Page 1 30904 UPDATED PROJECT INFORMATION DOCUMENT C ountry Name: Serbia and Montenegro (SaM) Project Name: Montenegro —Second Structural Adjustment Credit (SAC 2) Region: Europe and Central Asia Sector: Economic Management Project ID: PE-P074908 Borrower: Government of Serbia and Montenegro Implementing Agency: Ministry of Finance of the Republic of Montenegro Environment Category: C Date This PID Prepared: November 2004 Projected Appraisal Date: March 2004 Projected Board Date: September 2004 Country Background 1. Under the present federal structure of SaM, the two constituent republics—the Republic of Serbia and the Republic of Montenegro—are macroeconomically autonomous and are responsible for nearly all aspects of economic policy. The proposed operation will focus on Montenegro, the smaller of the two republics. 2. The 1990s was a lost decade for SaM. Although the country started the period relatively well integrated with the world economy and with higher standards of living than most other transition economies, the SaM economy was devastated as a result of armed conflicts, international sanctions, and trade shocks stemming from the break-up of the SFRY during the 1990s. 3. By the time of the Federal elections and Serbian parliamentary elections in the last quarter of 2000, which brought to office reform-oriented governments with a mandate to bring greater democracy, modernization and integration with the international economy, Montenegro had already made significant progress in stabilizing the economy and implementing a reform program. In November 1999 the Montenegrin Government declared the German mark (DM) an official parallel currency. One year later the new Central Bank of Montenegro (CBM) declared the DM the sole legal tender in the republic. During 1999 and 2000, the Government of Montenegro financed its budget deficit with substantial foreign grants. 4. The Montenegrin Government has made significant progress in structural reforms since 1998. Montenegro had gradually obtained de facto autonomy in foreign trade, adopted its own customs administration and established a liberal trade regime. By mid-2000, the Government of Montenegro reduced the average tariff to about 3 percent. The Montenegrin Government has also liberalized prices; undertaken a mass privatization program; restructured and privatized nearly all commercial banks; and enhanced the transparency and management of public expenditure. 5. Montenegro’s stabilization efforts succeeded in laying the foundation for economic recovery by curtailing inflation which fell to 25 percent in 2000 from 128 percent in 1999 (and well below the 115 percent recorded in Serbia in 2000). By 2002, inflation in Montenegro had fallen to single digits. Real GDP rebounded from the steep 9 percent decline in 1999 (which reflected the impact of the Kosovo conflict), growing by 4 percent in 2000. 6. Nevertheless, subsequent economic performance has been disappointing. While most macroeconomic statistics in Montenegro are either not available or are unreliable, available estimates indicate that GDP growth has been modest in the past 3 years, unemployment has remained high, and job creation has been negligible. In addition, external and fiscal imbalances have remained unsustainably large. 7. While transition reforms have progressed, they are incomplete, were not always planned in an integrated fashion and were introduced with inadequate attention to implementation capacity. The size and scope of Government intervention in the economy remains large and the capacity of public sector institutions to Page 2 implement reforms remains weak. The reform effort of recent years has improved governance, public s ector transparency and financial discipline, but more needs to be done in each of these areas. One of the key challenges the Government now faces is building strong institutions with the capacity and incentives to carry out the recently adopted formal elements of reform. 8. The authorities realize the significance of the satisfactory progress in these policy areas for placing the country on a sustainable growth path and are determined to collaborate with international financial institutions towards successful implementation of their reform agenda. To this end, the Government in cooperation with the IMF and the World Bank has formulated a medium-term stabilization and reform program for 2002-05, which has been supported by a three-year Extended Arrangement approved in May 2002. Attaining sustainable growth and improved living standards, low inflation, and a viable external position constitute the main objectives of the program. As was envisioned in the Transitional Support Strategy agreed with the Government, the proposed operation will focus on key medium-term structural and institutional reforms and complement the macroeconomic program supported by the IMF. Objectives 9. This operation aims to assist the Government of Montenegro to undertake key structural reforms to promote growth and to support further fiscal consolidation. Description 10. The program to be supported by the proposed operation intends to achieve these objectives through specific reforms in the areas of: (i) the financial sector; (ii) the energy sector; (iii) pension and health; and (iv) public administration. The SAC 2 program will build on reforms supported by the first Structural Adjustment Credit. The financial sector reforms would help to promote growth through increased (and increasingly efficient) financial intermediation. Pension, health and public administration reform would ultimately support ongoing fiscal consolidation. Energy sector reforms would support both growth and fiscal consolidation by overcoming episodes of supply shortfall and ensuring the financial self-sufficiency of energy utilities. Increased institutional transparency and accountability and increased focus on implementation capacity are themes thread through each of the five policy areas. SAC 2 will also provide crucial financing to help close Montenegro’s budgetary gap in a sustainable fashion. Financing 11. It is anticipated that the operation will be in the amount of around US$18 million equivalent disbursed in two equal tranches. Implementation 12. As a result of the highly devolved nature of SaM and the different starting points and pace of reforms in the two constituent republics, the proposed operation will focus on the Republic of Montenegro. The Ministry of Finance of Montenegro will serve as the main Government counterpart which will ensure the overall coordination among several other agencies involved in the program: the Ministry of Labor and Social Affairs, the Pension Fund, the Ministry of Economy, the Electric Power Company of Montenegro (EPCG), the Ministry of Health, and the Health Insurance Fund. Reforms to be supported under the Bank operation will be implemented through a variety of mechanisms, including inter-agency working groups. Bank experts will assist the relevant officials and working groups. Sustainability 13. Key to the sustainability of the proposed operation will be strong progress on the overall structural reform agenda and maintenance of macroeconomic stability. Both of these are supported under the proposed operation. Poverty Category 14. The operation will support immediate and longer-term poverty reduction through its support for macroeconomic stability which will reduce the risk of shocks which could adversely affect the living standards of the poor and through its support for economic growth. Page 3 Environmental Aspects 15. The Loan focuses primarily on promoting sustainable economic growth and no environmental issues a re foreseen. In accordance with the Bank’s operational Directive on Environmental Assessment (OD 8.60), no environmental category rating is required. Contact Point : Bruce Courtney Program Team Leader The World Bank 1818 H Street N.W. Washington, DC 20433 Telephone No.: (202) 458-5242 Fax No.: (202) 614-7776