ICRR 13757 Report Number : ICRR13757 IEG ICR Review Independent Evaluation Group 1. Project Data : Date Posted : 10/13/2011 Country : Hungary Is this Review for a Programmatic Series? Yes No Series ID : First Project ID : P114991 Appraisal Actual Project Name : Hungary - Financial US$M ): Project Costs (US$M): 1,400 0 Sector And Macro Stability Loan (dpl) L/C Number : L7800 Loan /Credit (US$M): Loan/ US$M ): 1,400 0 Sector Board : Financial and Private US$M ): Cofinancing (US$M): Sector Development Cofinanciers : Board Approval Date : 09/22/2009 Closing Date : 12/31/2010 12/31/2010 Sector (s): Banking (60%); Central government administration (20%); Compulsory pension and unemployment insurance (10%); Health (5%); Non-compulsory pensions insurance and contractual savings (5%) Theme (s): State enterprise/bank restructuring and privatization (28% - P); Debt management and fiscal sustainability (28% - P); Other social protection and risk management (17% - S); Regulation and competition policy (17% - P); Health system performance (10%) Evaluator : Panel Reviewer : ICR Review Group : Coordinator : Michael R. Lav Rene I. Vandendries Ismail Arslan IEGPS2 2. Project Objectives and Components: a. Objectives: The objective of the proposed operation was to support the Government's fiscal reform and financial stability programs. This is taken from the Program Document, Section V, paragraph 115. b. If this is a single DPL operation (not part of a series), were the project objectives/ key associated outcome targets revised during implementation? No c. Policy Areas: The main policy areas addressed by this operation were : (1) Fiscal Reforms (2) Financial Sector Stability Program (3) Pension Reforms (4) Health Sector Reforms Although Hungary had graduated from IBRD borrower status in 2007, this loan (equivalent to Euros 1 billion) was requested as part of Euros 19.8 billion package which also included Euros 12.3 billion from the IMF and Euros 6.5 billion form the European Union. d. Comments on Project Cost, Financing, Borrower Contribution, and Dates: The program cost US$1.4 billion financed by IBRD loan in that amount . The program was appraised in July, 2009 and approved by the Board on September 22, 2009. After Board approval, the loan agreement was never signed and the loan never became effective, and the Government requested that the "loan commitment be released" in December, 2010. 3. Relevance of Objectives & Design: a. Relevance of Objectives: The objectives were highly relevant . Hungary was severely affected by the 2008/9 financial crisis, despite good progress during the first part of the decade in addressing fiscal imbalances . When the crisis reduced risk tolerance, Hungary lost access to foreign exchange financing in the second half of 2008 and was forced to request a Euro 5 billion repurchase-based facility from the European Central Bank for short term foreign exchange funds. The objective of the loan was to provide financing to Hungary as part of an IMF /EU/IBRD package, with the policy objective of providing support to the Government's fiscal reform and financial stability programs. These objectives were entirely appropriate . b. Relevance of Design: The design was highly relevant . The two tranche approach would have provided Hungary measured financial support in the initial stage of reform implementation, and the second tranche would have provided an opportunity for continued technical assistance as Hungary implemented the later stages of the program, while providing additional financial support. 4. Achievement of Objectives (Efficacy): The objectives were not achieved as the project was never made effective . The reason for this is explained under Bank Performance below. While all this was going on, the Government reform was proceeding and the government met all the prior conditions for the first tranche and all but one condition of the second tranche regarding pension reform . Important components of this reform program included : First Tranche : Fiscal Reforms Reduction in the general deficit to 3.3 percent of GDP in 2008, with a deficit target of 3.9 percent of GDP in 2009, adoption of a fiscal responsibility law, adoption of revenue neutral tax reforms to reduce the tax wedge on labor and bolster potential growth establish a Fiscal Council as mandated by the Fiscal Responsibility Law to scrutinize the budget and report to Parliament. Financial Sector Stability Program Establishment of Banking Sector Safety Net Measures via Additional liquidity measures Increased deposit protection Government guarantees on new bank borrowing Capital strengthening facility Hungarian Financial Supervisory Authority adopted an intensified inspection program for the largest commercial banks to evaluate financial conditions on a consolidated basis The central bank of Hungary initiated stress tests of banking portfolios for banks representing 75 percent of banking sector assets Increase in insurance premiums for banks . Pension Reforms Government submitted to Parliament and Parliament approved amendments to the Pension Law introducing new parametric reforms to improve sustainability of the public pensions system (gradual increase in retirement age, new indexation rule, penalties for early retirement . Health Sector Reforms Government approved new regulations to promote the containment of pharmaceutical and medical appliances expenditures. Second Tranche : Fiscal Reforms Fiscal Reforms -- Reduction in the general deficit to 3.9 percent in 2009 and a deficit target of 3.8 percent of GDP in 2010. Government has implemented budgetary provisions covering mandatory health service, child care benefits and family allowances, housing subsidies, household natural gas consumption, and district heating to ensure improvement in the financial stability of the social support system . Government approved a budget appropriation consistent with the mandate of the Fiscal Council . Financial Sector Stability Program The Banking Support Program is maintained and the tri -partite Stability Committee is established . Government submitted to Parliament an amendment to expand the powers of the supervisory authorities to take pro-active actions and to quickly react to systemic financial risks . Complete for the largest commercial banks representing at least 75 percent of the assets of the banking sector an intensified inspection program, and implement supervisory actions to address deficiencies where applicable. The Cabinet has issued an amendment to the Government decree on accounting standards for banking institutions, specifying standards for classification, valuation and treatment for accounting purposes, of rescheduled, renegotiated, and restructured credits and related provisioning requirements. Pension Reforms The Government continues to maintain pension reform policies thereby ensuring fiscal stability . The Ministry of Finance has submitted to the Government Cabinet draft amendments to the Pension Law providing proposed regulations for the payout phase of the second pillar, including the design of annuities products, indexation rules, and the menu of pension payout options for retirees from the privately funded system --- This was the only condition which was not met . Health Sector Reforms The Ministry of Health has issued guidelines concerning the corporatization of hospitals, The Ministry of Health has issued a decree strengthening the role of general practitioners in the provision of health care. 5. Efficiency (not applicable to DPLs): 6. Outcome: Outcome is not rated since the project never became effective . a. Outcome Rating : Not Rated 7. Rationale for Risk to Development Outcome Rating: a. Risk to Development Outcome Rating : Non-evaluable 8. Assessment of Bank Performance: a. Quality at entry: Board approval lagged by 11 months approval by the IMF of its Stand -by which also released EU funds . This delay stemmed from a dispute over pricing of the loan . It was initially understood by Bank Regional Staff and the Government of Hungary that Hungary would receive the IBRD on standard IBRD terms, even though Hungary had graduated. However, with the intervention of Senior Management, the Operations Committee package of February, 2009, proposed a loan maturity of 5 to 7 years, with a front end fee of 1 percent and a 2 percent spread over LIBOR. Although negotiations over terms continued, the Government only succeeded in achieving an average maturity of 8.5 years with no change in front end fee or cost . These terms contrasted with standard IBRD terms which would have been 18 years average maturity, spread over Libor of 1 percent, and a 0.25 percent front end fee. The Government determined that the revised terms would have made the loan more expensive than the IMF funding, and declined to pursue the loan and ceased work on the program with the Bank for more than 6 months. Eventually the Government agreed that the loan be presented to the Board, but by that time Hungary had already regained access to other sources of foreign exchange. The Government never signed the loan (to avoid paying the front end fee ), and the Government sent a request that the loan commitment be released, which it did in December, 2010. Because of all of these issues, quality at entry is rated moderately unsatisfactory . at -Entry Rating : Quality -at- Moderately Unsatisfactory b. Quality of supervision: Quality of Supervision Rating : Not Applicable Overall Bank Performance Rating : Moderately Unsatisfactory 9. Assessment of Borrower Performance: a. Government Performance: Government reacted reasonably to the change in price signals it received from the Bank . It implemented most of the program, except for a "soft" second tranche pension condition (calling for presentation of a reform to the Cabinet) which it did not pursue as it nationalized the pension system rather than strengthening it as a private sector responsibility . Government Performance Rating : Moderately Satisfactory b. Implementing Agency Performance: Same as government. Implementing Agency Performance Rating : Moderately Satisfactory Overall Borrower Performance Rating : Moderately Satisfactory 10. M&E Design, Implementation, & Utilization: a. M&E Design: M&E design as presented in the PD was satisfactory . Macro indicators had been identified as well as external monitoring indicators such as spreads on credit default swaps for sovereign bonds and the emerging market bond index reported spreads . Bank sector health would be evaluated on the basis of capital levels and financial conditions of credit institutions . Fiscal indicators would have been measured against program expenditure and debt levels in conjunction with the IMF . Reporting arrangements on pensions had been firmed up with the Ministry of Finance regarding streamlining the public pillar, while the private pillar would have been monitored more on a qualitative basis, namely, the proposed pay -out/annuities design of the system . In the health sector, assessments of institutional change would have been based on measurable indicators such as cost, efficiency, quality, and savings achieved via the new consolidated procurement procedures . b. M&E Implementation: Non-evaluable c. M&E Utilization: Non-evaluable M&E Quality Rating : Non-evaluable 11. Other Issues a. Safeguards: No safeguards issues were raised . b. Fiduciary Compliance: There were no issues of fiduciary compliance c. Unintended Impacts (positive or negative): Not applicable d. Other: 12. Ratings : 12. ICR IEG Review Reason for Disagreement /Comments Outcome : Not Rated Not Rated The NCO rating of "not applicable" is not an allowable choice for this review . "Not Rated" is the closest allowable choice to "Not Applicable". Risk to Development Non-evaluable Non-evaluable The NCO rating of "not applicable" is Outcome : not an allowable choice for this review . "Non-evaluable" is the closest allowable choice to "Not Applicable". Bank Performance : Moderately Moderately Unsatisfactory Unsatisfactory Borrower Performance : Moderately Moderately Satisfactory Satisfactory Quality of ICR : Satisfactory NOTES: NOTES - When insufficient information is provided by the Bank for IEG to arrive at a clear rating, IEG will downgrade the relevant ratings as warranted beginning July 1, 2006. - The "Reason for Disagreement/Comments" column could cross-reference other sections of the ICR Review, as appropriate. 13. Lessons: The Bank needs to have clearly documented policies regarding access to and costs of borrowing, especially for higher income borrowers where access and graduation from IBRD borrower status may be an issue . 14. Assessment Recommended? Yes No 15. Comments on Quality of ICR: The NCO is clearly and frankly written and describes very clearly the shift in Bank loan pricing policies which undermined this operation. a.Quality of ICR Rating : Satisfactory