Report No. PID5638 Project Name Russia-Proposed Social Protection... Adjustment Loan Region Europe and Central Asia Sector Social Assistance Project ID RUPE38573 Borrower Russian Federation Principal Responsible Entities Ministry of Finance, Ministry of Labor and Social Development # 9 Ilimka Street 103097 Moscow Environment Category C Date This PID Prepared June 12, 1997 Project Appraised March 21, 1997 Board Approval Date June 25, 1997 Country and Sector Background 1. Russia's transition to a market economy has been both wrenching and chaotic. Implementation of reforms has fluctuated from boldly market-oriented (e.g., capital markets development) to being captured by vested interest groups (e.g., case-by-case privatization) to near stagnation (e.g. agriculture). Average annual inflation remained high for most of the period, reaching a peak above 1300w during 1992 and falling below 100w only in 1996; measured GDP has fallen by 40t in real terms since 1991 and still fell by 6t in 1996; and there has been a dramatic increase in poverty, and various surveys indicate that despite some recent improvements 25-35w of the population are living in poverty. Notwithstanding the short-term fluctuations in policymaking and the dramatic decline in output, it is clear that a major economic transformation has taken place in Russia over the last several years. Over 70t of GDP is now produced in the private sector; prices and trade have been essentially liberalized; the monthly rate of inflation has dropped to below 2t on average for the past 12 months; and a trade surplus of US$23 billion was recorded in 1996. Recently, Russia returned to the international capital markets with two Eurobond issues of US$ 1 billion and DM2 billion respectively. 2. There have been severe social costs of economic and institutional transition in Russia. Since 1992, real money incomes and output have fallen by over 40w, and a gradual widening in income distribution among population groups and between regions has occurred. High average monthly rates of inflation have adversely affected the population, especially those on fixed incomes. Real earnings have fallen, and in 1996 real wages averaged less than half their level in 1991. In 1996, only some 40t of the work force was paid fully and on time. Unemployment, including disguised unemployment and underemployment, is now estimated to be close to 15 percent. 3. Pensions, unemployment benefits, child allowances and social assistance programs and short-term sickness and maternity benefits absorbed some 8t of GDP in 1995. In addition, enterprises and local authorities (oblast level) provide an array of social benefits, ranging from subsidized housing and utilities to cheap food and vacations. While income from formal and informal sector activities is the primary form of support for the majority of the population, the formal social safety net also plays an important role for many households. On average, public transfers accounted for 16.7t of household income at the start of 1996. Private transfers have always been an important component of the safety net in Russia, and while there is little accurate information on them, they appear to continue to be so. Finally, the NGO sector is emerging as an important complement to the overall safety net. Social insurance and unemployment assistance are financed through extra-budgetary funds (EBFs), supported by payroll taxes currently totaling 34.8w of the wage bill. Child allowances are a universal benefit financed from local revenues and supplemented with federal transfers. Such transfers are in the form of unconditional block grants to oblasts for a range of federal government obligations, of which child allowances are a designated priority. Social assistance is funded entirely from local resources. The Country's Adjustment Program 4. Since the elections in 1996, and especially since the formation of the new government earlier this year, the Government has become very concerned about social protection issues. This reflects the high political and social costs of arrears in social payments, especially pensions, brought on by fiscal pressures, as well as a growing realization that existing income transfer programs, even if fully funded, do not reach important vulnerable groups. The Government's strategy is articulated in the Program of Social Reforms 1996-2000, approved by the Government in February 1997, and in President Yeltsin's address to the Federal Assembly in March 1997. At the same time, new appointments have been made at high levels of the Government of individuals with credible track records of social reform in the regions, a favorable popular image and proven capacity to muster support for difficult decisions. In addition, several other appointments have been made which greatly strengthen the cadre of reformers working on social sector issues. These changes have brought new momentum and energy to the reform program in the social sectors. 5. The Government's social protection strategy focuses on: (i) creating an efficient pension system, in line with modern western practice that would be financially viable and provide adequate social protection to the poorest groups; (ii) providing economically efficient employment opportunities, while improving labor force productivity and labor market flexibility; (iii) reallocating public (federal and sub-federal) financial resources devoted to social protection so as to increasingly target income - 2 - support to needy households; and (iv) Clearly delineating of responsibility for social issues at the federal, regional and local levels. The Proposed Loan 6. The SPAL would support the Government's Social Protection Reform Program in order to gradually develop an effective system of income support and poverty relief to meet the needs of a market economy. It would also support efforts to reduce the adverse effects of transition on the poor and vulnerable population groups. The key areas covered by the SPAL are social insurance (including pensions and short-term insurance for sickness and maternity), unemployment assistance, social assistance and child allowances. It will pursue poverty alleviation by raising and protecting minimum benefits, and through better targeting. It will help establish a viable social safety net by introducing structural reforms in pensions and welfare programs. In order to help safeguard the Government's macroeconomic stabilization targets, the SPAL will emphasize efficiency improvements in the safety net programs and the reallocation of resources within existing programs towards needy groups, without increasing public expenditures, as severe fiscal constraints prevent the Government from undertaking reallocations from other sectors in the short term. The proposed reforms will represent major changes in the system of social protection and income transfers, and are expected to have a significant impact on alleviating poverty and stabilizing incomes among vulnerable groups, and prepare for more targeted safety net interventions in the future. 7. The proposed SPAL of US$800 million will be released in three tranches, the first of US$300 million upon effectiveness (July 1997); the second of US$250 million on fulfillment of second tranche conditions (expected December, 1997) and the third of US$250 million on fulfillment of third tranche conditions (expected June, 1998). Disbursements of the Loan will be subject to a standard negative list of ineligible goods and countries of origin. Disbursements will not be linked to specific purchases and, hence, there will be no procurement requirements. 8. Monitoring of SPAL activities beyond supervising the implementation of SPAL conditionalities principally refers to the appropriate use of the federal transfers in the pilot schemes and the payment of child allowances, as well as to poverty monitoring and program participation, in connection with the social assistance pilot programs, household surveys of income and program participation. Progress on the SPAL tranche conditions will be supported and maintained through technical assistance and studies in the framework of the Portfolio Development Loan (PDL), the Employment Services and Social Protection Loan (ESSP), and the proposed Social Protection Implementation Loan (SPIL). 9. The initiatives introduced under the proposed SPAL and supported by it and by related technical assistance address the inefficiencies of the previous system of social protection and are expected to be determinant in reshaping them to meet the needs of a -3 - market economy and lay a solid foundation on which Russia can build a pension and welfare system that corresponds to its needs. The initiatives will achieve the following: (i) while the difficult fiscal and financial situation precludes large increases in benefit payments, higher pensions and regular pension payments will be secured for some 4 million of the poorest pensioners, and minimum unemployment benefits will be set at a level which will allow a somewhat better standard of living for the unemployed; (ii) the current US$27 billion/year (5.5w of GDP) pension system will be stabilized: arrears will be drawn down and eliminated, the revenue base of the PF strengthened, and the process towards better financial management of the PF, which is a longer term process, will have been set underway through better collection procedures and through a gradual audit of the PF; (iii) systemic pension reform will be well underway: voluntary pension legislation will have been enacted, and the process of enacting legislation for systemic reform will have reached the legislature; supported by a strong public campaign to explain the tradeoffs; (iv) the unemployment benefit system will have been restructured, making it a targeted system providing benefits for all eligible laid-off workers, and delivering active services in an appropriate labor market context (i.e. where programs lead to jobs or job opportunities); (v) the labor code will have been revised to provide a market-oriented framework for employer-employee relations; (vi) the US$2.8 billion/year (1- of GDP) child allowance program will be undergoing complete restructuring towards an affordable, poverty-targeted, means-tested program; (vii) the US$3.5 billion (1.25t of GDP) program of social insurance short- term benefits will have been restructured and reduced, focusing exclusively on sickness and maternity benefits; and (viii) streamlining of social assistance will be underway. Contact Point: Mr. Hjalte Sederlof, Task Manager The World Bank 1818 H Street N.W. Washington, D.C. 20433 Telephone No.: (202) 473-2524 Fax No.: (202) 477-0711 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by the Public Information Center week ending October 3, 1997. - 4 -