Documentof The World Bank FOROFFICIAL USEONLY ReportNo. 38470-BG INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSEDLOANFOR A FIRST SOCIAL, SECTORS INSTITUTIONAL REFORM DEVELOPMENT POLICY LOAN(SIR DPL I) INTHE AMOUNT OFEURO 114.0MILLION (US$lSO MILLIONEQUIVALENT) TO THE REPUBLIC OF BULGARIA February20,2007 HumanDevelopmentUnit SouthCentralEuropeCountry Department Europeand CentralAsia Region This document has a restricteddistribution and may be usedbyrecipients only inthe performance of their official duties. Its contents may not otherwise be disclosed without World Bankauthorization. GOVERNMENT OFBULGARIA FISCAL YEAR January 1-December 31 CURRENCYEQUIVALENTS (Exchange Rate Effective as of January 31,2007) CurrencyUnit US$1.oo BulgarianLev (BGN) 1.51 BGN 1-00BGN US$0.66 1.00 EUR US1.29 US$1.oo 0.78 EUR WEIGHTS AND MEASURES Metric System ABBREVIATION AND ACRONYMS ALMPs Active Labor Market Policies BEEPS Business Environment and Enterprise Performance Survey BGN BulgarianLev or Leva (plural) BNB BulgarianNational Bank CBA Currency Board Arrangement CEP Council for Economic Policy CFAA Country Financial Management Assessment CKOKO Center for Control and Assessment o f the Quality of Education CPAR Country Procurement Assessment CPS Country Partnership Strategy CoM Council o f Ministers DPL Development Policy Loan EBRD EuropeanBankfor Reconstruction and Development EC European Commission ECA Europe and Central Asia Region ESW Economic and Sector Work EU EuropeanUnion FDI ForeignDirect Investment FSAP Financial Sector Assessment Program GDP Gross Domestic Product GFMIS Financial Management Information System GMI Guaranteed MinimumIncome GNI Gross National Income GOB Government ofBulgaria GP General Practitioner HD HumanDevelopment IBRD International Bank for Reconstructionand Development ICR ImplementationCompletion Report ICT Informationand Communication Technology IFIs International Financial Institutions ILO International Labor Organization IMF International Monetary Fund JIM Joint Inclusion Memorandum LDP Letter o f Development Policy MDGs Millennium Development Goals MES Ministry ofEducationand Sciences MoF MinistryofFinance M o H MinistryofHealth MoLSP MinistryofLabor andSocialPolicy MTEF MediumTermExpenditure Framework NAMRl3 National Association of Municipalitieso f the Republic of Bulgaria 2 NFC National Framework Contract FOR OFFICIAL USE ONLY NHIF National Health Insurance Fund NMS-8 NewMember States of the EU(as of May 1,2004 exc. Cyprus &Malta) NSI National Statistical Institute NSSI National Social Security Institute OECD Organization for Economic CooperationandDevelopment os1 Open Society Institute P A L Programmatic Adjustment Loan P D Program Document PEIR Public Expenditure and InstitutionalReview PFM Public FinancialManagement PHRD Population and HumanResource Development PIRLS Progress inInternational Reading Literacy Study PISA Program for International Student Assessment PPI Proton-Pump Inhibitors PPP Purchasing Power Parity ROSCs Reports o f the Observance o f Standards andCodes SBA Stand-ByArrangement SDR Special Drawing Right SER State EducationalRequirements SGP Stability and Growth Pact TA Technical Assistance TIMSS Trends inMathematics and Sciences Study TSA Treasury Single Account USAID United States Agency for InternationalDevelopment VSL Variable SpreadLoan WB World Bank Vice President: Shigeo Katsu Country Director: Anand K. Seth Sector Director: TamarManuelyanAtinc Sector Managers: Arup Banerji, ArminFidler, Hermanvon Gersdorff, andMamta Murthi Team Leader: DanielDulitzky This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not be otherwise disclosed without World Bank authorization. Republic of Bulgaria FIRST SOCIAL SECTORS INSTITUTIONAL REFORM DEVELOPMENT POLICY LOAN TABLE OFCONTENTS LOANAND PROGRAMSUMMARY 5 I INTRODUCTION 7 I1 .. ............................................................................................................................. .......................................................................................................... COUNTRY CONTEXT .................................................................................................................... RECENT ECONOMIC DEVELOPMENTS INBULGARIA ............................................. 9 9 11 POVERTY AND THE SOCIAL SECTORS........................................................................ MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY................................ 14 I11. MAINSECTORISSUES .................................................................................................................. HEALTH .............................................................................................................................. 16 16 EDUCATION....................................................................................................................... 19 21 IV 24 V .. SOCIAL PROTECTION ...................................................................................................... THE GOVERNMENT'S PROGRAM ............................................................................................ BANKSUPPORT TO THE GOVERNMENT'S STRATEGY ..................................................... COLLABORATIONWITH THEIMF AND OTHER DONORS ....................................... LINKTO CPS ...................................................................................................................... 40 40 RELATIONSHIP TO OTHER BANK OPERATIONS ....................................................... 40 41 LESSONS LEARNED.......................................................................................................... 42 VI . ANALYTICAL UNDERPINNINGS.................................................................................... 43 THE PROPOSEDSOCIAL SECTORS INSITUTIONAL REFORM DEVELOPMENT POLICY LOAN ..................................................................................................................................................... POLICY AREAS.................................................................................................................. 45 46 53 VI1 . FISCALIMPACT OF THE REFORMPROGRAM............................................................ OPERATIONIMPLEMENTATION .............................................................................................. POVERTY AND SOCIAL IMPACTS................................................................................. 57 57 59 FIDUCIARY ASPECTS....................................................................................................... IMPLEMENTATION, MONITORING AND EVALUATION........................................... 60 63 RISKS AND RISK MITIGATION....................................................................................... ENVIRONMENTAL ASPECTS.......................................................................................... 63 ANNEXES ANNEX 1:LETTEROFDEVELOPMENTPOLICY 65 ANNEX 2: OPERATIONPOLICY MATRIX ............................................................................................. ................................................................................. 71 ANNEX 3: BULGARIA:FUNDRELATIONS ............................................................................................ -73 ANNEX 4: COUNTRYAT A GLANCE 77 MAP OF BULGARIA ..................................................................................................................................... ....................................................................................................... 79 The First Human Development Loan was prepared by an IBRD team consisting of Hermann von Gersdorff (Social Protection SectorManager for the ECA Region and HD Country Coordinator for the SouthCentral Country Department); Daniel Dulitzky (Sr. Economist and Task Team Leader); Juan ManuelMoreno (Sr. Education Specialist); Steven Bakker (Education Consultant); Christian Bodewig (Economist); Boryana Gotcheva (Sr Operations Officer); Kari Hurt . (Operations Officer); Rosalind Levacic (Education Consultant); Nickolai Mladenov (Education Consultant); Reema Nayar (Sr . Economist); Jaanus Pikani (Health Consultant); Peter Pojarski (Operations Officer); Andreas Seiter (Health specialist); Alan Thomson (Health Consultant); Steve Kenny (Health Consultant); Lars Sondergaard (Economist); Rebekka Grun (Economist); Stella Ilieva (Economist. ECSPE); Lire Ersado (Economist. ECSHD). Jean Charles de Daruvar (LEGEC). Nicholay Chistyakov (LOAG1); and Siew Chai Ting (ECSPS). Peer reviewers were: Carolina Sanchez Paramo (Senior Economist. SASHD). Michelle Riboud (Sector Manager. SASHD). Jesko Hentschel (Country Sector Leader. LCSHD). and Stefan Koeberle (Director. LCSOS) Albena Samsonova. Gabriel Francis. and Svetlana . Raykovaprovided administrative andoperational support inBulgaria andWashington. D.C. 4 LOANAND PROGRAMSUMMARY RepublicofBulgaria FIRST SOCIAL SECTORSINSTITUTIONAL REFORM DEVELOPMENT POLICY LOAN Borrower Republic o f Bulgaria ImplementingAgency Ministryo fFinance, MinistryofHealth, Ministry ofLabor and Social Policy, Ministryo f Education and Science Amount Euro 114.0million(US$150 million equivalent) Terms Variable Spread Loan (VSL) inEuro with 17 years maturity including five years grace period and level repayments Tranching Single tranche Description The proposed loan i s intended to support the Government of Bulgaria to meet some o f the challenges o f EU accession and integration. In particular the DPL will support the adoption and implementation o f policies to (i) improve the institutional framework inthe labor and social sectors to more closely align their policies with EU standards; and (ii)improve the efficiency o f the health, education, and social protection systems to maintain a fiscally sustainable expenditure framework and improve access to basic social services. Benefits It is expected that at the end o f the DPL series (i)the employment rate will have increased to at least 60 percent, (ii) the hospital sector will be streamlined and more resources will be allocated to outpatient care, therefore reaching a larger percentage o f the underserved population, (iii) a basic package o f drugs will become more affordable and therefore available to a wider segment o f the population; and (iv) quality o f education will have improved, and completion rates will have increased. Risks 1) Political risks include (i) possibility that the coalition the government o f three parties may not be able to reach consensus on some important reforms; (ii) opposition to new education funding formula and changes inhealth financing and provision by some stakeholders (teachers union, municipalities that will see a loss in resources for education or closing o f hospitals, BulgarianMedical Association) 2) Technical risks include the limited implementation capacity insomelineministries 3) Institutional risks include the potential change in attitude o f the government towards future phases o f the D P L now that the accession to the EU has materialized, reducing the leverage 5 capacity o fthe World Bank to guide policy changes. 4) Macro risks are related to Bulgaria's economic vulnerability due to the country's significant current account deficit, inflation pressure, and the fiscal demands o f EU accession which may grow inthe future. Mitigation measures include (i)involving all parties in the coalition through work with their representatives in government (deputy ministers); (ii)devising mitigation measures to counteract potential negative impact of change in education financing formula; (iii) other Bank instruments use (investment loans, grants) to build capacity at line ministries; (iv) building a relationship with EU teams supervising Bulgaria's early EUmembership process; (v) supporting labor policies aimed at increasing flexibility in the labor market and facilitating adjustments o f the economy inresponse to negative aggregate shocks; and (vi) increasing the Bank's surveillance once the IMF moves fiom monitoring an active program to surveillance. Operation IDNumber PE-PO94967 6 IBRD PROGRAMDOCUMENT FORA PROPOSEDFIRST SOCIAL SECTORSINSTITUTIONAL REFORM DEVELOPMENT POLICY LOAN FOR THE REPUBLIC OFBULGARIA I. INTRODUCTION 1. This Program Document (PD) describes the first o f three planned Social Sectors Institutional Reform Development Policy Loans (SIR-DPL Ior simply DPL I). The proposed loans are intended to support the Government o f Bulgaria (GOB)to meet some o f the challenges o f integrating into the EU. Inparticular the DPL series will support the adoption and implementationo fpolicies to: Improve the institutional framework in the labor and social sectors to more closely align their policies with EUstandards; and Improve the efficiency o f the health, education, and social protection systems to maintain a fiscally sustainable expenditure framework and improve access to basic social services. 2. The policies supported by the D P L series were not fully reflected or guided by the adoption o f the acquis communautaire and other accession processes, but remain nonetheless relevant for the integration agenda, because o f their focus on fiscal sustainability, social inclusion and access to services, issues that have been highlighted by the European Union (EU) in the various assessment reports o f candidate countries. The need to address these issues during early membership has been a key lesson from the experience o f the EU new member states. In addition, the policies supported by the DPL series will increase the transparency o f public expenditures for health and education and in that way support the Government o f Bulgaria (G0B)'s efforts to reduce corruption - a key concern o f the European Commission (EC) with respect to Bulgaria's integration into the EU. 3. DPL Iwill be the first policy-based operation prepared entirely by the new governing coalition which won the Parliamentary election inJune 2005. The new Government has come to power with an ambitious reform agenda, as reflected inthe health sector strategy currently being discussed with the country's key stakeholders and the education sector strategy approved by Parliament in June 2006, and with the commitment to implement the Joint Inclusion Memorandum signed with the EU in 2005. By selectively supporting the implementation o f some o f the components o f these two strategies as well as the introduction o f changes to current labor market and social protection policies, the DPL series will complement and expand the work undertaken under the recently completed Programmatic Adjustment Loan (PAL) program. The previous PAL program covered a broad range o f topics ranging from infrastructure and the financial sectors to social services. Following completion of the P A L program and during the preparation o f the recently approved Country Partnership Strategy (CPS) the government requested assistance from the Bank to continue supporting reforms inthe social sectors and it was agreed that the DPL series would focus on these sectors exclusively. 4. The first phase o f the program i s dominated by the introduction o f changes in the social protection sector to create additional incentives for employment generation, and the definition o f a new fbnding mechanism for schools. These measures are accompanied by 7 actions to stabilize public spending on health, mitigate the impact o f the changes ineducation financing on access, and improving the institutional capacity in the education and health sectors. The second phase will focus on supporting full implementation o f the new education financing formula, introduction o f governance changes in the sector, implementation o f some o f the actions included inthe medium term vision for social protection, and additional actions to maintain financial balance inthe health sector. The third phase supports the consolidation o f the financing and governance reforms in the education sector and implementation o f structural reforms in the supply o f health care services; this phase is also expected to show some early results from the previous two phases o f program implementation. The reforms are progressing at a different pace owing to the different degree o f preparedness inthe sectors, the structural and medium-term nature o f some o f the reforms, and the time necessary to build consensus for major policy changes, but the program is balancedover the three phases. 5. In some cases the DPL series will support only the initial phase of policy changes. Many o f the issues are complex and the necessary policy reforms are long-term innature- most EU countries are still struggling with some o f the problems tackled in this DPL series. For example, the restructuring o f the supply o f health care services i s a long term policy that will show some early results towards the end o f the program but will not be fully implemented until after the program's ending. In the case of education financing, full implementationwill require at least three years because the reallocation o f resources resulting from the change inthe financing formula can create large differences between the current and the revised allocations among municipalities. Therefore it is necessary to provide some time for municipalities to adapt to these changes to avoid any adverse impact on access to education services. This i s one o f the key reasons why a programmatic approach has been chosen. While longer to implement, the first irreversible steps to change the financing of the education sector financing, establish a system for student assessment, and restructuring the hospital sector will have been taken before the end o f the D P L series. The long-term outcomes to which the D P L program i s contributing, but which are not likely to be realized until after the three-year DPL program, are an increase in employment and reduction inlong term unemployment, an increase in quality o f education and increased access to underserved populations, and an improvement in health outcomes through better access to basic health care and drugs. 6. The accession o f Bulgaria to the EU represents a turning point in its history. If the experience o f new member states is any indication, this will also alter the nature o f Bulgaria's relationship with the Bank. Inthat sense, the value added o f the DPL can be found not only in providing budget support for the implementation o f reforms, but also in assisting the government to define the critical path for achieving key reforms and outcomes contained in the sectoral strategies; providing or mobilizing technical assistance to develop technical options; focusing the attention o f the needed stakeholders; and establishing a timeframe for the reform process. Given the dynamism created in the Bulgarian economy and its institutions as a result o f accession, the DPL series has been designed with added flexibility in phases two and three to accommodate to the GOB needs ina rapidly changing environment. 8 11. COUNTRY CONTEXT' RECENTECONOMICDEVELOPMENTS INBULGARIA 7. Over the last eight years, Bulgaria has made impressive progress towards long- term stability and sustained growth. Following a difficult transition which culminated in a severe crisis in 1996-97, macroeconomic stability was reestablished and has been maintained by prudent fiscal policies and strict discipline in incomes policy anchored in the Currency Board Arrangement (CBA) adopted in 1997. Fiscal consolidation reduced the overall fiscal deficit from 15.2 percent o f GDP in 1996 to a balanced budget in2003 and generated a fiscal surplus in2004 (1.8 percent o f GDP) and 2005 (2.3 percent). The external and public debt to GDP ratios declined from nearly 100 and 107.4 percent o f GDP respectively in 1997 to about 68 and 32 percent respectively in 2005. As a result o f these policies and deep structural reforms, average growth reached the levels o f the eight EUNew Member States (NMS-8)at about 5 percent per year in 2000-05 (estimated at 5.6 percent in 2005) and inflation has declined to single digits from hyperinflation levels. Unemployment also declined from 18 percent in 2000 to 10.7 percent by end-2005, but masks a continued low labor market participation rate. 8. A broad structural reform agenda has contributed to solid economic performance. The severity o f the 1996-97 crisis and the prospect of EU accession changed the political economy in the direction o f reforms. Between 1998 and 2002, most o f the non- infrastructure enterprises and banks were privatized or liquidated, trade and prices were liberalized, energy reforms made important progress, and the first steps were taken in regulatory reform to improve the investment climate. As a result, growth is ledby the private sector which now accounts for two-thirds o f total gross value added with an equal share of total employment. Integration with external markets expanded with trade in goods and services increasing relative to GDP from 94 percent in 1998 to almost 140 percent in 2005. Foreign direct investment (FDI) flows increased during the period, but remained broadly constant as a share o f total investment. Investor confidence improved over time - both domestically and externally. Bulgaria's long-term foreign currency debt was upgraded to an investment grade rating inthe summer o f 2004. 9. However the external position has remained under pressure, with the external current account deficit continuing to widen. The external current account deficit at 11.8 percent o f GDP in 2005 almost doubled compared to 2004 and i s deteriorating further in the first half o f 2006. Strong private demand for consumption and investment goods and record highoil prices have contributed to substantial increase inmerchandise imports of almost 10 percentage points o f GDP in 2005 compared to 2004. Export performance in 2005 was affected adversely by summer floods but data for the first half o f 2006 suggest that the recovery is already under way. FDIinflows remained strong and covered most o f the current account deficit despite the lack o f large privatization deals in 2005. Gross official reserves continued to provide ample coverage o f imports o f goods and services. This has allowed early repayment on the remaining Brady bonds and prepayment o f debt to the International Monetary Fund (IMF) and the World Bank. Thus, external public debt was reduced to below 20 percent o f GDP by May 2006 and i s currently with an improved currency and interest All macroeconomic data and projections in the Program Document are as of October 24, 2006 and do not reflect follow-up updates or revisions based on the Bulgaria's Convergence Programme, 2006-2009 (December 2006) or the State Budget Law (State Gazette No 108 ofDecember 29,2006). 9 structure. At the same time, private sector external indebtedness is growing rapidly to finance larger stock of FDIs and strongbank lending. An analysis of macroprudential indicators used to predict crises suggests that "Bulgaria i s not at present crisis prone"2 although important risks and vulnerabilities exist and continued careful monitoring is required. Figure 1: Bulgaria: itabilityandGrowth CPIInflation FiscalBalance 1200 (% change, annual average) 5 1000 0 800 -10-5 600 400 200 -15 0 -20 I External Debt and Debt Senice Investment 120 (% ofGDP) 30 35 T 40 110 x 30 25 20 1 1 100 25 0 90 20 -20 80 15 2: 70 -40 10 10 60 - 5 -60 50 5 0 -80 40 0 "2 "2 Z2 E: g g g g i g g - GDl%of GDP A G D F (198911) -Externd Debt -External Debt Service(RHS) Real GDP -34 Current Account Deficit and Net FDI 34 (% change) (%of GDP) 29 -. 20 24. 1015 19- 14- 9 - 5 ..-6 0 ..-11 -5 Current Account Deficit 0 FDI A.-16 -10 H k m H i H i # I -GDPgrowth. 19954 -GDPannual growth -15 Source: WorldBankstaff estimates basedon data from N BNB, MOF (GFSZOOf), and NEA. , Bulgaria: 2006 Article I V Consultation, Third Review Under the Stand-By Arrangement ..., IMF Country ReportNo. 061298, August 2006. 10 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 10. The medium term macroeconomic framework centered on the CBA i s expected to support rapid and sustainable economic growth inthe first years of EU accession and prepare Bulgaria for monetary integration soon thereafter. The medium term outlook envisages a robust growth o f 6 percent per annum, a gradual narrowing of the external current account deficit, and a reduction in debt to GDP ratios. Growth would be driven by a continuous rise in investment and improved export performance in line with the recovery in external demand from the EU and the increased competitiveness o f Bulgarian goods on international markets. Consistent with the planned upgrades inthe infrastructure sectors and early EUmembership, investment i s likely to grow at a higher speed and exceed 31percent o f GDP in 2009. Inflation is projected to decline to 3.5 percent in 2008-2009 which would support Bulgaria's meeting the criteria for entering the euro zone. External current account deficit i s projected to remain highreflecting catch-up effects but would be gradually declining from estimated 12.4 percent in 2006 to 9.8 percent in 2009. FDI inflows are expected to continue to be the primary source o f balance o f payments financing provided that the remainingstructural and institutional impediments are addressed, including weaknesses inthe business climate, public administration, and the judicial system. Gross external debt i s projected to decline gradually to 67 percent o f GDP by 2009 from estimated 69 percent at end 2006. 11. The current course of fiscal policy i s basically appropriate to ensure macroeconomic stability, growth and poverty reduction in the medium term. The Government is committed to continue runningoverall fiscal surpluses in 2007-2009 although on a declining trend. In the face o f deteriorating external account deficit, the Government decided to increase the expected budget surplus in2006 to at least 3 percent of GDP. To this effect, the Government agreed with the Fund to save 50 percent of the expected revenue overperformance and refrain from spending 7 percent o f discretionary expenditure. In addition, substantial downsizing o f the state administration has already begun with close to 4,000 positions cut since the beginning of 2006 while further 1,400 positions planned for closure by the end o f 2006. Planned surplus for 2007 i s 2 percent of GDP, which i s projected to decline to less than one percent by 2009. 12. The main fiscal challenge in the medium term will be to absorb the expected sharp increase intransfers from the EUby consolidatingand increasingthe efficiency of existing expenditures. The net overall financial effect o f expected EU grant funds is projected to be highly positive on Bulgaria, about 3.7 percent o f annual GDP on average during2007-2009, ifthe country takes all the available funds. A large share o fthese funds is expected to go to support education initiatives, upgrading o f roads, implementation o f the European common agriculture policy, and environmental standards. If the Government absorbed all the available funds, the fiscal position would deteriorate by about 2 percent of GDP3. Taking into account the already highlevel o f public spending, and the need to contain domestic demand, the Government decided to cap the level of public expenditures as a share o f GDP at 40 percent and substitute existing expenditures with EUfunds. Bulgaria: Public Finance Policy Review, Leveraging EUFundsfor Productivity and Growth, February 2006, the World Bank. 11 13. Improving the allocation of public expenditure requires creating a more efficient and transparent expenditure management system with enough flexibility to adjust quickly and efficiently to macroeconomic shocks. The central key pressure points on the fiscal position are in health care, education, and the social protection system. The Public Expenditure and Institutional Review (PEIR) for Bulgaria4demonstrated the need to improve allocations to address the issues o f overcapacity in health and education and to improve the targeting o f social protection programs, which constitute about one-third o f total public spending. Although important steps have been taken since 2002, particularly to improve the financial position of the pension system, to improve the targeting o f social assistance, and to address issues o f overcapacity in health care, the agenda is still unfinished while the ageing population andrisinghealth care costs pose continuous challenges. 14. Medium-term risks and gradual progress towards monetary integration, weigh heavily on the fiscal stance. Inthe context o f the domestic environment, there are the risks o f the loss o f momentum in the implementation o f structural reforms and the weakening of macroeconomic discipline. Pressures to increase spending associated with EU accession without corresponding expenditure saving or substitution may lead to relaxation o f fiscal policy which would further increase domestic demand pressures and their impact on external imbalances and inflation. The economy is also vulnerable to external shocks, including further increases in oil prices and interest rate increases, and greater capital flow volatility or the falling short of FDI flows from the levels needed to finance the large external current account deficit. Furthermore, the gradual progress towards monetary integration raises additional macroeconomic challenges. Greater monetary integration has potential benefits, butitis notwithout risks given the large structural differences betweenBulgaria and countries in the Eurozone. The preparation for, and eventual adoption of, the Euro will increase the need for deeper economic restructuring, inaddition to enhanced macro-financial discipline, to ensure adherence to the conditions for participation inthe currency area. 15. Given the constraints of the CBA, labor market policies are another important component of the broad policy reform agenda. Ensuringflexibility of labor market i s key for reallocating labor from low to higher productivity activities. Thus, the economy can flexibly adjust to shocks and the competitiveness o f Bulgarian companies would be substantially improved. By supporting policies to achieve increased flexibility in the labor markets the D P Lprogram will contribute to this objective. 16. Deeper economic restructuring i s needed to address risks and vulnerabilities and to achieve successful integration with EU and global markets. Despite the positive developments over the last eight years interms of macroeconomic stability and advancement with structural reforms, important gaps inreforms and performance remain relative to the EU New Members States. Despite a well diversified trade partnership and a liberal trade regime which provides Bulgarian producers with easy access to global markets, its economy has yet to benefit more hlly from its integrationwith the EUand external markets. Bulgaria's export capacity remains limited compared to the NMS-8 countries. Competitiveness remains mostly limited to unskilled labor-intensive and energy-intensive activities. This can be explained by Bulgaria: PublicExpenditureIssuesand DirectionsforRefom,The WorldBank,2003. 12 the remaining gaps instructural reforms inBulgaria relative to the NMS as shown inFigure 2 below for two phases o f the reform agenda. Figure 2: Bulgaria and CEEC: Progress in Structural Reforms, 1999-2005 FirstPhase ofReforms SecondPhase of Reforms EBRDIndex FBRDIndex t?-w-y Poland CzechRep, Estonia Latvia Poland Hungary Slovak Rep, Estonia Lithuania Czech Rep, Latvia Slovenia Bulgaria Croatia Croatia Bulgaria f4 2005 Slovenia 2005 Romania f4 1999 Romnia m 1999 3.6 3.8 4 4.2 4.4 4.6 2.2 2.4 2.6 2.8 3 3.2 3.4 3.6 3.8 4 4.2 Source: EBRD Transition Indicators; Indicators for the initial phase o f reforms are calculated as unweighted averages o f indicators for small-scale privatization; price liberalization; trade and foreign exchange system. Indicators for the second phase o f reforms are calculated as unweighted averages o f indicators for large-scale privatization; governance and enterprise restructuring; competition policy; banking reform and interest rate liberalization; securities markets and non-bank financial institutions; infrastructure reform. 17. The following core reform agenda, supported by macroeconomic policies that address risks and vulnerabilities, would help accelerate Bulgaria's convergence to the EU income levels: (i) improving the quantity and quality o f physical and human capital accumulation, by focusing on upgrading skills and the transport network, and improving efficiency and transparency inpublic administration; (ii) enhancing labor market adjustment and the creation o f employment by implementing labor market reforms that better balance labor adjustment, the creation o f employment, and unemployment risks, and include the rationalization o f the social protection system to enable the reduction of payroll taxes; and (iii)implementing institutional reforms intwo areas-reducing legislative and regulatory complexity in order to improve competition in the domestic market, and moving toward a rules-based system by implementing judicial reform to increase reliance o f economic transactions on contracts andtheir efficient enforcement. 18. The IMF has completed the third review of the Stand-By Arrangement (SBA) in August 2006. A precautionary 25-months SBA with access of SDRlOOmillion was approved by the IMF Board on August 6, 2004, and the first review was completed on May 18, 2005, and the second in April 2006. The SBA-supported program seeks to reduce Bulgaria's increased external vulnerability and to achieve sustainable highgrowth through: (i) continued tight fiscal policy and measures to reduce bank liquidity inorder to reduce excess demand in the short run; and (ii) structural reforms to boost output and export capacity and export capacity in the medium-term. At completion o f the third review and in light o f Bulgaria's continued high external vulnerability, the IMF and GOBdecided to extend the SBA by 6 months beyond September 2006 to continue monitoring program implementation by end- 13 2006, and complete the reporting to the IMF Board by end-March 2007. Once Bulgaria joins the EU, its participation in the EU's Stability and Growth Pact (SGP),' with related multilateral surveillance, would help to sustain Bulgaria's prudent macroeconomic policies. 19. The DPL series is broadly consistent with the Medium T e r m Expenditure Framework (MTEF). The MTEF calls for a proportion o f spending on health as percentage o f GDP that will remain relatively flat and fluctuate between 4.3 and 4.4 percent. Likewise, the spending on education i s projected to fluctuate between 4.2 and 4.4 percent o f GDP. Some o f the reform measures supported by the D P L series will have a fiscal impact, as discussed in the respective section, but overall the entire program should be neutral in the medium term. This should be the case as the savings generated by some o f the reforms-e.g. the change inthe financing mechanism for schools-is used to finance quality and efficiency improvements-e.g. renovation o f schools to accommodate larger number o f students. POVERTYAND THE SOCIAL SECTORS 20. The continued growth since the 1996-97 economic crisis has led to improvements inliving standards, although deep pockets ofpoverty persist. Per capitaincome increased from US$1,200 in 1997 to US$2,740 in 2004. Nevertheless, per capita GDP remained at 30 percent o f EU average (in2003 PPP terms), which makes continued growth and convergence o f living standards towards EU standards a core policy goal. As incomes in Bulgaria have risen, poverty has fallen. Poverty, measured at two-thirds o f average per capita consumption in 1997, fell sharply fkom 36 percent in1997to 12.8 percent in2001. The depth and severity o f poverty also improved. The most recent poverty assessment prepared in 2003 showed a further reduction o f poverty, including reduction o f extreme poverty and eradication o f food poverty (a proxy for malnutrition). As poverty has fallen, the nature o f poverty has evolved with poverty becoming increasingly concentrated among vulnerable groups. Box 1 shows that household size, number o f children, education or occupation o f the head o f household, gender, ethnicity and location are the key determinants o fhousehold welfare andpoverty. The main objective of the SGP is to enforce discipline in the Euro-zone as a means to support price stability and sustainable growth. Budgetary discipline is gauged with respect to two criteria: a general government deficit-to-GDP ratio below three percent, and a debt-to-GDP ratio below 60 percent. Functioning of the SGP rests on two pillars: multilateral surveillance and corrective mechanisms. As regards surveillance, EUmember states are required to prepare a Convergence Program and update it annually. The EC prepares an assessmentof such convergence programs on the basis o f which the Council of the EU issues an opinion. As regards corrective mechanisms, the Excessive Deficit Procedure identifies and forces corrections of excessive deficits, definedunder non-exceptional circumstances as a deficit over three percent ofGDP. 14 Box 1: Who are the Poor? Thepoor are more likely to befound outsideSofia. The poverty rate inrural areas was estimated at 29.1 percent in2003, comparedto 18.7 percent inurbanareas. Welfare differences by location,however, become sharper when Sofia city is compared to other - urbanor rural- areas. Eventaking into accountthe differences inthe characteristics(suchas education, family size, etc.) betweenrural andurban households,the per capita consumption of households living outside Sofia ranges is 10-25percent lower thanthat for householdsliving inthe capitalcity. People living in large households with two or more children are more likely to bepoor. Only a fifth of the populationlive inhouseholds with five or more members, but they account for about 41 percent of the poor. People living inhouseholds with two or more children accountfor over athird of the poor. A strong correlate ofpoverty is ethnicity. Romahouseholdsaccount for about 6 percentofthe populationaccording to the survey, but for over a fifthof the poor. Per capita consumptionina Romahouseholdis only halfofthe consumptionof a similar householdof Bulgarian origin. Human capital is a strongpolicy leverfor reducingpoverty. Over two-thirds of the poor consist of people living in householdswhere the head has less than high-school education. Per capita consumption i s 30-35 percent higher in households where the head has completed high school or technical education and 45 percent higher when the head has completed university studies (relative to a householdwherethe headhasonly completedprimaly education). Private entrepreneurs and employed individuals are relatively protected from poverty. The poverty rate is significantly lower in households headedby employers, self-employed or employees, while the risk of poverty is twice as high inhouseholds headedby the unemployedandinactive(other thanpensioners)comparedto the rest of the population. Poverty is not gender neutral. The risk of poverty i s slightly higher inhouseholdsheadedby women, usually singleparenthouseholds. Whendifferences ineducation, locationandother characteristicsare taken into account,per capitaconsumption inthese householdsis 10 percent lowerthan inthose headedby men. mrce: BulgariaMTHS data, 2003. 21. A simulation of the poverty headcount index up to 2005 also indicates further reduction inpoverty. Since recent data on poverty i s unavailable, a simulation exercise was performed using the 2001 poverty rate o f 12.8 percent and annual household consumption data, using the notion o f growth elasticity o f poverty which measures the change inpoverty for a given change in growth.6 Table 1 shows the simulated poverty rates for different elasticity assumptions. Inall cases poverty would have decreased from the 2001 values. Table 1: Poverty Headcount Index Simulation 2001 2002 2003 2004 2005p Householdper capitaconsumption expenditures (Bulgarian Lev) 1492 1710 1853 2068 2227' Growthinhouseholdper capita consumption expenditures 2.9 14.6 8.4 11.6 7.1 Povertyheadcountindex 12.8 Povertyheadcountindex assuming: Growthelasticityof poverty = 1.O 10.9 10.0 8.9 8.2 Growthelasticityof poverty= 1.5 10.0 8.7 1.2 6.4 Growthelasticityof poverty= 2.0 9.1 1.5 5.8 4.9 Growth elasticityof poverty= 2.5 8.1 6.4 4.6 3.1 Growthelasticityof poverty= 3.0 1.2 5.4 3.5 2.7 Ingeneral the growth elasticity ofpovertywould be negative, as growth andpovertytend to move inopposite directions. For example, if poverty elasticity o f growth is 2, then a 1 percent increase in growth will lead to 2 percent reduction inpoverty. 15 22. Bulgaria i s on track to meet the Millennium Development Goals (MDGs). After 2000, improvements are more pronounced in school enrollments and smaller with respect to health indicators. It is important that improvements include gains among the most disadvantaged, as gaps in access to health care and education appear to be narrowing. However gaps in Bulgarian attendance rates in primary and secondary education are still among the highest in the ECA region. As with education, financial constraints (formal and informal out-of-pocket costs) and differences in quality o f services accessed are in part responsible for lower health outcomes among poor and disadvantaged groups. Minorities, Roma in particular, are more likely to fall through the cracks o f the education and health systems with their lower access compounded by social exclusion. Box 2: Bulgaria's ProgressToward the MDGs Government Objectives BaselineData Updateon Status 2005 TARGET 2015 Target Eradicate extremepoverty percent ofpopulation 7.9 (2001) n.a. 3.2 1.5 below US$2.15per day percentofpopulationbelow US$2.76per day 12.8 (2001) 6.4 (2005) Achieve universal education percentnet enrollment rate -primary school 98.5 (2001-02) 99.7 (2004-05) 97-98 100 percentnet enrollment rate-lower secondaIy 83.1(2001-02) 84.2 (2004-05) 86-90 100 school percentnet enrollment rate secondary - 68.3 (2001-02) 77.3 (2004-05) 73-75 90 school Improve maternal health Maternalmortality ratio per 100,000 live 19.1(2001) 10.02(2004) 18 16 births Combat HMAIDS, malaria and other diseases Tuberculosis incidence(new casesper 48 (2001) 42.4 (2004) 40 26 100,000) Polio immunizationrate(percentof children 94.4 (2000) 94.1 (2004) 98 100 under two years of age) Reduce infant mortality Infantmortality rateper 1000livebirths 14.4 (2001) 11.6 (2004) 13 9 Ensure environmental sustainability GDP per unit of energy use (PPP US$per kg 568 (1997) n.a. 653 751 , `'Due to of oil equivalent) lack of data, figure for 2005 is basedonassumedgrowth elasticityofpovertyof 1.5. See paras.25 andTable 3. Sources:National StatisticalInstitute and World Bank, UNICEF. 111. MAINSECTOR ISSUES HEALTH 23. Health service provision i s inefficient, access to care less than universal, and the National Health Insurance Fund (NHIF)i s not financially sustainable. The reform that introduced health insurance in Bulgaria was meant to achieve universal coverage in a financially sustainable manner, while promoting the efficient use o f resources and improving quality. Eight years after the passing o f the health insurance law, health outcomes are beginning to show a reversion in the negative trend observed during the 199Os, but it i s also becoming apparent that many aspects o f the original plan require additional fine-tuning and that some o f the main reforms are yet to be completed. In Bulgaria problems remain in the following areas: 16 . Current spending i s biased towards more expensive inpatient care, and the current payment and monitoring systems for hospitals do not contribute to managing the growth o fpublic spending adequately; The excess capacity o f hospitals and unequal allocation o f resources across regions has not been addressed; Spending on pharmaceuticals, at 80 Euro per capita - o f which about 50% is out-off- pocket- i s still low in comparison to other European countries but i s increasing and has the potential to become a major burden for the NHIF budget and limit access to basic drugs for poor households; and Access to health care services i s not universal 24. Spending in health may become unsustainable as the NHIF assumes its role of single purchaser of health services. The NHIF was created with the expectation that it would become the sole financier o f the majority o f health care services. The transition towards this has been slower than expected. In 2005 NHIF purchased services in hospitals representing about 50 percent o f their budget. Having both the Ministryof Health (MoH) and NHIF purchase inpatient care services with different payment mechanisms sends confusing signals to providers and promotes strategic behavior on their part, duplicates administrative costs, and prevents NHIF from fulfilling its role o f strategic purchaser. In addition, neither payment mechanism -as they are currently administered and monitored- provides an incentive for providers to contain spending and at present do not really reflect hospitals' operating costs. 25. Since about 50 percent o f public spending on health goes to hospitals, any long term plan to control spending should address that sector. A recent study on the financial sustainability o f the NHIF estimated that in 2006 the deficit could exceed 25 percent o f total revenues, and that if nothing changes the deficit could climb to 47 percent in 2007. On the revenue side, there i s an accumulated debt from 1.7 million non-contributors in2004 who had not paid for a period ranging from 3 to 36 months, with an accumulated debt o f BGN 300 million approximately. The hospital sector currently has a stock o f arrears o f BGN 67Mn or about 6 percent o f NHIF spending (December 2005). Although a small number compared to other European countries, the increasing trend over time reflects a structural problem that couldbecome serious inthe future.7 26. Traditional efficiency indicators on inpatient care show progress but the fundamental problem of excessive infrastructure prevails. Most countries inEurope have faced the problem o f excessive hospital infrastructure and adopted measures to consolidate inpatient care into fewer hospitals and to reduce the lengths o f stay at hospitals as a way to curtail spending. Bulgaria has reduced the number o f beds but evidence suggests that more could be done. Pilot studies in the Gabrovo, Lovech, Stara Zagora, and Razgrad regions to evaluate the functioning o f hospitals and assess the extent by which there could be excess capacity inthe sector found that (i) there is excess capacity in all the regions analyzed; (ii) in some cases there i s excessive utilization o f hospitals due to the lack o f alternative facilities that could address some o f the more simple conditions at a lower price; (iii) some hospitals perform social functions, like taking care o f terminal patients, and long term medical care; For example in Slovakia the annual flow of new debt the health sector was approximately S K K 5 billion in 2003, equivalent to 42 percent of total spending by the health insurance funds. The situation i s similar in other New Member States like Hungary and Lithuania. 17 (iv) distortions inhospital practices are frequent, like discharging and re-admitting patients in order to be paidtwice andcode-creeping inorder to matchmore expensive payment codes. In the case o f Stara Zagora for example, the pilot study estimated that the number o f reported discharges was about 76 percent higher than the theoretical estimate based on population needs. In addition it estimated that the theoretical number o f discharges could be handled with 910 beds instead o fthe current 1,973. 27. Pharmaceuticalpolicy inBulgaria i s under similar constraints as in other countries of the region. The mainproblems inthe pharmaceuticalsector are: i.EventhoughspendingonpharmaceuticalsisnothighforEuropeanstandards,ithasbeen growing at an accelerating rate. ii.Thereareinefficienciesinthesystem,suchasspendingforexpensivedrugswithlimited value, delayed listingo f generics anduncontrolled hospital drug spending. iii.Access tomedicinesisnegativelyaffectedbyhighco-payments for severaldrugsthat belong to a basic package o f healthcare in other countries with similar demography and economic conditions as Bulgaria. Most drugs in Bulgaria are only reimbursed to 25 percent o fthe price consumers paid. iv. Current procedures for drug pricing and including new drugs on the positive list are extremely bureaucratic and not inline with EUregulations. (see Box 3) 28. As a "rule o f thumb", drug expenditure has a "natural growth rate" inmiddle-income countries at about twice the rate o f GDP, even if expenditures are managed well. This is due to several factors, such as an aging population with higher prevalence o f chronic diseases; medical progress, offering new break-through treatment options that become immediately essential; and individual prioritization o f needs, making better healthcare a priority over other consumption choices for citizens that move up into the economic "middle class". The challenge then i s not to reduce expenses in drugs but to control their growth rate and make basic drugs affordable to every household, ina financial sustainable manner. Box 3: ReimbursingdrugsinBulgaria Proton-PumpInhibitors (PPI) are amodemtreatmentfor duodenalulcer andreflux disease-frequent conditionsseen inday-to-day gastro-enterologicalpractice. InBulgaria,three different proton-pump-inhibitorsare onthe reimbursementlist: Drugs A, B, andC (Brandnames havebeenexcluded from the document). All three are equally effectiveand safe: (www.drundinest.org, "Most comparative clinical studies between the drugs in this class have shown that all PPIs are comparably effective for treating acid- related gastrointestinal disorders, including GERD.Since all PPIs are similarly effective, the choice of which PPI to use will typically depend onyour doctor'spreference and/or yourprescription benefitsformulary. ") However, as only drug A i s available as ageneric inBulgaria,the costs to NHIFandto thepatient varydramatically(see Table). Dosagesaresimilar for similar indications, but evenif twice the dosage of drugA would berequired,the cost advantageremains significant. Ifonly drugA would bereimbursed,NHIF mightbeableto increasethe reimbursementrateandthereby improveaccess for poorerpatients. Retail price ex VAT Costs to NHIF Drug A 20 mg 3.44 1.57 14 tablets DrugC 20 mg 32.47 11.39 14 tablets DrugB 20 mg 24.48 7.02 2 x 7 tablets 29. Low income groups have limited access to health care. A household survey conducted in 2002 to determine the true cost o f health care for households gathered information about informal payments, utilization, and health spending by households of different socioeconomic and ethnic background. The results suggest problems with access for low income groups and in some cases the presence o f informal or unregulated payments in 18 order to receive care. According to the survey approximately 13 percent o f households did not approach their general practitioner (GP) because they could not afford to pay for the expenses associated with the examination, and 29 percent o f those referred to a specialist by a GP did not consult them for the same reason. Financial reasons are quoted by 90 percent o f Roma and about 50 percent o f Bulgarians as the main reason for not seeking admittance to inpatient care. Finally, access to pharmaceuticals i s also a problem: about 11 percent o f households did not purchase medicines that had been prescribed by a doctor (25.7 percent in the case o f Roma). EDUCATION 30. Bulgaria appears to be facing a decline inthe quality of education and a national system for quality assessment i s still lacking. The information on quality o f education in Bulgaria i s sparse, but there are some solid indicators suggesting that it has not improved over the last decade. For instance, in the area o f mathematics, Bulgarian eight-graders participated in three rounds of an international study (i.e., the Trends in International Mathematics and Sciences Study (TIMSS)) in 1995, 1999 and 2003. Of all the countries in the sample, Bulgarian eighth grade students faced the steepest decline in mathematics and science achievement. While it could be argued that the curriculum reform implemented just during those years partly explains such results, the magnitude o f the decline clearly points to a worrying quality drop in lower secondary schools in Bulgaria. Moreover, too many students still drop out without completing secondary education: over one-fifth of youth leave school with only lower secondary compared to 7.5 percent inthe NMS. And the quality o f learning results i s also unequally distributed among the student population. Recent external evaluations o f 4th graders done by the Open Society Institute concluded that the average student in the "Roma schools" in the sample had not even mastered half o f the curricula taught, and this performance fell short o f their peers in non-Roma schools.* In such a challenging context, Bulgaria has lacked a national system for the monitoring o f student performance and the overall assessment o f education quality. This i s further aggravated with the absence o f Bulgaria from international quality assessment test initiatives on a consistent basis like PISA (Program for International Student Assessment) and PIRLS (Progress in International Reading Literacy Study). 31. In addition Bulgaria does not have the institutionalcapacity to assess the impact of reforms on the quality of education. Currently, the Ministry o f Education and Science (MES) determines quality standards and the core curriculum, and 28 regional inspectorates o f the MES monitor schools' compliance with education legislation. This monitoring process collects basic indicators such as participation and attainment in a decentralized fashion, but this data is not being used effectively to manage the system. Today it is not possible to supervise quality systematically, rewarding or cautioning schools according to performance, or targeting measures to improve the quality o f teaching where they are needed. Further, municipalities are largely incharge o f school management and capital expenditure -without a strongregime to hold them accountable for delivering quality. * Inthe sample, the "Roma schools" were not identified as such. However, in conversations with the municipal education teams incharge of the schools which were tested, we learnt that the poorest performing schools were schools where there were more than 70% Roma students. 19 32. Net enrollment rates are lower than desired, and participation varies by ethnic and socioeconomic status. Participation rates among the school age population have increased over the last decade (Table 2). Net enrollment ratios at pre-primary, basic andupper secondary levels are all higher today than they were 10 years ago. Nevertheless the net enrollment ratio in lower secondary education - at 84 percent - i s still low, and gains in participation at this level have slowed down in the last five years.' The sharp fall in net enrollment rates between primary and lower secondary, still a part o f compulsory education, i s o f concern. Upper secondary shows impressive increases, although to some extent this reflects the recent increase in the duration o f some programs." The low participation rate affects mostly the poor and vulnerable, many o f whom fail to complete compulsory education. Table 2 :Trends inNet Enrollment Rates in School Education Source: National Statistics Institute 33. Bulgaria is experiencing a demographic transition, with the school-age population shrinking substantially. However, a generous education infrastructure remains from before the transition, and the current financing regime locks in inefficiencies. As Figure 3 shows, student numbers declined by more than 25 percent in the period 1992 to 2005. Municipalities have been closing down schools in recent years in response to this decline, but there has not been a systematic planto adapt to this demographic transition. Therefore, a large infrastructure overhang remains and grows, leading to declining student-teacher ratios and growing per student costs. There are a large number o f schools that operate with very low student-teacher ratios; about 31 percent o f municipal schools operate with ratios below 11 -both inrural and urbanareas. Inaddition, the stock ofnon-teaching personnel reflects recruitment practices from before Bulgaria's political and demographic transition, which did not necessarily follow cost-effectiveness considerations. In Bulgaria's schools there are currently 43 non-teaching staff for every 100teachers.l1 Age enrollments, defined as participation o f the relevant age group independently o f the educational level are higher, however and close to universal, suggesting that a significant fraction o f the lower secondary age group may still be inprimary education, while others may have progressed to upper secondary. lo The duration o f several (but not all) upper secondary programs was increased by one year to 5 years in 2002/03, while the denominator refers to a four year age cohort. Nevertheless, absolute enrollments also increasedby about 14% between2000101 and 2003104, despite the fall inthe population age cohort. 11 The data quoted here on "non-teaching staff' are data from the Annual Census o f School from the National Statistical Institute. However, school visits across the country suggest that these numbers do not always include all the non-teaching staff which is associated with the schools. Often, school principals who fill out the surveys have excluded security staff or cafeteria personnel if these staff members are paid by the municipality andor outsourced to a private fm.Insome instances, schools visited by the World Bankteam inthe outskirts o f Sofia 20 Figure3: Teacher and student numbersand realexpenditureper student Student and teacher numbers, index, Realexpenditure per student, index, 1992-2005 1997-2006 -Students (index, 1992=100) 190, 105 i .......Teachers(index, ..... 1992=100) 170 4 ,..-. 2 150 - 0 X 4 130 - e? 3 80 - 110 - 15 - 90 1, Source: National StatisticalInstitute andMinistry of Finance 34. The current financing mechanism i s not creating incentives for an efficient management of resources. This problem i s twofold: resource allocation i s centralized and financing i s input-based. First, as resource allocation to schools i s determined at the central level, schools or local authorities cannot react to local demands and flexibly meet the needs of students and parents. Second, salary expenditure i s tied to the number o f teachers and non- teaching staff, which inturn i s determined by detailed MES regulations. Inother words, local authorities' freedom to adjust human and capital resources i s limited, and at the same time, financial incentives encourage them to keep the current inefficient student-teacher ratio. 35. The optimization o f the school network could save substantial amounts of money even ifit focusedpurely onthe largemunicipalities where distancesbetweenschools are small. For instance, there are 667 municipality schools located in "urban" areas within large municipalities (Le. with a population greater or equal to 60,000).'* Out o f these schools, only 320 operate with student-teacher ratios greater than or equal to 14. SOCIAL PROTECTION 36. On the verge of acceding to the EuropeanUnion, a major challenge for Bulgaria i s the low labor force participation and employment rate. In spite o f having increased from 50 percent in the beginning o f 2003 to 59 percent in mid-2006, the employment rate remains low compared to the EU-15 and most new EUmember states and substantially below the EU Lisbon target rate of 70 percent by 2010, as can be seen inFigure 4.13 At present, 68 had 4 security guards, guarding tiny school buildings on a %-hour basis. In one instance, in the Village of Marchevo the expenditure on the security guards exceeded the expenditures on teachers' wages. l2 There are 29 municipalities (out of 264) which have a population greater than 60,000. l3 All figures applyto age 15-64. 21 percent o fthe employment is created by the private sector but a sizable share of it i s tied up in low productivity jobs in agriculture, forestry and services, much of it in informal activities. Accelerated efforts are necessary to meet the target intime. Despite the growth o f the private sector, attracting andretainingpeople inemployment will be difficult given that 35 percent o f the population aged 15-64 remains economically inactive, the workforce i s aging and the demographic decline sets limitations for its renewal. Figure 4: Employment Rates andthe Extent o fRegulations inthe Labor Market, Selected Countries Figure 4.1. The employment rate is lower than EU-15 1Figure 4.2. Over a fifth of firms report labor regulations and the New Member States and well below the Lisbon and skills as moderate or major obstacles target for 2010 89, Percentageof fins repolting labor regulations and skills a L`tmSIra*i"(ng* moderateor majorobstacle to business Croatia Bulgana Romania ELI8 \QLabor Market , m Skills andeducatlan of w O i k m ;ource: For Figure 1, IntemationLabor Organization (ILO) I 3Nor Force Surveys (2003), for Figure2, InvestmentClimate Surveys, 2002 37. Despite the positive trends in employment, the problem of non-employmentand under-employment in Bulgaria is serious compared to EU countries. The overall unemployment rate has been reduced substantially fiom 13.7 percent in 2003 to 9 percent in mid-2006 as a result o f accelerated growth and net employment generation in the private sector supported by active labor market programs. However unemployment remains persistent, especially among the youth and the less skilled. The incidence o f long-term unemployment i s high: 54 percent o f the unemployed are jobless for longer than one year and 21.2 percent are first-time job seekers. 38. The labor market exhibits high rates of informality. Bulgaria still has one o f the highest shares of undeclared work among the "old" and new members o f the EU, on the one hand providing a cushion for workers who cannot find a job inthe formal sector, and on the other hand entailing a loss in budget revenues. For 2004, the EC estimated the share o f undeclared work in Bulgaria at 22-30 percent o f GDP compared to 14-15 percent average for the new EUmember states. Informality points to various bureaucratic and regulatory rigidities and to limited flexibility of employment which hinder labor market adjustment and job creation. As shown in Table 3 in comparison to the new member states Bulgaria's labor market i s more rigid in particular in terms of the difficulty o f hiring workers, reflecting barriers to hiringworkers on temporary and fix-term contracts.l4 14The difficulty o fhiring index measures (i) term contracts canbeused only for temporary tasks; (ii) whether the maximumduration o fterm contracts; and (iii) ratio o f the mandated minimumwage (or apprentice wage, the ifavailable) to the averagevalue addedperworker. 22 Table 3: Flexibility of EmploymentIndex, Selected Countries,2006 Source:World Note: Flexibility-of-Employment indexes varying between 0 and 100, with higher values for more rigid regulation, measure various aspects of laborregulation 39. The current design of social assistance does not provide incentives for job searching. Certain population groups remain reliant on social benefits under the Guaranteed MinimumIncomeProgram(GMI) for over ten years without being accountable for job search and improving skills and qualifications. These are mostly low-qualified long-term unemployed and people without employment history who are not eligible for unemployment benefits and end up receiving social assistance, which they combine with informal emp10yment.l~ The overall number o f social assistance beneficiaries i s not very high - between 220,000 and 230,000 people in 2004-2006; however a significant share o f them - close to 85 percent - are people of working age, and over 75 percent o f the working age GMI assistance beneficiaries are registered unemployed.16 The low employment rate is also associated with the large increase in the number o f recipients o f disability pensions and benefits. Compared to 1999, in 2004 the number o f disability pensions due to general sickness increased by 54 percent. During the same period, the number o f social disability pensions granted increased 6.7 times while the number o f beneficiaries that only receive a disability pension declined, as duplication o f entitlements were allowed. Working age disability pensioners comprise 5 percent o f the working age population and 13.6 percent o f the economically inactive. The employment o f 50 percent of the disability pensioners could potentially increase the employed in the economy by 4 percent. Social services provision i s decentralized and expanding however not yet contributing significantly to employment throughjob creation inthe social services sector or by enhancing thejob opportunities outside 15By law, unemployment benefits are insurance-based, with duration of maximum 12 months and require employment and contribution record of minimum9 months inthe last 15 months as qualifying conditions. Long- term unemployed andpeople with no work history cannot satisfy these conditions. l6This represents more than 60 percent of the unemployed in the second quarter of 2006 (Labor Force Survey data) 23 it, e.g. for mothers o f pre-school aged children and caregivers through increase inthe access to affordable childcare, affordable daycare for people with disabilities and long-term care for the elderly. IV. THE GOVERNMENT'SPROGRAM 40. The coalition government that took office inAugust 2005 set the goal to prepare new comprehensive strategies inhealth and education, to be validated by the Council o f Ministers (CoM) duringthe first halfo f 2006 and approvedby Parliament soon thereafter. The education strategy was approved by Parliament inJune 2006 while the health strategy i s currently under discussion at the CoM. Government's Strategy on Health 41. The draft health strategy i s built around nine strategic objectives and actions oriented towards improving health outcomes, increasing efficiency and access, and achieving financial sustainability. The main strategic objectives are: Improving the health o f the population, by increasing citizens' awareness about healthy lifestyles andincreasing the focus on prevention; Delivering high-quality and guaranteed healthcare services, by improving the accreditation system for healthcare establishments and increasing access to healthcare services through the reduction o f financial and geographic inequities; Emphasizingthe role o f primary outpatient care, by refiningthe payment mechanisms and clearly defining the division o f the responsibilities between the primary and the outpatient specialized medical services; Optimizing the network o f the health care providers, by improving the links between outpatient and inpatient care, devising a masterplan and implementation strategy for achieving a more efficient hospital network; strengthening hospital management, and revisingthe prospect payment system for hospitals; Implementing a transparent and fair pharmaceutical policy, by increasing the awareness o f patients, controlling prices and rationalizing the drug prescription practices and drug therapies usedbyhealthcare professionals; Developing the human resources o f the health sector, by aligning medical education content and systems to EU standards and improving the qualifications o f health managers at different governance levels inthe health system; Securing the financial stability and sustainability o f the system in the long-term, by promoting the rational use o f pharmaceutical products, creating an efficient and effective drug reimbursement policy, refining the models o f primary and specialized outpatient healthcare and the restructuring o f inpatient care, improving compliance for health insurance contributions, improving the negotiation process for the National Framework Contract, increasing the monitoring and enforcement capacity o f the NHIF, improving the prospective payment system, developing a voluntary health insurance, and introducingregulated co-payments; and Applying the European Union's regulations and directives, including the development o fprojects to be supported by EUstructural funds. To overcome the challenges in the sector the Government has devised a two-prong strategy, which includes stabilization, short term actions, and structural, medium term 24 reforms. These actions are expected to tackle both supply and demand driven problems. In addition the Government is considering changes in the prevailing model o f financing and provision aimed at introducingmore competition inthe health sector. 43. To stabilize spending the NHIF i s enforcing the collection of revenues and introducing additional financial controls inhospitals. First and most immediate, the NHIF i s taking steps to improve revenue collection, for example cross-checking the collection and service databases with the newly-created National Revenue Agency, who took over the collection o f health premiums from National Social Security Institute (NSSI). A Memorandum o f Understanding was signed between this institution and the MOH to exert more control on large firms. Since then the number o f audits to providers and users has increased and debt collection on contributions by large companies has improved. According to NHIF these actions have resulted in an increase in collections o f about BGN 20 million in the first half o f 2006. Second, inorder to keep better control and monitoring on spending by providers NHIF i s requiring all providers to report their spending electronically. Third, to prevent strategic behavior on the part o f hospitals NHIF is becoming the single payer o f hospital services inthe country (with some minor exceptions). Unifyingmost health spending under NHIF would have the advantage o f reducing strategic behavior on the side of providers-which tends to increase spending; reducing administrative costs; and increasing the bargaining power o f NHIF. Fourth, the MOH has signed recovery plans with all the hospitals where the MOH is the majority stakeholder. These plans contain provisions for the hospitals to maintain a certain financial position, collect unpaid debt, and keep spending below hospital revenues. Hospital directors have been made accountable for the implementation o f these plans, which are already showing a decrease in the stock o f hospital debts relative to 2005. 44. The NHIF is also planning to introduce changes to the National Framework Contract, which sets the prices o f health services and i s negotiated annually with the Bulgarian Medical Association and the National Association o f Dentists. The main change i s to introduce volume ceilings for hospital services. The experience in many European countries and Canada shows that setting prices is not enough to limit spending by health care facilities, as they can control volume o f services and recover any reduction in prices by increasing admission rates. Manycountries inEurope have introduced limits inbothprice and quantities o f services provided by hospitals, and NHIF i s planningto introduce a similar policy, either through an amendment to the health insurance law, or the inclusion o f such provision in the draft budget law for 2007. 45. On the supply side, the Government is planningto restructure the hospital sector to adapt it to the current practices of health service provision that rely more and more on outpatient, less expensive care. Optimizing the hospitals network is a difficult political issue and therefore it requires building consensus first by collecting evidence and communicating it to the public and major stakeholders. The government has decided that the first step in this process will be to implement a hospital masterplan to assess the needs o f the population and compare them to actual services provided. There have been some successful experiences with the restructuring o f hospitals that followed this path, like the case of Estonia, where a restructuring plan was set up in 2000 with the goal o f reducing the number of hospitals from 78 to 21 by 2015. Usingdemographic and epidemiological models the demand for health care was estimated, as well as optimal catchment areas by type o f facility, so that for a given catchment area the maximum time limit to reach the hospital would be one hour. 25 Based on these criteria Estonia identified 3 regional hospitals for tertiary care, 4 central hospitals, 11 country hospitals, and 3 smaller hospitals. Between 1993 and 2001 the number o f hospitals went from 115 to 67, the number o f beds decreased from 14,000 to 9,000, and average length o f stay moved from 15 to 8.7 days. 46. The hospital masterplanning exercise will not only propose a new, more streamlined network o f hospitals. It will also estimate their ideal location, the type o f services that should be provided at each level, the organizational model for better management and accountability, the costs necessary to implement the network optimization program, and recommend alternative models to achieve a successful restructuring. It will also propose ways in which the private sector can participate inthe restructuring and functioning o f hospitals, like Public- Private-Partnerships. Even though the entire process can last a decade, the Government i s planning to start implementing the restructuring plan within the next three years, and is looking into other countries experience within the EUinorder to take advantage o f Structural Fundsto finance part ofthe process. 47. The government will improve its co-payment policy in order to limit unnecessary demand for health care without restricting access to basic services. Currently there seems to be a significant portion o f health expenditures paid in cash by the users. The amount o f these payments i s not clearly defined, irrespective o f the efforts o f the National Statistical Institute (NSI) to monitor health expenditures as one o f the components o f the expenditures done by households. Based on survey data concerning health care expenditures made in cash by households, recent estimates put these expenditures at BGN 38 (approx. EUR 20) per person each year for the 3000 households included in the survey sample. Extrapolating the sample results, this would mean about BGN 311-350 million per year o f cash payments (around EUR 160 milli~n).'~ Other estimates place out o f pocket payments at 25 percent of the total health care expenditures in the country, representing an additional 1.5 percent of GDP. 48. The current co-payment structure has to be reviewed in light o f two potentially contradictory facts: first, as discussed inthe previous section, out o f pocket payments -many o f which are co-payments- are creating a barrier to access for some groups. Second, there seems to be evidence o f unnecessary demand for some services like hospitals. One o f the goals o f universal health insurance i s to protect individuals from large negative shocks to their health, covering catastrophic or large health related payments. At the same time unnecessary demand for services should be limited by introducing adequate co-payments. The government will undertake a thorough review o f the current structure o f co-payments and the extent o f unregulated or informal payments and take the necessary actions to limit the negative effects o f co-payments and unregulatedpayments on access.l8 l7Penkov, Boyko, 2005ReportundertheWorldBankPAL3 PHRDGrant, "Voluntary HealthInsurance: Opportunities for HealthInsurance Development inBulgaria". l8 According to the HealthInsurance Law, every visit to the GP, the specialist (witha referral) or the dentist the insuredpatients pay a user fee equal to 1% of the MinimumSalary (currently minimumsalary is BGN 160/month, e.g. fee is BGN 1.6). Every day o f hospital stay is paidat 2% o fthe Minimum Salary. Ifthe insuredperson is hospitalized for more than 10 days ina given calendar year, the person is only paying user fee for the first 10 days o fhidher stay. User fees are NOT paidby a number o fgroups, includingbut not limited to: chddren up to 18, pregnant women, people insocial homes and orphanages, conscript military, people on social assistance, etc. (including also medical school graduates too, just as one curious example...). When lab tests are being conducted at the referral o f the GP, specialist or dentist, the patient pays at the lab a fee for collection o f 26 49. The government planon pharmaceuticals seeks to secure the financial sustainability o f drug spending byNHIF, sustain the role o fNHIF as the relevant payer for basic healthcare in Bulgaria, andbringthe regulatory framework inline with EUregulations. The Government i s proposing changes in the legislation that will increase the share o f generic prescriptions and protect NHIF against economically inefficient prescribing behavior by introducing reimbursement ceilings for therapeutic groups covering chemically similar (rather than identical) drugs with equivalent therapeutic value. The law addresses technical (for example registration, manufacturing, clinical research), administrative (such as licensing o fbusinesses) and economic aspects (pricing, reimbursement) and is based on European regulatory standards. The reimbursement policy has to improve in order to allow households access to basic drugs but not at the expense o f fiscal sustainability o f NHIF. A more rational reimbursement policy should satisfy both objectives. Once the law passes second reading (it has already been approved in general), Bulgaria will have a legislative framework that i s in line with EUmember states. The draft has been reviewed by Bank and WHO experts and has been deemed compliant with EU standards. It also follows many o f the recommended policies by the Bank like the adoption o f a generic drug policy. In order to regulate the implementation o f the law, 26 by-laws (ordinances) need to be developed, as the law itself i s fairly general incertain areas (for example pricing and reimbursement). The Government has requested Technical Assistance (TA) from the Bank to assist inthe drafting o f by-laws, which will define substantial details and procedure^.'^ The following Gantt Chart summarizes the Government's program inhealth for the next three years andhighlights major milestones: bio-material, not higher than2 levaper lab visit regardless o f the number o f tests for that visit. Fee for collection o f material is waived for people with no income, those insocial facilities, inchild orphanages and social care homes; and auser fee equal to 1%o fthe minsalary. Finally, co-payments for medications for home treatments entail a complex system o f full or partial reimbursement, based on a Positive Drug List approvedby MoHand a s ecial Reimbursement List o f NHIF. "By-laws are drafted by inter-ministerial expert groups, submitted by M O H and passed by the Council o f Ministers. 27 F 6 I i c I r B -9 I n c s :6 e g E 3 nE E Ld Government's Strategy on Education 50. The Government has embarked on a set o f ambitious initiatives reflected in the "National Program for the Development o f School Education (2006-2015)" approved by Parliament in June 2006. The program recognizes that the main challenges that the Bulgarian primary and secondary education system face include (a) a decrease in the quality and relevance o f skills taught; (b) a decline inparticipation rates, particularly in upper secondary education; and (c) an ineffective use o f existing resources. The combination o f these challenges will affect adversely the competitiveness o f Bulgarian school children in the EU labor market. In order to reverse these negative trends, the Government appreciates that it needs to increase access to education for all children and strengthening the quality o f the education process. To achieve these two goals, the program has identified six broad objectives: Orienting school education towards the stimulation o f thinking and independence, towards the formation o fpractical skills and towards personality building; Establishing an efficient internal assessment system through the wide-scale use of tests and introduction o f a system for national standardized external assessment; Decreasing the number o f drop-outs and increase enrollment rates for children in the compulsory schooling age; Strengthen the authority and improving the social status o f the teacher; Decentralizing the school network through the gradual introduction o f delegated budgets for all schools and providing more flexibility to municipalities to appoint school directors; and Optimizing the school network by introducing a single standard (per capita) financing formula and putting in place a system o f financial incentives for the closure o f ineffective schools. The MES is implementing a comprehensive national policy on student assessment and strengthening its institutional capacity for system-wide evaluation of education achievement and for quality assurance. One key factor inimproving quality o f education i s to foster critical thinking skills rather than focusing on memorizing facts. Since external assessment instrumentshave a great potential to influence teachers' behavior inthe classroom and to promote a result-oriented and learning culture in schools, critical and independent thinking and learning of functional skills can be enhanced using valid and fair testing instruments.However, those very goals may be hampered ifexams andtests do not set out to assess these important skills; or if they are used only for the purposes o f school and teacher accountability. National tests and examinations, properly used, will provide evidence about student performance, quality o f schooling, and the impact of specific education reforms on quality. For instance, a very ambitious curriculum reform has been implemented over the last decade, and it would be critical to gain evidence on how the new curriculum is faring with regards to student achievement. 52. The Centre for Control and Assessment o f the Quality o f Education (CKOKO) is the national agency which will institutionalize and sustain the goals o f an outcome-oriented education system. Similar agencies or institutes already exist - under different denominations andinstitutional modalities - inevery EuropeanUnion country, and they are emergingas one o f the key responsibilities o f central governments inthe education sector. The Government is planning to strengthen CKOKO's institutional and technical capacity in order to implement a series o f testing programs to assess the quality o f education in Bulgaria, thus providing 29 decision makers and education administrators with hard evidence to support policy changes andreforms inthe sector. 53. The second pillar for quality improvement i s the promotion and integration of ICTs in the school curriculum and in training of teachers, directors and inspectors. Bulgaria lags behind both the EU and the New Member States on access to computers in schools and use o f ICT ineducation. Only 33 percent o f schools are connected to the internet, while the EU average i s 80 percent and the NMS average i s 55 percent. In May 2006 the Council o f Ministers approved an updated action plan for the implementation of the National Strategy for the Introduction o f Information Technologies in Bulgarian Schools (2005-2007). The MES is in charge o f drafting the necessary legal amendments, teacher training, developing e-content and curriculum, while the State Agency o f Information Technology i s responsible for computerization and network infrastructure. The Strategy has two broad components. The first is to increase the quality o f teaching through the development and use o f internet based teaching and learning aids, training school teachers on the use o f Information and Communication Technology (ICT) in the education process, providing computers and connecting all Bulgarian schools to the internet. The second i s to increase access to education opportunities for disadvantaged social groups through strengthening distance learning opportunities, developing an educational internet portal and increasing the amount o f online content available to both students and teachers. 54. The MES i s undertakinga detailed assessment to identify legislative roadblocks to the integration o f ICT in the integration process. The changes have included, in the first phase, the introduction o f basic ICT training from grade 5 and during the second phase will change legislation to allow, inter alia, the taking o f electronic tests and record keeping o f students' scores. Duringthe next three years a significant and increasingportion o f capital spending at the Ministry o f Education will be directed to ICT related activities. The Government has planned to invest some BGN 141 million for implementing the Education and ICT Strategy between 2005 and 2007, making it the third largest item in capital spending in the education budget. In2005 over 40,000 teachers received basic training on the use o f ICT, some 27,000 computers and over 3,000 servers inthe schools and all Bulgarian schools were provided with internet access. 55. The most ambitious element of the government's strategy in education i s the financing and governance reform in municipal schools. The Government's Program contains a plan for decentralization and optimization o f the school network based on a three- pronged strategy: (i) optimizing the school network via a funding reform that will allocate money to municipalities by a unified standard per student, for both salary and non-salary expenditures; (ii) decentralization o f school management to empower schools to manage their humanresources via delegated budgets, and (iii) mitigatingmeasures to prevent anincrease in drop-outs during the reform transition (this i s integrated with the general drop-out reduction program) * 56. An agreement has been reached within the Government on the new financing formula for schools. MOF, the MES and the National Association o f Municipalities (NAM) have agreed on the definition o f the "unified standard". There will be four centrally set rates, varying according to population density. Municipalities inmore rural, less densely populated areas -which are also poorer in general- will receive higher per capita funding. During a transition period o f two years, municipalities losing out under this arrangement will receive 30 the nominally frozen amount o f their 2006 funding. The decision on the new financing formula will be approved by the Council o f Ministers and submitted to parliament alongside the Budget Act by 31 October, with effectiveness from January 1, 2007. The rationale behind letting money follow the student is to set incentives to align infrastructure and staff levels with current student numbers. Even if "losing" municipalities continue receiving the nominal 2006 allocation, there will still be a mounting financial pressure, as wages are expected to be increasingby approximately 5-10 percent a year innominal terms. Thus, the only way for the "losing" municipalities to be financially viable under the per capita scheme i s to consolidate their school network. Ifthat takes place, the "savings" generated can be invested inextending and improving the quality o f education services inthe consolidated schools. Fully realizing the expected outcomes o f the school network optimization would require a timely change in the primary and secondary education sector legislation. 57. The Government is going to implement mitigating measures to prevent increases indrop-out rates and unemployment of school staff as a consequence of the financing and governance reform. The MES, the MOF, and other key stakeholders in the education sector agree that optimization o f the school network will not take place without substantial support, guidance, monitoring and financial incentives from the center. There i s a risk that instead o f closing schools and re-allocating the freed resources, these may be spread ever more thinly across existing schools, with detrimental effects for education quality, safety standards and participation rates. The Government's Strategy therefore envisages financial stimulisupportingthe efficiency incentive generated bythe fundingreform. A budget line for `consolidation mitigation' programs has been included inthe 2007 draft budget. The detailed design o f both the participation agenda and the additional mitigation measures i s currently under discussion. The counterparts agree that it should contain at least a re-worked transport program and active outreach to parents, especially to those with children at risk o f dropping out. Inaddition some o f the active labor market policies could be targeted to school staff, for example matching their skills and supply with the currently unmet demand in childcare. Similar schemes have been successful in New York (`Satellite childcare'), and also recently been adopted by the UK Department o f Work and Pensions (`Support Childminder Network' and `Childminding under the New Deal'). 58. The Government i s considering additional actions with the objective of reducing dropout rates. The National Program provides for the following targeted actions, in addition to any special mitigation measures that will be introduced to reduce the risk o f school dropouts after the introduction o f the unified standard. First, the practice o f providing free textbooks and learning aids for students in primary education (grades 1-4) will continue and should gradually be extended to cover children with special needs. The full operation o f the Education Portal will assist this process directly by makingelectronic textbooks and learning aids more widely available. Second, the free school feeding program for students in primary education will continue, while special efforts are made to restore and return to operation school canteens inprimary and secondary schools. Third, the provision o f free transportation to students, combined with the development o f the semi-boarding facilities will continue with the goal to provide every centrally located school with at least one school bus (minibus) by 2008. Besides the national transport program and outreach to parents the government will introduce stricter compliance in the linkage o f social benefits to the school attendance o f the children. 31 59. The Government's Program also includes a comprehensive deregulation and decentralization agenda. The aim i s to devolve essential management powers to the local level through delegated school budgets, school-based management, easing o f class room size andteacher workload regulations, and a re-structuring o f the powers and tasks o f all involved institutions. Bulgaria began introducing delegated school budgets inthe late 1990s supported by a EU commission Phare program.*' By 2006, around 40 municipalities (out o f 264) have some form o f delegated school budgets, in which a formula allocates funds to schools and principals can manage their budget at the school level. The delegated share i s limited in practice and the school director has discretion only over all or parts o f the non-staff budget, as the number o f teaching staff is still determined by MES regulations. The Government plans to pushfor an extension o f delegated budgets only after the unified standard has been applied, in2008 and 2009, to provide time for school principals to be trained-an Institute for School Directors i s being set up inNovember 2006- and to allow for changes inthe legislation on centralized staff appointment. Both measures are envisaged inthe Government Program and should be inplace before budgets are delegated. As a first step in 2007 the MES i s planning to pilot in 10 municipalities the decentralized appointment of school directors. The following chart summarizes the Government's plan for the governance and financing reform: 2oA system o f delegated school budgets means that each school receives a lump sum budget for the financial year. This is a single sum o f money which includes money to pay for the salaries o f teachers and other staff as well as all the non-staff expenditures, such as utilities, learning materials, school ceremonies, office supplies, and regular maintenance o f the school building. Under a unified standard per student the school receives a single lump sum, with no indication as to how much is for salaries and how much for non-salaries. This is up to the school authorities to decide. 32 Government's Strategy on Labor and Social Protection 60. The Government's program for labor, reflected in the "Employment Strategy 2004-2010" is harmonized with the overarching objectives of the European Employment Strategy for achieving full employment, quality and good performance at work and an inclusive labor market. It aims at providing opportunities to each individual in active age for freely selected and productive employment. The implementation o f the strategy i s expected to bring about labor force growth o f at least 5 percentage points, permanent reduction o f unemployment to below 10 percent and participation in active labor market measures and programs o f at least 25 percent o f the long-term unemployed. The strategy i s addressing the labor market constraints with a range o f policy instruments, among them: (i) income policy reform for employment promotion, (ii)active measures to reduce unemployment and increase labor force participation, (iii) promotion o f entrepreneurship and opening o f small and medium enterprises, (iv) transforming informal into formal employment and making work more attractive, (v) enhancing the capacity o f the labor force to remain active longer (active aging policy), (vi) enhancing the adaptability o f the businesses and workforce to the changing labor market demand and supply, (vii) improving the quality o f human capital through investing in life-long learning. Specific medium- and short-term measures following from the Employment Strategy are implemented through Annual Employment Action Plans. On September 25, 2006, the Government and the nationally representative organizations o f employers and employees signed an Economic and Social Development Pact o f Bulgaria till 2009. The parties reached an understanding on the need to reform the labor legislation, income and social insurance policies, including to abolish the seniority bonus-an additional remuneration for length o f service only- and replace it with merit and qualification-based wage increases, and to limit the role o f the state in employer- employee relations. The parties agreed on measures to strengthen vocational education and develop by 2007 a national strategy for life-long learning, to work towards increasing the employability o f the vulnerable population groups, reduce unemployment to below 9 percent and achieve an employment rate o f 61 percent by 2010. 61. In social protection, the main activities include overcoming education disadvantages, increasing access to social assistance, health and social services for vulnerable groups, in particular people with disabilities and vulnerable ethnic minorities. The government's program i s reflected in the EU Joint Inclusion Memorandum (JIM) signed by the EUand the Government o f Bulgaria on February 3,2005, the Strategy for Poverty Reduction and Social Inclusion, the Poverty Reduction Action Plan for 2006, the Action Plan for Equal Opportunities for People with Disabilities 2006-2007 and other strategic documents. In the medium-term, the GOB programs envisage measures to prevent the institutionalization o f children and promote their reintegration in family environment, improving the care for people with disabilities, especially for those placed in institutions for mentally disabled, improving the access o f vulnerable groups, including ethnic minorities to schooling, health care and improved nutrition. The Government established the Agency for People with Disabilities as an executive agency with the Ministryo f Labor and Social Policy (MoLSP) and in March 2006 approved a strategy aiming at make it the "one-stop-shop" for medical certification, social assessment and social integration services for people with disabilities. To promote labor market integration o f people with disabilities, the Government i s diversifying and scaling up targeted active labor market programs and services for them, including pilot training programs and incentives for employers to hirepeople with disabilities. The Government legally opened the provision o f employment and social services for non- 34 state providers (businesses, individual professionals and non-governmental organizations) and public-private partnerships. Certain services are decentralized and transferred for management to the municipalities while financing remains the responsibility o f the state budget. The expected outcomes o f these policies are reduction o f poverty, keeping inequality at a low level, increasing the access to social care o f highquality, reduction o f the placements ininstitutional care, andreducingthe number of early school leavers from the current level of 20 percent (2005) to the EUaverage o f around 15 percent2', 62. In light of the low employment levels and the disincentives to job searching created by the social assistance programs, the Government i s embarking on a program to improve the effectiveness of social spending and to create an environment conducive to employment promotion. The Government will promote labor demand both by lowering the cost o f employment through the reduction o f the cost o f labor for the employers and by promoting more flexibility in working hours and employment contracts. The high cost of employment in Bulgaria i s associated mainly with the burden o f social security taxation. Figure 5 shows that social security contributions inBulgaria are among the highest in Central and Eastern Europe. It forces employers to cut back new hiringon formal labor contracts and to try to remain competitive by hiring and paying informally and cutting on social contribution payments. The Government has proposed amendments to the Labor Code to introduce increased flexibility o f working hours and fix term and part-time contracts. It i s also introducing changes in the social insurance code to lower the pension insurance contribution rate by 6 percentage points from 29 to 23 percent, so as to ease the social contributions burden on employers. The lower cost o f employment i s expected to motivate the creation o fnew jobs and to motivate the conversion o f unofficial 'obs into official ones, increasing the quality o f the existingjobs interms o fpay andbenefits.LJ2 Figure 5: Social Security Contributions in Bulgaria and EUcountries - Social Security Contribution Rates in Europe 40 30 20 10 I o I Source: UnitedStates Social Security Administration Note:* indicatescontributions after changes in2006 21Early school-leavers' rate is the percentage o f population age 18- 24 who have finished eighth grade at the most and are not attending educational and vocational courses Source: EUROSTAT 22The last is possible because a major feature o f labor market informality i s that jobs are only partially unofficial, meaning that they are registered but the wages declared for tax purposes are significantly lower than the ones paid inreality. 35 63. On the supply side, the Government's employment action plans aim at improving employment activation measures within the social assistance system, limiting the extent of subsidies for low qualification jobs and increasing the focus on Active Labor Market Policies (ALMPs) which have demonstrated a positive net effect on employment. 23 The National Employment Action Plan for 2006 contains a series o f actions aimed at shiftingthe focus from low quality job subsidies to skill enhancement and qualification programs to promote durable employment: A reduction by 54 percent in the number o f beneficiaries o f the main program offering low-quality community jobs - "From Social Assistance to Employment" from 91,630 to 42,000 while increasing considerably the investment in programs that promote skill acquisition inthe private sector to match its needs, qualification, andtraining, Gradual relative expansion o f on-the-job training and qualification programs linked to private sector skill needs Giving preference to first-time applicants to employment under the "From Social Assistance to Employment" program; Introducing targeted literacy and vocational training programs for 2,500 individuals from vulnerable groups, particularly Roma; Increase individual incentives to find employment by adopting amendments to the Employment Promotion Act to introduce a monthly bonus for recipients o f social assistance who find employment at their own initiative, paid as a top-up to their monthly salary for one year Inthe mediumterm, introducingchanges to the disability insurance programto reduce the perverse incentives embedded inthe system, including changes inthe medical assessment process and the assessment criteria. 64. Figure 6 shows that in2006 the planned spending on active labor market programs has remained the same as percentage o f GDP but the number o f services provided has come down, mostly to reflect the decrease in low quality supply o f jobs in the "From Social Assistance to Employment" program. 23The programchangeswill beguidedbythe findings of the netimpact evaluationo f the existing ALMPs which was conductedin2005-06. 36 Figure 6: Active Labor Programsand Expenditures2003-2006 0.60 200000 0.50 TI e! 0.40 150000 d L 0.30 3a2 '$E Y) 100000 n 0.20 u) 50000 0.10 0 0.00 2003 2004 2005 2006 (plan) ,, nTraining --Other Training From Social Assistance to Employment 11 1 immSubsidized Jobs - Other Subsidized Jobs From Social Assistance to Employment . 1 +State Budget ExpenditureShare of GDP Source: World Bankstaffcalculations based onMoLSP data 65. Employment activation measures and changes in the design of social welfare benefits will allow for a better targeting of social assistance expenditures to the most vulnerable groups while providing more structured support for those who can work to participate in the labor market. Social assistance i s provided through two mainprograms - the GMI and the Energy Benefit programs. The GMI program i s well targeted and with strong redistributive effect among the poor transferring more than half o f the benefits to the bottom 20 percent o fthe population. However, its coverage i s low, workfare requirements are weak and it is inno way conditional to job search and labor market integration requirements. Thus the program encourages passive reliance on social assistance and state provision o f subsidized low-skilljob placements, and leaves the recipients in a dual poverty and inactivity trap. Measures aimed at removing adverse work incentives and ensuring that the social system i s more focused to core risk and vulnerable groups will help address the dual aim o f promoting more activation and less passive reliance on Government transfers. To retarget social assistance programs the government has introduced changes in the legislation which limit GMI assistance for working age long-term beneficiaries without disabilities or sickness to a maximum o f 18 months and suspend their right to reapply for 12 months thereafter. The government will also keep the GMI benefit level for working age beneficiaries without disabilities or sickness at the minimumlevel by applying the base coefficient. 66. The Government program lays the ground for long-term productivity increases through employment policy and education reforms. There may be a short-term trade-off between employment and productivity: as a result o fmeasures to cut the cost o f labor (e.g. the 6 percentage point cut inthe pension contribution rate) which would promote the entry o f low productivity workers, average productivity inthe economy may fall. This may be balanced, at least inpart, by the formalization o f higher-productivity informal jobs, by the introduction o f greater flexibility and extension inworking hours, and by making wages dependent mainly on productivity rather seniority. However, in the medium and longer run, the Government measures are set to trigger productivity increases in the economy, by increasing skills o f the existing workforce through encouraging employers' investment in qualification programs and 37 the inflow o f well educated, higher productivity labor market entrants as a result o f education reform. 67. The development of inclusive and demand-driven social services will help reduce inactivity and foster integration in the labor market of social groups at risk of losing competitiveness in the labor market. These include mainly people with disabilities, caregivers to people with disability and parents (mostly mothers) o f young children. The government will increase the availability o f affordable community- and home-based professional care for people with disabilities which will allow reintegrating o f able-bodied family members in the labor market and acquisition o f pension rights instead of life-long reliance on social assistance. The provision o f affordable child care i s very important for removing barriers to re-employment o f their mothers. The Government is planningto develop pilot experiences to make social services and the labor market more sensitive to the employment and training needs o f people with disabilities. The following Gantt Chart summarizes the Government Program: 38 UI b H V. BANKSUPPORT TO THE GOVERNMENT'S STRATEGY LINKTO CPS 68. The links between the D P L series and the Bulgaria CPS are strong, both formally and conceptually. The CPS-which was presented to the Board on June 13, 2006-includes as part of its base case scenario a series of three DPLs in the social sectors for a total o f $450 million. This comprises 50 percent o f the overall base case lending and the only budget support operations to be financed by the Bank during the next three years. The policy changes to be supported by the D P L series are intended to set the stage for implementing the health and education strategies prepared by the government and to provide the backbone that will guide investment operations in the social sectors-financed by both the Bank and other multilateral organizations. 69. Conceptually, two o f the four overarching goals supported by the CPS are being acknowledged inthe DPL series: a. Raisingproductivityand employment in support of private sector-led growth along the lines of the EU's LisbonAgenda: The three programmatic DPLs (FY07-09) would support the productivity and employment agenda by focusing on: (i) the reform of the labor framework and social protection system to increase employment by lowering payroll taxes, reducing social assistance dependency, reforming disability benefits, and increasing formal employment through more flexible work arrangements and better incentives to participate inthe formal economy and (ii) the reforms inthe education sector to strengthen the institutional capacity to monitor and improve quality and increase accountability to lay the foundation for long-term productivity growth. . b. Fiscal sustainability and improved capacity for absorption of EU funds: The DPL series would focus on improving the efficiency o f the health, education, pension and social assistance systems to support their financial sustainability and effectiveness. In health, the focus will be on improving financial sustainability of the NHIF, restructuring of the hospital sector, and improved efficiency inthe pharmaceutical sector. Ineducation, the DPLs will support finance and governance reforms that would help improve both the quality of education, and how efficiently the resources available for education are being used. The reforms in these sectors will also open windows o f opportunity to utilize EU funds as new programs are being created or old programs reformed. COLLABORATIONWITH THE IMFAND OTHERDONORS 70. The IMF Board, on August 6, 2004, approved a 25-month SDR 100 million Stand-By Arrangement of a precautionary nature. The IMF supports the Bulgarian authorities' economic program as articulated inthe Memorandum o f Economic Policies dated July 21, 2004. Cooperation between the Fund and the Bank has been and continues to be strong, especially with respect to the general fiscal issues, education and social protection sectors which are included in the IMF program. For example, the IMF program includes fiscal surplus targets while the Bank supports improving the efficiency o f the hospital sector which i s a major contributor to fiscal arrears. The IMF program also includes structural benchmarks related to the increase o f work-time flexibility, the submission o f the education 40 sector reform strategy to Parliament and a reduction in the number o f redundant teaching positions which are all complementary to the proposed D P L program. O n May 17, 2006 the IMF decided to extend its program in Bulgaria by 6 months (until March 31, 2007) after having involved the Bank actively in the discussions related to the social sectors. After the expiration o f the SBA, the relationship would move towards regular surveillance. While the Bank continues to rely on the donor coordination responsibility o f the Council for Economic Policy (CEP), the Bank maintains strong and effective working relationships with donor partners. These include the Open Society Institute (education decentralization) and the EU (the absorption o f structural funds). RELATIONSHIP TO OTHER BANKOPERATIONS 71. The DPL series i s complementary to existing and planned operations in the social sectors, and i s intended to become the pillar around which future investments and policy dialogue inthese sectors will be structured. The current health sector reform project includes a component on hospital restructuring inselected municipalities and some technical assistance for hospital master-planning activities. In addition one of its main activities is the strengthening o f the management and administrative capacity o f the NHIF, an essential condition to improve financial sustainability and efficiency inhealth care provision. 72. The proposed social inclusion project (FY07) will help to address the needs of Bulgaria's most vulnerable groups (national minorities-in particular Roma-people with disabilities, children in institutionalized care and others), in support o f meeting the goals of the JIM signed with the EU. This operation will complement the DPL series in its objective to improve targeting o f social welfare programs to reduce distortions in the labor market, develop and agenda to improve the delivery o f social welfare services and promote access to quality education. An Institutional Development Fund Grant has recently become effective. The IDF grant will support capacity building in the Ministry o f Education and Science through the strengthening o f CKOKO, the planned Institute o f Directors and the MES department in charge o f developing programs aimed at absorbing European Social Funds.The proposed regional development project (FY09) would address regional imbalances by strengthening capacity to manage the programming and strategic allocation o f EU structural funds, integrate them into public expenditure management and the intergovernmental fiscal system, and capacity building at regional and local levels for project preparation and absorption o f EU funds. It i s expected that the increased capacity o f Bulgaria to absorb structural funds will feed into some o f the policies supported by the D P L series, like the hospital restructuring, as has been the case in other countries in the region, like Estonia and Latvia. 73. The D P L series i s inmany cases a continuation o f the P A L 111, presented to the Board in 2005. While the PAL I11was muchbroader in scope-having only one o f its five pillars devote to the social sectors-the DPL's more narrow focus allows for a higher degree o f As mentioned before the DPL complements and completes some o f the changes undertaken under the P A L series. Some aspects and actions undertaken under the P A L I11 24The five pillars in PAL. I11 were: sustaining structural reforms, establishing a market-fr-iendly business environment, deepening financial system, improving public sector governance, and investing in human capital and strengthening socialprotection. 41 will continue to be developed and monitored by other parts o f the World Bank Program for Bulgaria. For example the Economic and Sector Work (ESW) "Investment Climate for Private Sector Growth and Employment" will make sure that objectives and commitments made under the P A L I11continue to be pursued. The following table shows some examples of complementarity between the P A L and DPL. ActionsSupportedby PAL111and DPLI-Selectec Examples Actions supportedunder PAL I11 Actions supportedby DPL I Adoption o f 10-year strategy and 5-year actionplan to enable Additional actions inplaceto integrate minorities to education the integrationo f children from ethnic minorities into (e.g. fully functional Center for Educational Integration) education. Enactment o f legislationfor the establishment o f Center for Educational Integrationo f Ethnic Minorities. Introduction o f obligatorypre-primary school year to ensure equal access o f ethnic minority children to regular schools Update COM resolution on schoolfinancing to increase Adoption o fnew unifiedstandard for allocating funds to efficiency o f staffing ingrades 9-12 inmunicipal schools municipalitiesfor general school educationandrolling out o f the per capita school financing model Expansion o f output-based financing mechanisms for inpatient Expansiono f output basedfinancing to the totality o fhospitals care (to cover morethan 50 percent o fall hospital payments in2005) Launcho f hospital restructuring inMinistry o f Health and Continuationo f hospital restructuring inmunicipal hospitals municipal hospitals Increaseinlabor market flexibility through enactment o f Increase inlabor market flexibility through enactment o f legislationfor non-discrimination inthe labor market and legislationto increaseflexibility o f working time, part-time and legislationreducing the incidenceandincentives for abuse o f fixed-term contractual arrangements;also through folding the sick leave senioriry bonus inthe base wage Regulatory amendments for privateprovisiono f employment Move from passive reliance on welfare to social integration services; adjustment o f criteria for selection o fprovidersto through work allow more privateparticipationinthe provision o f employment services; Introduction o f income testing o fmonthly family support for Beginevaluation o f impact o fchanges insocial assistance on children labor supply Opening social servicesprovisionfor non-governmental Introduceannualmonitoringandevaluation o f the effectiveness providers; development o f minimumstandardsfor social o f social assistance programs and social services services; replacement o f licensingo fproviders with registration (except for child care services) Adoption o f Strategy for Integrationofthe Disabledand new Developedandpilotedprograms and services for labor market disability legislationintroducing social assessmentalong with integrationo fpeople with disabilities. Reform o fmedical the medical assessmento fdisability; introduction o f secondary disability assessmentboards to improve quality o f assessment, legislationto facilitatethe integration o f the disabled in and replacement o fmultiple categorical disability benefits with educationand the labor market individual assessmento f disability andneed. LESSONSLEARNED 74. There are two main sources from which to draw lessons - the recently completed Bulgaria P A L program and the analysis o f the social sectors in NMS-8. Whde all o f the lessons from the P A L program are important for the DPL series, it i s worth noting two: (i) EU accession and integration are often the drivingforce behind many reforms, but the Bank can add value by helping the Government to design an implementation strategy for those reforms and by providing lessons from international experience; and (ii)the use o f an umbrella programmatic policy-based lending program, despite its complexity, can be an effective instrument to concentrate high-level government commitment to support implementation o f difficult reforms.25 Lessons from working with the NMS-8 are well 25 See PALICR, April 20,2006. 42 documented in the Bank's briefing to the new Government o f Bulgaria.26 Inparticular, it i s noted that continuedpursuit o f structural, institutional and governance reforms i s necessary to achieve the growth and productivity increases necessary for convergence with the other EU member states (see Box 4). Additionally, progress in public finance reform i s necessary to rationalize expenditures for efficiency and growth orientation, and to meet the financial demands o f EUmembership. ANALYTICAL UNDERPINNINGS 75. The operation is well integrated with the World Bank's analytic and advisory work. As part o f the preparation activities for the DPL Ithe Bank team prepared policy notes in health, education, and social protection providing a comprehensive overview o f the three sectors, highlighting the main problems, and identifylng key areas where Bank intervention would be needed. In addition the D P L team prepared brief technical notes on hospital restructuring, the pharmaceutical sector, education financing, assessment o f quality of education, labor market and unemployment, disability cost containment, social assistance and social services delivery, breaking the poverty and dependency cycle for ethnic minorities. 76. Inthe education sector, and as part of the preparation of the DPL I,the World Bank education team has worked closely with the MES and MOF in compiling a school level expenditure data base, and investigating the drivers o f costs in education. So far, an exhaustive analytical note on teacher and non-teacher compensation has been prepared, and another note on maintenance costs i s under preparation. The education team has also prepared a chapter for the forthcoming follow up to the February 2006 Public Finance Policy Review -which has been the basis for estimating the fiscal impact o f the education reforms. The most recent Country Economic Memorandum was also consulted inthe preparation of the DPL I, butit does not focus on the social sectors extensively. 77. Finally the ongoing dialogue on poverty and living standards through the poverty assessment programmatic work should provide additional information to be used in setting baseline indicators and measuring the impact o f various reforms supported by the DPL program. The programmatic work on poverty includes a household survey with education andhealthmodules that will be usedto look at the effect o f stabilization measures inhealth on out o f pocket spending and changes in the education financing on dropouts and access to schooling. 26Towards a New Partnership for Successful EUIntegration, 2005. 43 Box 4:DPL support to improvingGovernancein Bulgaria There is generalagreement that governanceandtransparencyhave improvedinBulgariaduring the last few years. Accordingto the CPS, "There hasbeenapositivetrendas far as administrativecorruptionis concerned,althoughrecentsurveysshow a slight deteriorationbetween2004-05." TransparencyInternational's 2005 corruptionperceptionindex ranks Bulgariain55" place among 159 countries (but still betterthan Polandand closeto Slovakia), andhas shownsteady improvementsfor Bulgariabetween1998-2002, with aleveling offthereafter.The EBRD-WorldBank BusinessEnvironmentandEnterprisePerformanceSurvey(BEEPS) shows adeclineincorruptionas aproblemof doingbusiness inBulgaria from 2002-05. As mainareas for unofficialpaymentsby firms, BEEPSshows obtaining govemmentcontracts, obtainingbusiness licensesand permits, dealingwith customs,anddealing with the courts. The latest EUreport, which determinedBulgaria's readinessfor accessioninJanuary of2007 discussesthe progressinthe fight againstcorruption at length. It lists anumberof actionstakento fight corruption, like: (i) the amendments to the `law onthe publication of the assets of persons occupying highpublic positions', adoptedinAugust 2006 authorizingthe National Audit Office to cany out inspectionsto confirmthe accuracyof declarationsby persons occupying highpublic positions; (ii) the Amendments to the Law on PoliticalPartiesadoptedinAugust 2006, stipulating that members ofthe govemingandcontrolling bodies of the politicalpartieshaveto declareall their domestic andforeignassets, incomeand expenditureto theNational Audit Office. Politicalpartieshaveto nametheir donors as well as the type andvalue of donations. (iii) the Law onthe Administrationmandatingthe creationof inspectoratesdirectly subordinatedto the Minister inall ministries andmost stateagencies. These inspectoratesmayproposedisciplinaty or legalmeasuresagainst staff incase ofmisconduct. A `Chief Inspectorate'hasbeenestablishedinthe Council of Ministerswhich reportsto the PrimeMinister.It is inchargeof coordinatingandassistingthe activities of the ministerial inspectorates. The Chief Inspectoratei s the secretariatof the Anti-Corruption Commission. The Commission'sstaffhas now beenincreased.Contactpoints for receivingreportsof corruptionhavebeenestablishedinmanystate bodies.A planfor conductinganti-corruptiontraining for about 50,000 officials at all levels of the administrationhasbeendrawnup. (iv) The ratificationby Bulgaria ofthe UNconventionagainstcorruption.(v) Amendmentsto the Law onthe ProfessionalOrganizationsof PhysiciansandDentists adoptedinAugust 2006 aimingat heaviersanctionsfor breachesofprofessional ethics. Finally, the EuropeanCommission has also deemedthe procurementandfinancial managementsystems in Bulgariaacceptableto handleadministrationof ESFs. The reportshows that further progress is still necessaryinthe area ofjudicial reform andthe fight againstorganized crime and corruption.The Commissionhas establisheda mechanismto cooperateand verify progressinthese areas afteraccession. This will bebasedon Articles 37 and38 of the Act of Accession. BothBulgariaandRomaniashallreport regularlyonprogressinaddressingspecific benchmarks.And the Commission will provide internaland external expertiseto cooperateandprovide guidanceinthe reform process andto verify progress. The Commission's reportswill assesswhether the benchmarkshavebeenmet. Shouldeither countryfail to address the benchmarksadequately, the Commission will apply the safeguardmeasures ofthe AccessionTreaty.They leadto the suspensionofthe current Member States'obligationto recognisethose judgementsandexecutewarrants issuedby either country's courts or prosecutorsfalling under the principle of mutualrecognition. The benchmarksto beaddressedare as follows: -Adoptconstitutionalamendmentsremovinganyambiguityregardingtheindependenceandaccountabilityofthejudicialsystem. -Ensureamoretransparentandefficientjudicialprocessbyadoptingandimplementinganewjudicialsystemactandthenewcivilprocedure code.Report onthe impactof these new laws andof the penalandadministrativeprocedurecodes, notablyonthe pre-trial phase. -Continuethereformofthejudiciary inordertoenhanceprofessionalism,accountabilityandefficiency.Evaluatetheimpactofthisreformand publishthe results annually. -Conductandreportonprofessional,non-partisaninvestigationsintoallegationsofhigh-levelcorruption.Reportoninternalinspectionsofpublic institutionsandonthe publication of assets of high-levelofficials. -Take further measures to preventandfight conuption, inparticularat theborders andwithin local govemment. -Implementastrategytofightorganisedcrime,focussingonseriouscrime,moneylaunderingaswellasonthesystematicconfiscationofassets of criminals. Report onnew and ongoing investigations, indictments andconvictionsinthese areas." The CPS acknowledgesthat improving governanceandstrengtheninginstitutionsis one ofthe mainchallengesinBulgaria. "Moving towards a transparent,honestand efficientjudiciary is one of the key requirementsfor improving the businessenvironmentandmeeting EUaccession requirements." Thereforethe Bankhas agreedto provideextensiveTA for judicial reform, initially throughtwo activities,first, non-lendingTA for Supportfor Justice Sector Modernization and Reform. Second, anIDF grant that will be submittedas aproposalin2006: Combating Corruption-Strengthening Anti-Corruption Capacity in the Ofice of the Prosecutor General. 7% would eventually lead to additional activities in the sector, to complement the European Union involvement. Eventhough the DPLprogramdoes not address governance andcorruptionexplicitly, many ofthe policy actions agreedwith the Governmentwill improve governanceandincreasetransparencyinthe social sectors. Specifically(i) the unificationof paymentsto hospitalswill increasethe transparencyinfinancing ofhealthcareas it will preventhospitalsfrom double billing for a givenprocedure;(ii) the law onpharmaceuticalswill increasethe transparencyinthe decisionmakingprocessfor approvalofdrugs as well as pricingandreimbursementpolicies; it will also promote abetter use of resourcesby theNHIF;(iii) the introductionof changes inthe financing of schoolwith aunified standard will improve governance inthe educationsectoras it willbecomeclear howmucheachschoolshouldreceiveaccordingto the numberof students ithas; (iv) finally the introduction oftesting andquality assessmentinstrumentsshouldreducethe practice of privatetutoring by public schoolteachers and improve transparencyinadmissionto universities (an outcomeat the endofthe programrather than a DPL 1outcome). Inadditionsome milestoneshave beendiscussedwith the government andare includedinthe chartsthat lay out the implementationofthe strategiesinhealthand education, likethe implementationofa study on informal paymentsandananalysisof co-paymentsinthe healthsector. I 44 VI. THE PROPOSED SOCIAL SECTORS INSITUTIONAL REFORM DEVELOPMENT POLICY LOAN OPERATIONDESCRIPTION 78. A social sector DPL series is the right instrument for supporting Bulgaria in its transition towards full EUmembership. Bulgaria made significant progress inmeeting the EUaccession criteriajoining the community inJanuary 2007. However to converge towards EU standards o f living will require addressing those areas which will affect the productivity o f the work force, the efficiency o f public spending, the inclusion o f minorities, and addressing regional disparities. Since many o f the gaps are related to the social sectors the GOB has requested Bank assistance inthese sectors specifically, recognizing their importance for convergence and their pressingneed for further reform.27 The new coalition government (inpower since August 2005) has made a commitment to prepare and present medium-term health and education strategies. The education strategy was approved by Parliament in June 2006 while the health strategy is currently being discussed at the Council o f Ministers. A D P L series focused on the social sectors would assist the government to transform these relatively high-level strategies into concrete action plans with measurable indicators of progress. The DPL series will provide a framework for implementation o f the strategies and for targeting the work o f other donors. Finally, the DPL will commit the attention o f the highest levels o f Government, and particularly the Ministry of Finance, to work together with the social sector ministries, an issue that cannot be underestimated when important reforms- like introduction o fnew financing formula for the education sector-are contemplated. 79. A programmatic approach is preferable to other alternatives. Given the medium- term horizon o f both the education and health strategies, a series o f single tranche loans i s determined to be the best option to support their implementation. A series o f DPLs will allow for sufficient flexibility to adjust to new information and changing circumstances during implementation o f the new strategies and to change the scope o f the operation, if necessary, over time. This is likely to happen as experience innew member states has shown that rapid changes in the Bank's work program in these countries were required. The series structure will also permit the specific sectors to follow different paces o f reform. Having a three year flexible program provides an anchor for policy dialogue with social sectors during Bulgaria's early membership inthe EU. It is expected that during this transition some new actions will have to be considered, particularly those supporting absorption o f EU funds. Finally, a programmatic approach also fulfills the goal o f providing a policy "umbrella" that could frame future investment and technical assistance operations in the social sectors by the Bank, and align the interventions o f other donors. 80. The need for flexibility has been incorporated in the project design, which relies heavily on the government's strategies and programs. The strategies prepared by the Government provide a broad framework for the reforms in health, education, and labor and social protection. The DPL series contribution to the government's program lies in the provision o f concrete action plans in each sector together with technical assistance, and specific monitoring indicators o f progress. The DPL series i s helping to transform ideas into actions within a timefiame. The need for flexibility in light o f a very dynamic situation prompted by EU accession and post-accession needs has been incorporated in the design of 27The Government o f Bulgaria is relying on other sources for completing reforms in the areas o f governance, judiciary, and infrastructure. 45 the program inthe form of: (i) few actions in the policy matrix, all o f them triggers; (ii) very broadly defined actions, extracted from the government's strategies, accompanied by very thorough action plans described inthe program document; (iii) broad definition o f triggers in phases two and three in order to accommodate to changes in the client's demands during the first years o f EUmembership. POLICY AREAS Followingi s a description of the main areas supported by the DPL series. For each main area a set of actions to be included in the Policy Matrix are proposed. 81. The DPL series has two overarching objectives that are closely linked to the CPS objectives. These are: (i)Increase employment and lay the foundations for long-term productivity growth by providing incentives for job creation and improving quality of education and; (ii) Promote fiscal sustainability through efficiency gains in social sectors and improve access to social services. A description o f the actions being supported by the DPL under each objective and the expected outcomes follows. I Increaseemploymentandlaythefoundationsforlong-termproductivitygrowth by providing incentives for job creation and improving quality of education I.1. Problem: Low employment, relatively high unemployment rates, high percentage of long term unemployed, and high rates of informality in the labor market 82. The Government, through the Ministry o f Labor and Social Policy in particular, i s embarking on a program to promote employment, which includes interventions to alter incentives both on labor supply and labor demand sides. 83. Prior actionsDPLI.The following prior actions havebeen completed: (a) The Government has enacted amendments to the Labor Code to increase flexibility o f working time and fixed term and part-time contracts; (b) The Government has enacted amendments to the Social Insurance Code to lower the contribution rate for pension insurance by 6 percentage points from 29 to 23 percent; (c) The Government has enacted amendments to the Employment Promotion Act to introduce a monthly bonus for unemployed recipients o f social assistance who find employment at their own initiative. 84. Medium term actions (DPL I1 and DPL 111). In the medium term the DPL series will support the GOBto introduce impact evaluation systems o f the main active labor market programs. Based on the results o f the impact evaluations the DPL I1 and I11 will support further restructuring o f active labor market programs to strengthen on-the-job qualification and training programs linked to private sector skill needs and develop a medium term program and institutional framework for professional training and qualification consistent with European Social Fund priorities. Finally, the Government will continue its efforts to 46 make the labor market more flexible by folding the seniority bonus into the base wage. The mandatory seniority bonus which i s an additional remuneration for length o f service only, limits individualwage formation based on merit, increases the cost o f hiring employees with longer work history and hinders overall labor force mobility. Proposedactions for overarchingobjective 1 OverarchingObiective: Increase emvlovment and lav the foundationsfor long-termproductivity growth by providingincentives for job - - creationand improvin pality of edicakon IssuesiProblems Prior Actions (2006) Actions Second Phase ActionsThird Phase Low employment, The Government has enacted Fold seniority bonus into the base relatively high amendments to the Labor Code to wage unemployment increase flexibility of working rates, high time and fixed term and part-time percentageof long contracts term unemployed, andhighrates o f The Government has enacted informalityinthe amendments to the Social labormarket InsuranceCode to lower the contributionrate for pension insuranceby 6 percentage points from 29 to 23 percent The Government has enacted Restructureactive labor market Further restructure active amendments to the Employment programsto strengthen on the job labor programs phasing out PromotionAct to introduce a qualification and training those programs with little or monthly bonusfor unemployed programs linkedto private sector negative net impact on recipientsof social assistancewho skill needsand develop a medium employment find employment at their own term programand institutional initiative framework for professional training and qualification consistentwith EuropeanSocial Fund priorities I.2. Problem: Social Welfare Program design creates disincentivesfor job searching 85. To create additional incentives for job searching and lower reliance o f able-bodied individuals on social welfare programs the government will change eligibility criteria o f some social assistance programs. The DPL series will support the impact evaluation o f these changes and further reforms based on the results o f the evaluation. Baseline data and evaluation design will begin early in 2007. The DPL Iwill support the piloting o f some programs to integratepeople with disability into the labor market. 86. Prior actions DPL I. The following prior actions have been agreed: (a) The Government has developed and piloted one new project and scaled up one national program and two encouragement measures stipulated in the Employment Promotion Act to encourage labor market integration o fpeople with disabilities 87. Medium term actions (DPL I1 and DPL 111). In the medium term the D P L series will support the GOBto introduce an impact evaluation system o f the main social assistance programs and monitor their effect not only on poverty and social indicators but also on job creation. The next stages o f the DPL program will support additional measures to overcome the long-term dependency on social assistance benefits and transition to work by improving the targeting o f social assistance based on comprehensive impact evaluation of the GOB policy limitingGMI assistance to able-bodied long-term unemployed to 18 months, improved methodology for defining the poverty line, and refined structure o f minimum payments (minimum wage, minimum pension, social pension, guaranteed minimum social payment). 47 The DPL series will also support the introduction o f changes in the disability insurance program as it has been shown that growth o f that program has hindered the incentives for job searching. g quality of education Prior Actions (2006) Actions SecondPhase Actions Third Phase The Government has developed Governmenti s evaluating the Introduce annual programdesign and piloted one new project and impact of changes to the social monitoring and evaluation creates scaled up one national program assistance systemto introduce of the effectivenessof social disincentives for and two encouragement further revisions including assistanceprograms job searching measuresstipulated inthe improved eligibility and Employment Promotion Act to targeting encourage labor market integration of people with disabilities Redesign relativeamounts of minimumwage and minimum social payments (GMIsupport thresholds, social pension, social disability pension) to limit disincentives to work 88. Expected outcomes (by 2009). By the end o f the DPL Program, the expected outcomes are: i.Anincreaseintheemploymentratetoatleast60Percent(age 15-64,NSILFS data); ii.Areductionofnumberoflow-qualitysubsidizedjobsby25percentfromthe2005 baseline; iii.Reductionofatleast10percentinthenumberofhouseholdsreceivingsomesocial benefit from 76% percent inthe end o f 2003 (MTHS data); iv. An increase incontributions to social security larger than the growth rate o fwages. I.3 Problem: Quality of education has been decliningand the institutional capacityfor quality assessmentis lacking 89. The D P L Iwill support the Government's strategy to strengthen the MES institutional capacity to assess the impact o f curricular and other reforms on the quality o f education. This has the potential to radically switch priorities in policy making for the education sector, bringing the quality o f student learning to the top o f the policy agenda. The Centre for Control and Assessment o f the Quality o f Education will institutionalize and sustain the goals of an efficient, transparent, and outcome-oriented education system. The DPL series will be supporting four different testing activities in Bulgaria: a) a new placement test at the end o f 7th grade which has the potential to radically overhaul current patterns o f student access to upper secondary school; b) designing and piloting a new Matura, i.e., secondary school- leaving examination; c) new tests (sample or census-based) to be used strictly as system-wide evaluation o f education quality; and d) managing Bulgaria's participation in international achievement tests such as TIMSS, PISA, and PIRLS. Bulgaria has already participated in some international assessment studies but without sustained interest and funding fiom the MES, which prevents fiom taking full advantage o f the benefits associated with these international endeavors. For example, Bulgaria has not participated in PISA since 2002. The 48 DPL Iwill support the piloting o f the first o f those tests while the rest will be supported by DPL I1and D P L 111. 90. Prior actions DPL1. The followingprior actions have been completed: (a) The MES has approved the 2007-2009 program o f activities to be implemented by CKOKO and CKOKO has implemented a pilot sample-based national assessment of student performance ingrade 7; (b) Council o f Ministers has: (i) approved an action plan for the implementation of the National Strategy for the Introduction o f Information Technologies in Bulgarian Schools, and (ii) to implement such action plan. started 91. Medium-term actions. The DPL I1 and I11 will support the introduction of the remaining testing instruments, the Matura (by 2008), the participation in international tests, and the additional tests to be used for quality assessment.28They will also support additional measures to improve quality like training o f inspectors, school directors, and the further implementationo f the strategy for the integration o f ICT inthe school curriculum. Proposed actions for overarchingobjective1 Overarching Objective 1: Increase employment and lay the foundations for long-term productivity growth by providing incentives for job creation and improving quality of educati Issues/Problems Prior Actions (2006) Actions SecondPhase Actions Third Phase Quality of education has The MES hasapprovedthe 2007- Bulgaria takes part ina number of Resultsfrom Matura sample beendeclining andthe 2009 programof activitiesto be international assessmenttests, like testing in selected subjects are institutionalcapacity for implementedby CKOKO and PISA2006, PIRLS 2006, and disseminatedand sample testing quality assessmenti s CKOKO hasimplementeda pilot TIMSS 2007. InadditionM E S i s administeredin the remaining lacking sample-based nationalassessment organizes sample testing of subjects of student performancein grade 7 Matura inBulgarianlanguage and literature,Mathsand foreign languages Council of Ministers has: (i) MESis training50 percentof `new Electronictextbooks and approved an action plan for the inspectors' and `new school learningaids for all primary and implementation of the National directors'throughthe newly secondary curricula developed Strategy for the Introduction of created Institute of School and availablethrough Education Information Technologies in Directors Portal. Monitoringof levelsof Bulgarian Schools, and (ii) started use of ICTsi s regularly carried to implementsuch action plan out as well as impact evaluation of the useof ICTs on student learning. 92. ExpectedOutcomes. Bythe endo fthe DPLProgram, the expected outcomes are: i.CKOKOpreparesannualreportsontheassessmentofeducationqualityandmakes them available to schools, parents, other stakeholders in the education sector and public opinion ingeneral. ii.Placement ofstudents inupper secondary institutionsis done onthe basis of objective ability testing. '*The compulsory education in Bulgaria i s defined in terms of an age (16) rather than a required number of grades which needs to be completed. The age 16 often coincides with grade 7. 49 iii.Theresultsofthe4thgradenationalassessmenttestsandPISA2006resultsare being used by MES to review and introduce reforms inboth the school curriculum and in-service teacher training policies. . iv. All RegionalInspectors havebeenre-trained. v. 35 percent o f subjects inthe primary and secondary education curriculum have e- technology and multimedia content available to teachers and students. I1 Promote fiscal sustainability through efficiency gains insocial sectors and improve access to basic social services ILl Problem: Inefficiency in health serviceprovision and less than universal access to care, as well as threats to the financial sustainability in the National Health Insurance system 93. The government i s adopting stabilization measures to control public spending on health and introducing changes inthe pharmaceutical sector that should increase efficiency in the commercialization o f new drugs, increase access to basic drugs to underserved groups of the population, andhelp restore financial balance o f the NHIF. Prior actions DPLI.The following measures have been adopted (a) Inorder to improve the financial balance of its national health insurance system, the Government has: (i)increased the health insurance premium revenue; (ii) unified payment mechanisms for hospitals; (iii) included limits inthe volume o f services to be paid by NHIF to hospitals in the draft budget law for 2007; and (iv) signed recovery planswith University, national andregional hospitals with a State majority ownership; and (b) The Government has submitted legislation to the Parliament to improve pharmaceuticalapproval, pricing and reimbursementpolicies to increase the efficiency o fpublic spending on pharmaceuticals and access to essential drugs. 94. Medium-term actions. In the medium term the Government will continue implementing stabilization measures to maintain financial balance at the NHIF and start planning and implementing the structural reform in the hospital sector. The National Framework Contract and the hospital payment system would be improved to increase efficiencies and more rationale allocation o f health resources. Additional changes in the pharmaceutical sector would be implemented in order to simplify approval and pricing procedures even further and increase efficiency inNHIF spending on drugs. 50 Proposed actions for overarching objective 2 Overarching 0b.iective 2: Promote fiscal sustainability through efficieni - . gains in socialsectors and improve access to basic socialservices Issues/Problems Prior Actions (2006) Actions Second Phase Actions Third Phase Inefficiency in health In order to improvethe financial The role of the NHIFas a primary The role of the NHIFas a service provision and balanceofits nationalhealth payer of hospitalsis maintained primary payer ofhospitalsis less thanuniversalaccess insurance system, the and the paymentsystemis maintainedandthe contracting to care, as well as threats Governmenthas: (i)increased improvedto promotefor efficient and paymentsystem to hospitals to the financial the healthinsurancepremium useof resources. supportsmoreefficient useof sustainability in the revenue; (ii)unified payment resources. National Health mechanisms for hospitals; (iii) The Governmenthascompleted Insurance system includedlimitsin the volume of the masterplanningexercise and The Governmentis services to bepaidby NHIFto taken first steps towards its implementingstructural reforms hospitalsin the draft budgetlaw implementation. Iti s also to improvethe efficiency of the for 2007; and (iv) signedrecovery implementingadditionalmeasures hospitalsector, for example planswith University,national to improvethe financial balanceof consolidating hospitalsaccording and regionalhospitalswith a State the nationalhealthinsurance to the masterplan majorityownership system, for example enforcing implementationof recovery plans The stock of arrears in hospitals in hospitalsto limit growth of has decreased at least 10 percent arrears and usingaccreditationof with respect to the 2006 level facilities as a toolfor rationalizing services. The Governmenthassubmitted The Government further adopts legislationto the Parliament to and implements measures that improvepharmaceutical would improve pharmaceutical approval, pricingand approval, pricing, and reimbursementpoliciesto reimbursementpolicies to increase increasethe efficiency ofpublic the efficiency of public spending spending onpharmaceuticalsand on pharmaceuticals and access to access to essentialdrugs essential drugs (e.g. Unify drug lists into one single list based on INN name and ATCDDD classification) 95. Expected outcomes. By the end o f the DPL Series (2009), the expected outcomes are: i.financial projections of spending and revenues show the health system is financially sustainable; ii.the proportion of spending on outpatient care relative to inpatient care has increased by 5 percent; iii.consolidationactivitiesforhospitalsmoveefficiencyindicatorsclosertothoseof EU (e.g. average length o f stay, number o f beds, and inpatient admissions decreases); iv. The percentage o f the Bulgarian population reporting access to essential pharmaceuticals increases (baseline and outcome to be measured by household surveys in2007 and 2009) and the NHIF data shows a higher aggregate number o f prescriptions (per insuree) and a higher average reimbursement rate for an agreed list o f essential drugs; and v. NHIF data showing that pharmaceutical spending is within budget and growing at a rate not higher thantwice GDP growth. 11.2 Problem: Current governance andfinancing systemfor schools is not conducive to increased accountability and does notprovide incentivesfor efficient use of resources 96. The Government o f Bulgaria undertaking a governance and financing reform of the municipal school network, involving the introduction of a per capita fbnding formula and progressive devolution o f responsibilities to local and school levels. 51 97. Prior actions DPL1, The followingprior actions have been completed: (a) Council o f Ministers has approved: (i) a new financing formula ("unified standard"), for allocating funds to municipalities for their school networks; and (ii) plan for a the phased introductiono f the new financing formula. (b) Council o f Ministers has approved a package o f measures and incentives to support the introduction o f the unified standardand school consolidation Proposed actions for overarching objective 2 Overarching Objective 2: Promotefiscalsustainabilitythroughefficiencygains in social sectors and improve access to basic social services IssueslProblems Prior Actions (2006) Actions SecondPhase Actions Third Phase Current governance and Council of Ministers has Per student financingof schools is Startinginschoolyear 2008/09 financing systemfor approved: (i)a new financing beingimplementedusingthe all state schools are transferred schools is not conducive formula ("unified standard"), for unified standardin combination to municipalitiesand funded by to increased allocatingfunds to municipalities with the assistance package,with the unifiedformula. accountability and does for their schoolnetworks;and (ii) schools being consolidated notprovide incentives the planfor a phasedintroduction accordingto the planand the Delegatedbudgets and school- for efficient use o f of the new financing formula numberof municipalitieswith basedmanagementare rolled resources delegated schoolbudgetsincreased out nationally. Council of Ministers has approveda packageof measures and incentivesto support the introductionof the unified standard and schoolconsolidation 98. Medium-Term Actions @PL I1 and DPL 111). As described before, the Government's program for the governance reform in schools contains three main elements: (i) municipalitiesbyaunifiedstandardperstudent,whichincludesasinglesumof funding money for financing both salary and non-salary expenditures; (ii) introduction o f delegated budgets for schools, and (iii) introduction o f school based management. DPL I1and I11will support the implementation o f the financing formula and the necessary revisions in case the consolidation i s not taking place according to the plan or the impact evaluation reveals a negative effect inaccess inthe affected municipalities. It will also support the slow reduction inthe amount ofregulationsimposedbythe MESonmunicipalities andschools 99. Expectedoutcomes. Bythe end o fthe DPL Series (2009),the expected outcomes are: i.Anincreaseintheaveragepupilteacherratioforlowersecondaryschoolsfromthe 2006 level to the prevailingratio according to the best Europeanpractice ii.allmunicipalities, meetingthestandardsdefinedbyaninter-MinisterialWorking Group, will have access to the Government program o f measures and incentives to support school consolidation and the introduction o f the unified standard; iii.anincreasedsatisfactionofmunicipaleducationdepartmentheadsandofschool directors with the new school financing formula and with the package o f measures and incentives to support the introduction o f the unified standard and school; and consolidation (beneficiary assessment; measured against baseline survey); and iv. an increased parenustudent satisfaction with consolidated schools (beneficiary assessment; measured against baseline survey). 52 FISCAL IMPACT OF THE REFORM PROGRAM 100. The program is broadly consistent with the medium term expenditure fkamework, and the World Bank team has been working with both the Ministry o f Finance and the sector ministries in estimating the additional spending required to implement some o f the policies together with potential savings resulting from efficiency enhancing policies. Table 4 shows the consolidated budget and budget projections for 2005-2009 for health and education, as reported in the MTEF fkom June 2006. Due to the large projected GDP growth, both spending on health and education are expected to increase by about BGN 180-250 million per year, even though the sectors spending as percentage o f GDP will decrease in 2006 and remain constant thereafter. 101. The MTEF incorporates the expenses necessary to implement the reforms supported by the DPL series. In the case o f education, according to the MTEF summary report, "...Greater effectiveness should be pursued within the available budget resources for the education sector. It presumes optimization and gradual consolidation o f the large number of schools and higher education institutes at a reducing number o f students with the purpose o f increasing the studentdteachers ratio. Keeping the unnecessary capacity in the educational system requires considerable resources for salaries and maintenance expenditures. The released funds could be used for modernization o f the school base, higher salaries to teachers and upgrading o f their skills and qualification, improvement o f the curricula and introduction of modern training methods with the aim to improve the educational system results as a whole. The overall reforming o f the educational system i s also needed in view to stimulating human resource development and successfully training qualified staff meeting the contemporary needs o fthe labor market". 102. As for health the MTEF states that ``. .Inthe period 2007-2009 the expenditures on . healthcare are projected to grow by BGN200-220 million annually. However, more important i s the attainment o f greater effectiveness o f those expenditures, better control and optimization o f available resources and their targeting at improving the quality o f work o f doctors and hospitals." and "...The experience in other European countries shows that the regulation o f medicines' prices initselfis not sufficient for the attainment o f effective control over expenses on medicines (a lot o f countries apply a combination o f regulatory measures that comprise introduction o f additional payment for medicines prescribed, limitation o f the number o f prescriptions per patient as well as the amounts under the prescriptions, laying down a ceiling o f expenses on medicines, and the organizations o f doctors bear responsibility "...The improvement of the quality of provided health services presumes adequate for every excess expense)." Finally, the MTEF addresses the hospital consolidation plan: maintenance o f existing capital assets at public health institutes. The closure o f wards or o f entire health institutes havingunnecessary capacity as well as the merger o f hospitals with the aim of reducingthe total administrative costs will be hardand yet necessary decision. Thus, resources could be released for securing the pressingcapital expenditures". 53 Table 4: ExpendituresinEducationandHealth,MTEF 2005-2009 ConsolidatedStateBudget (BGN million) 2005 2006 2007 2008 2009 Report Program Forecast Forecast Forecast EDUCATION 1,814 1,907 2,153 2,333 2,586 Current Expenditures 1,637 1,779 1,965 2,116 2,396 CapitalExpenditures 177 128 188 216 190 Percentof GDP 4.3 4.2 4.2 4.2 4.3 HEALTH(PLUS RESERVE) 2,009 2,002 2,221 2,420 2,641 PercentofGDP 4.8 4.4 4.4 4.4 4.4 Source: MOF, Report onthe Three Year Budgetary Forecast2007-2009 103. The reduction in short term revenues from a decrease of 6 percentage points in the social security contribution i s expected to be offset by an expansion of the pool of contributing workers and a higher reported wage over the medium term. As a result o f the wage appreciation, the Government has projected that the contribution base for social insurance will be expanding over the next few years and will partly cushion the NSSI revenue decline. In the short term (2006 and 2007), the revenue shortfall associated with the cut i s expected to trigger an increase in central government transfers compared to 2005 which has been budgeted in 2006 and i s part o f the GOB'Smedium-term expenditure fi-amework 2007- 2009. Figure 7 presents the scenario, which for 2006 assumes nominal wage growth o f 11 percent and an increase inemployment by 4 percent or 118,000 jobs. 104. The change in the contribution rate was implemented from the beginning of 2006, and initial results are encouraging- unlike projected, the revenues of the NSSI did not decline in Q1 and Q2 of 2006. According to initial N S S I estimates, contribution revenues increased by 12 percent in the first 6 months o f 2006 compared to the same reference period in 2005. N S S I explains this mainly by the increase in officially reported incomes following the reduction in the contribution rate. Private sector wages grew by 12.2 percent in Q1 o f 2006 compared to Q1 o f 2005 - the highest wage growth rate for the past 5 years. Meanwhile employment also picked up, albeit at a more modest rate, with a reported 40,000 newjobs inQ1 and 4 2 o f 2006 compared to the same reference period in2005. 54 Figure 7: Estimatedfiscal costs o f social security contribution reform Employment Rate and Social Insurance Contribution Revenue Scenario, Bulgaria 2003-2009 62.0 -- L 10.0 ---9.0 80.0 -. 8.0 L 1e58.0 -- 7.0 E - 6.0 ; - 5.0 c e - 4.0 - 3.0 - 2.0 F t O 2003 2004 2005 2006 2007 2008 2W9 I RateScenano Employmem -+Social insumnceContributionRwnue (ownpmpctions), share ofGDP -+Social Insunme ContributionRersnue(MOF prqections), share of GDP --x---Transferb m Centnl Gommentto NSSVNSSI Deficit (MOF prolections),share of GDP Source: World BankstaffcalculationbasedonMOF, NSSIandNSIdata 105. The other reform supported by the DPL with significant fiscal implications is the education and governance reform. Figure 8 provides preliminary estimates o f the possible costs and savings o f moving municipal schools in Bulgaria to a per capita financing scheme. The graph on the left hand side o f Figure 8 illustrates the additional costs and savings under the reform compared to current spending on municipal schools. The graph on the right-hand side presents different scenarios for the future development o f education expenditure, depending on the implementation o f the reform. The underlying assumptions are explained r below. Figure8: EstimatedFiscalImpact of the ntroductionof Per CapitaFinanceto Schools Total spending on munlclpal schools with and without the funding reform Estimatestor 2009 in `000 Leva Educationspending in X of GDP ; 850,981 ,............ Difference: program-basedspending Baselinecase, , , , , -MOF proposal MOF proposalwithoutunaccounted 3.6 admin exp Total spending Efficiencygain Demographic Transport, Total W/O funding estimated by dividend refurbishing spending 3.5 reform MOF (curnulawe) and other with funding 2005 2006 2007 2008 2009 2010 mltlgation reform Source:MOF, World Bank schoollevelexpendituredatabase for BulgariaandWorld Bankeducationteam simulations 106. The total savings and costs arising fi-om the reform comprise (fi-om left to right in Figure 8): (a) an efficiency gain (estimated by the MOF when setting the initial hnding rates), (b) the "demographic dividend" (the saving associated with the fact that the student population i s declining) and 55 (c) expenditures on mitigating measures.29 107. The efficiency gain (component (a)) results from the following efficiency improvements: First, schools can be consolidated, i.e. the students from formerly two schools can be served bythe buildings and staff o f one school, which reduces the overall cost. Second, as stated above, there i s a disproportionately high number o f non-teaching staff in the Bulgarian school system. If this staff were reduced (over and above any reduction implied by school consolidation), it could generate additional savings. School level data shows that 794 schools in Bulgaria (that i s about 30%) operate at student- teacher ratios below 11. Measures to consolidate these schools and reducing the overall number to, say, 400 schools operating at ratios just above 11, could yield savings of over BGN 80m per year. Moreover, a parallel reduction o f non-teaching staff by 30% (7,000 people) could yield additional savings o f about BGN 20m. The total amount o f possible and acceptable savings i s a matter o f judgment. The figure o f nearly BGN lOOm shown in the graph contains the combined consolidation and non-teaching staff reduction savings considered possible by MOF. This first best scenario assumes that municipalities will respond to the incentives and support measures provided by the central level to consolidate schools. 108. The demographic dividend (component (b)) encompasses the savings that are made by central Government budget due to the fact that the new funding accrues per student and therefore accounts for declining student numbers. The dividend arises from comparing the funding amount (under the new per capita regime) without student decline with the funding amount with student decline. The demographic dividend grows per year (to the extent that school-age population shrinks every year) and, in 2009, i s estimated at BGN 60m. The positive fiscal effect o f the demographic dividend could be dampened if the population trend observed inthe last two decades i s reversed; some evidence suggests this could happen inthe near future. 109. Figure 8 also factors inany mitigating and support measures during reform transition. These would include a program to cover material improvement o f school buildings and a busingscheme, as well as parent-involvement strategies, and municipal capacity support. The annual expenditure for this i s estimated at BGN35m. 110. The fiscal projections on the right hand side integrate all elements o f the reform that have been agreed so far: schools will receive a per capita fundingamount from January 2007. This amount has been proposed by the MOF and agreed with MES and NAM and differs according to structural features o f the municipalities (e.g. population density). The baseline scenario assumes spending grows at the rate o f GDP. The line immediately below the baseline scenario shows how spending as percentage o f GDP goes down ifthere is full transition to the per capita funding rates suggested by the MOF and compensating losing schools during two years. The third scenario, generating the most savings includes additional savings from ~~ ~ 29The simulations show the pure effect of the changes supported by the DPL series. Irrespective of this it has already been established elsewhere that overall spending in education is well below the average o f comparable countries (as percentage o f GDP). It i s expected that as Bulgaria grows, overall spending will also grow and achieve values closer to N M S averages. 56 cutting all currently unallocated administrative e~penditure.~'Currently the Government i s considering to retain total education spending at the baseline (Scenario 1) level, and to compensate the reduction inper student amounts with increased program spending, including mitigating measures related to school consolidation (illustrated by the vertical arrow). VII. OPERATIONIMPLEMENTATION POVERTYAND SOCIAL IMPACTS 111. The HD DPL program would support improvements in health, education, labor markets and social protection that are expected to have an overall positive impact on living standards and contribute to increase equity in Bulgaria. The improvement o f the quality o f education i s expected to increase equity in the medium- and long-term by buildingmarket- relevant skills and thus improving the competitiveness and the earning capacity o f the future labor market participants. 112. Creation o f new jobs will be triggered by reforms that increase the flexibility o f the labor market, reduce the cost o f labor for the employers and motivate taking a job instead of long-term reliance on social benefits. The more flexible labor market decreases the barriers to hiringandfiring and allows overall better utilization o fthe working time. This is expected to bringan increase inthe incomes from work inthe form o f additional wages paid to the newly hired on more flexible employment terms, and a wage increase for the current workers. International evidence shows that the more flexible terms o f employment increase the insecurity o fthose who are employed on permanent formal contracts (those who are inside the labor market), but open more job opportunities for those who are outside and often more vulnerable (those who are unemployed, working in the informal sector, or working on part- time, fixed-term, seasonal or other types o f flexible contract arrangements). 113. The lower cost o f labor for the employers due to the reduction in social security contributions from 29 to 23 percent, is expected to broaden the contribution base, improve compliance, promote the creation o f new jobs, reduce labor market informality and increase overall job security. Initial evidence o f higher compliance and contribution base is already in place - for the first 6 months o f 2006, revenues from social insurance contributions went up by 0.8 percent. The official wages inthe private sector are expected to increase, however this does not necessarily mean that workers will be actually receiving more than when paid fully or partially informally. Even though take-home labor incomes may decrease as formal sector employment increases -since labor market legislation will apply to a larger segment o f the market- the quality o f the official/contractual jobs will increase compared to informality in terms o f stability o f employment, predictability o f earnings andjob security (e.g. eligibility to pensionbenefits and compensations incase o funemployment, sickness and maternity leave). 114. The policy measures targeting activation o f long-term unemployed on social assistance and labor market inclusion o f people with disabilities and other social groups with barriers to access to jobs are expected to have a distinct positive impact on incomes. As a 30These are obviously ceteris paribus simulations, and the Bank team i s not advocating additional decrease in the education budget as percentage o f GDP. The resources freed through the financing reform should be reinvested in the system. Ths can take the form o f activities to improve quality and reduce drop out rates, as discussed inprevious sections, or simply be fed back to increase the per capita funding rates. 57 result o f the difference between the amount o f the monthly social assistance transfer for an able-bodied individual and the lowest income from work (the minimum wage), the monthly income o f those joining the labor market will increase over 2.5 times. Additional gains will follow from the acquisition o f a work record, pension rights and entitlements to short-term benefits (sickness, maternity and unemployment). It i s important that the proposed time limit o f guaranteed minimum income payment to able-bodied, long-term unemployed on social assistance i s paired with activation and job placement measures, including subsidized employment. Although the implementation o f this measure will take place in an environment of growing demand for formal labor, there might be social assistance beneficiaries with low literacy and skills who could not be able to find jobs on their own. The DPL program will support comprehensive impact evaluation which will allow identifying the potential `losers' from this policy measure among the current 125,000 working age beneficiaries of social assistance, to measure how it will affect the welfare status o f the poverty household and to support the government inelaboration o f successful mitigation measures. 115. The actions supported inthe health sector are expected to increase access to basic care, as the reimbursement policies for basic drugs that are now preventing some groups from obtainingthem at affordable prices will be thoroughly revised. Inaddition the restructuring of hospital networks envisioned for the medium term should redraft the current mapping o f health care facilities and promote access by (i) shiftingthe focus from inpatient to outpatient care, and (ii) using the resources saved from the hospital restructuring to improve quality in lagging areas. 116. Ineducation, the actions supported by the DPL are expected to have a positive social impact through: improved student achievement at the secondary level, through a strengthened quality monitoring and supervision that is both evidence-based and gives a voice to parents, combined with greater school autonomy; increased student participation rates, through stronger incentives for schools to take students on; increased student completion rates, through stronger incentives for schools to retain and graduate students; improved equity in access through a differentiated funding regime that recognizes marginalized students andincentivates their enrollment and school retention improved teaching quality, through the availability o f solid and nuanced data on student achievement and the tailoring o f in-service teacher training to improve learning processes inschool. 117. The adoption o f the per-student financing formula i s expected to rationalize resource use in the school system, phase out suboptimal schools in terms o f student-teacher ratios, decrease the share o f spending on salaries and increase expenditures related directly to higher quality o f the learning outcomes (e.g. qualification o f the teaching force, improved curricula, textbooks and teaching methods). The MES has gathered quantitative and qualitative data on school closures prior to the introduction o f the new financing formula, in four municipalities. Both the quantitative data and the stakeholders' stories differ so widely across the cases studied that a common theme cannot be extracted. The only lesson emerging from the pilot appears to be that existing issues andtrends ina school catchment area are the main drivers o f participation and attainment, without school closures making a difference. Further work i s ongoing on tracking individual student names from closed schools across receiving schools in 58 the four municipalities. Internationally, the evidence on school consolidation i s sparse. The introduction o f per capita financing and governance reforms in various countries has not nearly led to the amount o f closures already observed and expected for Bulgaria and i s therefore not an ideal benchmark. A study in four rural communities in Nova Scotia found that the benefits o f consolidation, including the material improvement at the consolidated school, and the access to a bigger circle o f friends for both students and parents, outweighed the cost o f additional travel. Initial fears and opposition o f local citizens were not ~onfirmed.~~ A study o f consolidation in Ohio confirms these findings and cites greater choice o f courses for students as the main benefit32. Both studies do not observe an increase in drop-outs or long-term staff unemployment. 118. However, there i s a risk that school closures could lead indifferent students to drop out, and that this may particularly affect marginalized groups and rural areas. The Government acknowledges this and i s developing a comprehensive package to enhance student participation, for example through a busingscheme (enabling free choice o f school in a certain radius), free school meals and material improvement in consolidated schools. In addition, the effect o f the new funding regime will be closely monitored on a quarterly basis (see next section). Based on this, the fundingrates will be reviewed in order to counteract any adverse impacts. For example, students more expensive to teach (because o f bi-lingual requirements or special needs - this often affects the marginalized) may receive higher fundingrates. IMPLEMENTATION, MONITORING AND EVALUATION 119. The CEP under the Council o f Ministers, chaired by the Deputy Prime Minister and Minister o f Economy has undertaken the overall management and coordination of the government program, assuring representation o f all the Ministries involved inthe reform (Le. Health, Education, and Labor and Social Policy) and involvement o f M o F and Ministry of Economy in the discussion o f the reform program. It receives well-organized and effective support from the Directorate for European Integration and Relations with International Financial Institutions (IFIs) o f the Council o f Ministers. In order to monitor the implementation o f the program the Government will produce quarterly reports on the status of the actions included in the Policy Matrix, indicating progress achieved and highlighting any particular difficulties in their implementation. In addition, a number o f milestones for the program, identified during preparation o f the D P L Iare included in the Gantt Charts for health, education, and social protection respectively, and can be used as an additional monitoring instrument. 120. With regards to evaluation, there are many actions in the policy matrix that require careful evaluation. The institutional and implementation context o f the proposed reforms in education governance and financing does not allow for a rigorous impact evaluation. This i s because there i s no comparison group, as i s usually the case with reforms implemented at the macro level. However, it i s possible to monitor the development o f the desired outcomes before, during and after the reform. This requires the collection o f a baseline o f the indicators inthe policymatrix, anagreement ontheir target level andthe mechanisms for data collection 31Joyce McDonald: "The Process and Impact o f School Closures in Four Rural Nova Scotian Communities", Rural Communities Impacting Policy, 2003 32Tucker Self: "Post-consolidation Evaluation, the Effects Eight Years Later", Paper presented at the Annual Meeting o fthe Mid-Western EducationalResearch Association, Chicago 2002 59 together with the MES units responsible for their collection. Preliminary work for the monitoring o f the Guarantee Fund to support school consolidation is already taking place. A steering group with the MES, MOF, the NMA and experts has been set up to monitor the disbursement o f the Guarantee Fundand the development o f activities financed. The Bank has encouraged this development and pointed out that in addition, it would be desirable to combine the routine financial reporting o f municipalities to the central Ministries with the feeding back o f results indicators such as ' number o f students transported to consolidated schools'. 121. The Bank team agreed with MoLSP, OS1 and a representative of N S I to conduct jointly with OS1 an independent multi-topic household survey. The survey will be representative for consumption, incomes and non-monetary aspects o f poverty at national and regional (28) level and will include boosters to allow assessing the income, educational, health and labor market status o f the Roma and Turkish ethnic minority groups and comparing them with the country averages. The multi-topic household survey i s part of the programmatic work on poverty and living standards currently being conducted by the Bank, and will identify baseline indicators for the monitoring and evaluation o f the impact of the Bank assistance to Bulgaria in the first years o f accession. This includes the impact of the Decade o f Roma Inclusion initiative, the Social Inclusion Project currently under preparation, and the DPL program. Inaddition, with the household and additional data to be collected, the team will measure social deprivation and the impact on beneficiaries o f specific programs, like the strengthening o f the conditionality o f monthly child support to school attendance, the social investments in children at risk and the limitation o f the GMI delivery to able-bodied long-term unemployed to 18 months. The survey will also collect data on spending and access to health care, including pharmaceuticals, which will allow to evaluate the effect of the reform on access to basic health services. 122. Finally, the DPL program incorporates as a trigger the implementation o f an impact evaluation o fthe reform o f social welfare programs. 123. The participation of stakeholders in the program design has been assured through the support of the Government's strategies. The health and education actions in the policy matrix are based on the strategies prepared by the MOH and MES respectively. The preparation o f the strategies was done in a highly participatory manner. In addition the DPL program was discussed with the main stakeholders: the line Ministries, Ministry o f Finance and Ministry o f Economy; members o f Parliament and Parliamentary commissions for health and education; associations o f employers, teacher unions, general trade unions, and Bulgarian Medical Association and Bulgarian Nurses Association; health consumer groups and NGOs. Inboth education and health, field visits were organized during preparation and main components o f the program benefited from discussions in the field. Finally, the education reform was also discussed with the National Association o f Municipalities which has endorsed it publicly. FIDUCIARY ASPECTS Public Financia1Management 124. A Country Procurement Assessment (CPAR) was submitted to the Government in July 2004 which concluded that the environment for conducting public procurement in the country as high risk. This CPAR has informed PAL-3 and D P L preparation, specifically, the 60 regulatory framework for public procurement has been improved under PAL-3, and the government has made good progress in the initial implementation o f the CPAR action plan. Bulgaria has adopted a new public procurement law (effective as o f July 1, 2006) with the objective o f being fully aligned with the EU acquis. Development o f implementation regulations, model tender documents and training o f procurement national cadre are required to facilitate implementation o f the new law into practice. Procurement capacity issues exist particularly for the Ministry o f Education and Science. An IDF Grant was extended to the MES to build institutional capacity and improve performance inprogram developing, project management, outcome measurement and partnership development and thus to increase the capacity o f MES to absorb EU structural funds and other project financing. This IDF i s now effective. 125. The Bank has extended knowledge o f the country's Public Financial Management (PFM) and fiduciary risk i s considered low. A Country Financial Management Assessment (CFAA) was prepared in 2003. The CFAA highlighted strong features of or significant achievements inPublic Financial Management (PFM), including: (i) a well developed system, (ii)soundlegislationandfunctioningexternaloversightinstitutions(namelytheNational a Audit Office and the Parliament); (iii) enhanced budget process and comprehensiveness --the latter through a significant reduction o f the number o f extra-budgetary funds--, (iv) the beginning o f a pilot programmatic approach in three ministries, (v) the development of a Treasury Single Account (TSA) to service all budgetary institutions; (vi) improved realism of budget estimates, (vii) the restructuring o f the capital expenditure function, (viii) strengthened cash management, (ix) an adequate internal control fkamework In 2003, fiscal transparency was considered high.While the overall financial management risk to Bank funds was deemed low, the CFAA made important recommendations -notably in the areas o f controls - that the Government implemented, including under PAL-2 and PAL-3, and with continued technical assistance from the donor community. 126. Under PAL-2, the government developed a comprehensive program for strengthening public expenditure management. This included actions designed to increase allocative efficiency and transparency inbudget formulation; to strengthen the budget execution system and processes. The Government also strengthened the effectiveness o f internal and external accountability arrangements. Capital expenditure management processes and systems were aligned with European Union standards. The government moved forward with the implementation o f the new Financial Management Information System (GFMIS) with the long-term aim to expand the GFMIS to all spending entities in government. There i s an update inthe accounting law, which became effective inJanuary 2005. 127. Under PAL-3, the government (i) improved its internal an audit practices - the Public Internal Financial Control Act was amended in December 2005 to strengthen public internal financial control and establish proper internal audit mechanism in the country; (ii) improved its external audit practices; (iii)improved public expenditure management processes, including introduction o f a medium term fiscal framework, (iv) expanded program budgeting in nearly half the ministries, (v) introduced accountability for results, and (vi) further improved management o f capital expenditures. 128. The D P L series i s in many cases a continuation o f the PAL-3, As mentioned before the D P L complements and completes some o f the changes undertaken under the P A L series, 61 as illustrated in the action table (paragraph 73) showing some examples o f complementarity between the P A L and DPL. Disbursement,Accounts,Auditing, and ClosingDate 129. The proposed SIR D P L Iamount o f US$l50 million equivalent has been converted into Euro during Negotiations. The borrower is the GOB, represented by the MOF. The proposed D P L l i s the first o f the three planned development policy loans totaling up to US$450 million equivalent as provided for inthe CPS, which was presented to the Board on June 13th, 2006. Disbursement of funds will be triggered by satisfactory progress in the reforms set forth in the loan. The loan will be disbursed in one tranche immediately upon effectiveness. The proposed loan will follow the Bank's disbursement procedures for development policy lending. Disbursements will not be linked to specific purchases, thus evidence will not be needed to support disbursements, nor will procurement requirements be necessary. Upon approval o f the loan and notification by International Bank for Reconstruction and Development (IBRD) o f loan effectiveness, the government will submit a withdrawal application to the IBRD. At the request o f the MOF, the IBRD will deposit the proceeds o f the loan into a foreign exchange deposit account (deposit account) designated by the government that form part o f the general reserves o f the country and acceptable to the Bank, such account to be held at the BulgarianNational Bank (BNB). Prior to that, the Bank will withdraw from the Loan Account a front end fee amounting to 1 percent o f the loan amount, subject to any waiver. This account is available for budget financing and will be managed by and subject to the control o f the MOF. The government shall ensure that upon deposit o f the net proceeds of the loan into said account, an equivalent amount will be credited inthe Borrower's budget management system, ina manner acceptable to the IBRD. 130. Ifafter the loanproceeds are deposited inthe BNBaccount, the proceeds areused for ineligible purposes as defined inthe loan agreement, IBRDwill require the borrower to either: (a) return that amount to the Deposit Account in BNB for use for eligible purposes or (b) refund the amount directly to IBRD. 131. The administration and accounting o f the loan proceeds will be responsibility o f the Ministry o f Finance. The standard country rules will be followed by treasury for administration and accounting. The government will maintain accounts and records, or ensure that such items are maintained, showing that loan disbursements were in accordance with provisions o f the Loan Agreement. Such accounts and records will be maintained in a form acceptable to the Bank. The proceeds o f Loan deposited at the treasury account with BNB will be used to cover budget expenditures. The MOF will be responsible for the Operation's administration and for preparing the withdrawal application, maintaining the deposit account as required. The MOF, with the assistance o f the BNB, will maintain records o f all transactions under the Operation in accordance with sound accounting practices. The government will report to the IBRDon the amounts deposited inthe foreign currency account and credited to the budget management system within 30 days o freceiving such fund. 132. The IMF conducted a safeguards assessment o f the BNB in 2002 and found that safeguards are generally adequate. Recommendations bythe IMFwere promptly addressed by the BNB. Past audits and the positive assessment by the IMF provide significant assurance that the loan will not be inappropriately used. The Bank had chosen to exercise its prerogative to audit the deposit accounts under PAL1 and PAL2, and the audits were unqualified and acceptable to the Bank.Accordingly, the Bank decided not to require an audit 62 o f the loan proceeds under PAL-3. Considering the Bank's knowledge o f the public finance management systems, the ongoing improvements o f these systems and considering the positive assessment o f the BNB made by IMF, the Bank will not require an audit o f the loan proceeds under this DPLl, which i s consistent with PAL-3 operation. ENVIRONMENTAL ASPECTS 133. No significant environmental impacts are associated with D P L I. The reforms supported by the program are related to the adoption o f policies and only a few could have a future environmental impact. Specifically, reforms in the education sector are expected to result in consolidation o f schools, and this will in turn require changes in some schools infrastructure (e.g. school rehabilitation). Similarly, the reforms in the health sector are expected to lead to changes inthe hospital sector, including consolidation, conversion o f some facilities, and therefore require investments in hospital infrastructure. These actions which may have environmental impact are expected to occur only during the second or third phase o f the DPL program. The rehabilitation o f education and health infrastructure would require compliance with the national environmental and construction codes which are now in line with EUstandards. R I S K S AND R I S K MITIGATION Risks MitigatingFactors Political 1. Since the coalition parties are 1. Coalition Government may not be represented in each Ministry by a different able to reach consensus on some important deputy minister, the Bank team i s involving reforms, which canbe politically costly all parties in the preparation process by individual andjoint discussions. 2. Ensure close support by key Ministers such as MES/DPM, Min. o f Economy and MOF 2. Opposition to the new education 1. With Bank technical support, MES funding formula and changes in health devising mitigation mechanismto help losing financing and provision by some stakeholders municipalities consolidate their school (teachers union, municipalities that will see a network to reap efficiency savings. loss in resources for education or closing o f 2. Bank team provides support to MES hospitals, Bulgarian Medical Association) incommunicatingthe new fundingformula to stakeholders 3. Bank team reaching out to major stakeholders such as parliamentary commissions for education and health, the teacher trade unions, Association o f Municipalities 4. Phased approach to build consensus through hospital masterplanning exercise, and emphasize communication o f the reform to the general public 3. Mitigation program -Guarantee MES, MOF and Bank team identify 63 Fund- for school consolidation is not monitoring indicators to ensure resources are utilized according to original Government allocated according to agreed criteria and strategy through agreed mechanism. Specific criteria for the use o f the "Guarantee Fund" are agreed by the tri-partite working group (MES, MOS and NAM) and approved by the Council o f Ministers. Technical 1. The Health Sector Reform Project i s Implementation capacity insome line being used to build capacity in the Ministry ministries i s limited o f health for different reforms and i s providing funds to hire the necessary technical assistance. 2. In education the Bank team is providing technical assistance directly participating in discussions with the joint working group in charge of the design o f the new financing formula for schools as well as on mitigation mechanism to support school consolidation 3. The newly approved Education IDF Grant will support the MES in raising capacity in strategic areas supported by the DPL program. Institutiona1 1. The Bank i s building a relationship Government's attitude to DPL supported with the EU team supervising Bulgaria's measures may change after EU accession, early membership and studying options for and leverage capacity o f Bank to guide policy assisting in absorption o f EU funds. In changes will become more limited addition the flexibility o f the D P L series would be able to account for some o f the changes in Government priorities after accession. Macro 1. Labor policies supported by D P L are Bulgaria's economic vulnerability due to the intended to increase flexibility in the labor country's significant current account deficit, market and facilitate adjustments of the inflation pressure, and the fiscal demands o f economy in response to negative aggregate EUaccessionwhich may grow inthe future shocks 2. Monitoring by IMF will continue and Bank will increase surveillance when IMF moves to a surveillance rather than an active program function 64 ANNEX 1:LETTEROFDEVELOPMENT POLICY BULGARIA: FIRST DEVELOPMENT POLICY LOAN (DPL-1) LETTER OF DEVELOPMENT POLICY February 5, 2007 Mr.Paul Wolfowitz President International Bank for Reconstruction and Development Washington D.C. Dear Mr. Wolfowitz: 1. W e appreciate this opportunity to request continuing support from the World Bank for the implementation o f our medium term reform agenda and, on behalf o f the Government o f Bulgaria, we request a First Development Policy Loan (DPL-1) for U S $150 million equivalent to initiate the series o f three development policy loans as per the new Country Partnership Strategy (CPS) between the World Bank and the Republic o f Bulgaria approved by the World Bank Board on June 13Ih', 2006. W e believe that this new series o f development policy loans provides the appropriate vehicle for Bank support in addressing our medium term policy and institutional reform agenda, and in supporting the country in its full integration into the European Union after the accession on January 1, 2007. 2. Following completion o f the Programmatic Adjustment Loans (PALS) program and during the preparation o f the recently approved CPS we requested assistance from the Bank to continue supporting reforms in the social sectors and it was agreed that the D P L series would focus on these sectors exclusively. Conceptually, two o f the four overarching goals supported by the CPS are being acknowledged in the D P L series: Raising productivity and employment in support of private sector-led growth along the lines of the EU's Lisbon Agenda: The three programmatic DPLs (FY07-09) will support the productivity and employment agenda by focusing on: (i) reformofthelaborframework andsocialprotectionsystemto increase the employment by lowering payroll taxes, reducing social assistance dependency, reforming disability benefits, and increasing formal employment through more flexible work arrangements and better incentives to participate in the formal economy and (ii)the reforms in the education sector to strengthen the institutional capacity to monitor and improve quality and increase accountability to lay the foundation for long-term productivity growth. 65 1 Fiscal sustainability and improved capacity for absorption of EU funds: The D P L series will focus on improving the efficiency o f the health, education, pension and social assistance systems to support their financial sustainability and effectiveness. In health, the focus will be on improving financial sustainability o f the National Health Insurance Fund (NHIF), restructuring of the hospital sector, and improved efficiency in the pharmaceutical sector. In education, the DPLs will support finance and governance reforms that would help improve both the quality o f education, and how efficiently the resources available for education are being used. The reforms in these sectors will also open windows o f opportunity to utilize EU funds as new programs are being created or old programs reformed. 3. W e expect that at the end o f the D P L series (i) employment rate will have the increased to at least 60 percent; (ii) the hospital sector will be streamlined and more resources will be allocated to outpatient care, therefore reaching a larger percentage o f the underserved population; (iii)a basic package o f drugs will become more affordable and therefore available to a wider segment o f the population; and (iv) quality o f education will have improved, and completion rates will have increased. 4. W e have maintained macroeconomic stability as a precondition for the effectiveness and sustainability o f the above program. W e will maintain the Currency Board Arrangement (CBA) until the adoption o f the Euro. The C B A has served Bulgaria well, providing a stable monetary environment, contributing to l o w inflation, and boosting confidence. W e are fully committed to take all o f the necessary steps to support it. W e will continue to implement a cautious and flexible fiscal policy, which i s a key to safeguarding external viability under the CBA. W e have aimed to reach, and then maintain, a broadly balanced fiscal stance in the medium term, remaining prepared to adjust our fiscal policy in case o f further widening o f the external current account deficit. 5. The IMF has completed the third review o f the Stand-By Arrangement (SBA) in August 2006. A precautionary 25-months SBA with access o f SDR100 million was approved by the IMF Board on August 6, 2004, and the first review was completed on M a y 18, 2005, and the second in April 2006. The SBA-supported program seeks to reduce Bulgaria's increased external vulnerability and to achieve sustainable high growth through: (i) continued tight fiscal policy and measures to reduce bank liquidity in order to reduce excess demand inthe short run; and (ii) structural reforms to boost output and export capacity in the medium-term. At completion o f the third review and in light o f Bulgaria's continued high external vulnerability, the IMF and GOBdecided to extend the SBA by 6 months beyond September 2006 to continue monitoring program implementation by end-2006, and complete the reporting to the IMF Board by end-March 2007. Once Bulgariajoins the EU, its participation in the EU's Stability and Growth Pact (SGP), with related multilateral surveillance, would help to sustain Bulgaria's prudent macroeconomic policies. 6. In the course o f preparing the First Development Policy Loan, we have developed and implemented various components o f our reform program that will be 2 66 continued in the series o f D P L 2 and 3. The final design o f DPL-1 has benefited fiom a strong monitoring and evaluation system, implemented in coordination with the Bank and built during the preceding series o f PALs. This has enabled us to take actions necessary to ensure the sustained implementation o f policies and the successful outcomes o f institution-building efforts. The programmatic approach o f the PALs will be transferred to the DPLs as it provides us with the flexibility to make sound adjustments in our program and to build on new information and additional experience in institutional design and implementation in moving towards the successful achievement o f our strategic objectives and program outcomes. 7. This Letter o f Development Policy summarizes the elements o f our program supported by DPL-1 and with expected follow up in DPLs -2 and -3, while the reform program outcomes and the critical steps taken to achieve those outcomes are summarized in the accompanying Matrix o f Performance Benchmarks and Desired Outcomes. 8. The first phase o f the program i s dominated by the introduction o f changes in the social protection sector to create additional incentives for employment generation, and the definition o f a new funding mechanism for schools. These measures are accompanied by actions to stabilize public spending on health, mitigate the impact o f the changes in education financing on access, and improving the institutional capacity in the education and health sectors. The second phase will focus on supporting full implementation o f the new education financing formula, introduction o f governance changes in the sector, implementation o f some o f the actions included in the medium term vision for social protection, and additional actions to maintain financial balance in the health sector. The third phase supports the consolidation o f the financing and governance reforms in the education sector and implementation o f structural reforms in the supply o f health care services; this phase is also expected to show some early results from the previous two phases o f program implementation. 9. The DPL overarching objectives related also to the Country's strategic priorities and the approved CPS are: Overarching Objective 1: Increase employment and lay the foundations for long- term productivity growth by providing incentives for job creation and improving quality of education 10. Through actions under this objective the D P L series will solve several problems. 11. First, low employment, relatively high unemployment rates, high percentage of long term unemployed, and high rates of informality in the labor market are an issue. Our government, through the Ministry o f Labor and Social Policy in particular, is embarking on a program to promote employment, which includes interventions to alter incentives both on labor supply and labor demand sides. Under the D P L 1 we have enacted amendments to the labor code to increase the flexibility o f working time and fix-term and part-time contracts. W e also have enacted amendments in the social insurance code to lower the pension insurance contribution rate by 6 percentage points from 29 to 23 percent. Finally, we enacted amendments to the Employment Promotion 3 67 Act to introduce a monthly bonus for unemployed recipients o f social assistance who find employment at their own initiative. 12. Second, we will tackle theproblem of the Social Welfare Program design creating disincentivesfor job searching. To create additional incentives for job searching and lower reliance o f able-bodied individuals on social welfare programs the government will change eligibility criteria o f some social assistance programs. The D P L series will support the impact evaluation o f these changes and further reforms based on the results o f the evaluation. Baseline data and evaluation design will begin early in 2007. As part o f DPL-1 we have developed and piloted programs and services for labor market integration o f people with disabilities. 13. By the end o f the DPL Program, the expected outcomes are: i.Anincreaseintheemploymentrateto atleast60Percent(age 15-64, NSI LFS data); ii.A reductionofnumberoflow-qualitysubsidizedjobsby25 percentfrom the 2005 baseline; iii.Reductionofatleast10percentinthenumberofhouseholdsreceivingsome social benefit from 76% percent inthe end o f 2003 (MTHS data); and iv. An increase incontributions to social security larger than the growth rate o f wages. 14. Third, we will address the problem that quality of education has been declining and the institutional capacity for quality assessment is lacking. The D P L Iwill support our strategy to strengthen the Ministry o f Education and Science's (MES') institutional capacity to assess the impact o f curricular and other reforms on the quality of education. This has the potential to radically switch priorities in policy making for the education sector, bringing the quality o f student learning to the top o f the policy agenda. The Centre for Control and Assessment o f the Quality o f Education (CKOKO) will institutionalize and sustain the goals o f an efficient, transparent, and outcome- oriented education system. The DPL series will be supporting four different testing activities in Bulgaria: a) a new placement test at the end o f 7th grade which has the potential to radically overhaul current patterns o f student access to upper secondary school; b) designing and piloting a new Matura, i.e., secondary school-leaving examination; c) new tests (sample or census-based) to be used strictly as system-wide evaluation o f education quality; and d) managing Bulgaria's participation in international achievement tests. As part o f DPL-1 we have approved a three-year plan for CKOKO, and our Council o f Ministers approved action plan for the implementation o f the National Strategy for the Introduction o f Information Technologies in Bulgarian Schools and begins implementation. 15. By the end o f the DPL Program, the expected outcomes are: i. CKOKOpreparesannualreportsontheassessmentofeducationqualityand makes them available to schools, parents, other stakeholders inthe education sector and public opinion in general; ii.Placementofstudentsinuppersecondaryinstitutionsisdoneonthebasisof objective ability testing; 4 68 ... 111.Reports on student performance are sent to municipal education authorities, with detailed specific analysis and concrete recommendations;All Regional Inspectors have been re-trained; and iv. 35 percent of subjects inthe primary and secondary educationcurriculum have e- technology and multimedia content available to teachers and students. Overarching objective 2 : Promote fiscal sustainability through efficiency gains in social sectors and improve access to basic social services 16. Under this overarching objective we will address two main problems. 17 First, the inefficiency in health serviceprovision and less than universal access to care, as well as threats to the financial sustainability in the National Health Insurance system. The government i s adopting stabilization measures to control public spending on health and introducing changes in the pharmaceutical sector that should increase efficiency in the commercialization of new drugs, increase access to basic drugs to underserved groups of the population, and help restore financial balance o f the NHIF. As part o f the DPL-1 we adopted a number of measures inorder to improve the financial stability of NHIF: (i) increased the health insurance premium revenue; (ii)unified payment mechanisms for hospitals, (iii) included limits in the volume o f services in contracts between NHIF and hospitals in the draft NHIF budget law; (iv) signed recovery plans with hospitals where MOH i s majority shareholder; and (v) the Parliament has approved legislation, at least through the first reading o f the Health Commission, which would improve pharmaceutical approval, pricing, and reimbursement policies to increase the efficiency o f public spending on pharmaceuticals and access to essential drugs. 18. By the end of the DPL Series (2009), the expected outcomes are: i. financial projectionsofspending andrevenues show thehealthsystemis .. financially sustainable; 11. the proportion o f spending on outpatient care relative to inpatient care has increased by 5 percent; iii.consolidationactivities for hospitalsmoveefficiencyindicators closerto those o f EU (e.g. average length o f stay, number o f beds, and inpatient admissions decreases); iv. The percentage of the Bulgarian population reporting access to essential pharmaceuticals increases (baseline and outcome to be measured by household surveys in 2007 and 2009) and the NHIF data shows a higher aggregate number o f prescriptions (per insuree) and a higher average reimbursement rate for an agreed list o f essential drugs; and v. NHIF data showing that pharmaceutical spending is within budget and growing at a rate not higher than twice GDP growth. 19. The second problem is that current governance and financing system for schools is not conducive to increased accountability and does not provide incentivesfor efficient use of resources. W e are undertaking a governance and financing reform o f the municipal school network, involving the introduction o f a per capita funding formula and progressive devolution o f responsibilities to local and school levels. Under DPL-1 have already approved new unified standard for allocating funds to municipalities for 5 69 their school networks and the plan for a phased introduction o f the new financing formula. We also approved a package o f measures and incentives to support school consolidation and the introduction o f the unified standard. 20. By the end o f the DPL Series (2009), the expected outcomes are: i.an increase in the average pupil teacher ratio for lower secondary schools from the 2006 level to the prevailing ratio according to the best European practice; ii.all municipalities, meeting the standards defined by an inter-Ministerial Working Group, will have access to the Government program o f measures and incentives to support school consolidation and the introduction o f the unified standard; iii.in.anincreasedsatisfactionofmunicipaleducationdepartmentheadsandof school directors with the new school financing formula and with the Government Program o f measures and incentives to support school consolidation and the introduction o f the unified standard (beneficiary assessment; measured against baseline survey); and iv. an increased parent/student satisfaction with consolidated schools (beneficiary assessment; measured against baseline survey). 21. W e would like to reiterate that the Bulgarian Government is committed to continuing reforms and, in particular, to sustaining and continuing the reform agenda needed for the integration into the EU as defined above. A new government program will further define the specific actions inthe months ahead. We look forward to the World Bank's support to Bulgaria in its development program including through development policy loans focusing on the current and future reform agenda. Plamen Oresharski Ministerof Economy andEnergy Ministerof Finance Sofia, Bulgaria February 5, 2007 6 70 ANNEX 3: BULGARIA:FUNDRELATIONS As o fDecember 31,2006 I. MembershipStatus:Joined09/25/1990;AcceptedArticleVI1109/24/1998 11. GeneralResourcesAccount: SDR million Percent Quota Quota 640.20 100.00 Fundholdings o f currency 833.70 130.23 Reserve position inFund 33.14 5.18 111. SDR Department: SDR million Percent Allocation Holdings 0.71 N/A Fundholdings o f currency 833.70 130.23 Reserve position inFund 33.14 5.18 IV. OutstandingPurchasesandLoans: SDRmillion Percent Quota Stand-by Arrangements 0 0 Extended Arrangements 226.63 35.40 V. FinancialArrangements: Approval Expiration Amount approved Amount drawn TYlX - date {SDR million) {SDRmillion) Stand-by 08/06/2004 03/31/2007 100.00 0.00 Stand-by 02/27/2002 03/15/2004 240.00 240.00 EFF 09/25/1998 09/24/2001 627.62 627.62 VI. ProjectedPaymentsto Fund:(SDR million; basedon existinguse o fresources and present holdings of SDRS):~~ Forthcoming ~~~~~ Principal 78.45 78.45 52.30 17.43 ChargedInterest 11.21 6.93 2.94 0.59 Total 89.66 85.38 55.24 18.02 VII. SafeguardsAssessment: Under the Fund's safeguards assessment policy, the Bulgarian National Bank (BNB) was subject to an assessment with respect to the SBA which was approved on February 27, 2002. The assessment, completed on June 12, 2002, identified certain weaknesses and made 33Onexpectationbasis. 73 appropriate recommendations, as reported in IMF Country Report No. 02/174. An updated assessment, which was conducted with respect to the current SBA and completed on November 23, 2004, found that the BNB's financial statements had been improved and earlier audit qualifications eliminated, the scope o f the internal audit function had been widened and a risk-based audit methodology had been introduced. N o major vulnerabilities in the safeguards framework were identified. The mission's recommendations to further solidify Bulgaria's safeguards are being implemented. VIII. ExchangeArrangement: An amendment to the Law on the Bulgarian National Bank (BNB) effectively established a currency board arrangement from July 1, 1997. The deutsche mark was chosen at par as the peg currency, which has since been replacedwith the euro at the rate o f lev 1.95583 per 1. According to Article 30 o fthe Law on the BNB, the BulgarianNational Bank shall be bound to sell and purchase on demand euro against levs up to any amount within the territory of this country on the basis o f spot exchange rates which shall not depart from the official exchange rate by more than 0.5 percent, inclusive o f any fees, commissions and other charges to the customer. Bulgaria has accepted the obligations o f Article VIII, Sections 2, 3, and 4 o f the Articles o f Agreement, and maintains an exchange system that is fiee of restrictions on the makingo fpayments and transfers for current international transactions. IX. Article IV Consultation: The last Article IV consultation was concluded on August 2,2006 (see IMF Country Report No. 06/298). The Acting Chairman's summing-up o f the discussion was circulated as SUR/06/84. Bulgaria i s on a 12-month cycle. X. FSAPParticipationandROSCs: Bulgaria participated in an FSAP held from October 29 to November 14, 2001. A follow-up to the FSAP update was conducted as part o f the 2004 Article IV consultation mission. Table 17 provides information on the productiono f ROSCs. 74 Table 17. Bulgaria: ROSCs Standard/code assessed Date o f Document issuance number ROSC - Fiscal transparency module 08/05/2005 IMF Country Report No. 05/300 ROSC -Detailed assessments usingthe data quality assessment 12/12/2003 IMF Country framework Report No. 03/393 08/07/2002 IMF Country ROSC update -Data dissemination and fiscal transparency. Report No. 02/172 ROSC - Monetary and financial policy transparency, banking 07/15/2002 IMF Country supervision, securities regulation, insurance regulation, and payment Report systems No. 02/188 ROSC update -Data dissemination, fiscal transparency, transparency 03/08/2001 www.imf.org of monetary and financial policies, bankingsupervision, deposit insurance, insurance supervision, securities market supervision ROSC -Data dissemination, fiscal transparency, transparency o f 03/17/2000 www.imf.org monetary policy, bankingsupervision, system o f deposit insurance, insurance supervision, securities market supervision Experimental ROSC - Data transparency, fiscal transparency, 08/27/1999 www.imf.org transparency o f monetary policy, bankingsupervision, system o f deposit insurance, insurance supervision, securities market supervision, insurance supervision, accounting and auditing practices XI* Technical Assistance: Table 8 provides information on IMF technical assistance activities since 999. 75 Table 18. Bulgaria: Technical Assistance, 1999-2006 Dept. SubjectiIdentifiedNeed Action Timing Counterpart MAE Accounting Expert Jun. & Aug.iSep.99 BNB MAE TransparencyRepodBasedCore Principles Mission Jul. 99 BNB MAE Depositinsurance Mission Oct. 99 BNB MAE Accounting Expert Feb.00 BNB MAE Paymentsystedliquidity managementi Mission May00 BNB badcuptcylegislation MAE Bankruptcylegislation Expert Jun. 00 BNB MAE Foreignexchange Mission Nov. 00 BNB MAE Accounting Expert Nov.-Dec.00 BNB MAE Short-termadvisorpaymentsystem Expert Jun.01 BNB MAE Accounting and InternalAudit Expert Apr. 02 BNB MAE ForeignExchange Expert Apr. 02 BNB MAE Review ofTA needsresultingfrom FSAP Mission May02 BNB MAE Accounting Expert Aug. 02 BNB MAE Accounting Expert Oct. 02 BNB MAE Accounting Expert Mar.-Apr.03 BNB MFD Accounting Expert Oct. 03 BNB MFD Accounting Expert Oct. 04 BNB MFD Policies andtools to managerapidcreditgrowth Mission Dec. 04 BNB MFD FinancialAccountingandInformationSystems Mission Apr. 05 BNB MFD Accounting and internalaudit Expert Oct. 05 BNB MFD FinancialManagementSystemsImplementation Expert Jan.-Feb. 06 BNB MFD Insurancesupervision Expert May.06 FSC MFD Inflationforecast Expert Jun. 06 BNB MFDiLEG Secuitiessettlementsystedlegislation Mission 0ct.-Nov.06 BNB FAD BudgetGeneral Expert Jun.99 MOF FAD Tax administration Expert Jul. 99 MOF FAD PublicExpenditureManagement Mission Sep. 99 MOF FAD BudgetGeneral Expert Oct. 994ct. 00 MOF FAD Tax Administration Mission Jan. OO-Feb.00 MOF FAD Tax AdministrationAdvisor Expert Apr.-Jun. 00 MOF FAD Tax Administration Expert Apr.-May 00 MOF FAD Tax Administration Expert May-Jun. 00 MOF FAD Tax Administration Expert Jun.00 MOF FAD Tax Administration Expert Sep. 00-01 MOF FAD ExpertInstallationmissiodTaxAdministration Expert Oct.00 MOF FAD Tax Administration-Follow-upMission Mission Jan. 01 MOF FAD Public ExpenditureManagement Mission Jan.-Feb. 01 MOF FAD Missionfor Workshop Mission Jun. 01 MOF FAD TaxAdministrationFollow-upMission Expert Sep. 01 MOF FAD Customsadministration Mission Oct. 01 MOF FAD Taxpolicy Mission Jan. 02 MOF FAD BudgetGeneral Expert Apr. 02-Mar. 03 MOF FAD TA ExpertInstallationMission Expert Apr. 02 MOF FAD Tax AdministrationFollow-UupMission Mission Apr. 02 MOF FAD Tax Administration Expert Sep.4ct. 02 MOF FAD BudgetGeneral:Inspection Expert Jan. 03 MOF FAD Tax Administration-InstallationVisit Expert Mar.03 MOF FAD Tax Administration Expert Mar.-Apr. 03 MOF FAD Public ExpendimreManagement Expert Apr-Sep. 03 MOF FAD Tax Administration Mission Apr. 04-May. 04 MOF FAD AccrualAccountingand BudgetExecutionReforms Mission Sep. 05 MOF FAD ProgramBudgeting Expert1I Sep. 05 MOF LEG Tax legislation Mission May. 06 MOF STA BOPstatistics Mission Jun.-Jul.99 BNB STA GDDS Mission Jul. 99 BNB STA Nationalaccounts Mission Nov.99 NSI STA Price statistics Mission Jun. 00 NSI STA BOPstatistics Mission Dec.00 BNB STA Producerprices Mission Nov.01 NSI STA Producerprices Mission Apr. 02 NSI STA Price statistics Mission May02 NSI STA Producerprices Mission Jan 03 NSI STA DataROSC Mission Jan.03 BNBIMOFINSI STA SDDS Mission Sep. 03 BNB STA Producerprices Mission Sep. 04 NSI 76 ANNEX 4: COUNTRY AT A GLANCE BULGARIA: FIRST SOCIAL SECTORS INSTITUTIONAL REFORM DEVELOPMENT POLICY LOAN(SIRDPL I) Europe & Lower- POVERTYand SOCIAL Central middle- Bulgaria Asia income 3evelopmentdiamond' 2005 Population,mid-year (millions) 7.7 473 2,475 GNI percapita (Atias method, US$) 3,450 4,113 1,918 Life expectancy GNI (Atlas method, US$ billions) 26.7 1,945 4,747 T Average annual growth, 199905 Population(%) -1.0 0.0 1.o Laborforce (%) -1.5 0.6 1.4 GNI Gross per 1 1 primar) Most recent estimate (latest year available, 1999-05) capita enrollmen Poverty(% ofpopulationbelownationalpovertyline) 13 Urbanpopulation(% of totalpopulation) 71 64 49 Life expectancyat birth (years) 72 69 70 1 Infantmortality(per 1,000 live births) 12 28 33 Child malnutrition(% ofchildren under5) 5 12 Access to improvedwater source Access to an improvedwater source (% ofpopulation) 99 92 82 Literacy (% ofpopulationage 15+) 98 97 89 Gross primaryenrollment (% ofschool-agepopulation) 105 104 114 -Bulgaria Male 106 105 115 Lower-middle-incomegroup ~ Female 104 102 113 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1985 1995 2004 2005 Iconomic ratios' GDP (US$billions) 17.6 13.1 24.3 26.6 Grosscapitalformation/GDP 32.2 15.7 23.5 28.0 Exportsof goods and serviceslGDP 42.8 44.8 58.0 60.8 Trade Gross domesticsavinpslGDP 31.8 14.2 13.2 11.4 Gross nationalsavingslGDP 31.7 11.9 16.0 16.9 CurrentaccountbalancelGDP -0.8 -1.5 -5.8 -11.8 Interest paymentslGDP 3.8 1.7 Total debtlGDP 79.2 64.4 Total debt servicelexpork 16.6 15.1 Presentvalue of debtlGDP 66.3 1 Presentvalue of debtlexports 99.1 Indebtedness 1985-95 1995-05 2004 2005 2005-09 (average annualgrowth) - GDP -2.0 2.9 5.7 5.5 5.8 Bulgaria GDP per capita -1.2 3.8 6.5 5.8 6.6 Lower-middle-incomearoup ~ Exportsof goods and services -22.7 6.9 13.0 7.2 12.2 STRUCTUREof the ECONOMY 1985 1995 2004 2005 (% of GDP) Growth of capitaland GDP (%) Agriculture 11.9 10.8 9.3 I Industry 62.8 32.7 29.9 30.4 Manufacturing 18.6 18.9 Services 25.3 59.3 60.3 Householdfinal consumptionexpenditure 51.6 70.6 69.9 72.0 00 01 02 03 04 Generalgov'tfinal consumptionexpenditure 16.6 15.3 16.9 16.6 -GCF -GDP O5 I imports of goods and services ~ 43.2 46.3 68.2 77.4 1985-95 1995-05 2004 2005 (averageannualgrowth) 1 Growth of exportsand imports(%) I Agriculture -4.2 2.6 3.0 -8.6 Industry -4.0 2.5 5.8 7.3 Manufacturing .. 6.4 10.0 10.0 Services -2.6 1.9 5.7 6.6 Householdfinal consumptionexpenditure -3.5 3.6 5.4 7.6 Generalgov't final consumptionexpenditure -5.0 3.7 3.9 3.8 Gross capitalformation -10.7 17.0 14.7 23.3 imports of goods and services -26.1 11.8 14.1 14.6 Note: 2005 data are preliminaryestimates. Thistable was producedfrom the DevelopmentEconomicsLDB database. * The diamondsshow four key indicatorsinthe country (in bold)comparedwith its income-groupaverage. Ifdata are missing,the diamondwill be incomplete. 77 Bulgaria PRICES and GOVERNMENT FINANCE 1985 1995 2004 2005 Domestic prices Inflation (%) (% change) I l5 T Consumer prices 62.1 6.3 5.0 ImplicitGDP deflator 0.2 62.8 4.8 3.9 Government finance (% of GDP, includescurrentgranfsj Currentrevenue 55.2 38.9 38.5 37.2 Currentbudget balance -3.3 5.4 5.7 Overallsurplusldeflcit -5.2 1.2 1.2 -GDP deflator b C P I TRADE 1985 1995 2004 2005 (US$ miiiionsj Export and import levels (US$mill.) Total exports (fob) 10,688 4,967 9,541 10,212 I 115,000T Consumergoods 2,125 1,360 2,992 3,465 Investmentgoods 1,791 690 8,030 9,354 Manufactures 800 5,027 5,216 Total imports(cifl 11,199 5,319 12,911 13,636 Food 545 123 Fueland energy 2,217 1,816 "I Capitalgoods 4,532 1,001 3,985 4,175 Export pnce index (2000-100) 135 117 140 175 QQ 00 01 02 03 04 importpnce index (2000=100) 53 116 130 163 rn Exports rn Imports Termsof trade (2000=100j 257 101 108 107 BALANCEof PAYMENTS 1985 1995 2004 2005 (US$ millions) Currentaccount balanceto GDP (%) Exports of goods and services 11,760 6,738 13,852 15,996 importsof goods and services 11,872 6,636 16,657 20,585 Resource balance -112 102 -2,805 -4,589 Net income -101 -432 291 312 Net currenttransfers 74 132 1,098 1,144 Currentaccountbalance -139 -198 -1,416 -3,133 Financingitems(net) 562 676 2,029 3,655 Changes in net reserves -423 -479 -613 -522 1-151 Memo: Reservesincludinggoid (US$ millions) 1,545 9,238 8,535 Conversionrate (DEC, iocai/US$) 1.86E-3 6.72E-2 1.6 1.6 EXTERNAL DEBT and RESOURCE FLOWS 1985 1995 2004 2005 (US$ millions) :omposition of 2004 debt (US$ mill.) Total debtoutstanding and disbursed 10,379 15,661 IBRD 444 1,498 1,453 IDA 0 0 0 A:1,498 Total debtservice 1,140 2,456 L C:1,183 IBRD 31 121 126 IDA 0 0 0 Compositionof netresourceflows Officialgrants 22 393 Officialcreditors 38 127 Pnvatecreditors -98 1,070 Foreigndirectinvestment(net inflows) 90 2,005 Portfolioequity (net inflows) 0 0 F 7,955 World Bank program Commitments 193 150 E Bilateral - Disbursements 15 204 200 Principalrepayments 0 80 85 Net flows 15 124 115 Interestpayments 31 41 40 Net transfers -16 83 74 Note: This tablewas producedfrom the DevelopmentEconomicsLDBdatabase. 8/12/06 78 MAP SECTION 22°E 23°E 24°E 25°E 26°E 27°E 28°E This map was produced by the Map Design Unit of The To 0 20 40 60 80 Kilometers World Bank. 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