s a backlog o f over 1 million cases,6 so that resolution o f bankruptcy and other proceedings are seriously delayed thereby impeding resolution o f disputes. Capacity i s not the core issue, as, for example, the City Court o f Zagreb i s one o f the largest in Europe with 350 judges. Procedures are cumbersome. There i s little incentive for judges to settle cases expeditiously. There are no administrative courts, so even minor disputes are referred to Most FDI has been in a few large privatized enterprises (especially telecommunications and pharmaceuticals) and three large privatized banks. There is, however, an added element o f uncertainty in that the magnitude o f workers’ remittances and tourism in Croatia’s very open economy makes data collection difficult, leading t o large errors and omissions in the balance o f payments, which came t o minus $1 b i l l i o n in 2002. This i s a rough estimate because cases receive n e w identification numbers as they are appealed and heard in different courts. 5 the judicial courts. Resources are lacking; for example, there i s inadequate access to precedents and there are few trustees available to implement bankruptcy proceedings. Poverty and Social Issues 1.13 Poverty measured by the standard used across transition countries (US$4.30 a day per person) i s at 4 percent, while poverty according to the Millennium Development Goals i s at 1 per~ent.~ Unemployment i s high at 14 percent reflecting past labor market rigidities including constraints which limit layoffs and greatly increase their costs thereby inhibiting new hires. Individual dismissals are costly and there have been many barriers to collective dismissals and substantial legal restraints to temporary employment. M a n y workers lack adequate skills to participate in emerging markets. Finally, the privatization problems discussed above and administrative barriers to enterprise development limit j o b creation which i s equivalent to only 3.5 percent per year o f the labor force, a very l o w rate compared to EU accession and EU countries.8 ’Lack o f adequate accounting for refugees and their role in the economy m a y lead t o some underreporting. See Croatia Country Economic Memorandum, Report No. 25434-HR, Chapter 6. F o r example, the rate o f job creation in 2000 for Bulgaria was 6.8, for Lithuania (1998-99) 9.7, Poland (1998-99) 5.3, France (1984-91) 6.6, and Germany (1983-90), 6.5. 6 2. World Bank Products and Services Strategic a n d Policy Advice 2.1 A dialogue o n Bank assistance began soon after independence, but was interrupted for about a year due to security concerns. Croatia became a member o f the Bank o n February 25th, 1993 as one o f the successor states o f the former Socialist Federal Republic o f Yugoslavia. The cease fire instituted in March 1994, between Serbian and Croatian forces in Croatia, and the “Washington Agreements” which provided a framework for peaceful resolution o f disputes allowed the Bank to resume work on an assistance program, leading to the Board’s approval o f the Emergency Reconstruction Project in June 1994, followed by a Health Project in February 1995. Country Assistance Strategies 2.2 The mid-1990’s country strategy’ sought to support Croatia’s transition from stabilization to transformation with sustained growth by: (1) reforming public finance; (2) encouraging private sector-led growth, and (3) rebuilding and upgrading infrastructure. A poverty assessment and a C E M were planned for FY96. These were relevant objectives, although there was no focus o n governance. However, the government did not consistently accept wide-ranging reforms and at times rejected adjustment lending, while the Bank’s Board o f Directors remained concerned about Croatia’s support for Bosnian Croats, seen as regionally destabilizing. The country strategy proposed a base case lending program for FY95-98 o f US$690 million. 2.3 The 1999 CAS was a joint IBRD/IFC document with the objective of: (i)reducing the size o f the public sector and increasing efficiency; (ii) improving governance; (iii) creating conditions for competitive real sector development; and (iv) containing poverty. These objectives were in accord with the challenges facing Croatia, but the program proposed in the CAS did not take adequate account o f the government’s unwillingness to accept a strong reform program in governance, privatization, and other key areas. A base case lending program o f US$589.9 million for FY99-02 was proposed, including a SAL for US$200 m i l l i o n and a railway modernization project for U S $ l O l million. The long-delayed public expenditure review and poverty assessment were again proposed. 2.4 The 2001 CAS Progress Report (CAS PR), prepared jointly with IFC, was drafted after the coalition government took office following the death o f President Tudjman. The CAS PR again proposed a wide-ranging reform program with a base case scenario for FY02-03 for US$282.0 m i l l i o n including the SAL. 2.5 Evaluation o f Strategies. The strategies presented in the two CASs were generally well designed with a focus on the three issues (public sector expenditure, sustainable growth, and, starting with the second CAS, governance) identified in Chapter 1,but were The country strategy was presented to the Board after the Emergency Reconstruction Project and Health Project were approved. 7 not fully relevant because they assumed that the end o f open hostilities presaged government support for a broad structural adjustment program. Intentions to reform public investment and administration, and the judiciary, were difficult to operationalize. The FY99 CAS recognized shortcomings inprivatization but did not propose solutions, nor did i t address some priorities such as education. The client survey conducted in 1998 revealed that poverty reduction was not perceived as a Bank priority. As mentioned, Bank support for adjustment was also limited for a t i m e by Executive Directors' concerns that Croatia was providing budgetary support for Croats i n Bosnia, and was contributing to regional instability. As adjustment lending failed to materialize, the Bank allowed infrastructure lending to expand and supported a larger public investment program with limited retargeting, at a time when Croatia needed to reduce and retarget public expenditures. (The FY99 CAS base case lending program oddly did not program any adjustment lending to follow the SAL because o f a presumed weakening commitment to reform.) T h e strategy in the CAS PR was more relevant, because by this time the government was willing to pursue reforms and actively sought a rapprochement with the European Union. Implementation o f Strategies: Overview 2.6 Bank lending has totaled US$1,198.1 m i l l i o n through F Y 0 4 (see Table 2.1 below), o f which US$168 m i l l i o n occurred before a country strategy was approved," and US161.5 m i l l i o n thus far in F Y 0 4 after the CAS PR. Lending during the C A S periods fell short o f CAS proposals by 25 percent (US$868.6 m i l l i o n achieved compared to US$1,141 .9-US$17191.O m i l l i o n proposed), but t h i s hides a much larger mismatch as 12 proposed projects were dropped while 4 projects not proposed in CASs were approved. As a result o f this, and together with slippage in approving proposed lending, only 30 percent o f lending was approved as proposed in a CAS, while another 30 percent o f lending was approved without having been proposed in a CAS, although this was mostly reconstruction lending well-tailored to the emerging situation. Forty percent o f lending had been proposed in a CAS but was approved only after 1 to 4 years delay. Finally, some investment operations increased dramatically in size, which acted as an offset to the dropped adjustment operations. The delays occurred during both the mid- 1990's and FY99 country strategies, while implementation has been o n target since the CAS PR in FY02, including the S A L . See Attachment 1, which lists all loans proposed and implemented relative to the CASs. Table 2.1: Proposed and Actual Lending (US$ Millions) Pre-1995 mid-1990's 1999 Post- CAS 2001 CAS Total TOTAL Lending country country Progress Report, CAS Progress Report CAS 1995-2001 1994-04 strategy strategy 2004 Proposed 300.0-350.0 589.9 277.0 I 166.9-1216.9 1141.9-1191.0 Actual 168.0 457.4 156.2 255.0 868.6 161.5 1,198.1 *The 1999 CAS proposed lending o f US$160 million in 2002 which was superceded by the CAS PR. Lending for FY04 comprised the Rijeka Port project from the CAS PR and a new energy project. Sources: Business Warehouse as o f 09/02/2003, mid-1990's country strategy, CAS 1999, CAS Progress Report 2001 loIn addition, from 1969 to 1989,20 loans for U S 2 6 3 . 9 million were granted to the former SFRY which resulted in tangible asset creation in the territory o f Croatia. Since these were not the result o f a country assistance strategy for Croatia, they are treated only if and when they had a specific impact on the country assistance strategy. One such loan i s Istria Water and Sewerage, approved in 1988 but for which implementation continued until 2002, and which addressed specific environmental concems. 8 2.7 In essence, the Bank's actual Table 2.2: IBRD Commitments by Sector lending program to date has focused (as o f December. 2003) on infrastructure and reconstruction Sector Total Percent (see table 2.2), while shortfalls in (US$ million) Economic Policy 202 17 adjustment, governance, judicial Energy 5 1 reform, public administration, Financial Sector 134.5 11 poverty reduction, education, and, to Health, Nutrition, Population 69 6 a lesser degree, health, reflected Private Sector Development 12.3 1 dropped projects and delays. Public Sector Govemance 5 1 Important issues such as fiscal Rural Sector 84.7 7 adjustment came to be addressed Social Protection 27.3 2 only towards the end o f the period, Transport 453.4 38 leaving for the future a larger work- Urban (includes Reconstruction) 168.6 14 out program than would have Water Suvvlv and Sanitation 36.3 3 otherwise been needed. Total 1198.1 100 Source: Business Warehouse. ESW: Overview 2.8 Through the 1990's, important components o f the proposed ESW program (especially the public expenditure review and the poverty report) could not be implemented because o f a lack o f government agreement, while the impact o f the work which was completed was low, even if it was generally o f good quality. From FYOl and the CAS PR on, both the overall quality and impact o f the program have been satisfactory. The program i s reviewed in more detail Table 2.3: Ratings on Closed Projects, FY99-FY03 (percent, by commitment amount) later in Chapter I1and i t s Substantial Satisfactory Likely impact evaluated in Outcome Sustainability Institutional Chapter 1 11. Development Croatia 65 100 28 Lending: Overview o f CEEC (Excl. Baltics) 92 87 65 Project Quality ECA I9 81 54 Bankwide - 81 76 - - 53 2.9 Project evaluations Source: Statistical annex A, table 5 a and, for CEEC, Business Warehouse database as o f October 2003, for FY89-FY03. by OED to date largely reflect projects formulated, approved and implemented during the more difficult years through FYO1. For example, the Highway Sector loan with i t s unsatisfactory outcome rating supported a three year time slice o f the highway program, from 1995-97. The Croatia portfolio has so far performed less well than the average for ECA, with only 65 percent o f lending receiving satisfactory ratings,' compared to 79 percent for E C A and 81 percent for the Bank as a whole. Croatia fares even less well when compared to i t s cohort o f CEE countries, excluding the Baltic countries. The ratings for Institutional Development Impact also are below average for E C A and the Bank as a whole. All projects are rated high in sustainability. " Ratings are based on Business Warehouse data updated by the ratings in the Project Performance Assessment Report for the Highway Sector, EFSAL, TA, Capital Market Development, Emergency Transportation and Mine Clearing, and Istria Water Supply loans. 9 2.10 The picture for the 11 ongoing projects i s quite different than that for Table 2.4: Active Projects closed projects. Croatia fares better than Projects at risk, percent, by number E C A and Bankwide averages in ratings for Croatia 0.0 ongoing projects, with no projects rated at EC* 8.0 risk. Intensive project supervision and, for Bankwide 16.4 post FYOO projects, more careful project Source: Statistical Annex 5. table 5c. formulation with active participation o f a more reform-minded government are all factors which play a role in this improvement. In addition, the World Bank Country Office plays a proactive role in addressing issues before they become problematic. ReconstructionLending 2.1 1 Reconstruction played an important role in Bank assistance through much o f the 1990s. The Emergency Reconstruction loan (FY94) was useful in financing equipment and parts lost in the war, power, flood control, and community reconstruction, and i t s outcome was rated satisfactory. The Coastal Forest Reconstruction and Protection Project (FY97) i s helping to restore and protect forest land in the coastal zone, which was important for the environment and tourism. The Emergency Transportation and Mine Clearing project (FY97) financed reconstruction o f roads, bridges, and railway lines, repairs to Ploce Port, and mine clearing. I t also improved governance in opening up demining operations to international competitive bidding. Eastem Slavonia (FY98) supported reconstruction o f war-damaged infiastructure, improvement o f flood control and wastewater management, and clearing o f land mines. Containing and Retargeting Public Expenditure to Reduce the Debt Burden 2.12 L i t t l e was achieved in this area during the 1990s, but some progress has been made post-FYO1. The Bank has supported reform o f the large and poorly targeted public expenditure program. T w o pieces o f ESW have played an especially important role. “Croatia: A Policy Agenda for Reform and Growth” (February 2000) assisted the then new government to formulate i t s agenda. I t observed that government expenditure had increased by more than 15 percentage points o f GDP since independence, that deficits were growing, and that the transformation o f productive sectors had stalled. It proposed reductions in transfers and expenditures on defense, social security, public sector wages and employment, acceleration o f efforts to privatize state-owned banks and measures to create a business friendly environment. Reforms were proposed to improve allocative efficiency, provide incentives for domestic savings and investment, and promote education. I t was well received and many o f i t s suggestions are being implemented. 2.13 The Public Expenditure and Institutional Review (PEIR) “Croatia: Regaining Fiscal Stability and Enhancing Effectiveness” (FY02),12 which had been blocked for years by the previous government, detailed the causes o f increased public sector spending and fiscal deficits. The PER proposed specific reforms in public sector wage management, health, pensions, education, social assistance and child allowances, publicly owned l2The study was also published as a World Bank Country Study in March 2002. 10 transportation, and the need for further reductions in defense outlays, and identified process improvements in budget management. In so doing, it drew on an, internal note o n health policy, the FY97 CEM, and “Croatia: A Policy Agenda for Reform and Growth” (FYOO). Many o f the proposals are being implemented. Most recently, the Croatia Country Economic Memorandum (FY04) presented a program for fiscal reforms with a strategy for growth through European Integration, based on the Stabilization Association Agreement. I t is too early to gauge impact, but the report was well-received. 2.14 Adjustment lending played a central role in Bank assistance to reform the public expenditure program. The SAL (FY02) supported improved coordination and management in economic policy making, enhancing fiscal discipline through limiting excessive and poorly targeted government expenditures with the help o f improved budget processes, transparent subsidies, and reforms in health care and pensions. 2.15 Bank assistance was less effective in transportation, despite the well-formulated Transport Sector Study “Policy Directions for Transport” (FY99). The Study noted that Croatia’s demand for transport had fallen sharply (railways and ports) or grown only modestly (roads) since the war, and that Croatia’s existing transport infrastructure generally provided ample capacity to satisfy demand. It also noted that efficiency could be substantially improved, with significant scope for fbrther privatization and commercialization. Despite this, in highways the government pursued huge increases in investment in over-designed roads13 financed in part by expensive short t e r m credits, which caused the Highway Sector Loan (FY95) to receive an outcome rating o f unsatisfactory. Highway expenditures were moderated somewhat after 2000, but are s t i l l high. Meanwhile, maintenance on existing roads slipped badly. Problems have also emerged in railroad reforms. The ongoing Railway Modernization and Restructuring Project (FY99) seeks to improve efficiency, increase transparency o f government support, reduce budgetary transfers, and prepare for privatization. However, there i s as yet n o progress towards establishing the legal framework for privatization, nor are there significant reductions in staff, and a large investment program has been approved by Parliament with subsidies continuing at one percent o f GDP. 2.16 Results in the health sector are mixed but with distinct recent improvements. Although the outcome o f the First Health Project (FY95) was rated satisfactory, this was based in large part on i t s support for physical infrastructure, while the project ended up doing l i t t l e to assist Croatia to improve efficiency and retarget expenditures. The project did not help to target benefits better (received by 80 percent o f the population), health care systems were not reformed, and transparency in health insurance was not improved. However, the ongoing Health 2 project (FYOO) appears to be more useful. While the project again focused o n physical infrastructure, i t contained two small pilot components for reform o f the provincial health systems and public health programs. With large unexpected cost savings through I C B and improved transparency, funds were reallocated to these two components. Pilot reform programs are n o w being implementedin many counties to enhance the role o f the primary care physician, while the cost-effective public l3For example, unit prices for motonvay construction were about 140 percent above those in Western Europe. See the Project Performance Assessment Report for Highway Sector Loan. 11 health system i s being expanded. Finally, the S A L program helped target benefits and improve financial management in the health sector. 2.17 The Bank recognized early o n that Croatia’s pension system was fiscally unsustainable and supported pension reform through ESW since the mid 1990’s (much o f i t informal) and through the SAL which supported passage o f key legislation and the broadening o f the wage tax base. The long-delayed Pension System Investment Project (FY02) was approved after the pension reform had been implemented, and the project i s intended to support capacity building in pension supervision, registration, and the Pension Reform Institute, and financing o f the initial reform years’ incremental costs. It i s too early to gauge results, but shortfalls in the tax system supporting pensions will need to be kept under review. Promoting Growth 2.18 The challenge for the Bank was to assist Croatia’s transformation to a market economy to sustain growth and help Croatia integrate with the economies o f the EU, including meeting EU ceilings for debt. Results have been mixed over time. The 1997 CEM, which had been long delayed, noted the impressive stabilization program, but also shortfalls in implementing the structural reforms needed for growth. The C E M proposed government-led enterprise restructuring or exit for loss-making enterprises, strengthening bank regulation and supervision, introducing capital market reforms, and a retrenchment and transformation o f the public sector, especially health and pension programs. I t made the case that government-led SOE restructuring can be problematic, although this was nonetheless implemented with Bank support for some large enterprises. The overall impact was modest, since the government at that time was not reform-minded. 2.19 The privatization o f (SOEs, and privatization and restructuring o f the banking sector were supported by the EFSAL (FY97) and its associated Technical Assistance Loan (FY96).14 Bank restructuring was a resounding success (see para. 3.8). However, privatization o f enterprises was almost as resounding a failure, as detailed in paras. 3.10-12. The privatization o f SMEs was flawed and has resulted in stagnation and many failures. The EFSAL also supported reforms and steps towards privatization for larger SOEs, but only the case o f the public telephone company was clearly successful, although an offer for the partial privatization o f the petroleum company was recently accepted. Progress in privatizing the power company has been agonizingly slow. The five large, unprivatized shipping companies remain a costly drain o n the state, with possibly a single exception. Collectively, the large-scale SOEs generated losses equivalent to 3.5 percent o f GDP during the most recent period for which data are available ( 1996-2000),’5 despite laying o f f more than one-quarter o f their work force. Despite these shortcomings, the Bank did not effectively object, nor have subsequent operations yet fully addressed the shortcomings o f the EFSAL. The Project Performance l4T h e First Technical Assistance (FY96) project provided consultant assistance which helped design the voucher privatization plan under which many SOEs were sold, assisted in planning to restructure SOEs for o i l and gas, and provided advisory services to the Bank Rehabilitation Agency. A Project Performance Assessment Report for the E F S A L and TA loans i s available. l5CEM FY04. 12 Assessment Report (PPAR) rated the outcome o f the EFSAL as moderately unsatisfactory. 2.20 The Capital Markets Development project (FY96)16 supported the Securities Depository Agency (SDA) which enjoys an expanded regulatory reach over the sale and purchase o f private company assets. By contrast, the Croatian Securities Commission (CROSEC) i s withering as only three companies have gone public on Croatia’s securities market, partly because o f shortfalls in privatization (see para. 3.12). The Investment Recovery Project (FY98) provided a line o f credit to four banks to provide liquidity and improve management. I t s outcome was rated moderately satisfactory. 2.21 The S A L (FY02) supported a large number o f reforms including strengthening market institutions (i.e. a new company law) and the competitiveness o f the economy (including passage o f a new bankruptcy law), and enhancing flexibility in the labor market by supporting, for example, legislation to limit compensation for group layoffs to the equivalent o f 6 months wages. The loan has closed after disbursement o f the second tranche in October 2003, and outcome was rated as satisfactory. 2.22 FIAS’ report “Administrative Barriers to Foreign Investment” (FYO1) was a good companion to the S A L that identified barriers to foreign investment and proposed specific solutions and institutional reforms. A committee chaired by a Deputy Prime Minister managed implementation, and about 80 percent o f the agenda has been approved, although implementation o f some measures such as updating the land registry will take years to complete. 2.23 Other Bank lending also addressed the challenge o f sustainable growth. The Bank assisted agricultural development with the Farmers Support Services Project (FY96) that supported research and seed development together with a training component to enhance policy analysis. This project was successful in i t s narrowly defined purview,17 and improved policy analysis supported by the project was important in revising the income support scheme to divorce i t from production and focus it o n family farmers. The Istria Water Supply project achieved i t s objective o f improving infrastructure needed to accommodate increasing levels o f tourism, as well as local demand. I F C has been active as described in box 2.1 below. For more detail, see attachment 2. 2.24 A National Environmental Action Plan (FY02) would have been more useful had it more clearly identified key priorities needed to satisfy requirements for EU membership. This was later more clearly done in the F Y 0 4 CEM. Improving Public Administration and the Judiciary 2.25 Although identified as an early priority, Bank support for sector reforms materialized only recently. A JudicialhXegulatory Reform project, which had been l6The PPAR for the EFSAL, the associated Technical Assistance loan and the Capital Markets Development project i s available. ” The Bank had proposed an Agricultural Sector Adjustment Loan in the CASs, but government did not respond positively. 13 proposed for FYOI, was not implemented, and, in its place, a LIL, the Court and Bankruptcy Administration Project (FYOl), i s now being implemented. I t seeks to improve the capacity o f the commercial courts through better technology and training, supporting an improved regulatory framework for trustees, and improving the professionalism, competence and integrity o f commercial court judges and trustees, and to provide lessons for more wide-ranging reforms in the future. The Real Property Registration and Cadastre Project (FY02) aims to improve the agricultural land market by addressing operational efficiency in selected land offices and improving consistency between data in the cadastre and land-books. Box 2.1: IFC AND M I G A IFC’s committed portfolio as o f October 2003 was U S 9 7 . 5 million, in addition to which I F C has helped i t s clients mobilize about U S 9 8 million in syndicated loans, to support bank financing o f SMEs, a box and cardboard company; Pliva, the largest pharmaceutical company in Central and Eastern Europe; Croatia Capital, a venture capital fund. Projects have generally been successful. Although the investment climate has been improving, a number o f impediments to FDI remain (see paragraph 3.4 and attachment 2) and most FDI does not go to greenfield investments. Technical assistance includes the F I A S report and support for the new leasing law. MIGA extended three guarantees to Austrian banks totaling $78.6 million to expand the leasing capacity o f a subsidiary branch i n n Croatia, and to develop lending through Slavonska Banka to SMEs i tourism, agriculture, agribusiness, wood processing, and business materials. Croatia might have benefited from a larger MIGA program, but as Croatia moves towards joining the EU, the window i s narrowing for t h i s kind o f useful role. Source: IFC and MIGA. 2.26 A recent internal assessment o n country procurement found that Croatia has well- established public institutions, and an effective public procurement law and public procurement administration. However, it also found that a detailed evaluation system needed to be developed since bids were evaluated largely o n the basis o f price, that guidelines on contract negotiations should be prepared and issued to procuring entities, and that the procurement profession should be included formally as a career stream in the c i v i l service framework and improved training made available. Procurement problems remain, especially for large projects, some o f which escape standard procedures. 2.27 The Croatia Country Economic Memorandum (FY04) presented a comprehensive agenda o f reforms needed to improve Croatia’s approach to the EU, including measures to improve governance, depoliticize public administration, and improve capacity and coordination. I t is too early to gauge impact, but the proposals are well targeted to the issues facing Croatia. Finally, Croatia has received IDF grants aimed at building capacity for monitoring judicial efficiency and strengthening budget management, but with delays in approval and the recent change in government, benefits are yet to materialize. Social Welfare and Poverty Reduction 2.28 The Economic Vulnerability and Welfare Study (FYOO) was concluded after many years o f delay by the government. I t found that poverty measured by the standard for transition countries at US$4.30 per day was 4 percent, which relatively small amounts o f well-targeted expenditures could substantially reduce. Poorly educated individuals and 14 the elderly comprised important segments o f the poor. Excessive employment regulations and the high direct costs o f employment (including large mandatory packages for layoffs) constrained the labor market and added to unemployment and poverty. The SAL assisted Croatia by supporting reduction in regulations and costs o f employment and by supporting the elimination o f arrears in social assistance and the improved targeting o f child allowances. The pension reforms and capacity building described above should have some impact o n the elderly poor who do receive pensions, but many o f the elderly poor do not benefit from pensions. Resource Mobilization and Aid Coordination 2.29 The Bank has worked closely with other donors. Coordination i s especially close with the EU, whose support through the Community Assistance for Reconstruction, Development, and Stabilization (CARDS) program has played an increasingly important role in reconstruction, judicial and governance reforms (see box 4.2). In working to develop support for education reform (as discussed in the F Y 0 4 CEM), coordination with the EU’s support o f vocational education has been useful. EBRD lending to Croatia i s at about the same level as the IBRD, and i t has been active in privatization o f SOEs, financial sector development, and municipal and infrastructure investments. EBRD officials stated that coordination with I F C i s good, but that i t could be improved with the Bank, although the Bank’s work on legislation and regulation has been very helpful. 2.30 During the 1990s, bilateral assistance was quite limited, although Japan provided some grant funds for technical assistance and preparation o f Bank projects, while G T Z o f Germany focused o n technical assistance for the financial and enterprise sectors. After 2000, bilateral assistance increased substantially. U S A I D has been very active in areas such as judicial/legal reform, although the program i s expected to wind down in the next few years, in view of the actual and expected increase in the role o f the EU. Earlier issues which had emerged regarding coordination with the Bank’s Court and Bankruptcy Administration Project have been overcome and cooperation i s n o w very good. DFID and GTZ are also providing assistance for legal reform. DFID also supports reforms in the health and social protection sectors. The Bank has also worked closely with NGOs such as Catholic Relief, which has been important in refugee programs associated with reconstruction, and Open Society which focuses o n improving voice and accountability, as well as in aspects o f education reform. 2.3 1 The government plays the main role in aid coordination, a positive development, and the Bank has worked closely with the government in this regard. The Ministry o f European Integration (MEI) plays the key role, with a permanent working group, chaired by a Deputy Prime Minister, with the ME1as secretariat, which n o w covers all state-run projects. In addition, the Ministry o f Finance coordinates with the IFIs, while the Ministry o f Foreign Affairs coordinates with the bilateral donors. 15 3. Assessment o f the Development Impact o f the Bank 3.1 The Bank has been active in all three areas identified earlier as being in need o f substantial reform. In public expenditure management, the Bank’s assistance has had little impact in improving the efficiency o f spending in highways or railroads, but has been instrumental in inducing the start o f reform in energy, health, and pension programs. In the area o f private sector development, shortfalls in the privatization process have been an important constraint o n growth while limited progress has been made in helping reduce the budget deficit which pre-empts resources that could be used for private sector development and clouds the long-term outlook for debt sustainability. O n the other hand, the Bank’s assistance to strengthen the financial sector has been highly successful. Finally, the Bank’s program has had some impact on selected areas o f public administration, but thus far little impact in the area o f judicial reform. Containing and Retargeting Public Expenditure to Reduce the Debt Burden 3.2 The impact of Bank assistance on restraining and retargeting public expenditure has not been as strong as planned, and further reforms are needed. This section addresses sectoral issues, while systemic reforms o f public expenditure management and administration are discussed in paras. 3.16-3.19. 3.3 Public expenditure on transportation comprises almost 5 percent o f GDP in Croatia, versus 1.5 percent in the U.K. and France. Yet, transportation contributes only 8 percent to GDP, only marginally higher than the EU average o f 6.5 percent. The U-shaped geography o f Croatia and the need for a national road system i s only a partial explanation. High unit investment costs for motonvays based o n excessive standards are a concern. Despite the Highway Sector Loan,” the government launched in 1998 construction o f a large motonvay program,” outside the original road investment plan agreed at the outset o f the Highway Sector Loan, and consisting for the most part o f uneconomic investments with l o w economic returns due to excessive standards for relatively l o w levels o f traffic. The government elected in 2000 made some partially successful efforts to downsize the program, but the aggregate level i s s t i l l excessive. Second, the condition o f Croatia’s road network either only improved marginally or was worse at the end o f the project than at the beginning, depending o n the precise measure used. This was mainly the result o f inadequate funding for road maintenance. (Only 63 percent o f roads are in good condition compared to 95 percent or more in most large Western European countries). In railroads the Bank’s assistance i s also not yet having the desired impact, with progress o n restructuring and privatization lagging and with large subsidies (exceeding 1 percent o f GDP) continuing. Recently, the government approved a large investment program, which appears to run counter to the goal o f efficient privatization. ’’ See Project Performance Assessment Report, Highway Sector Project, Loan 38690, Report No. 28381, W o r l d Bank. l 9 Especially the Zagreb-Split motonvay (which i s not one o f the Pan-European Corridors). Internationally recognized appraisal techniques were not used, and n o assessment was provided o f economic benefits. 16 3.4 The Bank has promoted an improved legal structure for the Energy Sector, but, substantial restructuring i s yet to begin and the pace o f implementing legislation i s quite slow. Five major reform laws were passed in 2001,20 but implementation schedules (except for unbundling) remain to be specified. However, the recently approved Energy Efficiency project2' supported creation o f a new energy service company to develop, finance and implement energy efficiency projects. In Environment, the Bank has had some impact through the Istria and Municipal Water Supply projects, as w e l l as through the Forestry Reconstruction project. However, a hoped-for broader sectoral approach to environment proposed in the F Y 9 9 CAS and the CAS P R has not materialized. 3.5 Croatia spends over 7 percent o f GDP on health, compared to 5 percent for the CEECs and 6.6 percent for the EU. While health indicators have been improving over time (see annex A, table 2) and are similar to Croatia's neighbors (see table 3.1 below), further reforms are needed to make desirable, as well as affordable, improvements towards EU standards. Primary health care i s underemphasized, public health programs are lacking, and health insurance i s inefficient. Recent reforms better match care to needs and public health programs are expanding, but it i s too early for these reforms supported by Health I1(FYOO) to have had an impact. Pension reform i s also beginning to take hold, and a three pillar pension system has been introduced. Pension expenditures s t i l l exceed 13 percent o f GDP and deficits are above 4 percent o f GDP, although this i s reduced from 1999 when the deficit on account o f pensions was more than 6 percent o f GDP. Further reductions are expected with already legislated retirement age increases. Improved compliance and other reforms are s t i l l needed. Table 3.1: Health Indicators Maternal **SDR for Infant Mortality Ratio Incidence of TB **SDR for tracheal, Countries Rate (per 1000 (new casesper ischaemic heart bronchial/ lung live births) (per O0' Oo0 live 100,000 per year) disease births) cancers Croatia 1.68 6.86" 31.01 162.83 41.36 Bulgaria 14.40 19.07 48.80 190.03 29.26 Czech Republic 3.97 3.31 12.63 184.20 47.55 Hungary 8.13 5.15 28.69 225.46 64.84 Poland 7.67 3.53 26.28 133.47 52.49 Romania 18.41 34.03 127.54 228.36 35.89 Slovak Republic 6.24 15.64 18.33 287.99 40.13 Slovenia 4.25 17.22 18.02 100.15 40.64 EU Average* 4.14 5.62 11.55 98.12 31.66 CEEC Average 10.41 13.02 49.33 185.30 45.41 Note. For year 2001, unless otherwise indicated;* indicates year 2000 data. **Standardized Death Rates. Sources: WHO EURO, Health For All database, 2003. 2o (1) Energy L a w to establish rules o f accountability and transparency; (2) L a w o n the Electricity Market t o establish the conditions for a competitive electricity market; (3) L a w o n Gas Markets to establish conditions for a competitive gas market; (4) L a w o n the Regulation o f Energy Activities; and (5) L a w o n Oil and O i l Derivatives Market t o improve access to o i l and gas pipelines. 21 Loan to the National Power Utility combined with a GEF grant. 17 Promoting Growth 3.6 Although GDP growth has been sustained and inflation kept low, private sector development i s playing too small a role and government expenditures and deficits too large a role for growth to be sustainable. The government’s fiscal balance, the current account deficit and debt need greater attention as external debt has increased from 20 percent to more than 80 percent o f GDP from 1994 to 2003. The debt service to exports ratio has increased very rapidly and i s now close to 30 percent (annex A, table 2). Croatia’s foreign exchange reserves provide some cushion, but are no substitute for the smaller deficits needed for medium and longer-term sustainability. Foreign direct investment has not played a dynamic role in broad-based industrial sector restructuring, and industrial exports are relatively stagnant, reflecting a lack o f success o n the part o f the Bank’s assistance in privatization and private sector development. Although manufacturing exports may not play the dominant role in Croatia as in other countries because o f Croatia’s receipts from tourism and workers remittances, high wages do impede exports, as Croatia’s wages are higher than in almost all o f i t s closest competitors, including the Czech Republic (one-third higher), Slovak Republic (twice as high) and Bulgaria and Romania (almost five times as high).22 O n the positive side i s the increase in domestic savings, despite government deficits. While FDI has not played a broad role in restructuring the economy and has been concentrated in a few large investments, i t i s substantial and came to 7.2 percent o f GDP in 2001 and 4.0 percent o f GDP in 2002, about average for CEE and the Baltic Countries (5.0 and 6.4 percent o f GDP for 2001 and 2002, r e ~ p e c t i v e l y ) .Standard ~~ and Poor has rated Croatia’s foreign currency debt as BBB-since 1997, just below Thailand, China and the Slovak Republic, but above Bulgaria. 3.7 The Bank’s ESW and adjustment lending which addressed these issues were fully relevant but only partly efficacious. Government spending has not been as constrained (nor as well targeted) as recommended by the Bank. H a d Bank recommendations on public sector expenditure been more fully implemented, the macroeconomic outcome would have been more positive. 3.8 The Bank, through the EFSAL, SAL, technical assistance, and ESW, has played an important role infinancial sector reforms which have been quite successful. Financial sector reform addressed the large number o f weak and undercapitalized private banks which emerged after independence, while state banks were being rehabilitated. The Croatia National Bank (CNB) implemented a program o f diagnostic supervisory audits, resulting in the closure o f 13 banks in 1998 and 1999.24 Privatization o f state banking began with the EFSAL-supported program in 1997, and all but two state-owned banks have now been privatized. The government has decided to privatize these last two banks and i s developing a strategy to do so. The banking sector is now 92 percent foreign- owned. Most banks are well capitalized and generally compliant with the core principles for effective banking supervision. Needed further structural improvements concern 22 Although wages are higher in Slovenia, productivity there i s almost twice as high, so that labor costs are lower. 23 EBRD Transition Report Update, 2003. 24 CEM, FY04. 18 bankruptcy processes and creditor rights.25 Banks face foreign exchange risk as foreign currency. deposits - exceed foreign currency loans, and foreign currency loans to enterprises are not matched by export Table 3.2: Financial Sector Performance earnings.26 1996 2001 Spread between lending and deposit 3.9 As an overall indicator o f rates, Kuna 14.3 6.4 improved financial sector competitiveness, Spread between lending and deposit 14.4 3.6 spreads have been decreasing (see table rates, in foreign exchange 3.2), bank assets as a percent o f GDP have Broad Money(M4) in percent o f 34.0 52.0 been increasing, and the financial sector GDP Loan to deposit ratio* 92.6 82.0 has been deepening as indicated by the Nonperfonning assets o f Banking increase in broad money as a percentage 9.2 7.2 system, percent o f total assets o f GDP. The Financial System Stability Bank assets in Dercent o f G D P 62.5 74.0 Assessment found that the financial *excludes government accounts Source: FSSA. system i s n o w more resilient and can absorb moderate macroeconomic stresses, that banks are generally well capitalized, nonperforming assets have decreased as a fraction o f total assets, and that supervision i s acceptable though aspects could be strengthened. Croatia merited a 3+ rating for banking reform in the EBRD’s Transition Report for 2001, as did Latvia, Poland, and Slovenia and just below top-rated Hungary, Estonia, and the Czech Republic. Table 3.3: Private Sector Share of GDP Country 1994 M i d 2 0 0 2 3.10 Progress in private sector development Croatia 40 60 i s much less positive, despite the EFSAL’s and (much more recently) the SAL’Sstrong focus 40 75 on this sector.27 Croatia’s private sector Poland 55 75 accounts for only 60 percent o f GDP. Even Romania 35 65 though many transition countries started out Slovenia 30 65 with similar rates o f private sector participation Source: EBRD Transition Report Update 2o03, in GDP, Croatia’s private sector i s now one o f the smallest as a percentage o f GDP. 3.1 1 The l o w private sector share o f GDP i s the result o f disparate trends for the three enterprise subsectors. First, the newly established private enterprises are dynamic with value added increasing from 9 percent to 16 percent o f GDP between 1996 to 2000. These are mostly small scale, although with some recent increase in average size. Second, and in contrast, the privatized SOEs’ contribution to GDP shrank, albeit marginally, from 14 percent o f GDP to 13 percent. Finally, the remaining SOEs’ value added declined from 10 percent to 7 percent o f GDP. 3.12 Privatized SOEs have been stagnant because privatization was problematic. Privatization processes have been cumbersome and confusing. O f even greater concern, 25 “Republic of Croatia: Financial System Stability Assessment”, IBRDIIMF, August 2002. 26 The problems o f managing a mixed-currency system were highlighted recently with the very large i n f l o w (about US$2 billion) into the banking system when Croatians deposited DMs “mattress savings” as DMs were converted to Euros, which then l e d to a large increase in bank lending which was difficult t o contain. 27 Reforms supported by the S A L are too recent to have had an impact o n available data. 19 the State Audit Agency found serious irregularities in four-fifths o f 500 cases examined. Insider buyouts, heavily favored under Croatia’s privatization program, frequently led to corrupt and inefficient outcomes, including stripping o f assets which should have been turned over to the Croatian Privatization Fund (CPF) for auction; repayment o f debts incurred by shareholders from company funds; illicit use o f company assets to collateralize and guarantee private mortgages; and failure by the CPF to terminate company supply contracts o n which private payments were in arrears.28 Four hundred and thirty privatized enterprises have reverted to public ownership by the CPF,29 and many others may follow since the CPF holds additional share-purchase contract commitments with 96,000 employees o f privatized SOEs. Nearly 40 percent o f these privatized enterprises remained unprofitable for 1996-2000.30 While the new private sector enterprises account for an increasingly large proportion o f GDP, delay in reforms, including implementation o f many recommendations o f the FIAS report, strongly suggests that progress could have been much more rapid. The EFSAL impact o n PSD has not been satisfactory either regarding the privatization o f SME SOEs or reforms/privatization o f the large SOEs. 3.13 The privatization agenda i s clearly not yet finished and there remains a substantial adjustment/transformation yet to be accomplished. The roles and responsibilities o f the CPF need to be more clearly defined, and CPF needs stronger support from the Programs and institutions that support SOEs are s t i l l not transparent and their impact i s difficult to assess. They s t i l l receive preferential treatment, avoid hard budget constraints, and generate large losses. Finally, exit i s inhibited since the bankruptcy system does not work well because o f large backlogs in the courts, lack o f well-trained trustees, and lack o f a regulatory framework which would allow trustees to work effectively. These are the issues which the Bank’s Court and Bankruptcy Administration Project (FYO1) i s beginning to address. 3.14 Despite these shortfalls, the reforms supported by the S A L should have a substantial impact on private sector development in the future. The improved Company L a w strengthens minority shareholders’ rights and liberalizes rules which had hindered share transfers, among other reforms, while some barriers to domestic and foreign Amendments investment have been a l l e ~ i a t e d . ~~ to the bankruptcy law strengthen creditors’ rights and bolster courts and related institutions. A new streamlined rules- based, fixed fee business licensing and registration procedure, including a one-stop shop entity, has been established. For the remaining SOEs, the government publishes quarterly accounts, ensures cash payments for all government purchases from these enterprises, and require that SOE accounts receivable and payable are kept current. 28 These and other issues concerning privatization are discussed more fully in the PPAR for the EFSAL. 29 The CPF s t i l l manages about 1,200 enterprises, o f which 175 are majority owned, including major enterprises in shipbuilding, agriculture, and tourism. 30 CEM FY04. 3’ The CPF recently was left without a chief executive for 16 months. 32 Administrative procedures related t o investor entry and expatriate employment have been simplified, and the time required to process visas and work permits has been reduced, among other reforms. 20 3.15 In agriculture, the Bank has had a modest but useful impact with the Private Farmer Support loan which was targeted to research and training, as w e l l as the cadastre project. The agrokombinats remain a major problem that has as yet been ineffectively addressed by the Bank’s ESW. Improvements are also needed to enhance the performance o f private sector agriculture. Subsidies are high compared to accession countries (and n o w amount to 4.4 percent o f the central government budget, an increase fi-om 2 percent in 1995-98), although producer price supports are similar to those in the EU. Bank support for improved land markets under the ongoing Cadastre project i s too recent to be evaluated. Improving Public Administration and the Judiciary 3.16 Public administration efficiency should be improved by realigning ministries and strengthening policy management. The government’s core functions in key ministries such as the Ministry o f Finance need to be strengthened, including policy development and determination o f reform priorities. Conversely, the government s t i l l plays a larger role than appropriate in many sectors including energy, transportation, agriculture, and industry. Political appointments extend through many levels rather than being restricted to the very highest levels in each ministry. The F Y 0 4 C E M sensibly proposed that political appointments should be limited to the Ministerial and Deputy Ministerial levels, as widespread political appointments deprive ministries o f much-needed technical expertise. The public administration wage bill i s high at 11.9 percent o f GDP, compared to 9.9 percent in Slovenia,33 9.5 percent in the Czech Republic,34 and 9.1 percent in the Slovak Republic.35 The government enacted several wage freezes which were only partly successful, despite Bank proposals in the PER (FY02) and other ESW for selective wage controls which would have promoted restructuring. Overall staffing i s not excessive.36 The SAL supported implementation o f some priority reforms to improve governance, such as to bring all sources o f revenue and expenditures on-budget beginning in 2002 (although highway funds are treated specially). Municipal government “reforms” in 1995 increased the number o f municipal governments from the 104 that existed at independence to more than 424, in addition to which there are 123 towns, and the city o f Zagreb. Most municipalities have populations below 3,000. Despite a fairly broad l i s t o f powers, funding remains highly centralized; the Bank has noted that substantial gaps exist between the two, and that Croatia should take a position o n amalgamation o f local governments, but as o f now, none has been f ~ r t h c o m i n g . ~ ~ 3.17 Although judicial reform i s one o f three key areas in which the EU has stated that progress i s needed if Croatia i s to move closer to accession negotiation^,^' there i s to date only halting progress. The Bank should focus more o n supporting reforms that enhance 33 IMF Article I V Consultation, 2003 34 IMF “Czech Republic: Selected Issues and Statistical Appendix”, January, 2004 35 CEM FY04. 36 Staff in central and general government comprises 4.9 percent o f the population, in line with a sample o f seven comparable countries. However, it appears that the non-civilian public sector may be relatively large, and as security concerns continue to be addressed through n o n m i l i t a r y means, this could be reduced. 37 CEM FY04. 38 The others are to speed up refugee return and full cooperation with the The Hague tribunal. 21 incentives for improved performance including timely settlement o f cases, improved access to precedents, computerization, expanded roles for bailiffs, wider use o f and upgrading o f trustees, and use o f administrative courts to settle issues such as wages. 3.18 While most cases ofpublic procurement appear to be satisfactory and the recent internal assessment on country procurement covered the basics for project procurement, there are at least several instances o f larger-scale government projects which raised procurement issues, including in the Highway Sector, and, reportedly in other sectors. I t would be important for the next country procurement assessment to look into these issues to assess the effectiveness o f the procurement framework as it applies to all projects, large and small. 3.19 Croatia ranks below the EU accession countries in the key governance indicators, especially in r u l e o f law, political stability, and voice and accountability, as shown in the chart below, and well below Hungary, Poland, and the Slovak Republic in each o f these areas. Croatia will need to improve i t s govemance indicators as part o f i t s efforts to enhance relations with EU and EU accession countries. Governance Indicators, 2002 Control of Corruption Go\ emment Effectiveness Political Stability \‘oice and Accountability 0 10 20 30 40 50 60 70 80 90 100 ~ CROATIA ID HUNGARY 0 POLAND B SLOVAK REPUBLIC 0 EU Accession Countries* ~ Source: Kauffman, Kraay, and Mastruzzi, “Governance Matters 111”, World Bank, 2003 *Excluding Cyprus and Malta, for which no data are available. Poverty Alleviation and Unemployment 3.20 The Bank has been less active in poverty alleviation and social development than would have been desirable, largely because until 2000 the government did not welcome Bank assistance in this area. The Economic Vulnerability and Welfare Study (FYO1) was long-delayed, having been o n the agenda since the mid-1990’s country strategy. While 22 the Bank supported pension and other social sector reforms (see above), it has not yet had a strong impact o n poverty alleviation. For the fiture, the labor market reforms supported by the SAL should have an important impact o n poverty and unemployment. While the Bank i s beginning to have an important impact in health, it has not been active in education, identified as a weakness in the Vulnerability Study, and where a proposed project was dropped from the lending program, because o f lack o f interest o n the part o f the government. Finally, both the first and the second client surveys (see box 4.1) indicated that the Bank was not perceived as being involved to any great extent in poverty alleviation or unemployment. Outcome o f the Country Assistance Program39 Relevance 3.2 1 The Bank proposed relevant assistance programs in the two CASs and the CAS PR. However, prior to FY02, the assistance program as implemented was less relevant, as the government turned aside proposals for adjustment and sector reforms in public administration, the judiciary, health, and other sectors. In addition, as noted in para. 2.5, the Bank at times limited access to adjustment assistance because o f concerns about Croatia’s financial support for Bosnian Croats in Bosnia and possible destabilization there. The resulting lending program focused much more o n infrastructure than the CAS proposals, and less on reform needed in public expenditure, debt, growth, and govemance. Since FY02, relevance has improved substantially as the focus has shifted to the needed reforms, especially with the implementation o f the PER, the Vulnerability Assessment, the SAL, and the Bankruptcy LIL. Most recently, the Bank’s activities to promote closer relations between Croatia and the EU have been fully o n target, as illustrated, for example, by the proposals presented in the F Y 0 4 CEM. EfJicacy 3.22 Efficacy through FYOl was low, with many attempts to influence policy achieving only l i t t l e success, so that even proposed analytic pieces (investment reviews, poverty assessment) were sidelined by the government; results in the project portfolio were mixed with specific shortfalls in key operations including the Highway sector loan and the EFSAL. Despite this lack o f efficacy and shortfalls in achieving CAS objectives, the Bank did not reduce the proposed level o f lending in the F Y 9 9 CAS. I nthe event, actual lending f e l l far short. Efficacy after FYOl has improved and i s rated substantial with the implementation o f the SAL-supported program, the ongoing Health 2 project and the impact o f ESW, among other activities. Summary Rating of the Outcome of the Bank’s Assistance Strategy 3.23 Bank actions, which largely determine Bank performance, are only one contributor to the outcome and institutional development impact o f the Bank’s assistance strategy. Outcomes are also determined by the Borrower’s performance and other For a description o f rating methodology, see annex D “Guide o f OED’s Country Assistance Evaluation 39 Methodology.” 23 factors. The outcome o f country assistance through FYOl is rated unsatisfactory, as the government did not accept the need for key reforms proposed by the Bank as evidenced by the deterioration o f public expenditure performance, the continuing rise in debt, lack of reforms in public administration and governance, and lack o f progress in reducing poverty and addressing unemployment, and in the case o f privatization, lack o f progress in generating sustainable growth through privatization programs which were in part supported by the Bank. These evaluations are supported by the outcome ratings for completed projects, and the large mismatch between proposed and implemented assistance programs. The post FYOl program i s rated satisfactory, based o n higher ratings o f relevance and efficacy. There has been progress in restraining and retargeting the public investment program, in SAL-supported reforms, and in public administration and governance reforms, although the latter are proceeding at a slower than desirable pace. Finally, ratings for ongoing projects are better for Croatia than for E C A and the Bank as a whole. InstitutionalDevelopment Impact 3.24 Institutional Development Impact (IDI) i s rated high for financial sector soundness, where the impact o n institutions through the EFSAL and ESW has been strong. Concerning economic management, ID1through FYOl was modest, but subsequently it i s rated substantial, as a result o f the impact o f the P E R and the SAL. Bank assistance has not yet had much o f an impact o n the structure o f the public sector, and ID1here i s rated as modest for both time periods. The Bank has had a substantial institutional development impact on aid coordination, for which an ID1rating o f high is appropriate. An ID1rating o f substantial i s appropriate for financial accountability, although there i s a need for improvement in the way some large projects are handled. In general, where the Bank was able to implement work with substantial policy content in a receptive sector, ID1was high. With lesser policy content in less receptive sectors, ID1 was lower. Overall, ID1i s rated as modest prior through FYOl and substantial for subsequent years. Sustainability 3.25 The uniformly high ratings for sustainability among project ratings, and, even more important, the anchoring o f Croatia’s programs in i t s aspirations to j o i n the EU and to work ever more closely with EU countries, suggest a rating o f likely for sustainability. However, Croatia’s high debt, and the need for accelerated progress in privatization, governance, and other reforms needed to sustain growth, introduce a strong note o f caution conceming sustainability. Further reforms are clearly needed. 24 4. Contributions to Outcomes World Bank Contributions 4.1 The objectives o f the Bank’s assistance program were relevant to the development challenges facing Croatia. However, f i o m FY94-FYO1, the program actually implemented was quite different from that proposed. There were two reasons for this. First, reconstruction emerged as a continuing challenge and the Bank appropriately restructured the proposed program to address this challenge by adding three reconstruction projects to the program. O n the other hand, relevant public sector and agricultural adjustment loans were not implemented. The government was not ready to accept a poverty assessment during the 1990s so that this could not be implemented, and, similarly, the C E M was delayed. Even so, the Bank/Client dialogue was sustained to some extent, financed in part by T A grant funds in preparation for (subsequently dropped) adjustment lending but yielding some reform proposals that were later implemented. The divergence between expected government receptivity to reform and government performance during the 1990’s i s captured by the projected role o f government in GDP in the mid-1990’s country strategy, in which government expenditures were projected to peak at about 30 percent o f GDP, only slightly more than half o f the percentage actually reached. 4.2 Subsequent to FYO1, the proposed assistance strategy has been both relevant to the challenges facing Croatia and implemented largely as projected in the CAS PR. ESW (the P E E , CEMs, “Croatia: A Policy Agenda for Reform and Growth”) contributed to this positive outcome, with the SAL providing important operational support. 4.3 The Bank’s role as suggested by client surveys (box 4.1) appears to have been more important in implementing projects with appropriate safeguards, than in reducing poverty or improving g~vernance.~’ Box 4.1: Client Surveys The 1998 client survey respondents reported that the Bank’s most important contribution was t o foster growth while the least important was to help strengthen civic participation. The Bank was seen as most effective in supporting infrastructure, least in alleviating poverty. Respondents thought the B a n k was realistic and highly effective in adjusting t o changing country circumstances, but that the Bank needed t o b e more active in restructuring poorly performing projects. The 2003 Client Survey found that Croatians v i e w the Bank’s work in safeguarding against corruption in projects and programs that it funds with i t s procurement r u l e s as i t s most important activity, while the least important activities are helping t o reduce poverty and gender disparities. The Bank was found to be least effective in strengthening education and the judicial system (but that strengthening the judicial system was a high priority), and was most effective in strengthening infrastructure. The Bank was given h i g h marks for the w a y i t handles disbursements and other project-related activities. The most r o o m for improvement was in helping to strengthen the economy, jobsiemployment, education, reducing corruption and improving governance, and strengthening the judiciary. The Bank was also credited with going public with i t s attitudes toward Croatia, and making the results o f i t s activities known publicly. M a n y felt that the B a n k exhibited correctness, clear rules, and measurability o f attainments. There was a feeling among those with negative attitudes that the Bank’s real interests are hidden, and that i t i s blackmailing s m a l l countries such as Croatia o n the part o f the b i g ones. 40 For methodology o f the client surveys, see attachment 3. 25 Client Country Contribution 4.4 Through FYO1, Croatia was faced with regional conflicts and was torn between choosing inward and outward-looking development paths. Although the Bank was seen as an important bridge to Westem Europe, the reform messages brought by the Bank, through formal and informal ESW were often not well accepted. This ambivalence i s reflected in unfulfilled CAS programs and halting efforts at reform which resulted in increasing government participation in the economy, large budget deficits, and a degree o f economic instability. Subsequent to FYO1, the country has been much more clearly focused o n joining the EU and reforming i t s economy accordingly. But the change would have been more complete i f Croatia had also addressed the faulty privatization programs, the large role for politics in public administration and efficiency, and effectiveness o f public administration. The highway program remains an important issue for public finance reform, despite some improvements since 2000, and there are shortcomings in education which impinge on social development. Despite these drawbacks, there i s general agreement in Croatia o n pursuing reforms to enable it to j o i n the EU. The key question i s whether implementation o f reforms can be accelerated so as to make more realistic the country’s ambition to j o i n the EU in the next few years. Aid Partner Contributions 4.5 The Bank has worked closely with the IMF in assisting Croatia. The IMF’s f i r s t two programs were not completed (Croatia only drew o n the Standby Arrangement (SBA) approved in 1994 and the Extended Fund Facility approved in 1997 for the initial drawings and then allowed the programs to lapse with very partial implementation), which reflects a close parallel in the Bank’s unsuccessful attempts to promote structural reforms during these years. However, the SBA approved in 2001 and the ongoing SBA, approved in 2003, have been successful in terms o f program implementation and ~ ~ have complemented the program supported by the SAL. technical a s ~ i s t a n c e ,and 4.6 Croatia has in the last few years benefited from substantial assistance from the EU’s CARDS program (see box 4.2) and from the national dialogue which i s supporting Croatia’s efforts to j o i n the EU, spurred by the S A A . This i s n o w an important lynchpin for all other assistance programs. The EU i s supporting a variety o f programs including refugee assistance and vocational training, and plans to support state audits to improve privatization performance. EU organizations such as Support for Improvement in Governance and Management (SIGMA) have also been important. 4.7 USAID has played a key role in furthering reforms supported by the Bank’s assistance program. U S A I D support for judicial reform, governance, capital markets development, treasury, pension reform, and the cadastral survey in Zagreb, have all been important in this respect. U S A I D has funded SAL counterpart staff, thereby removing an important constraint to SAL implementation. When disagreements did emerge, as in studies for judiciary reform relevant to the Bank’s Bankruptcy and Court Administration project, they were resolved. Similarly, the British Know-How Fund provided financing 41 These SBAs were based o n programs agreed between Croatia and the IMF, but did not involve financial assistance. 26 for technical assistance for EFSAL implementation. The Bank’s assistance for reconstruction was furthered by a number o f bilaterals and by NGOs, such as the Catholic Relief Services, and the Open Society Institute-Croatia. Box 4.2: European Union Assistance The EU CARDS program allocates about 60 million Euros per year to Croatia, which have been used to support 16 projects in 2001,29 in 2002,39 i n 2003. The EU Ambassador to Croatia sees the W o r l d Bank as having an important role, and relations with the local office are very close. There are important overlapping areas o f interest related to the Bank’s lending program including reforms o f public administration, the legal system and its implementation, and cadastral improvements. Non-lending activities have also been important. Conceming war recovery, the EU identified counties in Dalmatia which were severely impacted, and the Bank supported Regional Development Workshops o n these counties, which helped the EU t o formulate programs in these counties, which should be good models for the other counties. S I G M A (a joint venture o f O E C D and EU Phare) analyzed public administration and made recommendations as reported i n the CEM (FY04) which would also serve as a good basis for Bank-supported reforms i nthe future. T h e EU Ambassador also felt that the Bank has a n important role to play i n improving health and education strategy and programs, although the EU takes leadership in vocational training. EU also focuses o n support for refugees and building capacity o f local governments to prepare for Regional Funds. Public opinion polls show that 70 percent o f Croats want t o join the EU. As preconditions to opening negotiations o n EU membership, Croatia needs t o completely satisfy 3 political conditions: full cooperation with the Court o f Intemational Justice in The Hague, speeding up return of refugees, and progress o n judicial reform. Negotiations need to be opened by 2004 if there i s to be any hope of joining the EU in 2007. 4.8 EBRD has played a useful role in i t s numerous investments with i t s collaboration with I F C o n specific projects. I t has also assisted the private sector development goal more broadly by supporting programs to develop entrepreneurship and in helping to reform selected public enterprises. Impact o f Exogenous Factors 4.9 The downturn in the world shipping industry had a serious impact o n Croatia’s shipyards and made their sale, agreed under the EFSAL, difficult. The conflict in Kosovo was exogenous and greatly reduced tourism for several years, although by now tourism has fully recovered. O n the positive side, EU Accession agreements by many o f Croatia’s neighbors have an important demonstration effect re-enforcing the depth o f actions to support Croatia’s goal o f joining the EU. Conversely, the earlier entry o f neighbors, at least until Croatia could j o i n the EU, might divert some potential FDI away from Croatia. 27 5. Lessons and Recommendations 5.1 A lesson from the pre-FY02 program, and especially the unsatisfactory outcome o f privatization and the EFSAL, i s that the Bank needs to be clear about government support for adjustment operations, closely supervise them, and modify/cancel them if necessary, rather than to allow faulty implementation to proceed. For countries aspiring to accede to the EU, the Bank also needs to develop the case at the highest levels more clearly for health and education reform, where these and related aspects o f social development are not directly addressed by EU programs. Conversely, large projects for infrastructure, such as the Highway Sector Project, are not necessarily beneficial in the absence o f policy reform as signaled by the lack o f a firm tie-in to an adjustment program. Large infrastructure sector or investment operations should not substitute for adjustment operations to make up for shortfalls in lendingprograms. 5.2 Moderate GDP growth based o n factors such as tourism and workers remittances can hide, at least for a time, problems in transformation o f productive sectors, especially where GDP i s recovering from depressed levels due to war, as happened in Croatia. Since the case for adjustment can be difficult to make in these circumstances, i t needs to be based o n solid ESW, including informal ESW where necessary, and presented convincingly at the highest levels. The successful financial sector reform i s instructive, where this case was made to the National Bank. 5.3 For privatization, the key lesson i s that insider buy-outs should not be favored or given special incentives which may make corrupt outcomes more likely. Guaranteed buy-backs hrther undermine the quality o f privatization, and leave the problem unresolved. Market-based opportunities to purchase enterprises should be widely available to promote competition in the purchase o f assets. Recommendations 5.4 The forthcoming country assistance strategy should set out the key reforms needed for Croatia to successfully pursue membership in the EU. The F Y 0 4 C E M already provides a good outline for this agenda, which should focus o n a fiscally responsible and well-targeted role for government, improved govemance and judiciary reforms, pursuing the privatization agenda, and the health and education reforms needed to bring Croatia towards EU standards. 5.5 The Bank should support rationalizing and retargeting public expenditure, in l i n e with public revenues, to support reforms in health, education, and infrastructure. In so doing, special care should be taken in the transportation sector. The disappointing outcome o f the Highway Sector Loan and continuing lack o f adherence to appropriate standards (despite some improvements) and maintenance have resulted in highways continuing to absorb large amounts o f resources needed for other higher priority programs. Lack o f progress o n the Railways Modernization project to date raises a similar concern. Consideration could be given to making a large component o f the lending program conditional on effective reforms in public investment, for which the transportation sector would be an important example. 28 5.6 A second focus o f Bank assistance should be improving growth, attacking unemployment and strengtheningdebt sustainability by promoting private sector development. One aspect o f this would be to ensure that privatization o f SOEs or reprivatization o f failed enterprises i s successful, e.g., does not favor insider buyouts. A second aspect would be to monitor the SAL-supported reforms, aimed at improving the environment for private sector development, in order to assess whether further measures are needed. 5.7 Finally, the Bank’s assistance should focus o n improving the core functions o f government, public administration, and the judicial sector. 29 Annex A: Statistical Annexes Annex Table 1 : Croatia at a Glance Annex Table 2 : Croatia-Key Economic and Social Indicators, 1990-2002 Annex Table 3 : Croatia-Development Assistance and World Bank Lending Annex Table 4 : Economic and Sector Work Annex Table 5 : Ratings for Croatia Annex Table 6 : Croatia-Bank’s Senior Management, 1992-2002 Annex Table 7 : Croatia-Millennium Development Goals Annex Table 8 : Proposed and Actual Lending 31 Annex A Annex Table 1: Croatia at a Glance 8/20/03 Europe 8 Upper- POVERTY and SOCIAL Central middle- Croatia Asia income )evelopment diamond' 2002 Population, mid-year (millions) 4.4 476 331 Life expectancy GNI per capita (Atlas method, US$) 4,640 2,160 5,040 T GNI (Atlas method, US$ billions) 20.3 1,030 1,668 Average annual growth, 199642 Population (%) 4.6 0.1 1.2 SNI Gross Labor force (%J 4.4 0.4 1.8 xr primary Most recent estimate /latest year available, 199602) =pita nrollment Poverty (% of population below national povefty line) Urban population (% of total population) 59 63 75 Life expectancy at birth (years) 74 69 73 1 Infant mortality (per 1,OOOIive births) 7 25 19 Child malnutrition (% of children under 5) 1 Access to improved water source Access to an improved water source (% OfpOpulatiOfl) Illiteracy (% ofpopulation age 15+J Gross primary enrollment (% of school-age population) 2 91 91 3 102 90 7 105 - Croatia Male 92 103 106 ~ Upperiniddle-income group Female 91 101 105 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1982 1992 2001 2002 Economic ratios' GDP (US$ billions) 10.2 19.5 22.4 Gross domestic investmeWGDP 13.4 24.7 Trade Exports of goods and services/GDP 59.6 48.5 Gross domestic savings/GDP 18.9 18.4 T Gross national savingdGDP 16.3 20.7 Current account balancdGDP -3.2 3omestic Interest payments/GDP 3.2 2.5 -? Investment savings Total debffGDP 55.7 59.9 Total debt service/exports Present value of deWGDP 27.6 54.8 1 Present value of debvexports 99.8 Indebtedness - 1982-92 199242 2001 2002 200206 (average annual growth) GDP .. 3.6 3.8 5.2 4.0 Croatia GDP per capita .. 4.7 3.8 5.3 4.3 Uppermiddle-income group Exports of goods and services .. 5.9 9.0 STRUCTURE of the ECONOMY I (% of GDPJ Agriculture .. 14.9 9.7 Industry .. 33.1 342 Manufacturing .. 29.2 24.3 20 Services .. 52.0 56.1 Private consumption .. 57.3 56.6 General government consumption .. 23.8 25.0 -GDI *GDP Imports of goods and services I 1982-92 199242 2001 2002 Growth of exports and imports (%) (average annual growth) Agriculture .. 4.1 0.7 Industry .. 2.7 4.3 20 Manufacturing .. 2.1 6.0 10 Services .. 4.4 4.8 0 Private consumption .. 2.7 4.6 General government consumption .. 0.4 -3.9 -10 Gross domestic investment .. 7.6 13.7 Imports of goods and services .. 4.8 9.3 Note: 2002 data are preliminaryestimates. This table was produced from the Development Economics central database. * The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. Annex A (continued) 32 Croatia PRICES and GOVERNMENT FINANCE I 1982 1992 2001 2002 Inflation (Oh) Domestic prices I10 T (% change) 663.6 4.9 il Consumer prices lo’ Implicit GDP deflator 594.9 2.9 2.9 Government Rnance (% of GDP, includes current grants) Current revenue 35.0 46.0 46.8 97 98 99 00 0, Current budget balance -2.1 -1.6 2.2 -GDP deflator ‘-0-CPI Overall SUrDlUS/defiCit -3.7 -3.9 -5.1 TRADE I 1982 1992 2001 2002 Export and Import levels (US$ mill.) (US$ millions) Total exports (fob) 4,445 4,752 10000~ Raw materials, excluding fuels 286 241 397 474 7 500 Mineral fuels and lubricants Manufactures 1,878 2,393 5 000 Total imports (ci0 4,461 8,764 Food 314 691 2 500 Fuel and energy 418 1,174 I Capital goods 468 3,005 0 Export price index (1995=100) 150 Import price index (1995=100) 149 I Exports Imports O2 Terms of trade (1995=100) 101 BALANCE of PAYMENTS 1982 1992 2001 2002 i Current account balance to GDP (“h) Io (US$ millions) Exports of goods and services 6,107 9,625 Imports of goods and services 5,547 10,659 Resource balance 559 -1,034 Net income -1 70 -529 457 Net current transfers -91 966 10 Current account balance -617 Financing items (net) 1,930 Changes in net reserves -167 -1,313 1-15 1 Memo: Reserves including gold (US$ millions) 167 4,704 Conversion rate (0% local/US$) 0.3 8.3 7.9 EXTERNAL DEBT and RESOURCE FLOWS 1982 1992 2001 2002 (US$ millions) 1 Composition of 2002 debt (US$ mill.) Total debt outstanding and disbursed 10,888 13,429 i IBRD 427 486 IDA 0 0 Total debt selvice 2,966 3,310 IBRD 37 51 IDA 0 0 Composition of net resource flows Official grants 67 Official creditors 16 5 Private creditors 718 1,101 Foreign direct investment 1,512 Portfolio equity 6 I F: 11.389 World Bank program Commitments 5 53 IA-IBRD E - Bilateral Disbursements 75 33 B - IDA D - Other muitiiateral F - Private Principal repayments 18 30 IC-IMF G - Short-tern Net flows 57 3 Interest payments 19 21 Net transfers 36 -18 Note: This table was produced from the Development Economics central database. 8/20/03 33 Annex A (continued) Annex A (continued) 34 DAC DONORS _ _ _ 3.8 110 149.3 290.4 953.1 703.3 1610 1215.8 EBRE _ _ _ 0 18.3 131.2 88.6 86.3 -10.5 55.1 IBRD _ _ _ -28 29.4 88.9 100.4 91.5 66.6 33.5 UNDP _ _ _ 0 0.1 1.2 0.1 1.1 1.2 0.1 TOTAL MULTILATERAL _ _ _ 33.8 59.4 225.7 205.1 207.2 75 130.2 TOTAL DONORS - - 0 3.8 143.7 208.9 516.2 1160.8 912.4 1684.4 1344.4 IBRE share o f multilateralassistance, % - - - 49.5 39.4 49.0 44.2 88.8 25.7 IBRD share o f total assistance, % _ _ _ 14.1 17.2 8.6 10.0 4.0 2.5 Annex Table 3b: W o r l d B a n k Lending b y Sector, 1990-2003 Data in US$ million Sector Board/ FY 990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 IBRD/ IDA Total Economic Policv 202 202 SAL 202 202 Environment 26 26 REAL PROP REG & CADASTRE 26 26 Enerev ENERGY EFF 5 5 Financial Sector 10 95 30 135 CAPITAL MARKET DEV. 10 10 EFSAL 95 95 hVESTMENT RECOVERY 30 30 Health, N u t r i t i o n and PoDulation 40 29 69 HEALTH 40 40 HEALTH SYSTEM 29 29 Private Sector DeveloDment 5 7 12 TECH ASST 5 5 TA INST REG REF PSD 7 7 Public Sector Governance 5 5 COURT & BANCRUPTCY ADM (LIL) 5 5 R u r a l Sector 17 42 59 FARMER SUPPORT SERV 17 17 COASTAL FOREST RECON 42 42 Social Protection 27 27 PENSION SYS INVST 27 27 TransDort 80 102 101 14 454 HIGHWAY SECTOR 80 80 EMG TRANSMINE CLR 102 102 RAILWAY MOD. & REST. 101 101 TRADE & TRA\-S FACIL 1 s SE EUR 14 14 RIJEKA GATEWAY 157 157 U r b a n DeveloDment 128 41 169 EMG RECON 128 128 EAST SLAVONIA REC 41 41 and Sanitation W a t e r SUDD~V 36 36 MUN ENV INFRA 36 36 Total Lendinp; 128 120 32 239 107 108 29 19 202 53 162 1,199 Source Business Warehouse. November 19,20 Annex A (continued) 35 Annex Table 4: Economic and Sector Work ~~ No. Document Title Date Report N o Document Type Croatia - Country Economic Memorandum: A Strategy for Growth through 1. 7,112003 25434 Economic Report European Integration Vol. 1 o f 2 (English) Croatia - Country Economic Memorandum: A Strategy for Growth through 2. 711,2003 25434 Economic Report European Integration Vol. 2 o f 2 (English) Trade Policies and Institutions in the Countries o f South Eastern Europe in the 3. 3/28/2003 24460 Sector Report EU Stabilization and Association Process Vol. 1 (English) Croatia - Regaining Fiscal Sustainability and Enhancing Effectiveness - A 4. 113012001 22155 Economic Report Public Expenditure and Institutional Review Vol. 1 (English) 5. Croatia - Economic Vulnerability and Welfare Study Vol. 1 (English) 4/18/2001 22079 Economic Report 6. Republic Of Croatia - Policy Directions for Transport Vol. 1 (English) 611511999 19447 Sector Report 7. Republic O f Croatia - Policy Directions for Transport Vol. 2 (English) 611511999 19447 Sector Report 8. Croatia - Beyond Stabilization Vol. 1 (English) 1211911997 1726 1 Economic Report Source: Imagebank, as o f September 23,2003. Annex A (continued) 36 d d d d d 2 a 2 2 : an. 2 R 2 a : - . .. 8 B B B m N s N O m ?? : : & m 0 0 0 0 0 4 g 0 . 0 N 0 0 0 . N 0 N N N m I m N - N 0 P 4 B m a 0 \oI? 0 0 m 0 m 0 0 N 0 - 0 0 0 0 0 m 0 B 2 2 Z Z 2 Z 2 m m d v i m vi m m \o P m m m m > > > > > > ij i z z z z z z R E m N L 3 - d .- I C C .r u. e L z VI z 0 .. m 2 Y g s 0 VI w u. - X Q) P N m N " N O 4 % s N vi m El m 0 0 d m 4 0 m 0 m 0 m m m 0 d 0 m 0 o m 0 d E E E E E E E E 37 Annex A (continued) Annex Table 5c: Projects at Risk Net Comm # Proj At Comm At % Commit Country # Proj % AtRisk Risk Amt Risk at Risk Estonia 1 25.0 0 0.0 0.0 0.0 Croatia 11 447.6 0 0.0 0.0 0.0 Hungary 1 31.6 0 0.0 0.0 0.0 Poland 10 996.7 0 0.0 0.0 0.0 Slovak Republic 5 281.6 0 0.0 0.0 0.0 ECA 277 15,943.0 49 18% 3,082.7 19% World Bank 1,354 94,444 267 20% 17,722 19% Data as of: 11/16/2000. Source: Business Warehouse as o f 11/20/2003. Annex A (continued) 38 Annex Table 6: Croatia - Bank's Senior Management. 1992-2002 Year Vice President Country Director Chiefmesident Representative 1992 Wilfried Thalwitz Kemal Dervis Ani1 Sood 1993 Wilftied Thalwitz Kemal Dervis Michel Noel 1994 Wilfried Thalwitz Kemal Dervis Michel Noel 1995 Wilfiied Thalwitz Kemal Dervis Michel Noel 1996 Johannes F. Linn Jean-Michel Severino Michel Noel 1997 Johannes F. Linn Jean-Michel Severino Michel Noel 1998 Johannes F. Linn Ani1 Sood Sandor Sipos 1999 Johannes F. Linn Amtraud Harhnann Sandor Sipos 2000 Johannes F. Linn Amtraud Hartmann Sandor Sipos 200 1 Johannes F. Linn Andrew Vorkink Vacant 2002 Johannes F. Linn Andrew Vorkink Indira Konjhodzic Source: World Bank Group Directory. 39 Annex A (continued) - Annex Table 7: Croatia Millennium Development Goals Indicators 1990 1995 1999 201 1. Eradicate exreme poverty and hunger Population below $1 a day (%) 2.0 Poverty gap at $1 a day (%) 0.5 Income share held by lowest 20% (1998) 8.8 Malnutrition prevalence, weight for age (% o f children under 5) 0.6 Prevalence o f undemourishment (% o f population) 15.0 2. Achieve universal primary education Net intake rate in grade 1 ("XI o f official school-age population) 57.1 22.6 School enrollment, primary (%net) 78.8 82.3 71.9 Persistence to grade 5, total (% o f cohort) Literacy rate, youth total (% o f people ages 15-24) 99.6 99.7 99.8 9s 3. Promote gender equality Ratio o f girls to boys in primary and secondary education (%) 97.3 96.8 97.2 Ratio o f young literate females to males (% ages 15-24) 99.9 100.0 100.0 1O( Share o f women employed in the nonagricultural sector (%) 44.8 44.9 45.8 Proportion o f seats held by women in national parliament (%) 31.0 31 4. Reduce child mortality Mortality rate, under-5 (per 1,000 live births) 12.5 10.4 9.5 5 Mortality rate, infant (per 1,000 live births) 10.7 8.9 7.7 Immunization, measles (% o f children under 12 months) 92.0 92.0 5. Improve maternal health Maternal mortality ratio (modeled estimate, per 100,000 live births) 18.0 Births attended b y health staff (% o f total) 6. Combat HIV/AIDS, malaria and other diseases Prevalence o f HIV, female (% ages 15-24) 0.0 Contraceptive prevalence (% o f women ages 15-49) 69.0 69.0 Number o f children orphaned by H!Y/AIDS Incidence o f tuberculosis (per 100,000 people) 61.0 Tuberculosis cases detected under DOTS (%) 7. Ensure environmentalsustainability Forest area (% o f land area) 31.5 31.9 31.9 Nationally protected areas (% o f total land area) 6.6 7.5 GDP per unit o f energy use (PPP S per kg o f oil equivalent) 3.9 4.1 C 0 2 emissions (metric tons per capita) 3.8 4.5 Improved water source (% o f population with access) 95.0 95.0 Improved sanitation facilities (% o f population with access) 100.0 100.0 Secure internet servers 44.0 44.0 8. Develop a Global Partnership for Development Unemployment, youth total (% o f total labor force ages 15-24) 29.8 Telephone mainlines (per 1,000 people) 172.1 282.8 364.8 Mobile phones (per 1,000 people) 0.1 7.4 65.9 230.9 Personal computers (per 1,000 people) 22.0 67.0 80.7 General indicators Population, total 4.8 million 4.6 million 4.4 million 4.4 million G N I (current USS) 18.1 billion 18.8 billion 19.7 billion 18.7 billion G N I per capita, Atlas method (current US$) 3,410.0 4,580.0 4,620.0 Literacy rate, adult total (% o f people ages 15 and above) 96.9 91.7 98.1 98.3 Fertility rate, total (births per woman) 1.6 1.6 1.4 1.4 Life expectancy at birth, total (years) 72.2 72.1 73.3 73.3 A i d (% o f GNI) 0.3 0.2 0.4 Extemal debt (% o f GNI) 20.4 55.9 64.7 Private fixed investment ( ! o f gross domestic fixed investment) " 17.3 78.4 Trade (% o f GDP) 163.8 88.1 89.4 95.6 Source: W o r l d Development Indicators Database, September 2003. Note: In some cases the data are for earlier or later years than those stated Annex A (continued) 40 Annex Table 8: Proposed and Actual Lending (US$ million) LENDING r Pre-1995 country strategy 1994 1995 TOTAL I Proposed Actual 128 40 168.0 Proposed 200.0 100.0-150.0 300.0-350.0 Actual 80.0 31.5 239.0 106.9 457.4 1999 CAS 1999 2000 2001 TOTAL Proposed 108.3 257.6 224.0 589.9 Actual 108.3 29.0 18.9 156.2 2001 CAS Progress Report 2002 2003 TOTAL Proposed 202.0* 75.0 277.0 Actual 202.0 53.0 255.0 TOTAL I Proposed I ,166.9- 1,216.9 I Post-Progress Report 2004 TOTAL Proposed Actual 156.5 161.5 Proposed 1,230.9 Actual 1,198.1 *The 1999 CAS proposed lending o f US$ 160 million in 2002. However, for 2002, the 1999 CAS was superceded by the CAS Progress Report. Source: Business Warehouse as o f 09/02/2003, mid-1990’s country strategy, CAS 1999, CAS Progress Report 2001. 41 Annex B List o f People Interviewed Government Officials Ingrid Anticevic-Marinovic Goran Granic Minister, Ministry o f Justice Deputy Prime Minister Govt. o f Rep. o f Croatia Andro Vlahusic Minister Davorko Vidovic Ministry o f Health Minister Ministry o f Labour and Social Welfare Cilic Davor Assistant Minister Vera Babic Ministry o f European Integration Assistant Minister Ministry o f Labour and Social Welfare Slavko Linic Deputy Prime Minister Confirmed Ruzica Terze Government o f Rep. o f Croatia Assistant Minister Ministry o f Labour and Social Welfare Miroslav Bozic Assistant Minister N i n o Zganec Ministry o f Agriculture and Forestry Assistant Minister Ministry o f Labour and Social Welfare Roland Zuvanic Minister Mr. Sc. Vanja Bilic Ministry o f Maritime Affairs, Pomocnik Ministrice Transport and Communications Igor Raguzin Krunoslav Placko Senior Counsellor Assistant Minister Ministry o f Economy Ministry o f Economy Boris Maksijan Venko Curlin Counselor, Ministry o f Economy Deputy Minister Ministry o f Public Works, Olja Zaninovic Reconstruction and Construction Deputy Head Foreign Economic Relations Department Josip Kulisic Ministry o f Economy Assistant Minister Ministry o f Finance Darko Polanec Ministry o f Economy Ana Hrastovic, Ministry o f Finance Advisor, World Bank Vlatka Kucevic Executive Director’s Office Ministry o f Economy Zeljko Grzunov Mr. Sc. Vladimira Ivandic Assistant Minister Ministarstvo Financija Ministry o f Public Works, Reconstruction and Construction Annex B (continued) 42 BanWFund Staff Harry Broadman - Manager o f SAL, ECA Kyle Peters - Former Sector Manager Peter Parker - Highway Sector, E C A Ani1 Markandya - Environment Elana Kasterova - Transport Specialist, ECA Arntraud Hartmann - former Country Director Michel Audige - Lead Transport Specialist, ECA Manuel Marion - Lead Water and Sanitation Specialist, E C A Hans Flickenschield - Mission Leader, IMF Ilene Photos - TA Project Manager, E C A Tetsuya K o n u k i - Economist, IMF Yves Duvivier - E C A (Privatization and John Norregaard - Resident Representative, Public Enterprise Reform) IMF Julius Varallyay - Former L e a d Country Andrew Vorkink - Former Country Director Officer M y l a Taylor Williams - Country Program Tetsuya K o n u k i Coordinator IMF (HQ) Albert Martinez - P A L Task Manager, Indira Konjhodzic E F S A L Task Manager Country Manager Gerard0 Corrochano Sanja Madzarevic-Suj ster E F S A L Task Manager Country Economist, The W o r l d B a n k Croatia Country Office Olivier Godron - E F S A L Task Manager, Country Economist Bruce Courtney Country Economist, The W o r l d B a n k Michel Noel - Former Division Chief Croatia Country Office Akiko Maeda - Task Team Leader, Health Other Institutions Rena Eichler - N e w Task Team Leader, Health Vesna Zivkovic Depository Agency Bernard Funck - Sector Manager, E C A Katarina Ott Sandor Sipos - Former Resident Head Representative in Country, E C A Institute f o r Public Finance Lubomira Beardsley - Legal Department Jack Connolly Country Rep., C R S Csaba Csaki - Agriculture Department Ms. M a r i j a Kolaric Catherine Kleynhoff - Former Country M e m b e r o f the B o a r d Officer Croatian B a n k f o r Reconstruction and Development 43 Annex B (continued) Vedrana Carevic Director o f Foreign Credit Transaction Vitomir Begovic Dept., Croatian Bank for Reconstruction Head o f Office and Development Office for Social Partnership Govt. o f Croatia Jacques Wunenburger Del. o f the E C to Croatia Ivica Smiljan Head o f Office Predrag Bejakovic Deloitte & Touche Instut za javne financije Lidija Pavic-Rogosic M i m a Pavletic-Zupic Director Assistance Director ORDAZ Agency for Protection o f Market Competition Vlado Puljiz Center for Social Studies Mario Markovic L a w Faculty Head o f Dept. Agency for Protection o f Zeljko Lovrincevic Market Competition Institute o f Economics Branimira Kovacevic Tomislav Reskovac Sr. Adviser President Agency for Protection o f Open Society Institute o f Croatia Market Competition Ivan Kolar, President Maladen Cerovasc Croatian Farmers’ Association Adviser Agency for Protection o f Market Dunja Vidosevic Competition President First Housing Savings Association Maja Landsman Director Bozena Mesec Intl. Fin. Inst. Dept. Secretary to the Fund Croatian National Bank Croatian Privatization Fund Martina Dalic Josip Kregar Chief Economist Professor Privredna Banka L a w Faculty Jadranka Primora Ante Babic Executive Dir. o f Fin. Institution Vice President Economia Moderna William Jeffers Director Vedran Sosic USAID Member Economia Moderna Zoran Bohacek President Croatian Association o f Banks Annex B (continued) 44 Zeljko Ivancevic Zlatan Janes General Director Head o f Department Croatian Employers’ Association Agency for Protection o f Market Competition Sima Krasic Auditor General Zeljka Skrbina State Audit Agency Senior officer International Financial Lidija Pernar Institutions Department Assistant Auditor General Croatian National Bank State Audit Agency William A. Jeffers I v o Sulenta Mission Director Deputy Director USAID, American Embassy Zagreb CROSEC Srecko Macekovic Andrija Stampar Deputy o f the Management School o f Public Health Board Stipe Oreskovic Head Clay W. Epperson Andrew Krapotkin Program Officer EBRD USAID American Embassy Zagreb Davor Bajuk, L.L.B. Legal Advisor Richard Howard Central Depository Agency Inc. Deloitte & Touche d.o.0. Laura Garagnani Lidija Horvatic Counsellor Director European Union Croatian Employers’ Association Biserka Birus Ljiljana Marjanovic Relationship Manager Bank o f Zagreb 45 Annex C CROATIA COUNTRY ASSISTANCE EVALUATION Management Action Record o f OED Recommendations and Management Response Major Monitorable OED Management Response Recommendations Reauirina a ResDonse The Bank should lend to assist Croatia’s Management fully agrees that any future Bank infrastructure development only where support for infrastructure investment should be linked government support for reforms i s adequate to sound sectoral reform. In the past this was and faulty past policies are replaced by more attempted through policy dialogue, with varied appropriate policies. impact. The proposed Programmatic Adjustment Loan (PAL) program - will likely have a pillar for fiscal consolidation w h i c h will possibly include Railway reforms - should be a more effective instrument for ensuring this linkage. The Bank should assist reforms in health, Management fully agrees that the Bank should education, and pensions to achieve fiscal support reforms in health, education, and pensions - balance and improved sector performance. not only because public expenditure i s h i g h but also because the effectiveness o f such spending needs to improve. Management proposes t o reinforce i t s ongoing investment support for pension and health reforms by addressing associated financing sustainability issues through the P A L program, and to support reforms in the education and health sectors through investment lending aimed at strengthening sector management and service delivery. Future assistance should focus o n improving Management fully agrees that Bank support for the core functions o f government, public public administration and judicial sector reforms administration reform, and judicial sector should be a high priority in the Bank’s assistance reform with lending contingent o n adequate program for Croatia, and recognizes that such government ownership o f reforms. reforms cannot be implemented unless there i s sufficient government ownership o f them. To that end, the proposed P A L program would support reforms o f public administration, public expenditure management, and the judiciary, noting that these reforms typically take long to bear fruit. The Bank should assist government to Management agrees that the B a n k should support devise programs and policies to accelerate acceleration o f transformation o f enterprises the transformation o f enterprises privatized privatized under faulty past programs. The proposed under faulty past programs, including the P A L program w o u l d include support for disposal o f reprivatization o f enterprises reverting to non-performing state-owned assets, as well government ownership, while ensuring that completion o f enterprise privatization, including this reprivatization cannot be repeated in the agro-kombinats. future. 47 Annex D Guide of OED’s Country Assistance Evaluation Methodology 1. This methodological note describes the key elements o f OED’s country assistance evaluation (CAE) m e t h ~ d o l o g y . ~ ~ CAEs rate the outcomes of Bank assistanceprograms, not Clients’ overall development progress 2. An assistance program needs to be assessed on how well i t met its particular objectives, which are typically a sub-set o f the Client’s development objectives. If an assistance program i s large in relation to the Client’s total development effort, the program outcome will be similar to the Client’s overall development progress. However, most Bank assistance programs provide only a fraction o f the total resources devoted to a Client’s development by donors, stakeholders, and the government itself. In CAEs, OED rates only the outcome o f the Bank’s program, not the Client’s overall development outcome, although the latter i s clearly relevant for judging the program’s outcome. 3. The experience gained in CAEs confirms that program outcomes sometimes diverge significantly from the Client’s overall development progress. CAEs have identified assistance programs which had: 0 satisfactory outcomes matched by good Client development; 0 unsatisfactory outcomes in Clients which achieved good overall development results, notwithstanding the weak Bank program; and, 0 satisfactory outcomes in Clients which did not achieve satisfactory overall results during the period o f program implementation. Assessments of assistance program outcome and Bank performance are not the same 4. By the same token, an unsatisfactory assistance program outcome does not always mean that Bank performance was also unsatisfactory, and vice-versa. This becomes clearer once we consider that the Bank’s contribution to the outcome o f i t s assistance program i s only part o f the story. The assistance program’s outcome i s determined by the j o i n t impact o f four agents: (a) the Client; (b) the Bank; (c) partners and other stakeholders; and (d) exogenous forces (e.g., events o f nature, international economic shocks, etc.). Under the right circumstances, a negative contribution from any one agent might overwhelm the positive contributions from the other three, and lead to an unsatisfactory outcome. 5. OED measures Bank performance primarily o n the basis o f contributory actions the Bank directly controlled. Judgments regarding Bank performance typically consider 42In this note, assistanceprogram refers to products and services generated in support o f the economic development o f a Client country over a specified period o f time, and client refers to the country that receives the benefits o f that program. Annex D (continued) 48 the relevance and implementation o f the strategy, the design and supervision o f the Bank’s lending interventions, the scope, quality and follow-up o f diagnostic work and other AAA activities, the consistency o f Bank’s lending with i t s non-lending work and with its safeguard policies, and the Bank’s partnership activities. Evaluation i n Three Dimensions 6. As a check upon the inherent subjectivity o f ratings, OED examines a number o f elements that contribute to assistance program outcomes. The consistency o f ratings i s further tested by examining the country assistance program across three dimensions: (a) a Products and Sewices Dimension, involving a “bottom-up” analysis o f major program inputs -- loans, AAA, and aid coordination; (b) a Development Impact Dimension, involving a “top-down” analysis o f the principal program objectives for relevance, efficacy, outcome, sustainability, and institutional impact; and, (c) an Attribution Dimension, in which the evaluator assigns responsibility for the program outcome to the four categories o f actors (see paragraph 4. above). Rating Assistance Program Outcome 7. In rating the outcome (expected development impact) o f an assistance program, OED gauges the extent to which major strategic objectives were relevant and achieved, without any shortcomings. Programs typically express their goals in t e r m s o f higher-order objectives, such as poverty reduction. The country assistance strategy (CAS) may also establish intermediate goals, such as improved targeting o f social services or promotion o f integrated rural development, and specify h o w they are expected to contribute toward achieving the higher-order objective. OED’s task i s then to validate whether the intermediate objectives produced satisfactory net benefits, and whether the results chain specified in the CAS was valid. Where causal linkages were not fully specified in the CAS, it i s the evaluator’s task to reconstruct this causal chain from the available evidence, and assess relevance, efficacy, and outcome with reference to the intermediate and higher-order objectives. 8. Evaluators also assess the degree o f Client ownership o f international development priorities, such as the Millennium Development Goals, and Bank corporate advocacy priorities, such as safeguards. Ideally, any differences o n dealing with these issues would be identified and resolved by the CAS, enabling the evaluator to focus o n whether the trade-offs adopted were appropriate. However, in other instances, the strategy may be found to have glossed over certain conflicts, or avoided addressing key Client development constraints. In either case, the consequences could include a diminution o f program relevance, a loss o f Client ownership, andor unwelcome side- effects, such as safeguard violations, all o f which must be taken into account injudging program outcome. 49 Annex D (continued) Ratings Scale 9. OED utilizes six rating categories for outcome, ranging from highly satisfactory to highly unsatisfactory: Highly Satisfactory: The assistance program achieved at least acceptable progress toward all major relevant objectives, had best practice development impact o n one or more o f them. N o major shortcomings were identified. Satisfactory: The assistance program achieved acceptable progress toward all major relevant objectives. N o best practice achievements or major shortcomings were identified. Moderately Satisfactory: The assistance program achieved acceptable progress toward most o f i t s major relevant objectives. N o major shortcomings were identified. Moderately Unsatisfactory: The assistance program did not make acceptable progress toward most o f i t s major relevant objectives, or made acceptable progress on all o f them, but either (a) did not take into adequate account a key development constraint or (b) produced a major shortcoming, such as a safeguard violation. Unsatisfactory: The assistance program did not make acceptable progress toward most o f i t s major relevant objectives, and either (a) did not take into adequate account a key development constraint or (b) produced a major shortcoming, such as a safeguard violation. Highly Unsatisfactory: The assistance program did not make acceptable progress toward any o f i t s major relevant objectives and did not take into adequate account a key development constraint, while also producing at least one major shortcoming, such as a safeguard violation. 10. The institutional development impact (IDI) can be rated as: high, substantial, modest, or negligible. ID1measures the extent to which the program bolstered the Client’s ability to make more efficient, equitable and sustainable use o f i t s human, financial, and natural resources. Examples o f areas included injudging the institutional development impact o f the program are: 0 the soundness o f economic management; 0 the structure o f the public sector, and, in particular, the c i v i l service; 0 the institutional soundness o f the financial sector; 0 the soundness o f legal, regulatory, and judicial systems; 0 the extent o f monitoring and evaluation systems; 0 the effectiveness o f aid coordination; 0 the degree o f financial accountability; 0 the extent o f building NGO capacity; and, 0 the level o f social and environmental capital. Annex D (continued) 50 11. Sustainability can b e rated as highly likely, likely, unlikely, highly unlikely, or, if available information i s insufficient, non-evaluable. Sustainability measures the resilience to risk o f the development benefits o f the country assistance program over time, taking i n t o account eight factors: technical resilience; financial resilience (including policies o n cost recovery); economic resilience; social support (including conditions subject to safeguard policies); environmental resilience; ownership by governments and other k e y stakeholders; institutional support (including a supportive legalh-egulatory framework, and organizational and management effectiveness); and, resilience to exogenous effects, such as international economic shocks o r changes in the political and security environments. 51 Annex E Government Comments on the Draft CAE REPUBLIC OF CROATIA METfSTRY OF FINAh'CE Zagreb, 25 March 2004 The World Bank Operations Evaluation bepajmcnt Attn: Mt. AJay Chhibber, Director Fax: 00 1302 477 6391 Re: Croatia - Country Assistance Evaluation Dear Sirs: W e refer to your l e t u dated February 19, 2004 including the draft o f the Croatia Country Assistance Evaluation, where you a sk us to provide you with our views on the Bank assistance to Croatia during 1991-2003. First o f all, we would emphasise our good and highly cooperative relationship with the WorId Bank during the concemed'period o f time, esspecially in the sense that the World Bank h a s provided fjnancial sources and contributed greatcly to the social and economic recovery of Croatia after the war. Concerning the docwent in question, we agree with the overall tone o f it, however, we have noticed that the data used are mostly outsf-date. Please note that: a) the data on percentage o f the population schooling mentioned in Section 1.9, page 3, matches data from 1981, b) the collateral registry mentioned in Section 3.9 h as been established in February 2004 and i s to become fully operative by the end o f this year, c) data mentioned in Section 3.10 are taken from EBRD's Transition Report for 2001 while Transition Report for 2003 i s available. The evaluation shows us the mismatch in approved and proposed lending, ts w e l l ' as delays occuring in many ofjhc porpostd lending. We believe these points should be taken into consideration by n e w CAS presently being formulated, in order to avoid same mistakes. Therefore we w e l c o m e . n w CAS document which should set out the key reforms needed for Croatia's mcmbcrshjp in the EU and we strongly welcome Bank's assistance and support in that mattcr. Yours sincerely, ASSISTANT M3NISTER OF FINANCE ' Joslp Kulifid .. I Annex E (continued) 52 cc: Mr. Ad Melkert,Executive Director Mr. A n a d K Seth, Cowtry Director i 53 Attachment 1 Croatia: ProDosed and Actual Lending Country Strategy ProposaWew $ (millions) Actual $ (millions) Purpose FY94 Emergency Recon pre-CAS 128 FY94 128 FY95 Health pre-CAS 40 FY95 40 Mid-1990’s countrv strateey FY96-98 Highway Sector - 11 FY95 80 C FY96-98 F m e r Support - li FY96 17 b FY96-98 Cap. Markets -11 FY96 9.5 b FY96-98 Technical Assistance New - 11 FY96 5 a,b FY96-98 EFSAL - li FY97 95 b FY96-98 Coastal For. New -11 FY97 42 Recon. FY96-98 Emrg. Mine-Clearing New - 11 FY97 102 Recon.,c FY96-98 1nvst.Recov -11 FY98 30 b FY96-98 Mun Inf. Env (Rijispl) -11 FY98 36 3 C FY96-98 East Slavonia New -l i FY98 40.6 Recon.,c FY96-98 PSAL -li dropped a FY96-98 ASAL - li dropped b FY96-98 Employitraining -l i dropped d FY96-98 Energy Privatization -l i dropped b,c FY96-98 Forestry - li dropped e FY96-98 Zagreb Heating -11 dropped C FY96-98 Health I1 -11 FYOO, a (see FY99 CAS) FY99 CAS FY99 Railways CAS 101 FY99 101 2 FY99 T.A.11 CAS 7.3 FY99 7.3 all FYOO Health I1 CAS 25 FYOO 29 2,5 FY 00 SAL CAS 200 FY02 202 all FYOO Trade CAS 9.3 FYOl 13.9 4 FYOO CourtsiBankruptcy CAS 5 FYOl 5 3,4 FYOO Kastela Bay Cultural CAS 18.3 dropped 4 FYOl Energy Restruct. CAS 50 dropped 2 FYOl JudiciallRegulatory Ref. CAS 30 dropped 3 FYOl Social Protection CAS 30 dropped 5 FYOl Pension Sys.Inv. CAS 20 FY03 27.3 5 FY02 National Environment CAS 40 dropped 4 FY02 Road Maintenance CAS 31 dropped 2 FY02 Rijeka Port CAS 40 FY04 156.5 4 FY02 CAS PR FY 03 Cadastre CAS 25.7 FY03 25.7 3 N.A. Energy Eff. CAS PR N.A. FY04 5.0 2 ” The mid-1990’s country strategy did not specify amounts or fiscal year for proposed projects Purpose Code as defined in each CAS, with reconstruction added to original program, Mid-1990’s country strategy: (a) Reforming public finance; (b) Encouraging private sector growth, (c) Rebuilding and upgrading infrastructure, (d) Poverty, (e) Environment FY99 CAS: (1) Short-term macro and financial stability, (2) Sustainable growth: reducing size of public sector and increasing efficiency; (3) Sustainable growth: improving govemance, (4) Sustainable growth: promoting competition, infra, improving environment, culture, (5) Sustainable growth: poverty alleviation FY02 CAS PR: a s for FY99 CAS, with poverty alleviation redefined as social protection Attachment 1 (continued) 54 The Bank initiated lending to Croatia prior to a CAS with the Emergency Reconstruction Project (ERP) (FY94, US$128 million), and a Health project (FY95, US$40 million). The mid-1990’s country strategy proposed fourteen projects for FY96-98, for US$350 million, but only 6 were approved during the country strategy period. Four new projects were added, including three relevant reconstruction projects which addressed the impact o f fighting with Serbia.43 Only one o f the seven projects (Health 11 ) which slipped from the country strategy period was subsequently implemented, and six were dropped, including two adjustment operations, signaling delayed t r a n ~ f o r m a t i o n . ~ ~ Twelve projects were proposed in the FY99 CAS base case for FY99-02, while two ongoing projects approved in FY99 (Railways and T.A.) that had not been in the FY95 CAS were noted. Only one o f the twelve projects was implemented during the C A S period, while two were implemented subsequently. The C A S Progress Report was issued in FY02 as the democratically elected government sought Bank assistance for reform and enhanced relations with Western Europe. In sharp contrast to the slippage noted above, all o f the five projects which the CAS PR proposed FY02-03, including the S A L , are n o w being implemented. Cooperation o n E S W also improved, and the Public Expenditure Review and the Poverty Report were also implemented. ______________ 43 East Slavonia Reconstruction project and Emergency Transportation and M i n e Clearing Project. 44 An Agriculture Sector Loan and the Public Sector Adjustment Loan, the latter after a considerable M amount o f resources had been expended. T h i s experience with adjustment lending was consistent with I F relations with Croatia, which saw its Extended Arrangement (approved March 12, 1997, for SDR 353 million) lapse unused after the initial purchase. 55 Attachment 2 Overview o f IFC Operations* (Member o f I F C since 1993) 1. IFC Activities Investment Portfolio: I F C investments in Croatia have been in the forrn o f equity and loans in the financial markets and in general manufacturing projects. As o f end October 2003, I F C committed portfolio in Croatia stood at US$97.5 million comprising: Equity and a loan investment in a paper mill plant, aimed at rebuilding and modemizing the facility; Quasi equity investment in a leading pharmaceutical complex; Equity and a loan investment to modernize a ship repairing facility in Rijeka; Loan investment in Croatia Banka as a pre-privatization facility; Loan investment to a regional bank for a credit line to support housing finance and SME on-lending; and Equity investment in a venture capital fund. Also, over the years, I F C has helped i t s clients mobilized about US$98 m i l l i o n in syndicated loans. 2. IFC Results I F C has been successful in supporting several commercially productive enterprises in Croatia with strong foreign exchange eamings and employment opportunities, as well as in developing the financial sector. I F C has also been helping strategically important Croatian companies to grow into regional industry leaders. Some o f the IFC’s successful projects are: Bjelovarska Banka, a small regional bank, which was later merged into Erste & Steiermarkische Bank. I F C financing helped the bank become one o f the few intermediaries actively providing t e r m finance to SMEs and to companies operating in less developed regions outside Zagreb. Belisce: Croatia’s leading producer o f packaging paper and cormgated boxes. I F C helped the company to enhance i t s intemational competitiveness and increase exports, comply with intemational environmental standards, and acquire 100 percent o f the shares in a cardboard and packaging material company in neighboring Slovenia, creating one o f the largest cardboard and packaging materials makers in south-eastem Europe. This was the f i r s t cross-border acquisition in the papedpackaging industry in Southem Europe. Pliva: This i s the largest pharmaceutical company in Central and Eastem Europe. I F C has supported the growth and strategic development o f the company’s research and development infrastructure. This project has a broad positive impact o n Croatian * Providedby IFC’s Europe & Central Asia Department. Attachment 2 (continued) 56 society through providing employment opportunities to local scientists in their home country, and thus helping to curb o f the high level o f “brain drain”. 0 Croatia Capital Partnership LP (CCP), a 10-year private-equity fund. IFC’s investment in CCP increased the Fund’s profile, helped i t reach a critical size, and improved i t s portfolio companies’ access to financing. 3. Economic Problems/Opportunities in the Country that Have Affected Portfolio Performance Since 1999, the investment climate has improved. The 2000 election has improved political stability. The government that took office has pursued structural reforms, fiscal sustainability, and has encouraged foreign direct investment. The government has also been successful in privatizing some key sectors o f the economy, notably the financial services industry and telecommunications. There i s an increased optimism about Croatia’s growth prospects as the EU accession process i s gaining momentum and the country has strong external liquidity. As a result, I F C has increased i t s activities in Croatia during 2000-2003, committing funds in 6 projects for a total o f about US$96 million. 4. Obstacles to Greater Private Activity and Foreign Direct Investment To date the majority o f Foreign Direct Investment (FDI) flows to Croatia have been related to the privatization program. There has been limited greenfield FDI. Obstacles to further increases in FDI include: (i) difficulties and complexities in business licensing and registration; (ii)ineffective land register and cadastre; ( iii) long delays in granting visas and work permits; (iv) a fiscal, regulatory and legal policy framework not in line with best international practice; (v) slow privatization process o f public utilities, infrastructure and the tourism sector; (vi) lack o f a clear and transparent legislative environment; and (vii) slow restructuring in sensitive sectors such as agriculture and shipbuilding. 5. IFC’s Strategy Croatia’s economy i s at a relatively advanced stage so that IFC’s interventions can be more sophisticated and oriented towards catalyzing market-based solutions to private and public sector issues. Financial Sector The banking sector has undergone restructuring and consolidation. Several major foreign banks have entered the market, most o f them with greenfield operations. The privatization process is w e l l advanced with major banks sold to foreign banks. As a result the market i s more competitive, profitability i s improved, and deposits have grown indicating increased confidence in the market. Therefore, in the banking sector I F C will focus on structured finance and housing mortgage transactions. Development in the non- banking sector has been much slower. Consequently, I F C strategy i s to increase i t s 57 Attachment 2 (continued) activities primarily with non-bank financial institutions with a focus on mortgage finance and development o f the local bond market. Real Sector IFC’s strategy i s to support privatization and post-privatization restructuring in key sectors o f the country such as tourism, shipbuilding, food processing, and construction material. IFC will support dynamic companies in Croatia that seek to extend operations across borders. Support for improving corporate governance i s another area where I F C will continue to have an important role to play in Croatia. SME Sector The growth o f S M E s in Croatia has been restricted by limited availability o f long-term funds and the perception o f high-risk held by the banking industry. Therefore, IFC will continue to follow a dual approach: strengthening the financial sector and providing credit lines for on-lending to SMEs. I F C has invested in a private equity fund with a focus o n the S M E sector. In addition to providing loans for on-lending to SMEs, I F C has been offering technical assistance to client banks to better enable lending operations to SMEs. Foreign Direct Investment (FDI) FIAS completed two studies in 2000, one on incentives reform, another o n administrative barriers to FDI. After a long process o f consultation with the government and the private sector, a comprehensive draft report on administrative barriers to investment was presented to the government in 2001. Since then, FIAS has provided assistance to the government in developing a structured methodology and applying a number o f tools for identifying administrative barriers and removing them in order to improve the overall investment climate in the c0unt1-y.~~ I t s recommendations provided a very valuable guide to the Government in modernizing administrative procedures to investors in Croatia. The analysis o f the report has encouraged the government to accelerate i t s reform and focus not only o n legislation, but also o n how regulations are applied in practice. Since 2001, the government has established a high-level coordinating group to address administrative barriers and bottlenecks identified in the F I A S study. However, 70 percent o f this program has not yet been implemented. Infrastructure I F C will continue to search for suitable investment opportunities in the infrastructure sector, focusing o n those transactions where I F C has a well-defined role to play. 45 Source: FIAS, Selected Administrative Procedures for D o i n g Business in Croatia, 21 August 2003 Attachment 2 (continued) 58 Cross Border Integration The private sector may play an important role in economic development and cross-border integration in the region. IFC strategy i s to support dynamic companies in Croatia that seek to extend across borders. Implementingthis strategy, I F C has invested in a paper manufacturing facility and in a leading pharmaceutical company, both looking for opportunities to expand their operation in the neighboring countries. IFC will also support regional infrastructure projects. 59 Attachment 3 Client Surveys: Methodology The Client Survey for 1998 was conducted on a stratified sample o f 198 key clients o f the World Bank in Croatia. The l i s t was compiled by the World Bank and given to a local market research agency. The key client l i s t o f the Client Survey consists o f people in Croatia who are directly involved in the planning, management or evaluation o f the World Bank’s program and those who have had sufficient experience with the World Bank’s activities and adequate infomation about i t s work. The client l i s t comprised people who work for govemment, for NGOs, the media, academic and research organizations, and the business community. Respondents were guaranteed anonymity. They were first informed o f the survey by the World Bank, then given the survey by the local market research agency, which followed up with telephone calls to ensure a high response rate. O f the 198 respondents who were contacted and sent questionnaires, 133 returned the completed survey, a response rate o f 67 percent, o f which 41 percent were govemment officials, 32 percent were entrepreneurs, 10 percent were NGO staff, 9 percent R&D staff, and 8 percent were joumalists. The Client Survey for 2003 was based on three focus group discussions in two cities, Zagreb and Osijek, although a background survey o f 1010 Croatians was also used to gain information o n perceptions. The focus groups comprised joumalists, members o f NGOs, economists, business managers, politicians and government officials. 61 Attachment 4 Chairman’s Summary Committee on Development Effectiveness Croatia Country Assistance Evaluation Meeting o f April 2 1,2004 1. The Informal Subcommittee (SC) o f the Committee on Development Effectiveness (CODE) met on April 2 1, 2004 to discuss the Croatia Country Assistance Evaluation prepared by the Operations Evaluation Department (OED). 2. OED Evaluation Findings. The evaluation finds that Bank loans to Croatia to support reconstruction had successful outcomes, but operations to reform public finance had mixed success. Although some r e f o m s (pensions and health) started in the 1990s, they were not wide- ranging, and public expenditures continued to grow with little retargeting. Since 2000, reforms in pensions and health deepened, and were initiated in other areas supported by Bank E S W and lending. Public expenditures, while s t i l l high, have since decreased as a percentage o f GDP. Operations to raise growth have also had a mixed impact. The fiscal 1997 E F S A L privatization program was flawed, while financial sector reforms were successful. The fiscal 2002 S A L reforms have had a positive impact on the labor market, and new bankruptcy and company laws should help improve enterprise performance over time. The impact o f operations to strengthen public administration has been limited. The S A L that has just closed helped improve some aspects o f budget management. At the present juncture, the Bank should assist Croatia to (1) rationalize and retarget public expenditure to support reforms in health, education and infrastructure, and to contain debt; (2) foster private sector-led growth first by improving the environment for founding new enterprises and second, by ensuring that privatization o f SOEs or reprivatization o f failed enterprises that are reverting to government ownership i s successful, in particular by not favoring insider buyouts; and (3) improve the core functions o f government, public administration, and the judicial sector. 3. Comments from Management. Management agreed with the major findings and recommendations o f the evaluation. It noted, however, that the report could have better highlighted the fact that while the Bank may not have had the full buy-in o f the govemment on governance and other issues, i t s involvement had been vitally important at an early stage to gain knowledge and to establish a presence in the country that had helped it to accelerate the transformation and reform process once conditions permitted. 4. Main Conclusions and Next Steps. Members welcomed the O E D evaluation, which they said was o f high quality, and broadly endorsed i t s findings and recommendations. They noted with satisfaction that Croatia would soon start negotiations for i t s eventual EU membership. Speakers noted the progress in the outcome o f the Bank’s assistance to the country after FYO1, and commended both the Bank and Croatia for this. Some o f them looked forward to a more robust lending and AAA program in the upcoming country strategy to help the country carry forward the reform agenda. A speaker said greater Bank focus was needed with respect to judicial, civil service and privatization reforms. Another speaker underscored the need for further investment in human capital. H e added that governance should be strengthened. Members noted that Croatia was a middle-income, post-conflict transition economy that was also in the midst o f EU accession negotiations, and said the Bank would have t o be extraordinarily innovative in responding to i t s unique challenges. T h e main issues raised by the Subcommittee are detailed below. Attachment 4 (continued) 62 5. The Chair representing Croatia agreed with the findings and recommendations o f the evaluation, including that the reform agenda had to be owned by the government. She commended the highly cooperative relationship between Croatia and the Bank since 1991, and noted that the office in Zagreb facilitated close cooperation with the Government on major reforms. She urged that the mismatch between approved and proposed lending noted in the evaluation, as w e l l as delays in some o f the proposed lending, be taken into consideration in the new country strategy in order to avoid the same mistakes. The speaker briefed the Subcommittee on the broad spectrum o f reforms underpinned by the recent SAL, and said an important development was that even after completion o f the S A L and the change in government at the end of 2003, there had not been a reversal o f reform. The authorities were convinced that their efforts to preserve macroeconomic stability and complete the necessary structural reforms were critical for sustainable growth. With respect to Croatia’s application for EU membership, she said that the European Commission had recently recommended that the European Council start membership negotiations with Croatia. 6. Donor Coordination. Subcommittee members underscored the importance o f working closely with other donors, particularly during preparation o f the next country strategy. They highlighted in particular the roles o f the EBRD and the EU, and said Croatia’s upcoming EU accession was an opportunity to coordinate work with other partners and identify appropriate priorities to maximize the impact o f each aid partner. Some speakers said a more substantive analysis o f IFC’s and MIGA’s role during the past decade would have been useful. Others asked for further information on h o w the Bank’s cooperation with donors, including the EBRD, could be further strengthened. Management responded that, as in the case o f the recent cohort o f new member countries to the EU, there would be a major focus o n coordination through the European Commission with the European institutions, including the EBRD and EIB. 7. Infrastructure. Several Subcommittee members underscored the importance o f infrastructure development for the sustainable development o f the country. They noted the important lesson that large infrastructure projects were not necessarily beneficial in the absence o f policy reform. A speaker asked h o w constraints in the key infrastructure areas were being addressed through policy dialogue and technical assistance so that infrastructure investment could be successfully scaled up. Another speaker noted the increase in the budget deficit caused by the financing o f highway sector projects aimed at building the capacity o f the economy to generate future savings. H e asked about the appropriate balance between building the capacity o f the economy and creating higher deficits, keeping in mind the risks o f macroeconomic instability. Management said that Croatia had a huge public sector in terms o f public expenditure to GDP. Any progress made on infrastructure had to be closely related to the reprioritization o f public expenditure. 8. The Importance of Ownership. The Subcommittee noted that the report underscored the limitations o f Bank involvement in the absence o f Government ownership o f lending programs. Speakers generally agreed that Government ownership was important for Bank operations in all countries. A speaker said that to regain political and social support for the reform process in Croatia, i t was important to define and implement a strategy where people could clearly understand what gains to expect from the reforms and why the reforms were constructed as they were. Another speaker asked about the role E S W had played in building government ownership. Some speakers noted that about two-thirds o f the approx. $1.2 billion o f IBRD lending to Croatia over a decade was committed under conditions that were not appropriate. One o f them said this kind o f commitment had real costs in terms o f fairness across the Bank’s ‘membership and in t e r m s o f the efficacy o f assistance to Croatia itself. Moreover, Croatia n o w had to bear the repayment burden. The speakers asked why the Bank had adopted this passive attitude, and whether there were different decisions that management could have 63 Attachment 4 (continued) taken or critical decision points that the Board was not alerted to. Another speaker noted that aid was more effective in environments o f good policy and effective institutions. H e asked h o w effective the Bank had been in disseminating good practices for improving the effectiveness o f aid, and what actions were envisaged to enhance the dialogue and consensus-building for the implementation o f successful public sector reforms. 9. Staff noted that almost all Bank financed activities in Croatia had focused on post war reconstruction and rehabilitation, and these had been judged by OED to have been largely successful. Through AAA and sustained policy dialogue, the Bank had helped successive governments to focus on structural reforms, bringing in the lessons o f relevant experience. The level and focus o f Bank assistance beyond rehabilitation and reconstruction, including adjustment lending, had also been suitably adjusted based o n the Government’s commitments t o reform. The $1.2 billion figure, staff added, referred to total commitments. Outstanding debt to the Bank was about h a l f that amount, representing less than five percent o f total Croatian debt and roughly two percent o f Croatian debt service. 10. Privatization and Other Reforms. Speakers noted with surprise that while the overall privatization process in Croatia had failed, financial sector reforms had been successful. They asked for the reasons behmd the relative success o f privatization in the bankmg sector, and what lessons could be learned from this experience. A speaker asked whether issues o f timing, speed and sequencing were behind the overall failure o f the privatization process. I t was important, he noted, for an appropriate legal and regulatory framework to be in place before actual privatization took place. Another speaker underscored the importance o f strengthening the private sector, and suggested that the Bank help the authorities to identify what sectors could be developed. A speaker said that the implementation o f an effective strategy directed at reforming public spending and at identifying priorities for increased public spending, as well as improvement o f the privatization process related to state-owned enterprises, were the fundamental issues the Government and the Bank should deal with if substantial progress was to be made in the medium term. 11. OED responded that reform ownership in the banlung sector had resulted f r o m duress. The sector had been in an extremely difficult position and the country had n o choice but to privatize. Staff added that privatization o f banlung had generally been more successful because i t had nearly always been associated with the participation o f strategc foreign partners as the primary instrument. However, public enterprise restructuring had been generally pursued by Croatia with a blend of tested and untested instruments. Going forward, lessons learnt would be applied to ensure transparent and competitive processes which lead t o efficient outcomes with minimal risks o f return to state ownershp. Chander Mohan Vasudev Chairman