Document of The World Bank FOR OFFICIAL USEONLY ReportNo. 37358-MD INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAMDOCUMENT FOR A PROPOSEDPOVERTY REDUCTION SUPPORT CREDIT INTHEAMOUNT OF SDR 6.8 MILLION (US$lO MILLION EQUIVALENT) TO THE REPUBLIC OF MOLDOVA September 20,2006 Poverty Reduction and EconomicManagement Unit Europeand CentralAsia Region This document has a restricteddistributionand may be usedby recipientsonly inthe performanceof their official duties. Its contents may not otherwise be disclosed without WorldBank authorization CURRENCY EQUIVALENTS (ExchangeRateEffectiveAugust 31, 2006) CurrencyUnit=Leu US$1 = 13.3 Lei FISCALYEAR January 1to December 31 WEIGHTSAND MEASURES Metric System ACRONYMS AND ABBREVIATIONS AER Annual EvaluationReport MTEF Medium-TermExpenditureFramework BEEPS Business Environmentand EnterprisePerformanceSurvey NBM NationalBank of Moldova CAS Country Assistance Strategy NGO Non-GovernmentOrganization CEM Country EconomicMemorandum NPV Net Present Value CFAA Country Financial AccountabilityAssessment O&M Operationsand Maintenance CIS Commonwealtho fIndependent States PAD Project Appraisal Document COA Court of Accounts PAR PovertyAssessmentReport CPAR Country Procurement Assessment Report PEFA Public Expenditureand Financial Accountability Assessment CPIA CountryPerformance Indicator Assessment PEMR Public Economic Management Report CRS Control and Revision Service PER Public ExpenditureReview DFID UKDonor PFM Public FinancialManagement EBRD EuropeanBank for ReconstructionandDevelopment PFR Public FinancialReview EGPRSP EconomicGrowth andPovertyReductionStrategy Paper PIP Public InvestmentProgram EU EuropeanUnion PPF Project PreparationFacility FDI ForeignDirect Investment PPG Public andPublicly Guaranteed FIAS ForeignInvestmentAdvisory Services PRGF PovertyReduction Growth Facility FSAP Financial Sector Advisory Program PRSC PovertyReduction SupportCredit FSU Former Soviet Union PRSP PovertyReduction Strategy Paper GDP GrossDomestic Product PSIA Povertyand Social Impact Analysis HIF HealthInvestmentFund QAG QualityAssurance Group IAS InternationalAccounting Standards RISP Rural Investment and Services Project IBRD InternationalBank for ReconstructionandDevelopment SAC StructuralAdjustment Credit IDA InternationalDevelopmentAssociation SCAs Savings and Credit Association IFC InternationalFinanceCorporation SDR SpecialDrawingRights IF1 InternationalFinanceInstitutions SIDA SwedenDonor IMF InternationalMonetaryFund SME Small andMedium Enterprise I-PRSP InterimPovertyReduction Strategy Paper SOE State-ownedEnterprise JSAN Joint StaffAdvisoryNote TA Technical Assistance LDP Letter o f DevelopmentPolicy TTFSE Trade and TransportationFacility for Southeast Europe MDGs MillenniumDevelopmentGoals UNDP UnitedNations DevelopmentProgram MOE Ministryof Economy VAT Value-Added Tax MOF Ministryo f Finance WTO World Trade Organization MOU Memorandumo f Understanding Vice President: ShigeoKatsu Country Director: PaulBermingham Sector Director: CherylGray Sector Manger: AsadAlam Task TeamLeader: LawrenceBouton REPUBLIC OFMOLDOVA PROPOSEDPOVERTY REDUCTION SUPPORT CREDIT CREDIT SUMMARY Borrower: Republic o f Moldova Amount: SDR 6.8 million(US$10 million equivalent) Terms: Standard IDA Terms, with 40 years maturity, including a 10-year grace period Objectives: The proposed Poverty Reduction Support Credit (PRSC) for the Republic o f Moldova follows an intensification of the Government's reform efforts over the past several years and is intended to bolster and deepen those efforts. More specifically, the proposed credit aims to enhance the Government's ability to accelerate economic growth and improve the efficiency o f its social programs and public administration - key elements in poverty reduction. To this end, the proposed PRSC will support selective areas o f the Government's reform agenda, as outlined in the Poverty Reduction Strategy Paper (PRSP) and the European Union (EU)-Moldova action plan, thereby complementing and reinforcing other Bank Group programs in Moldova, the International Monetary Fund (IMF)-supported Poverty Reduction Growth Facility (PRGF) and other donor activities. Closely aligned with the Country Assistance Strategy (CAS), the PRSC will support the EGPRSP objectives of: Improvingthe Investment Climate. Moldova is entering a new phase in its economic development where consumption driven growth - based on the export o f labor and inflow o f remittances - can no longer be expected to sustain current growth rates over the medium-term. Sustaining and accelerating future growth and poverty reduction in Moldova will depend on increases in domestic productivity which, in tun, will depend on the extent to which firms and farms address current low levels o f investment and innovation. The Government's agenda focuses on further improving the investment climate for private sector development. These efforts will also directly contribute to Government efforts to improve governance and reduce corruption. Key to Moldova's efforts to accelerate economic growth and poverty reduction will be improving the performance o f the agriculture sector. Similarly, reducing destabilizing economic impacts o f external energy price shocks will require improvements inenergy efficiency. Improvingthe Efficiency and Management of Public Resources. Better governance and public institutions are central to growth and poverty reduction. The EGPRSP i s conscious o f the constraint imposed by the insufficient functional and institutional adaptation o f the public administration to the requirements set by the transition from a centrally planned economy to a market economy. The EGPRSP recognizes that establishing a modern and efficient public administration i s necessary in order to achieve the country's longer-term development outcomes. Increased public investment spending, particularly inpublic infrastructure, will be needed inorder to support Moldova's private- sector led growth. This will require enhancing the strategic allocation o f public resources by improving the (Medium-Term Expenditure Framework (MTEF) process, public procurement practices and includingbetter public investment management. Reforms in a number of key sectoral areas can also improve the efficiency of public resource use, yielding increased fiscal space for more public investment spending without crowding out the private sector. Strengthening Pension and Social Assistance Systems. While the recent slowdown in poverty reduction highlights the need to improve the quality o f growth in Moldova, it also points to the need to strengthen existing social safety nets. The Government's program to improve delivery o f utility, infrastructure and social services i s reflected in the EGPRSP. The PRSC would strengthen the effectiveness and future fiscal viability o f the pay-as-you-go pension program by supporting efforts to complete the 1999 pension reform, including efforts to unify the pension system for all types o f pensioners. Improving targeting efficiency o f social assistance programs and gaining efficiency in program administration will be a necessary element o f Moldova's poverty reduction efforts. Benefits: Benefits are: (i)improved business environment and investment climate, which directly contributes to changing the quality o f growth and poverty reduction in Moldova by stimulating a stronger domestic supply response, particularly in the key agriculture sector; (ii)a more professional civil service combined with increased transparency and accountability o f public finances with improved public expenditure management and strategic allocation o fresources - through better medium-term budget planning, as well as strengthened procurement functions - enabling an increase in current low levels o f public sector investment, particularly in rapidly deteriorating public infrastructure; (iii) strengthening existing social safety nets for vulnerable groups by completing the 1999 pension reform and improving the targeting efficiency o f social assistance programs. Risks: Primary risks to the proposed operation include: (i) public financial management and procurement systems have been strengthened but fiduciary risks remain non-negligible; (ii)lowimplementation capacityatthecentral anddecentralizedlevel. Dovetailingthe PRSC with other Bank Group operations and donor activities that provide detailed support to capacity building helps mitigate this risk; (iii)Destabilizing external shocks, such as the volatility o f energy prices and ban on Moldova exports o f wine by Russia, could seriously affect public finances and delay implementation o f poverty reduction measures in the PRSP. The PRSC's support to prudent fiscal policy and medium-term budget planning, combined with an IMFPRGF program, mitigate these risks. Schedule o f Disbursements: The proposed credit, SDR 6.8 million (USSlO million equivalent) will be disbursed in total upon effectiveness o f the credit. Poverty Category: This is a poverty focused operation. Rate o f Return: NIA Project IDNumber: MD-PE-PO99166 11 CONTENTS I INTRODUCTION . ....................................................................................................................... 1 I1 COUNTRYCONTEXT Recent Economic Developments.................................................................................. ................................................................................................................. 2 A. 2 B. Macroeconomic Outlook andDebt Sustainability........................................................ 5 C. Poverty Profile ............................................................................................................. 8 I11 THEGOVERNMENT'SECONOMICGROWTHANDPOVERTY REDUCTION PROGRAM ........11 IV BANKSUPPORTToTHEGOVERNMENT'SPROGRAM . ......................................................... 12 A. B. Collaboration with the IMF andOther Donors.............................................................. Moving to the CAS High Case ................................................................................... 12 C.Analytical Underpinnings andRelationship to Other Bank Operations......................... 16 17 v. THEPROPOSEDOPERATIONAND POLICYACTIONS ........................................................... 20 A. Overall Description..................................................................................................... 20 Pillar I: A.ReducingRegulatory and Administrative CostsofBusiness Regulations...............22 Improving the InvestmentClimate ......................................................................... B. Improving Trade Facilitation.................................................................................... 23 24 C. Developing Agricultural Markets ............................................................................. . 25 27 Pillar 11: Improving the Efficiency andManagement ofPublic Resources......................... D ReducingEnergyVulnerability ................................................................................ 29 A. Building a Meritocratic Civil Service ................................................................... 29 B. 29 Improving the Strategic Allocation ofPublic Resources...................................... Implementing a Transparent andUniformRemunerationSystem....................... D. C. 30 Public Procurement............................................................................................... 35 Pillar 111: StrengtheningPensionand Social Assistance Systems ....................................... 36 A. Completing PensionSystemReform........................................................................ 36 B. Enhancingthe Distribution EfficiencyofSocial AssistanceBenefit ....................... 37 VI OPERATIONIMPLEMENTATION . ........................................................................................... 38 A. Poverty and Social Impact Analysis ........................................................................... 38 B. Implementation. Monitoring and Evaluation.............................................................. 40 40 D. C. Fiduciary Aspects........................................................................................................ Disbursement andAuditing ........................................................................................ 44 E . Environmental Aspects ............................................................................................... 44 F. Risks............................................................................................................................ 46 Tables: Table 1. Moldova: Macroeconomic Framework. 2001-2008........................................................ 2 Table 2. Moldova: Fiscal FinancingGap 2004-08 ........................................................................ Table 3. Moldova: Balance of Paymentsand External Financing Gap, 2004-08.......................... 6 6 Table 4. An Overview of Poverty inMoldova ............................................................................... 9 Table 5. Implementation of CAS High Case Triggers.................................................................. 13 Table 6. Moldova 2005 CPIA Ratings.......................................................................................... 16 Table 7. Prior Actions for PRSCl..................................................................................... 21 and 22 111 ... Figures: Figure 1. Moldova: Indicators o f Public Debt Under Alternative Scenarios. 2005-2-25 ..............7 Figure 2. Prices MoldovanFarmers Receive for Outputs and Pay for InputsRelative to World Prices, % (nominal rates o f protection) ....................................................................... 10 Boxes: Box 1. The EU-Moldova Action Plan.......................................................................................... .15 Box 2. Analytical Underpinnings and Links to Other Operations.................................... 19 and 20 Annexes Annex 1. Letter of Development Policy Annex 2. PRSC Policy Matrix Annex 3. FundRelations Note Annex 4. Country at a Glance Map Moldova Map IBRD34867 iv REPUBLIC OF MOLDOVA POVERTY REDUCTION SUPPORT OPERATION PROGRAMCONCEPTDOCUMENT I. INTRODUCTION 1. This program document proposes a single-tranche First Poverty Reduction Support Credit (PRSC-1) to the Republic o f Moldova for SDR 6.8 million(US$10 millionequivalent) on standard International Development Association (IDA) terms o f 40 years maturity including 10 years grace. The proposed operation i s an integral part o f the Bank's strategy to support the implementation of Moldova's Economic Growth and Poverty Reduction Strategy (EGPRSP) and EU-Moldova Action Plan. The move to supporting poverty reduction through programmatic lending is consistent with Moldova's level o f institutional, economic and political development and acknowledges the country's strong and sustained performance inrecent years. PRSC-1 i s the first in a series o f three single tranche operations that would facilitate the implementation o f cross cutting reforms aimed at improvingthe living conditions o f the Moldovanpopulation. 2. The first EGPRSP Annual Evaluation Report, circulated to the BoardinApril 2006, raised the concern that overall poverty reduction in Moldova has stalled in recent years despite continued strong growth performance. Indeed, the Bank's recent Poverty Assessment update shows that poverty in rural areas has actually increased. The Government i s aware that to address these stagnant poverty trends the quality o f economic growth needs to be changed. To accelerate economic growth and poverty reduction, the three pillars o f the PRSC will support the Government's efforts to: i)improve the investment climate so as to stimulate a greater domestic supply response; ii)increase the efficiency and management o f the public sector resources to create fiscal space for increased public investment spending; and, iii)strengthen social protection systems to better protect the poor and vulnerable groups. 3. Bilateral and multilateral donor assistance will continue to play an important role in supporting the implementation o f the EGPRSP and EU-Action Plan, given that the country's own resources fall short o f the levels required for achieving the objectives spelled out in the strategy. The PRSC i s an important step to further the principles o f harmonization, providing a framework for policy dialogue and decisions linked to progress in the implementations o f the critical areas o f the EGPRSP. Insupport o f the EGPRSP, the PRSC has created the momentum for a significant group o f donors to align their budgetary support under a common framework. The PRSC will be supported by co-financing from other multilateral and bilateral donors, includingthe United Kingdom (DFID), Sweden (SIDA) and the Dutch Government with close coordination with the EUinthe context o f the new EuropeanNeighborhoodPolicy initiative. 1 11. COUNTRYCONTEXT A. RECENT ECONOMICDEVELOPMENTS 4. Gross Domestic Product (GDP) Growth, Inflation and Exchange Rate. Since 2000, Moldova's strong growth performance has reversed a decade o f economic decline and rising poverty. The economy has grown by nearly 40 percent since 2000 with average real growth o f around 7 percent per annum. In 2005, the economy grew at 7.1 percent but developments in the first part o f 2006 point to some weakening (see next section). The major source o f growth inMoldova has been domestic household consumption and construction fueled by massive inflows o f workers' remittances - officially recorded at nearly 30 percent o f GDP in 2005. While growing slowly as a share o f GDP, private domestic investment has averaged only 17 percent o f GDP since the beginning o f recovery. Similarly, public domestic investment has remained very low (less than 2 percent o f GDP) with the result that public infrastructure, particularly roads, has continued to deteriorate with negative implications for growth. Duringthe recent recovery, the increase indomestic output has relied more on increased capacity utilization rather than significant additions to capacity. While remittance inflows are likely to continue to support strong consumption growth in the short run, over the medium-term the EGPRSP notes that Moldova will need to generate a stronger and more robust domestic supply response. Indeed, as the opportunities reaped from labor shedding and increased capacity utilization are exhausted, future gains in productivity will require increasing domestic investment and innovation. Table 1. Moldova: Macroeconomic Framework, 2001-2008 Actual I EstimatedI Projected 2001 2002 2003 20041 20051 2006 2007 2008 Real GDP growth(%) 6.1 7.8 6.6 7.4 7.1 4.0 5.0 5.0 CPI Inflation (average,%) 9.8 5.3 11.7 12.5 11.9 10.4 8.2 7.5 Exchangerate (average, MDLI$) 12.9 13.6 13.9 12.3 12.6 Real effective exchange rate, % -1.2 -6.1 -5.4 12.8 -1.3 -1.4 -4.4 1.2 Revenues and grants, % of GDP 29.2 29 6 34.0 35.4 39.5 39.3 39.5 39.3 Expenditure andnet lending, % of GDP 29.4 31.5 33.3 34.6 37.9 39.7 40.0 39.8 Primarybalance(cash), % of GDP 3.8 0.7 2.3 2.7 3.0 0.9 0.7 0.4 Overall balance (cash),%ofGDP -0.4 -1.4 0.2 0.8 1.7 -0.5 -0.5 -0.5 Current account balance, %of GDP -2.5 4.6 -7.1 -2.0 -7.3 -8.5 -6.8 -6.2 ExportsG&S growth(percent) 14.7 19.1 20.9 27.4 13.3 6.9 15.7 11.0 ImportsG&S growth(percent) 12.0 18.9 33.5 22.8 29.1 17.8 12.1 10.0 Gross official reserves (months of imports) 2.1 1.9 1.7 2.1 2.2 2.1 2.4 2.6 Total External debt/GDP,% 105.1 100.8 88.7 63.8 54.7 53.2 53.1 49.6 o f which, public and publicly guaranteed(PPG) 77.0 61.1 52.5 35.3 28.2 24.8 23.1 21.6 ExternalArrears (millions $US) 17 5 42.9 86.1 50.6 56.3 0.0 0.0 0.0 PPG Debt service to exports ofGNFS, % 17.2 14.3 12.5 9.3 6.9 5.6 4.7 4.1 NPV of PPG Debt serviceto revenues, % 224.3 174.8 115.8 80.2 61.8 45.9 40.4 34.0 Sources: Moldovanauthorities(MTEF), IMFArticle I V Staff Report, April 2006andWorld Bank Staffestimates Fiscalaccounts in the table are for those of the general government. 5. Agriculture i s the largest real sector o f the economy, accounting for nearly 20 percent o f GDP (30 percent if agroprocessing i s included), generating the majority o f Moldova's exports (59 percent), and employing over 40 percent o f the labor force. Like other sectors o f the economy, agriculture suffered during the transition, with agricultural value added shrinking by more than 50 percent. Moldova carried out its farm restructuring later than most other transition economies, which prolonged the contraction o f the sector. But with the launch o f the National Land Program in 1997-1998, there was a marked acceleration in the creation o f new peasant 2 farms and a coincident increase in agricultural production by the individual sector. These reforms resulted in a gradual increase insector output beginning in 2000. However, beginning in 2001, farm restructuring stalled and the sector was frozen in a semi-reformed state with approximately half o f agricultural land used by 300,000 individual family farms, and the other half o f the land still managed by 300-400 new corporate forms that are the heirs to the former collectives. The sector i s also characterized by underdevelopedand imperfect markets and policy uncertainty, which cause low agricultural producer prices and lack o f access to inputs. Thus, the sector has not been able to fully benefit from the land reform and farm restructuring efforts that have taken place. As a result, the agriculture sector has continued to underperform the industrial and services sectors in both absolute and relative terms. To generate sustained growth in the sector, the Government recognizes the need to build upon its earlier reform efforts by creating the incentives for continued farm restructuring, market-oriented production by individual family farms, and increased efficiency inthe sector. 6. In recent years, monetary policy has strived to achieve a number o f objectives, including maintaining a competitive exchange rate, keeping inflation low and accumulating a precautionary level o f international reserves. The large inflow o f remittances has contributed to appreciation pressure on the real and nominal exchange rate underscoring the need for more rapid improvement indomestic productivity. The National Bank o f Moldova (NBM)has actively intervened in the foreign exchange market and has been rapidly accumulating foreign exchange reserves. To rein in the monetary impact o f these interventions - and the inflationary pressures - the NBM sharply increased its sterilization efforts in 2005 and significantly slowed reserve money growth. Thus, despite the pick-up in energy prices in mid-2005, inflation dropped to 10 percent (y-0-y) at the end o f 2005, after peaking at over 14 percent in April 2005. The macroeconomic framework supported by the IMF PRGF program envisages a gradual decline in inflation over the program's three year horizon. 7. Fiscal Policy. The Government has maintained a prudent fiscal stance, with the overall cash balance o f the general government averaging only 0.2 percent o f GDP since 2001, with a budget surplus o f 1.7 percent o f GDP recorded in 2005. Recovery-induced buoyancy in fiscal revenues has given Moldova the fiscal space to increase public expenditures. Since 2001, both expenditures and revenues have increased faster than GDP. There is a need to maintain fiscal discipline and for recognizing that the share o f tax revenues and expenditures to GDP in Moldova already greatly exceed international norms for countries o f similar income levels. To avoid crowding out private sector activity, the fiscal space needed to implement the EGPRSP, particularly increasing public investment in infrastructure, will require inter- and intra-sectoral reallocation o f public expenditures and an increase in the efficiency o f public spending rather than increasingthe relative size o f government. 8. The bulk o f Moldova's fiscal revenues come from the taxation o f consumption - primarily the value added tax (VAT). The VAT (with a rate o f 20 percent) now supplies nearly 50 percent o f total consolidated budget revenues with over 87 percent o f that coming from the VAT collected on imports. Corporate and personal income taxes, on the other hand, each only contribute about 10 percent o f fiscal revenues. To broaden the tax base and increase revenues coming from direct taxation, the Government has been reducing tax rates. Since 2001, the corporate tax rate has been reduced from 28 percent to 20 percent in 2004. Similarly, personal ' See MoldovaAgriculturalPolicv Note Vol. I-Land, ReportNo. 36366-MD, World Bank, June 1,2006. 3 income taxes have also been reduced, with the highest marginal rate declining from 32 percent to 25 percent. The positive performance o f corporate and personal income tax revenues duringthe recovery has encouraged the Government to undertake further cuts in these taxes rates. Both the corporate tax rate and the highest marginal personal income tax rate are scheduled to drop to 15 percent inthe next few years. 9. On the expenditure side, the Government has focused spending increases on those programs that were cut dramatically at the end o f the 1990s and earlier. Since 2000, spending on health, education and social protection, which comprise nearly two-thirds o f total government expenditures, has increased by nearly 6 percentage points o f GDP. Public expenditures on capital and operation and maintenance o f basic infrastructure, however, have remained very small and have declined as a share o f GDP since 2000, with negative implications for public infrastructure, particularly the road network. The EGPRSP recognizes the importance o f increasing public investment and improving public investment management. As noted below, planned increases in public sector wages will need to be tempered to make room for additional domestic capital expenditures. Foreign grant and concessional financing will play a significant role incovering the cost o f increased public investment. 10. External Sector. As a small open economy, closer integration into the world economy and a rapid growth in exports must serve as an engine o f growth. While strong economic performance in Moldova's main trading partners has encouraged a rapid increase in exports (averaging 19 percent over 2001-2005), the remittance-fueledincrease inconsumption as well as higher energy prices have pushed up import growth even faster (averaging 23 percent over the same period). As a result, the trade deficit has continued to worsen, exceeding 40 percent o f GDP in 2005. With large inflows o f workers' remittances (31 percent o f GDP in 2005), the current account deficit has been more modest (averaging slightly over 4 percent o f GDP since 2000). The overall balance o f payments has been in surplus allowing for increases in internationalreserves. 11. Nearly 60 percent o f Moldova's exports are in the form o f agricultural products (including from the ago-processing industry) and predominately from the wine and beverage sectors. Though the direction o f trade has been slowly redirected towards the EU, this transformation has been much slower than in other transition countries. As a result, the majority o f exports are still bound for CIS members and Russia inparticular. With pressures on the real exchange rate to appreciate, the increased international competitiveness needed to close the trade gap will require an increase in domestic productivity. This will require significantly more domestic private and public investment, as well as foreign direct investment, than i s currently undertaken. 12. Since Moldova imports nearly all o f its energy needs, recent increases in energy prices have had a severe impact on Moldova. Fuel oil import prices rose by an estimated 44 percent in 2005. For the 2004-2005 period, Moldova paid $8O/thousand cubic meters (mcm) for natural gas imports from Russia. Early in 2006, however, the price o f natural gas was increased to $1lO/mcm and further increases (possibly to $160/mcm) innatural gas prices can be expected inthe near future. The direct impact o f this increase has been to widen the underlyingtrade and fiscal deficits. It has directly raised the cost o f electricity, natural gas and oil products procured bythe Government at all levels (adding 0.5 percent o f GDP to government expenditures). 4 13. Since the Government has largely passed these higher energy prices on to final consumers, there have beenrisingpressures for additional subsidies and transfers. Currently, the biggest government transfer program related to energy i s the nominal compensation scheme introduced in 2000 to assist more vulnerable categories o f the population to pay for heating and electricity. In 2005, there were nearly 260 thousand recipients o f this energy subsidy with expenditures amounting to 385 million lei or 3 percent o f the general government expenditures. This compensation ranges from 25 to 50 percent o f the cost o f the service. While this energy subsidy program transformed the former system o f privileges into a relatively more targeted program, the current program i s still not very efficient intargeting the poor. The criteria used to define the vulnerable groups are not well defined - based on a categorical target system - and more than one third o f the budget i s misallocated to the non-poor. (The distributional impacts o f higher energy prices are detailedinthe poverty andsocial impact analysis o f SectionVI). B. MACROECONOMIC ANDDEBTSUSTAINABILITY OUTLOOK 14. The macroeconomic framework currently inplace i s satisfactory. InMay 2006, the Executive Board o f the International Monetary Fund (IMF) approved a new three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) for an amount equivalent to Special Drawing Rights (SDR) 80.08 million (about US$ll8.2 million). The IMF supported program is designed to support growth and poverty reduction by maintaining macroeconomic stability, particularly in the face o f strong inflows o f remittances and sharply higher prices for imported energy. It also strives to improve the performance o f the financial sector, building upon the lessons o f last year's Financial Sector Assessment Program (FSAP). Key structural measures supported by the PRGF include modernization o f the tax administration, improving corporate governance and transparency for state-owned enterprises (as well as reinvigorating the privatization process) and trade liberalization. The macroeconomic framework which underpins the authorities' program is aiming for further gradual disinflation in the coming years. Further, the fiscal program strikes the appropriate balance between the objectives o f supporting disinflation and meetingthe country's extensive developmental needs. 15. The export o f labor and resulting inflow o f workers' remittances have come to dominate the economic and social landscape o f Moldova. Some 25 percent o f Moldova's economically active population is now working abroad. Workers' remittances, equivalent to 31 percent o f GDP, have increased disposable income and fueled a rapid growth in final consumption expenditures - the primary driver o f the current economic recovery. In addition, migration and the inflow o f remittances have also contributed to an increase in the equilibrium wage as well as the reservation wage o f workers. While the relatively abundant inflow o f workers' remittances is likely to continue over the foreseeable future, it i s unreasonable to expect that these flows will continue to grow at the same rapid rate. Further, since the beginningo f the economic recovery, increases in unit labor costs in Moldova have outstripped growth in labor productivity. Without increases in investment and innovation, it will become increasingly difficult to sustain past growth in labor productivity since the opportunities provided by labor shedding and factor reallocation inthe economy are gradually being exhausted. 16. But a number of external shocks risk dampening economic growth inMoldova. In late March, Russia's consumer protection agency announced a ban on imports o f wine from Moldova. As wine represents 30 percent o f Moldovan exports, o f which about 80 percent (10 percent o f GDP) traditionally go to Russia, the impact o f this ban - even if resolved relatively 5 quickly - will have medium-term effects on the macroeconomic outlook. Given its complete dependence on imported energy, the recent large increases in energy prices will put further pressure on the economy. Fueloil import prices increased by over 40 percent in2005 and natural gas prices were increased by 38 percent in early 2006 with further increases in natural gas prices expected (to $160/mcm). 17. As shown inTable 1, these external shocks are expected to contribute to slower real GDP growth in2006 (4 percent) as well as a weaker medium-term outlook (with real Table 2. Moldova: Fiscal FinancingGap200448 GDP growth o f 5 percent expected in (In percent of GDP; unless otherwise indicated) 2007-2008). On the inflation front, the 2004 2005 2006 2007 2008 NBMis aiming to achieve inflation inthe Est. Projections single-digit range over the PRGF program Revenuesand grants 35.4 39.5 39.3 39.5 39 3 Ofwhich: period. In an environment o f strong Grants(Oh/US$'GDP) Of millions) 0.4 1.3 0.5 1.1 1.4 15.8 36.2 52.4 exchange inflows, this Expendituresand net lending (cash) 34.6 37.9 39.7 40.0 39.8 demand continued sterilization efforts by Overall surplus(+),deficit(-) (cash) 0.8 1.7 -0.5 -0.5 -0.5 the NBM. The recent increases in energy Financing prices and a weaker exchange rate will -0 8 -1.7 0.5 0.5 0.5 Netdomestic 1.8 -1.6 0.2 -0.3 -0.3 necessitate relatively tight monetary policy -3.3 -1.0 -1.6 -1.1 -1.0 ~ ~ $ $ ~ n 0.1 0.1 inorder to achieve the gradual reductionin 0.1 0.1 0.0 other (including project loans) 0.5 0.8 1.5 1.4 0.8 inflation over the medium-term (with Financing gap o f ~ w 0.4 0.4 0.9 inflationtargeted to to percent (US$ millions) 11.4 15.0 35.3 per annum bythe end o f 2008). Sources, Moldovan authorities(MTEF). IMF Article IV Staff Report, April 2006 and World Bank Staffestimates. Note: Fiscal accountsare for the general government. 18. To support lower inflation, address the widening trade deficit and avoid crowding out private sector investment, fiscal policy will remain relatively tight and supportive o f monetary policy over 2006-2008. As shown in Table 2, the IMF PRGF program targets an underlying general government budget deficit o f no more than 0.5 percent o f GDP over the program period. Bilateral and multilateral donors are expected to support the budget's efforts to meet the EGPRSP spending objectives with external grants and concessional financing. The 2007 fiscal financing gap o f US$15 million i s projected to be covered by the proposed first PRSC and program support by other multilateral and bilateral donors, including the United Kingdom (DFID), Sweden (SIDA) and the Netherlands. 19. As shown in Table 3, higher energy prices and slower export Table 3. Moldova: Balanceo fPayments and ExternalFinancingGap, 200448 (In millions of U.S. dollars;unless otherwiseindicated) growth resulted in a significant widening o f the current account deficit 2004 2005 2006 2007 2008 Est. Proiections in 2005 and 2006. The external ~ Currentaccount -529 -211 9 -263 6 -2304 -239 4 outlook has been negatively affected (as a percento f GDP) -20 -73 -85 6 8 -6.2 by the Russian ban on imports of Capital andfinancialaccount 782 2111 2856 2987 299.7 Moldovan wine and the expectation Errors andomissions 1245 97 1 0 0 0 0 0.0 Overallbalance 1498 963 220 683 60.3 that Gazprom will increase natural gas Financing -149.8 -96.3 -38.7 -108.7 -145.4 prices still further. At the same time, Use of Fundcredit -21.6 -21.4 9.2 11.9 12.9 lower economic growth and some real Changeofgross official reserves (increase-) -148.0 -128.6 -50.8 -134.6 -171.0 Exceptionalfinancing 19.8 53.8 2.8 14.0 12.7 depreciation will serve to slow import growth with the result that the current Financinggap 16.7 40.4 85.0 Sources: Moldovanauthorities, IMF Article IV Staff Report, April 2006 and account deficit will improve in 2007- World Bank Staffestimates. 6 2008. The 2007 external financing gap o f $40.4 million would be covered by the proposed first PRSC, program support from the European Union (EU) and current official transfers from bilateral donors, including the UnitedKingdom (DFID), Sweden (SIDA) and the Netherlands. 20. Debt Sustainability. While Moldova i s one o f the most indebted countries in the region, rapid economic growth, appreciation o f the U S dollar with respect to other currencies (SDR, Euro, Yen), net repayment to creditors and favorable rescheduling operations have resultedina rapid decline inthe ratio o f total external debt to GDP - falling from 106 percent of GDP in 2001 to around 55 percent in 2005. Public and publicly guaranteed (PPG) debt (including arrears) amounted to around $820 million or 28 percent Figure 1. Moldova: Indicators of Public Debt Under Alternative Scenarios,2005-2025 I/ o f GDP at end-2005 (down from 90 65 percent o f GDP in 2001). By NPV of debt-to-GDP ratio 80 . /' ~ 2005, debt to multilateral creditors, -BaCll"o 70 . _ _ _ \o Relorn primarily the World Bank 6 0 - __>>OS! cxvcme l " e 5 tet ,,,' / (International Bank for 50 . /' ,/,, 40 Reconstruction and Development . /' (IBRD) and International Development Association (IDA)) and IMF amounted to nearly two- 0 1 """""""""" thirds o f total PPG debt. Debt to bilateral creditors, primarily Paris Club creditors (and chiefly Russia) comprised the remainder o f the total. Compared to 2001, debt to commercial creditors has declined to very small levels (less than 4 percent o f total debt). External arrears amounted to US$56 million (2 percent o f GDP) at end-2005 - owed mostly to Russia, the U S and Japan. These arrears were reduced during 2004-2005 as a result o f restructuring deals with bilateral creditors (Romania and Turkey), cancellation o f state guarantees on some o f the European Bank for Reconstruction and Development (EBRD) loans (Giurgiulesti and 0 1 """""""""" 2ws 2006 m: ?w8 2009 ZGIO zoii 2oi2 2013 2014 2015 ?i116 2017 i n i s 2019 2020 2022 2023 2024 ? o x Vininvest) and commercial creditors (Gazprom and Hewlett- Source IMF-BankStaffprojectionsand simulations I/Mostextremestresstestislesithatyieldshishestratioin2015 21 Revenue mcludinggmts Packard). Domestic currency public debt i s modest at around 10 percent o f GDP (held primarily by the National Bank o f Moldova). Private sector debt and energy arrears are approximately 17 and 10 percent o f GDP, respectively. 21. In2005, the NPV of PPGexternal debt is around 24 percent of GDP or 50 percent o f exports. The NFV o f PPG debt to revenues ratio i s around 62 percent (88 percent including 7 domestic currency public debt) while the ratio o f debt service to revenues is around 9 percent. All o f these values fall below the debt distress thresholds for countries with Moldova's Country Performance Indicator Assessment (CPLA) overall score.2 22. Consistent with the authorities' medium-term fiscal program, supported by the IMF's PRGF, a further decline in the debt-to-GDP ratio is projected, with the NPV of public sector debt-to-GDP ratio declining to 10 percent by 2025. The alternative scenarios and stress tests also show declining ratios over time (with the exception o f the most extreme test which posits a permanently lower GDP growth and, being a static exercise, assumes that public spending would not adjust to this lower growth). 23. Debt sustainability analysis suggests that Moldova does not face a structural debt sustainability problem. The M a y 2006 agreement with Paris Club creditors to restructure its external debt has alleviatedpressing short-term liquidity difficulties (which had been resulting in the accumulation o f external arrears) and frees up resources for other development needs. The Paris Club agreement consolidates roughly USSl50 million due on debts contracted before December 31, 2000. This amount consists o f arrears (US$68 million through end-April 2006) as well as repayments falling due from M a y 2006-December 2008 (US$81.8 million). The rescheduling i s structured on the so-called "Houston Terms". This agreement i s expected to reduce debt service due to Paris Club creditors during the program period from US$149.9 to US$60.8 million (mainly interest on the rescheduled amounts and payment on the arrears). Along with the funding from the proposed PRSC and other expected donor assistance, this rescheduling will reduce Moldova's financing gap over the program period. C. POVERTY PROFILE 24. A prolonged recession through the 1990s made Moldova the poorest country in Europe. By 1999, over 70 percent o f Moldovans were poor and over 60 percent o f the population was extremely poor. Moldova's social indicators, a measure o f non-income dimensions o f poverty, were also considered among the worst inthe region. 25. The recent economic recovery has led to a massive movement out o f income poverty. Between 1999 and 2003, over 37 percent o f the population moved out o f poverty in Moldova, marking the largest absolute decline in poverty in Europe and Central Asia over this period. The decline in absolute poverty was broad-based and poverty fell across all locations. Inequality, as measured by the Gini coefficient, has been on a slight downward trend since the late1990s. Starting in 2004, however, poverty reduction has stalled despite continued vigorous economic growth. Indeed, during the first three quarters o f 2005, the seasonally adjusted poverty rate actually increased, heightening concerns that rapid economic growth i s no longer reducing poverty. * According to the Bank's classification,the critical debt distress thresholds are: NPViGDP =40 percent, NPV/exports=l50 percent and debt service/exports=20percent. See joint IMF-Bank staff Debt Sustainability Analysis Annex included inthe IMF Staff Report for the 2006 Article IV Consultationand Requestfor a Three-Year ArrangementUnder the PovertyReduction and Growth Facility, EBS/06/61,April 21, 2006. See Annual EvaluationReport on the Implementation of the Economic Growth and Povertv Reduction Strategy, Governmentof Moldova, 2006, andMoldova, Poverty Update, ReportNo. 35618-MD, World Bank,April 25,2006, for more details on recentpoverty trends inMoldova. 8 26. Looking across geographic regions, as shown in Table 4, large TABLE4: ANOVERVIEWOFPOVERTYINMOLDOVA cities have experienced continued declines in poverty rates while the - (Inpercentage points, unless labeledotherwise) poverty 1999 2002 2003 2004 2005a/ stabilized.rate in small areas,towns however, has National poverty rate 73.0 40.4 29.0 26.5 28.5 where close to 70 percent o f the poor Large Cities 50.4 28.6 22.7 17.3 14.7 reside, poverty rates have been on an 80.9 62.3 49.4 45.7 48.5 upward trend since 2003. The data 76.9 51.0 35.7 37.1 42.5 suggest that members o f households GDP growth rate -3.4 7.8 6.6 7.3 8.4 whose heads are engaged in agricultural I activities face the highest risk o f Ginicoefficient 0.396 0.372 0.356 0.361 0.375 poverty. In addition, the agricultural a/zoo Sources: World Bank &National Bureau of Statistics. sector accounts for the largest share o f informal employment, where the poverty risk i s higher than inthe formal sector. The agricultural character o f poverty in Moldova i s not surprising in an economic environment where the agricultural sector has provided a significant source o f income for many households while at the same time experiencing a prolonged contraction throughout most o f the transition period. The continued underperformance o f the agri-food sector i s perhaps the most critical constraint to faster economic growth and poverty reduction. 27. While the initial turnaround o f agricultural output and decline in rural poverty was associated with the land privatization and farm restructuring program that began in the late 199Os, the recent uptick in rural poverty coincided with stalled farm restructuring characterized by a slight reversal o f the amount o f land usedby individual farms in2002 and 2003. The delay inrestructuring farms and getting land into the hands of individualfarmers is having an adverse affect on agricultural output and farmer incomes. Calculation o f total factor productivity (TFP) by farm type has shown that small, individual farms inMoldova are significantly more efficient than large, corporate farms. This is consistent with evidence from around the world, where agriculture in developed market economies is generally agriculture by individual family farms, and where many studies have shown that agriculture i s not generally characterized by economies o f scale. Infact, in Moldova today, individual farms produce over 70% o f agricultural output on 50% o f the land. By keeping 50% o f land tied up in inefficient corporate farms, the land available to family farmers i s reduced, which in turn reduces their income-generating opportunities and often restricts them to practicing subsistence agriculture. With few opportunities, many smallholders have no alternative but to rent their land at low rates to corporate farms, which usually pay in kind, and often do not pay at all. This further constrains incomes o f smallholders. 28. There are two reasons why rental prices paid by corporate farms are low, and the same arguments apply to agricultural wages. First, due to their large size, corporate farms specialize in field crops such as cereals and oilseeds that are typically low-margin, and these margins are further reduced by government policies such as export restrictions and other market distortions. Second, corporate farms are less efficient (lower TFP) and less profitable (according to official figures, only 55% o f corporate farms were profitable in2004). 9 29. Distortions and imperfections in agncultural output and input markets reduce the scope for farm restructuring and rural poverty reduction. Analysis shows that agricultural producers are receiving less for their outputs and paying more for their inputs relative to international parity prices than they s h o ~ l dThe . ~ effects on six major commodities are reflected in Figure 2, which compares the prices received by Moldovan farmers to international prices, after accounting for transportation, handling and other costs. The results show that, on average for these six commodities, farmers received 29% less on their sales than they should have based on world market prices over the period 2000 to 2004. Further, the situation has not been improving over time, and for crops like wheat and tomatoes, it has worsened considerably. This has a direct negative effect on rural poverty by squeezing the incomes o f farmers, and reduces the ability o fpeasant farms to succeed as viable businesses. Figure 2: Prices Moldovan Farmers Receive for Outputs andPay for InputsRelative to World Prices, % (nominal rates o fprotection) '' M e a t Maize Sunflower Tomato Apple Table grape 40% i 22% 24% 20% 0% I -20% -40% U U -41% -48% -60% ~ 0 Ouptutt Inputs Source: Moldova Agricultural Policy Note Vol. 11-Markets. Calculate as the averageof NominalRates of Protection from 2000 to 2004 for outputs, and the average for 2000 and 2003 for inputs. 30. While peasant farmer incomes are squeezed by poor agricultural terms o f trade, corporate farms are protected by favorable public expenditures and government policies. The repeated writing off, rescheduling and accumulation o f debt without consequence has allowed inefficient corporate farms to continue operating at a loss. At the same time, many government support programs are targeted to large, corporate farms.6 This i s done by setting restrictions on minimum farm size or ownership structure, or by targeting crops grown primarily by corporate farms. The combined effect o f such policies is to reduce the incentive for restructuring o f the large corporate farms, and limit the flow o f land and public support to peasant farmers. 31. This PRSC is designed to spur growth and rural poverty reduction through increased farm restructuring and enhanced competitiveness by improving policies in two key areas: Improving the investment climate through the development o f agricultural output and input markets (see Pillar 1.C below); Improving the efficiency and management o f public resources for the agricultural sector (see Pillar 1I.C.1below). See MoldovaAgricultural PolicyNote Vol. 11-Markets; ReportNo. 36366-MD, World Bank, June 1, 2006. See MoldovaAgricultural PolicyNote Vol. 111-Public Expenditures,ReportNo. 36366-MD, World Bank,June 1, 2006. 10 32. Despite Moldova's remarkable achievement in reducing income poverty, comparable progress has not been achieved along non-income dimensions o f poverty. There are persistent or increasing disparities in access to education and health care. For example, while enrollment rates have increased during the recovery period, they have been driven mostly by the increased participation o f richer households. Out o f pocket expenses for public services, which have been on the rise, have impacted the poor disproportionately. 111. THE GOVERNMENT'SECONOMIC GROWTHAND POVERTY REDUCTIONPROGRAM 33. The EGPRSP was presented to the Boards o f IDA and IMF inNovember 2004 and was the first full Poverty Reduction Strategy Paper (PRSP) prepared by the Moldovan authorities. It was developed in broad-based consultations with stakeholders and civil society, and benefited from a participatory process that was organized under the supervision of a Participation Council comprised o f representatives o f all stakeholder groups. This process has remainedinplace duringthe EGPRSP implementation period. 34. The EGPRSP establishes three medium-term objectives: sustainable and inclusive economic growth; reduction o f poverty and inequality and increased participation o f the poor in economic development; and human resource development. To achieve these objectives, the EGPRSP calls for a three-pillar strategy: (i)promotion o f sustainable and inclusive economic growth; (ii) improved human development; and (iii)strengthened social protection o f the most vulnerable groups. 35. Under the first pillar, the stated goals o f the EGPRSP are improvements in the business environment and access to infrastructure, and maintenance o f prudent macroeconomic management to promote sustainable growth. The EGPRSP attaches a highpriority to improving the business environment and investment climate to reverse a decline in investment, and thus foster quality economic growth. To ensure that growth is inclusive for the rural poor and the marginalized populations, the EGPRSP focuses on furthering agricultural and rural development. Recognizing that improving human capital is key to economic growth, the second pillar o f the EGPRSP rests on human resource development, through education and health. The EGPRSP pension and social assistance systems are at the center o f the social protection strategy - the third focuses on measures to increase access to and improve the quality o f education. Reforms o f the pillar o fthe EGPRSP. Reform o f the pension system will include the rationalization o f the social insurance system to ensure its long-term financial sustainability and pension adequacy. The social assistance system will be strengthened through improved targeting and efficiency to ensure that benefits reach the most vulnerable poor. Inachieving these strategic objectives, the EGPRSP i s conscious o f the constraint imposed by the insufficient functional and institutional adaptation o f the public administration to the requirements set by the transition from a central planned economy to a market economy. Establishing a modem, efficient public administration is, therefore, recognized in the EGPRSP as an important element in achieving the development outcomes o f the Government's poverty reduction strategy. 36. In April 2006, the Moldovan authorities prepared the first Annual Evaluation Report (AER) highlightingprogress in implementingthe EGPRSP from late 2004 to early 2006. In the Joint Staff Advisory Note (JSAN) the staffs noted that the AER provided a candid assessment o f the accomplishments and shortcomings of the past year, focusing on outcomes 11 rather than inputs. The AER highlighted the continued poverty reduction, but also noted areas where policy implementationhas been slower than originally envisaged. Staffs noted that reform momentum has been enhanced by the European Union-Republic o f Moldova (EU-RM) Action Plan, approved in February, 2005. Inthose areas o f endeavor where the two documents overlap, the EGPRSP and the EU-RMAction Plan are mutually consistent, and reforms have accelerated. 37. The report raised the appropriate concern that the decline in poverty among households in rural areas - where the majority o f the poor live - has stagnated. In this regard, the quality o f growth poses a major concern for the macroeconomic and poverty outlook. The AER recognized the need to implement sound policies and structural reforms aimed at revitalizing the business climate and creating the conditions conducive for private sector investment and productivity gains. Strengthening accountability and improving governance in the public sector, goals o f the public administration reform effort, are also acknowledged as key priorities inthe period ahead. 38. The report noted that, while the allocation o f resources to cover EGPRSP priorities in the social sectors has been reasonable, the increase in the level o f spending has not been accompanied by sufficient progress in improving the efficiency o f this spending. Inthe area o f social assistance, the AER noted that the system i s still fragmented and inadequatelytargeted. In education, the growing availability o f resources has still been insufficient to maintain the quality o f education and plans to optimize the school network are highlighted. The report notes that while indicators on maternal and infant mortality are below targeted levels, increasing the efficiency o f healthcare will be needed in order to maintain the benefit package o f universal health insurance. The need to increase public investment in infrastructure i s clearly recognized, but actual and planned budget allocations remain inadequate, raising doubts that the EGPRSP priority actions in this area will be met. The JSAN recommended that the authorities ensure better strategic linkages between the annual budgets, the Medium-Term Expenditure Framework (MTEF) and the EGPRSP. Strengthening the efficiency o fpublic spendingwill also be needed if the priorities specified inthat strategy are to be met. Iv. BANKSUPPORTTO THE GOVERNMENT'S PROGRAM A. MOVING THECASHIGHCASE TO 39. The 2004 Country Assistance Strategy (CAS) was presented to the Executive Board against a backdrop o f a difficult policy environment. Both the IMF (PRGF) and the World Bank Structural Adjustment Credit I11(SACIII) programs had recently gone o f f track with less than one-third o f the committed funds under these programs being disbursed. Further, the Government's Economic Growth and Poverty Reduction Strategy Paper (EGPRSP), which was adopted in mid-2004, contained policies and actions that reflected a radical departure from the Government's 2001 Economic Revival Program. These circumstances raised considerable concern about the government's commitment to the reform program articulated in the EGPRSP. As a result, the CAS adopted a cautious approach with the Base Case lending scenario including only investment operations targeted at the local and community level. 40. CAS High Case Triggers. At the same time, under a High Case lending scenario, the CAS left open the opportunity for a resumption o f policy based lending (i.e. a PRSC) provided that Government ownership o f the reform program was demonstrated in a good 12 implementation track record. To this end, the CAS developed a series o f key reform benchmarks that would provide the basis for evaluating reform progress incritical areas: the maintenance o f a stable macroeconomic framework and fiscal discipline, public sector reform and governance, improving the business environment, furthering pension reforms, and promoting liberal and market-oriented agricultural sector policies. Table 5. Implementationof CAS High Case Triggers CAS High Case Benchmark Imolementation 1. Meetingthe benchmarksspelledout Partially Accomplished in the EGPRSP'sannual Completedfirst annual EGPRSPprogress Report in April 2006 which provideda implementationplan. candid assessment of the accomplishmentsand shortcomingsinimplementingthe EGPRSP action plan (seeJSAN, April 28,2006, ReportNo. 35980-MD). 2. Maintaininga stable macroeconomic Fully Accomplished framework and fiscal discipline. New IMFPRGF program(May 5,2006); PrimaryFiscal Surplus of 2.7 and 3.0 percent of GDP achieved in 2004 and2005; Paris Club debt restructuring agreement achieved (May 12, 2006). 3. Public Sector reformand Governance Substantially Accomplished (a) Civil Service Reform (a) Supersedingthe CAS trigger, the Governmenthas embarked on amore ambitiousPublic AdministrationReformeffort incorporatingthe civil service - reformagenda - adoptingadraft strategy and implementationplan. A Bank administeredmulti-donorTrust Fundis providing technical assistanceto this reformeffort. (b) Public Financial Management (b) Cash availability statements are issuedby the Treasuryon amonthlybasis. (c) Public Procurement (c) CAS triggers on single source procurementand open tenderinghavebeen fully satisfied. A satisfactory draft public procurementlaw has beenprepared. 4. Improvingthe businessenvironment Fully Accomplished (a) Reducelicensingand inspection (a) CAS triggers on licensingand inspectioncosts fully satisfiedas i s the trigger costs and number o f inspections; on the number of inspections; (b) Reduceimport clearancetime at (b) CAS trigger on import clearancetime at the inlandterminal o f Chisinauhas inland terminal of Chisinau. been fully satisfied; 5. ImprovingSocial Protection: Pension Substantially Accomplished reform (a) No new types of pensionprivileges have been introduced; (b) Databaseto recordcollectionofpensioncontributions nearingcompletion. Approval of amendmentsto pensionlaw will enable pensionpaymentsaccording to actual individual contributions. 6. Agriculture Partially Accomplished Current land code maintained; requirementto export via the Universal CommoditiesExchangeabrogated; no direct administration of crop production; However, wasteful agriculture subsidies have increased. 41. As indicated inTable 5, most o f the reform benchmarks established under the CAS high case have been fully or substantially accomplished demonstrating a track record o f reform by the Government. In some areas, such improving the business environment (reducing licensing and inspection costs and import clearance times), and maintaining a stable macroeconomic framework (including external arrears clearance), the government has exceeded the CAS high case triggers. In the area o f public sector reform, the Government has moved beyond the limited reform trigger established for the CAS and launched an ambitious public sector reform with donor support. Insummary, this track record includes: Meeting the benchmarks spelled out in the EGPRSP's annual implementation plan. As noted earlier, the Government's first Annual Evaluation Report highlighted progress in implementing the EGPRSP and provided a candid assessment o f the accomplishments and shortcomings o f the past two years o f reform. e Maintaining a stable macroeconomic framework andflscal discipline. Economic growth has continued to be strong, inflation has been under control, the general government budget has been in surplus, and external debt ratios have declined rapidly. A new IMF 13 PRGF program was approved by the IMF's Executive Board o n M a y 5, 2006 with an agreed macroeconomic framework for the next three years. Following the IMF program, an agreement was reached with the Paris Club that resultedinthe rescheduling o f existing external arrears. Public Sector Reform and Governance. At the beginning o f 2005 the Government embarked on a major public administration reform (PAR) effort aimed at streamlining the public administration, improving the system and capacity for government decision making, reforming the civil service on merit principles and improving the systems for aligning government strategies and resources. This reform effort i s much more ambitious and extensive than envisaged under the CAS. With donor support, the Government has prepared a sound reform strategy and implementation planwhich it adopted inDecember 2005. A Bank administered multi-donor trust fund has been established to support this reform effort. Efforts to improve public financial management are being supported by a Bank investment operation. Increased competition for public procurement contracts i s evidenced by a decline in single source procurement from 51 percent to 45 percent o f the value o f contracts awarded (including utilities) and an increase in the use o f open tendering from 28 to 40 percent o f the value o f contracts awarded. Improving the Business Environment. Duringthe last few years Moldova has simplified business registration and licensing procedures, while reducing the required number o f licenses and documents for business registration. In2005, these reform efforts intensified with the adoption o f the so-called "Guillotine" law which reviewed and streamlined business regulations still further (as evidenced by the improvement in Moldova's 2005 BEEPS results). As a result, licensing and inspection costs have declined as have the number o f business inspections. In the area o f trade facilitation, progress in implementing the Trade and Transportation Facility for Southeast Europe (TTFSE) project and the alignment o f custom's legislations and regulations to EU standards have significantly reduced the time needed to clear the inland customs terminal. The adoption and implementation o f the Asycuda clearance system will contribute to the acceleration o f these improvements. Improving Social Protection. Steady progress has been made in implementing the 1998 pension reform program. No new types o f pension privileges have been introduced and the overall retirement age has beenraised from 60 to 62 for men and 55 to 57 for women. The Government has also made a commendable effort towards the system which bases actual pension payments on actual pension contributions with more than 75 percent o f the 5.8 million required records now entered into the contribution database system. Agricultural Reforms. The 2001 Memorandum o f Understanding (MoU) on Agriculture lays out a number o f agreed policy principles. Overall, the Government has largely adhered to the principles contained in this MoU. In particular, the Government has resisted pressures to change the land code and i s working with the Bank (as part o f the Rural Investment and Services Project (RISP) to develop a pilot land re-parceling program. Government policy towards agricultural markets has been largely market oriented. Export restrictions that had been imposed in 2005 will be removed as part o f the IMF PRGF program. The Government has refrained from imposing any policies directed at managing agricultural production. While the Government has been developing its extension and advisory services to provide support to independent farmers (under RISP) additional efforts will be required to rationalize subsidy and support programs to the needs o f post-privatization agriculture. Given current fiscal constraints, the existing subsidy program consumes only a small fraction o f the government budget. The PRSC 14 will support the Government's efforts to restructure agriculture expenditures, increasing the share o f spending on agricultural services and investment, and reducing share o f product and input subsidies. Box 1. The EU-Moldova Action Plan The EU-MoldovaAction Plan, signed in February 2005, covers awide range o f issues, includingdemocratization,health standards, legalreform, and economics. Inthe economic area, it is consistentwith the EGPRSPand includesthe following key elements: Administrative reform and reformof the judiciary Adoptingan ethics code for civil servants,judges and law enforcementbodies. Implementing a working program for regulatory reform. Amending laws concerningthe independenceand impartiality o f thejudiciary. Introducingadministrativereform of localgovernments. Macroeconomicstability and povertyreduction Makingprogress toward an agreementwith the IMF on acredible economicprogram. Developing aMedium-termExpenditure Framework(MTEF) consistentwith the EGPRSP Improvingpublic financemanagement, includingappropriateaudit ofbudgetrevenue andexpenditures. Developing acomprehensive strategy to modernizethe tax administration. Upgradingand extendingthe treasury system, includingby integratinginto the single treasury accountthe social and healthfunds. Improving investmentclimate Screening of national legislationto identify barriersto businessestablishmentandto progressivelyabolishthem. Taking steps to reduceover-regulation,improvetransparency and predictabilityand reduce further the burdenof licensingand inspectionregimes. Settingup adialogue on regulation,enterprise, and industrialpolicywith foreign investors. Enhancingthe prudential regulatoryframework for financialmarkets and supervisionto bring it in line with that in the EU. Creatinganational agency for competition protection, andproviding it with sufficient budgetarymeansto carry out its mandate. Trade promotion Harmonizinglegislationand procedureswith EUnorms on certification and control of origin of goods inMoldova. Preparinga plan of steps toward fulfillment of EUrequirementson animal healthand for the processingof animal products,and for hygiene in food processing. Source: IMF, StaffReport for the 2006 Article IV Consultationand Request for aThree-yearArrangementunder the Poverty Reductionand Growth Facility, May 5, 2006. 42. EU-Moldova Action Plan. Inaddition to demonstrating progress in implementing these key reform benchmarks, the Government's commitment to economic reforms has been further reinforced by its stated EU aspirations which culminated in the adoption of an EU- MoldovaAction Plan inMay 2005 (see Box 1). This plan aims to establish an increasingly close relationship between the EU and Moldova and involves a significant degree o f economic integration and deepening of political co-operation. Implementation o f the action plan will significantly advance the approximation of Moldovan legislation, norms and standards to those o f the EuropeanUnion. Consistent with the EGPRSP, from which it is largely drawn, the policy framework contained inthis EU action plan has sustainable development as its objective. Inthe 2005 elections, the Government retained its majority in Parliament giving it some breathing room to undertake major reforms before the commencement o fthe next political cycle. 15 43. CPIA ratings. The efforts by the Government to establish a Table 6. Moldova 2005 CPIA r; demonstrated track record o f reform "gs A\erage have also been reflected in steady PIOLDOVA D4 Borrower :PIA Cluster A : EconomicManagement improvements in the Bank's Country I MacroeconomicManagement 3 5 3 8 Policy and Institutional Assessment 2 Fiscal Policy 3 5 3 4 (CPIA) o f Moldova (see Table 6). The 3 DebtPolicy 3 0 3 4 .Average 3 3 3 5 Bank's assessment o f Moldova under 'PIA Cluster B : Structural Polldes this exercise has improved steadily over 4 Trade 3 5 3 8 the last several years. Inthe most recent 5 Financial Sector 3 5 3 1 6 BusinessRegulatoryEnvironment 4 0 3 1 rating exercise, Moldova received an Average 3 4 overall CPIA rating o f 3.5, higher than :PIA Cluster C : Pollcies for SoclalInclusioniEquity the rating o f the average IDA borrower. 7 Gender Equality 4 5 3 > 8 Equity of Public Resource Use 3 5 3 4 The improvement in Moldova's overall 9 BuildingHumanResources 4 0 3 4 rating was held back by the continued I O Social Protection and Labor 3 5 3 2 I1 Policies and Institutions for EnvironmentalSustainability 3 5 3 1 accumulation o f external payment 3 8 3 3 arrears in 2005. The recent Paris Club :PIA Cluster D : Publlc Sector Management and institutions agreement to restructure bilateral debt 12 P~operVRights and Rule-baredGovernance 3 5 2 9 I 3 Quality of Budgetaryand FinancialManagement 3 5 3 2 and clear external arrears will likely 14 Eificiencyo f Revenue Mobilization 3 0 3 4 contribute to further improvements in 15 Quality of Public Administration 3 0 3 0 Moldova's CPIA rating. Of particular 16 Transparency,Accountabilityand Corruption in the Public Sector 3 0 2 9 Average 3 2 3 1 note has been the increase in the critical herall CPIA 3 5 3 3 Public Sector Management and Institutions (Governance) cluster rating. In the CPIA exercises done since the CAS, no single rating criterion for Moldova has been downgraded. B. COLLABORATION WITHTHE IMFAND OTHERDONORS 44. IDA partnership with the IMF in Moldova's development strategy has been excellent over the past few years. The Bank and Fund Boards endorsed the EGPRSP in November 2004 as well as the first annual progress report (May 2006). Bank and IMF staffs have executedjoint work and have continued to carry out joint missions at least twice a year for macroeconomic policy dialogue with the Government. The IMF policy dialogue with the Government takes place in the context o f the ongoing Poverty Reduction and Growth Facility (PRGF), covering the 2006-2008 period. The PRSC has been prepared in conjunction with the PRGF to ensure the consistency o f the macroeconomic and structural policy reforms supported by both programs. The IMF is taking the lead on macroeconomic issues while IDA takes the lead on structural and social issues. In a number of areas where the mandates of the two institutions overlap, such as public finance, the work i s being closely coordinated to ensure that consistent advice i s provided to the authorities. The existence o f an IMF program i s an important input for the determination o f the adequacy o f the macroeconomic policy framework. (See Annex 3) 45. Donor support plays an important role in supporting the implementation o f the EGPRSP and PRSC programs. Coordination between IDA, the United Kingdom (DFID), Sweden (SIDA), and the Netherlands has been especially strong since all these donors have been collaborating in the preparation o f a single policy framework to be included in the PRSC. PRSC-1was catalytic in starting improved donor harmonization inMoldova. Duringpreparation o f the PRSC, DFID, SIDA, and IDA carried out joint missions in consultation with the European 16 Union. This harmonization process was carried forward through a Development Partnership Framework signed between the Government, IDA, the Netherlands, the United Kingdom (DFID), Sweden (SIDA), the UN, IMF, and EU entitled "Co-ordination and Harmonization of Government and Donor Practices for Aid Effectiveness in the Republic o f Moldova" signed in Chisinau on May 29, 2006. This Partnership Framework commits the parties to joint reviews, harmonization o f indicators, and prior actions and synchronization with Government budget cycles with a view to reducing transaction costs o f assistanceto the Government. c.ANALYTICALUNDERPINNINGSAND RELATIONSHIPTO OTHER BANKOPERATIONS 46. Analytical Work.The PRSC rests on a wide program o f analytic work carried out by the Government, the Bank, and other donors that have helped inform the design o f the PRSC. The recent Country Economic Memorandum (CEM) (2005) and Poverty Assessment (2004) and Poverty Assessment Update (2006) provide in depth analysis and recommendation related to growth and poverty reduction in support o f the implementation o f the EGPRSP. The studies underlinethe need to change the quality of growth inMoldova, moving away from the current consumption led, remittance fueled growth paradigm. They highlight the need to raise domestic productivity, particularly inthe agricultural sector, by improving the investment climate so as to encourage greater investment and innovation as the most direct means to accelerate growth and reduce poverty in Moldova. The CEM, Agricultural Policy Notes (2006), InvestmentClimate Assessment (2004), the annual Cost o f Doing Business Surveys, and the Trade Diagnostic Study (2004) provide a detailed analysis o f the business environment, providing recommendations to a reduce regulatory and administrative costs and improve trade facilitation as a means to encourage an acceleration in economic growth and poverty reduction. The CEM, as well as the Trade Diagnostic Study and Public Finance Review (2006), highlight the constraint to economic growth imposed by the deteriorating infrastructure and highlight the need to increase the currently low levels o fpublic investment. 47. The Public Economic Management Review (2003) and the Public Finance Review provide recommendations on improving the efficiency and management o f public sector resources. These studies examine public expenditures in the social sectors - education, health, social assistance, and pensions - and highlight the need to improve the strategic allocation o f public resources by increasing efficiency o f spending so as to free public resources to increase public investment. The studies also point to the need to establish a modem and efficient public administration, necessary in order to achieve the country's longer-term development outcomes. They provide recommendations on improving the MTEF process, public procurement practices, as well as public investment management. The Education Strategy Note (2006), the Health Policy Note (2007), Social Assistance Note (2007), and the Agriculture Policy Notes (2006) provide recommendations on improved public sector resource use to achieve better outcomes in these sectors. 48. The Bank's fiduciary work, Country Procurement Assessment Report (2003), and the Country Financial Accountability Assessment (2003), which has focused on the Government's financial and procurement systems, has been complemented by a recent multi- donor Public Expenditure and Financial Accountability Assessment (PEFA) (2006). The latest PEFA assessment has been produced during a period of significant overall reform o f public financial management in Moldova. The MTEF i s being strengthened and expanded, leading to improved budget preparation. The introduction o f a new FMIS i s planned which should offer 17 significant improvements in the quality and timeliness o f financial information. A new procurement law i s being developed, training and the development o f a strategy for public financial internal control i s ongoing. These studies provide an integrated assessment o f public financial management performance and the impact o f public financial management weaknesses, as well as the recommendations for reform which have informed the preparation o f the PRSC. 49. Bank Operations. The CAS Progress Report recognizes the PRSCs as the main instrument o f the Bank for providing support to the implementation o f the EGPRSP. It also states that complementarity o f efforts between programmatic support and investment lending i s key to making efficient use o f Bank resources. The current portfolio includes support for infrastructure (water and energy), private sector development, agriculture, community based development, public financial management, education, health, HIV/AIDs,and environment. 50. A number o f investmentprojects support institutional reforms and capacity building to help the government realize its vision o f a private sector led economy. The recently approved private sector Competitiveness Enhancement Project (2005) will assist Moldova in enhancing competitiveness o f enterprises through improvements in the business environment and making adequate standards, testing, and quality improvement services available to enterprises. The project will contribute to the overall government effort in the area o f improving business environment and provide strategic input, including continuous support for developing regulatory reform strategy, building institutional capacity for deregulation, and introducing Regulatory Impact Assessment (RIA) in the legislative process o f Moldova. The Trade and Transport Facilitation in Southeast Europe Project (2003) seeks to reduce non-tariff costs to trade and transport and reduce smuggling and corruption at border crossings. The Second Rural Investment and Services Project (2006) for Moldova provides long-term support to accelerate agricultural recovery and growth so that Moldova's agricultural and rural sectors can play their full role in providing the underpinnings for future income growth and poverty reduction. The project provides information, knowledge, and know-how to newly established private farmers and rural population, strengthens the emerging rural private sector, and expands the outreach o f formal financial sector to rural areas via the development o f Savings and Credit Associations. PRSC support i s aimed at leveraging these reform efforts and supporting complementary reform efforts to improve the business environment. 51. The Bank also supports a number o f projects aimed at improving the efficiency o f public sector resource use. The Public Financial Management Project (2006) aims to achieve effective and transparent management o f public finances by providing assistance to improve budget formulation and execution, a new financial management information system, and better internal control and audit capability. A Bank managed, multi-donor trust fund (2006) has been established to assist the government in their public administration reform efforts. The IDF grant for the Development o f Public Procurement Infrastructure (2004) follows up on the CPAR to assist the Government in the development o f its public procurement system. The project supports Capacity building, further development o f the procurement legislative framework, and increased automation o f public procurement functions. 52. Bank operations have also focused on improving resource use in specific sectors. The Quality Education in Rural Areas Project (2006) supports the Government's education program to enhance the quality o f teaching and learning in rural schools and improve the efficiency inpublic spending for education, particularly inthe context o f projected demographic 18 trends. The PrimaryHealth and Social Assistance project (under development) would scale-up the Bank's previous interventionsthrough competitive mechanisms established under the Health Investment Fund Project (HIF) (2000) and promote the use o f improved clinical and management skills also supported by the HIF. It would support the Government's efforts to further improve service delivery with focus on ensuring equitable access, especially o f the rural population, to quality health care and to buildthe clinical and management capacity o f the health workforce to improve quality and efficiency, while taking measurable steps towards financial sustainability o f the health care system. The Road Infrastructure Project (under development) would assist the Government in better mobilizing domestic resources by reforming road financing mechanisms and introducing competition in the execution o f road maintenance contracts. The Public Expenditure Review PERprocess and analytic work, such as the C E M and Trade Diagnostic Study, play an important role in providing advice on strategic priorities and appropriate government processes for the expansion o f infrastructure. 53. Finally, in the social sectors, Bank support i s provided in the context o f social development programs in health, education, and social protection. The Social Protection Management Project (1999) supports the Government's efforts to develop the capacity required to implement the pension reform and to support the development o f an efficient and sustainable social protection system. The Primary Health and Social Protection project (FY07) aims to assist the government in scaling up efforts to improve the targeting efficiency o f social assistance programs. Box 2. AnalyticalUnderpinningsandLinksto Other Operations Pillar I.Improvingthe InvestmentClimate A. ReducingRegulatoryand Administrative Costs CompetitivenessEnhancementProject addresses the needto reform Standards,reduceregulatory burdens,and improve the quality o f future regulationsthrough the use o fRegulatoryImpactAssessment(RIA); InvestmentClimateAssessment (ICA) and Country Economic Memorandum(CEM) providedunderlyinganalytical underpinnings; IMF PRGF programaddressesprivatizationprogram, SOE management,debt restructuring, and implementationof RIA. B. ImprovingTrade Facilitation Trade and Transport in Southeast Europe (TTFSE) programsupports the implementationof Asycuda and simplification of Customsproceduresgearedtowards improved trade facilitation; The Trade Diagnostic Study providedthe analytic underpinnings, analyzingthe main barriers to trade. C. DevelopingAgricultural Markets Rural Investmentand Services Project (RISP 2) supports the development of agriculture and business services in rural areas CEM and three AgriculturePolicyNoteson Land, Markets, and Public Expendituresprovidesthe analytical underpinnings; . ManagingFood Safety and Agricultural Health: An Action Plan(2006) whichprovidesrecommendationsinthe area of food safety and SanitaryandPhytosanitary(SPS) measures; IMF PRGF programaddresses some key constraintson export side (UCEon grain) and Council o fCreditors D. ReducingEnergyVulnerability EnergyI1Project (with SIDA) aims to improve energy efficiencyand reduce energy vulnerability; Povertyand Social Impact Analysis (a Noteon the impact ofhigher energyprices in Moldova)provides analytical underpinnings; IMF PRGF programsupports the Government's efforts to maintain costrecoveryprices for natural gas. Pillar11. Improvingthe Efficiencyand Managementof PublicSector Resources A. Building a meritocraticcivil service B. Implementinga transparentand uniformremunerationsystemfor civil servants 19 The Bank will administer a multi-donorPublic AdministrationReformTrust fund with fundingprovided by DFID, SIDA, and the Netherlands; Public EconomicManagementReport (PEMR) and Public FinanceReview (PFR) provideanalytical underpinnings. PFR preparedjointly with DFID, SIDA and EU. C. Improving the Strategic Allocation of PublicResources Public Financial Management(PFM) project (with SIDA andthe Netherlands) provideanalytical underpinningsand diagnostic, addresseskey PFM issues, and provides capacitybuilding; DFIDsupport to the Medium-TermExpenditureFramework; Multi-donor support for Public Expenditure and FinancialAccountability(PEFA) Assessment; IMF PRGF programaddresses some key constraintson cash management. C.1. Agricultural Spending CEM andAgricultural Policy Note on Public Expendituresprovide analytical underpinningsand diagnostic. C.2. TransportationInfrastructure Roadproject is under preparation and will provide capacitybuilding andtechnical assistance; Trade Diagnostic study and Public FinanceReview provide analytical underpinningsand diagnostic C.3. Educationspending Quality Educationin Rural Areas Project addressesaccess problems in rural areas; EducationPolicyNote; PFR provides analyticalunderpinnings anddiagnostic on improvingefficiencyof education spending; C.4. Health spending Primary Healthand Social Assistance project under preparation; HealthPolicy NotesandPFR provide analytical underpinningsanddiagnostic on improvingefficiencyofhealth D. Public Procurement InstitutionalDevelopmentFund (IDF) to DevelopPublic ProcurementInfrastructure InMoldova; Country Procurement Assessment Report (CPAR) provides analytical underpinnings, exploringthe strengths and weaknesses o fthe publicprocurement system. Pillar 111. StrengtheningSocial Protection Systems A. Pension Reform SocialProtectionManagementProject; PFR providesanalyticalunderpinnings and diagnostic on financial sustainability o fpension system. B. SocialAssistance Primary Healthand Social Assistance Projectunder preparation; EUFoodSecurity Programand DFID/SIDA financing pilot projectson improvingtargeting efficiency; PFR and Social AssistanceNote providesanalytical underpinningsanddiagnostic on improvingthe efficiencyof social assistancespending. v. THEPROPOSEDOPERATIONAND POLICYACTIONS A. OVERALL DESCRIPTION 54. The objective o f the proposed PRSC is to support the Government's economic growth and poverty reduction strategy. The proposed PRSC selectively supports the following areas o f the EGPRSP and EU Action Plan where the sustainability o f the key reforms requires consolidation, prioritization, cross-cutting support, and deepening to make real progress on the growth and poverty reduction agenda: 1. Improving the Investment Climate, through key policy actions to improve the investment climate and foster a more competitive enterprise and farming sector. With the impetus behind the current consumption led, remittance driven growth expected to wane, sustaining and accelerating future growth and poverty reduction in Moldova will depend on increases in domestic productivity. Achieving faster productivity growth, as well as 20 employment generation, will depend on the extent to which firms and farms address current low levels o f investment and innovation. K e y to Moldova's efforts to accelerate economic growth and poverty reduction will be improving the performance o f the agriculture sector. Similarly, reducing the destabilizing economic impacts o f external price shocks will require improvements in energy efficiency. 2. Improving the eficiency and management ofpublic resources, by helping the government build a meritocratic civil service, improve the strategic allocation o f public finances - with an enhanced focus on pro-growth investment spending on physical and human capital, and increasing competition inpublic procurement. Better governance and public institutions are central to growth and poverty reduction. The insufficient functional and institutional adaptation o f the public administration to the requirements set by the transition from a centrally planned to a market economy i s a key constraint to the efficient management o f public resources. Establishing a modem and efficient public administration i s necessary in order to achieve the country's longer-term development outcomes. Increasedpublic investment spending, particularly inpublic infrastructure, will be needed in order to support Moldova's private-sector led growth. This will require enhancing the strategic allocation o f public resources by improving the MTEF process, public procurement practices, and including better public investment management. Reforms in a number o f key sectoral areas can also improve the efficiency o f public resource use, yielding increased fiscal space for more public investment spending without crowding out the private sector. 3 . Strengthening Pension and Social Assistance Systems by supporting further reforms to pension and social assistance systems, including better targeting o f vulnerable groups by these programs. The recent slowdown in poverty reduction highlights the need to improve the quality o f growth inMoldova and strengthen existing social safety nets. The PRSC would support the Government's reform efforts to strengthen the effectiveness and future fiscal viability o f the pay-as-you-go pension program by supporting efforts to complete the 1999 pension reform, including efforts to unify the pension system for all types o f pensioners. Improving targeting efficiency o f social assistance programs and gaining efficiency in program administration will be a necessary element o f Moldova's poverty reduction efforts. PolicyArea Measuresimplementedbefore PRSC-I MaintainMacroeconomic Maintained a satisfactory macroeconomicframework Stability In2005, real GDP growth was 7.1 percent, inflationwas 10percentandprimary fiscal deficit was 3.0 percent of GDP. OnMay 5,2006 the IMF Executive Board approvedanew PRGFprogram. OnMay 12,2006, Paris Club creditorsagreed to a restructuringof externaldebt. Pillar I.Improvingthe Investment Climate A. Reducingregulatory and Adoption of Governmentdecree on Establishment of a Registry of Ofjicial Acts administrative costs of Regulating BusinessActivity based on regulatory review. businessregulations GovernmentadoptedDecree No 1030on Establishmento f a Registry of Official Acts RegulatingBusiness Activity. Implementationo fthe "Guillotine" Law resultedineliminating regulationsno longerneededor without legal standing. B.Improvingtrade Introduction of risk-based selectivity usingAsycuda selectivity module at the 21 facilitation Chisinau Customs terminal. The Moldovan Customs Department introduced risk-based selectivity by using the Asycuda selectivity module. By reducing documentary and physical examination o f imported goods, this contributed to the reduction o f the average monthly import clearance time at their inland terminal o f Chisinau to 70 minutes. C. Developing agricultural Total Liberalization of agricultural exports by making the Universal Commodities markets Exchange voluntaryfor all commodities Government Decision No. 384 was amended making the Universal Commodities Exchangepurely voluntary for all commodities as o f September 30, 2006. Pillar11. ImprovingThe Efficiencyand ManagementOf PublicSector Resources A. Building a meritocratic Adopt a strategy to ensure competitive merit based recruitment of civil servants civil service includingprocedures for open competitionfor vacantpositions, appointments and a system of civil service appeals. Decision o f the Parliament o f the Republic o f Moldova # 1227-XV approved the Concept o f the Personnel Policy inthe Civil Service. Approved central public administration strategy. B.Implementinga First phase of the remuneration reform implemented increasing base salaryfor transparent and uniform civil servants. remuneration system for civil servants The new law on public sector pay approved by Parliament, begins to address the problem o f low pay inthe civil service, The Government decision implementing this law for civil servants was passedinMay 2006. C. Improvingthe Strategic Create levelplayingfield for all agricultural supportprograms. Allocation o f Public Resources - Agricultural Government Decision modified existing procedureshegulations removing all Spending restrictions on access to subsidies and supports based on title, farm ownership structure, or size. D. Public Procurement Increased competitionfor public procurement contracts Increased competition evidenced by a decline in the use o f single source procurement from 51% to 10% o f the value o f contracts awarded, including utilities, and increase inthe use o f open tendering from 28% to 57% o f the value o f contracts awarded A. Completing Pension Continue implementation of individual account system System Reform Program Government reduced data entry backlog o f individual contributions by ensuring that 100percent o f 2005 contribution data submitted to the PensionFund by the submission deadline (March 3 1, 2006) was entered into the computerized contribution database. PillarI:Improvingthe Investment Climate 55. Inanalyzing the policy impediments to growth, the EGPRSP - and the Bank's own analytical work - identifies the following factors as major constraints to private sector development in Moldova: unstable legal and regulatory framework; excessive bureaucracy reflected in the large number o f permits, licenses, and authorizations; and, excessive interventions by control bodies. The recent 2005 BEEPS survey, for example, shows that "uncertainty about regulatory policies" and "business licensing and permits" are ranked among the biggest perceived problems to private sector activity. Given the importance o f the agricultural sector to the overall economy and the preponderance o f the poor that live in rural areas, 22 improving the performance o f the underperforming agricultural sector will be o f particular importance in accelerating growth and poverty reduction in Moldova. This pillar o f the PRSC seeks to help Moldova confront the challenges to economic growth identified in the EGPRSP and address some o f the critical bindingconstraints to growth and poverty reduction. A. Reducing Regulatory and Administrative Costs of BusinessRegulations 56. During the last few years Moldova has simplified business registration and licensing procedures and reduced the required number o f licenses and documents for business registration. These efforts have contributed to a decline in the perception o f corruption in the country, as measured by the decline inthe BEEPSresults on bribes paid as a percent o f sales and the percent o f firms saying unofficial payments are frequent. In 2004, the Government intensified its efforts to improve the business environment by adopting the "Concept o f Regulatory Reform". This strategy established the framework and priorities for implementing regulatory reform, including curbing business inspections, simplifying business licenses and tax administration, and limiting mandatory reporting for statistical purposes. This effort led to adoption o f a more radical law - the so called "Guillotine" law - which mandated a comprehensive review o f business executive regulations and eliminated those regulations that were no longer needed or did not have legal basis. Inparallel, the Government undertook steps to improve quality o f the law making by7 developing a National Regulatory Reform Strategy that targets reform o f the regulatory system. 57. The Government recognizes that, despite these reform efforts, Moldova still has one o f the highest regulatory compliance costs in the region. The EGPRSP stresses the importance o f (i)further streamlining o f business registration, and post-registration procedures o f issuing permits, licenses and similar documents; (ii) continuing o f the process o f reducing the number o f state controls and inspections; and (iii)increasing the efficiency o f paid regulatory services offered by public authorities, by setting fees for these services at cost recovering levels or providing services for free whenever there are no additional costs. The key elements o f the Government strategy will be reflected in a framework law on principles o f state regulation o f economic activity, currently under preparation. The strategy will focus on reducing the cost o f doing business, streamlining and simplifying regulations affecting opening and operation o f business in Moldova, and introducing mechanisms to improve systematically the quality o f new and existing regulations. Ultimately, the strategy will provide an explicit framework to accelerate on-going reforms o f laws and regulations contemplated inthe current government program. 58. The PRSC program will support the government efforts to further reduce regulatory compliance costs. The Government has already made remarkable progress in achieving reform benchmarks supported under the PRSCl. The results o f the Guillotine L a w implementation were reflected in the recently adopted Government Decree N o 1030 on "Establishment o f a Registry o f Official Acts Regulating Business Activity". In parallel, the Government is pursuing a 7 InDoing Business 2007, Moldova's overall global standing onthe ease o fdoingbusiness has declined substantially this year, slipping from 88th to 103rd. Although the decline is relative, reflecting the fast pace o f reforms inother economies and the expanded coverage o f the report, the deterioration is also due to remaining inefficiencies inMoldova's business environment, particularly inthe field o f construction licenses and permits. The report also makes note o f Moldova's recent progress with implementation o f regulatory reform, which due to the timing o f the report, have not been fully reflectedinthe Doing Business rankings. Nevertheless, it i s clear that further reforms are needed to make Moldova's economy more competitive and more attractive for local and foreign investors. 23 systemic approach to the regulatory reform implementation and improvement o f quality o f new legislation by adopting a comprehensive medium-term regulatory reform strategy and enacting a framework "Law on Basic Principles and Mechanisms o f State Regulation o f Business Activity", which has been submitted to the Parliament. 59. For PRSC2 and PRSC3, the Government will continue to implement the regulatory reform strategy. It will complete the review o f existing laws regulating business activities and undertake to further amend its business regulations in accordance with the Government Decree on the results of regulatory review. It will improve the quality o f regulation o f business activity by adopting the Law on Basic Principles and Mechanisms o f State Regulation o f Business Activities and implementing an Action Plan that includes the introduction and use o f Regulatory Impact Assessment (RIA) to the legislative process. 60. At the end o f the PRSC program, based on the implementation o f the regulatory reform strategy, it i s expected that there will be a significant reduction in regulatory compliance costs, as measured by the Cost o f Doing Business Surveys (carried out under the auspices o f the Competitiveness Enhancement Project) and confirmed by Moldova's indices in the Doing Business reports. Specifically, it expected that the average level o f licensing and authorization costs per firm will fall from its current level o f 52 percent o f GDP per capita in 2004 to a level o f around 30 percent GDP per capita. Further, the Government will maintain a frequency o f inspections at an average o f 8 inspections per year - down from its current level o f 12 inspections per year - with the average cost o f inspections per firm at or below 30 percent GDP per capita. B. Improving TradeFacilitation 61. The Moldova Customs Service (MCS) has improved significantly over the past two-three years, aligning legislation and regulations to EU standards, as well as automating the Customs declaration processing in the course o f implementing ASYCUDA-World. Data collected on custom clearance times indicates a significant reduction inprocessingtimes relative to last year. Progress in implementing the TTFSE project holds the promise that recent improvements inthe Customs Service will be accelerated. 62. However, inefficient and costly border procedures still exact a significant cost on businesses that have to use them as well as the authorities that have to administer them. These impediments lead to poor export competitiveness, make the country less attractive to foreign investment, and reduce the ability o f domestic f i r m s to participate in global production networks. Many o f the control mechanisms imposed by Customs and other border related agencies are designed to control fraud and increase revenue collection on existingtransactions. The M C S still collects about 70 percent o f total State Budget revenue, essentially through customs duties, VAT on imports, and excise taxes. Given its importance in mobilizing fiscal revenues, Customs has been under constant pressure to demonstrate its capacity to continue boosting its revenue collections. As a result, the strategy followed by Customs has put a significant emphasis on documentary requirements and checks, and introduced tough measures to address, in the short- term, corruption. Introduction o f risk management and selectivity in the declaration process, and o f targeting in the physical inspection o f goods has been regarded, until recently, as "loosening" the control with the risk o f diminishingthe revenue collection and making room for smuggling. 24 63. In addition to the emphasis on revenue collection, there are currently up to nine agencies present at border crossing points. While one-third o f the border entry processing time i s rightly attributed to the Customs Service, another one-third i s taken by the other agencies that are present at the border (often just to collect fees). In the surveys carried out under the TTFSE project, it i s estimated that about half o f the remaining time spent by trucks at border crossings reflects the poor organization o f traffic flows resulting from the high number o f agencies present at the border. Further, the sporadic unavailability o f staff o f these agencies contributes to unjustified delays o f vehicles and passengers. Consolidation o f these efforts would contribute to greater efficiency and improved trade facilitation. 64. A new organizational structure o f MCS was approved inJune 2005, which includes a dedicated risk analysis unit and a post release audit unit. The current implementation o f a risk management system was augmented by the introduction o f post release audit, both supported by the TTFSE project. This i s expected to lead to simplified and rationalized procedures while increasing compliance by the business community. Enforcement o f the newly approved regulations on Customs Brokers, transit procedures, and Customs regimes will provide for further simplification and transparency, but also leads to a serious restructuring o f the Customs brokers' profession. Implementation o f the above reforms i s meant to reduce clearance and border crossing processes by Customs, thereby reducing the transaction costs o f trade. 65. Under PRSCI, introduction o f risk management and selectivity, using the on-going ASYCUDA-World clearance system, has resulted in further reductions in import clearance times. For PRSCZ and PRSC3, a system o f Customs border and clearance performance indicators and reporting, to be maintained after the TTFSE project closing,8 will be agreed upon, and the number o f control agencies at the border will be reduced in line with EU practice. Customs will collect fees on behalfo f other agencies. 66. The implementation o f the reform program i s expected to reduce the average monthly import clearance time at the main terminal o f Chisinau and the average monthly border crossing entrytime to 30 minutes. Physical inspections by MCS, currently near 100percent, will not exceed 30 percent o f total declarations on a monthly basis. C. DevelopingAgricultural Markets 67. As illustrated above, Moldovan farmers receive less for their outputs and pay more for their inputs relative to international parity prices than they should. This squeezes farmer incomes, reduces the scope for farm restructuring, and decreases returns to factors such as land and labor. The causes for this are various policy distortions and market imperfections that vary by sub-sector. For commodities like cereals and oilseeds, a government requirement that forces all exports to pass through the Universal Commodities Exchange (UCE), which i s dominated by a small number o f multinational agribusinesses, restricts exports and creates a wedge between international and farmgate prices. Domestic wheat prices are also reduced by state market interventions aimed at stabilizing prices for urban consumers, such as profit margin caps on bread and the management o f the state grain reserves. For higher-value agricultural products like fruits, vegetables, livestock products, and wine (which i s the largest export), a major market constraint i s the inability to meet and certify international quality standards. Improving standards * Expected closing date is September 30, 2007 25 will be key to accessing higher-value markets such as EU countries and increasingly even domestic supermarkets. 68. On the input side, much o f the technology in modem agriculture i s encapsulated in advanced seed and seedling varieties. In the case o f Moldova, farmers are being denied this technology through restrictions on imports. Government protects domestic seed producers and research institutes by controlling the importation o f new varieties through a complicated licensing mechanism, including lengthy testing requirements. The reliance on domestic seed monopolies increases costs and reduces farm productivity. Another major constraint i s the lack o f access to credit. This i s being addressed in part through the new World Bank financed Rural Investment and Services Project I1 (RISP 11). However, the long-term viability o f the Savings and Credit Associations (SCAs) being supported under the project depends on strengthening the legal and oversight environment, which i s beyond the scope o f the project. 69. To accelerate and sustain growth in the sector, it i s necessary to complement farm restructuring with measures to improve the functioning o f agricultural input and output markets. Improving market opportunities will be key to increasingproducer prices, farm and farm worker incomes, and to spurring the investment and innovation needed to keep Moldovan products competitive as they access the EUand global market places. 70. The EGPRSP affirms the importance o f these issues and includes objectives to promote sustainable growth by continuing reforms in the sector, and building a strong commercial and institutional framework based on market economy principles. The EGPRSP recognizes that excessive regulation and inconsistent policies and their implementation have created a particularly poor business environment in the agricultural sector. It therefore aims to stimulate private initiative through market mechanisms and liberal agricultural policies. These policies are outlined in the EGPRSP and the Memorandum o f Understanding on Agriculture (MOU) signed with the World Bank in2001. 71. Consistent with the EGPRSP and MOU, Government has largely adhered to market principles by maintaining the Land Code, amending the Law on Production Cooperatives, and generally refraining from setting or influencing prices (with some exceptions). Government has also supported post-privatization agricultural enterprises through RISP project activities like provision o f extension and advisory services, and the formation o f SCAs. However, the commitment to market principles should be deepened in several areas. 72. Under PRSC1, Government will totally liberalize agricultural exports by making use o f the U C E purely voluntary for all commodities. This i s a reform that will affect commodities that represent over one third o f the value o f total agricultural production, and it i s something that can be done at virtually no cost (simply by issuing a decree). To better inform agricultural producers on international market opportunities and trends in commodity prices, Government will begin disseminating information on regional (Ukraine and Romania) prices for cereals and oilseeds in the local media, as a precursor to the development o f its own market information system. The Government has also agreed to undertake a study on improving its policies towards grain price stabilization, including the use o f a profit margin ceiling on bread and the management o f state grain reserves, to see ifpolicies with less distortionary implications can be implemented. 26 73* For PRSC2, Government will conduct a review o f the impact o f its export market liberalization efforts, with an emphasis on cereals and oilseeds. Ifthe review finds that producer prices continue to be depressed relative to international parity prices, PRSC2 will require Government to implement additional measures needed to ensure that farmers receive a fair price relative to international price parity, including transparent mandatory minimum oilseeds producer price formula benchmarked to international prices (to address potential monopsony issues in the market). Government will also undertake and begin implementation o f recommendations o f its study on improving grain price stabilization. In addition, Government will begin implementation o f an Action Plan that will, among other things, cover the liberalization o f the import regime for seeds and seedlings, improvements in the agricultural product standardization and certification system, and the development o f a market information system to include the collection and dissemination o f information on domestic cereal and oilseed prices. To enhance the sustainability o f the SCAs supported under RISP and RISP 11, a new law based on international best practice will be passed to provide for a multi-level o f licensing with correspondingreporting and supervisory requirements and with proper enforcement tools. 74. For PRSC3, the Government will continue implementation o f the Action Plan, including the scaling up o f the market information system to cover all basic commodities accounting for at least 5 percent of value o f agriculture production. Government will also complete the implementationo f the recommendationso f the grain price stabilization study. 75. At the end o fthe PRSC program, it is expected that the gap betweenprices received by farmers and international parity prices (measured by nominal protection coefficients) for cereal and oilseed crops will be reducedby 25 percent - implyingan increase inproducer prices, and hence income, receivedby domestic farmers. Price information on all basic commodities, in both domestic and international markets, will be reported at least weekly-and where possible, daily-in the local media. The liberalization o f the seeds and seedlings market will result ina 25 percent increase in the new varieties registered, with the maximum time to evaluate and test seeds and seedlings reduced to one and four years respectively. D. Reducing Energy Vulnerability 76. The recent increase in energy prices exposed Moldova's high vulnerability to external energy price shock. Due to the near total dependence on imports in meeting its primary energy needs and a relatively high energy intensity of its economy (in terms o f the energy consumption per unit o f GDP), Moldova faces significant downside risks to its economic outlook as the energy prices, and particularly the price of natural gas, continue to increase. Higher oil prices in 2005 and 2006, and the steep increase of the price o f natural gas from $80 to $110 per thousand cubic meters (mcm) in January 2006, are expected to increase the cost o f energy imports from $456 million in 2005 to about $600 million in 2006. While the cost o f electricity imports in 2006 i s expected to remain at the 2005 level (about $62 million), this cost is also likely to increase as the price o f natural gas supplied by Gazprom (Russia) to Moldova and Ukraine continues to approach the European parity price which is currently in the order o f $23O/mcm. 77. Energy sector reforms, which started with the establishment o f an independent energy regulatory agency (ANRE) in 1997 and culminated inprivatization o f about 70 percent o f the electricity distribution market in 2000, prepared Moldova to deal with the energy price shock 27 in the gas and electricity sectors through necessary tariff adjustments and maintenance o f financial discipline. ANRE raised domestic gas tariffs by 37 percent in February 2006, passing the full cost increase o f imported natural gas to the final consumers. This, however, is less likely to happen in the district heating sector (which i s dominated by Termocom - the state-owned company supplyingheat inChisinau) because heating tariffs are regulated by municipal councils. The Government recognizes that the mispricing o f heat supply is the main source o f quasi-fiscal activities in the energy sector (estimated at about $15 million inTermocom) and that heat tariffs need to be adjusted to the cost recovery level in order to return Termocom to financial viability (and enable the much needed capital investments in the sector). At the same time, the Government also recognizes that the rising energy prices require improvements in the social safety net, particularly its better targeting in order to efficiently protect poor households which may require energy subsidies o f about 1.7 percent o f GDP in2007. 78. The Government recognizes that Moldova i s highly vulnerable to energy price increases, and that upward price pressures are likely to be a fact o f life in the coming years. In developing its policy response, the Government also recognizes that: (a) gas imports are likely to continue to play a pivotal role in the energy balance o f Moldova in the long-term; and (b) Moldova has in its hands the task o f reducing its energy vulnerability by improving energy efficiency, reducing energy waste, and developing its own energy potentials - all o f which require significant investments. Therefore, under the PRSCZ, the Government will develop and start implementing a comprehensive energy efficiency strategy including measures to (i) gradually adjust energy tariffs (for gas, electricity and heat) to full cost recovery level; (ii) maintain the highcash collections rates for natural gas and electricity; (iii) Termocom and return Combined Heat and Power plants to financial viability; (iv) develop incentives and other measures to promote and facilitate investments in energy efficiency, energy savings, and alternative (renewable) energy resources; (v) improve targeting and ensure adequate funding for the safety net protecting the poor from the energy price increase; and (vi) improve institutional capacity in the government and ANRE for contingency planning and rapid response to an uncertain evolution o f energy prices inthe medium-term. 79. Oil and gas price pressures are driven by market forces that are essentially beyond the influence o f policy makers in Moldova, except for the policies governing energy (gas and electricity) transits through Moldova. In this area, under PRSC3, the Government aims to establish Moldova as a preferred route for the energy trade between the CIS energy market and the Energy Community in South East Europe (ECSEE), which i s a part o f the EU Internal EnergyMarket. The on-going benchmarking o f the energy sector legislation with provisions o f the ECSEE Treaty will provide a sound basis for adjustments o f the power market design in Moldova, including solutions to (i) cross-border electricity trade and congestion management; (ii)power system balancing and settlement; and (iii)gradual power market opening. Furthermore, the Government and ANRE will adopt an action plan for legal and regulatory compliance o f the Moldova's gas and electricity markets with the ECSEE. Adopting and implementing such an action plan would go a long way inimprovingtransparency and regulation inthe energy sector which are essential inattractingenergy trade and relatedinvestments. 80. A t the end o f the PRSC program, it i s expected that Moldova's energy intensity, measured by the total primary energy use (toe) per $1000 o f GDP at PPP rate will be reducedby 10 percent. Financial discipline in the sector will be maintained or improved, with cash collection ratios about 90 percent for natural gas and above 95 percent for electricity. Further 28 cost recovery o f gas, electricity, and heat tariffs for all categories o f consumers (including households and budgetary institutions) approaches 100 percent, thereby eliminating any source o f quasi-fiscal deficits in the sector. The poverty and social implications o f these objectives are explored inthe Poverty and Social Impact Analysis Section o f this document. Pillar 11: Improvingthe EfficiencyandManagementof PublicResources A. Building a Meritocratic Civil Service 81. Moldova aspires to improve the quality o f the public administration as a measure to deepen the impact o f the government policies and raise quality o f services to the citizens. Since approval o f the law on public service in 1995, the Government o f Moldova introduced elements o f a modern civil service. However, officials agree that the civil service has a deficit o f highly skilled staff capable o f performing analytical work, developing modem legislation, and providing high quality policy advice to the policy-making officials. Raising civil service professionalism in Moldova will require improved civil service training, performance management, and adequate incentives. It i s also important to establish a sound legal protection for unbiased performance o f the civil service duty as required by law, without interference and undue influence. 82. For PRSCl, The Government o f Moldova has adopted a Strategy o f Central Public Administration Reform which sets out an ambitious agenda aimed at modernizing its civil service to. European standards. Competitive merit based recruitment and a sound system o f remunerationlie at the core o f the civil service reform. The approval o fthe new civil service law, which establishes merit principles in recruitment, defines responsibilities to act in accordance with the law, obligations to raise professionalism, and rights for legal and social protections i s the first step supported by PRSC. The Government plans to adopt a Civil Service Law compatible with the international practice under PRSC2. Following the approval o f the law and secondary legislation, the Government o f Moldova plans to progressively introduce appointments to the civil service positions only on a competitive basis and according to merit. By PRSC3, all civil servants appointed to vacant positions will have been selected through competitive procedure. By that time the Government will have established a civil service database which will trace appointments, promotions and career changes o f civil servants. The Civil Service Law shall also establish legal protection o f civil servants against violations o f the law. The central civil service managing body will ensure supervision o f the observance o f the law and will act as a first instance o f appeal for civil servants. 83. At the end o f the PRSC program, all new civil servants to administrative posts in ministries and central agencies will be appointed through an open, competitive, merit based selection process as specified inthe new civil service law B. Implementing a Transparent and Uniform Remuneration System 84. A s noted, public sector wages in Moldova are low. The new Law o f Public Sector Remuneration (2006), which increases the basic salaries for civil servants and differentiates among 23 various salary grades, has begun to addresses the problem o f low pay in the civil service (under PRSCl). However, this new system o f remuneration does not fully resolve several problems: high pay compression; high ratio o f additional payments (base pay is only 25-30 29 percent o f take home pay); weak guidance for managers on how to implement performance related benefits; and a lack o f a central database on pay across the various ministriedagencies. As increments between the salary grades are very small, remuneration does not play a role in career motivation. The difficulty o f introducing a modem motivating pay system in the civil service stems from an ineffective system o fjob classifications and absence o f an analytical basis to establish equitable pay. The factors determining the size o f remuneration for civil servicejobs are not defined. This prevents the decision on salary levels from using sound analytical basis, giving rise to perceptions of imbalance between the pay andjob demands and obligations. 85. The PRSC supports the Government efforts leading towards the modernizing o f the civil service pay system. The Civil Service L a w should clearly define the scope o f the civil service which should cover permanent administrative positions in the public administration. By PRSC2, the Government will develop a modern and efficient system o f classification o f the civil service posts, including criteria for assessment o f posts against a system o f criteria characterizing the job (e.g., required level o f knowledge and skills, managerial and decision-making responsibility, the value of job outputs, etc.). By PRSC3, the Ministry o f Economy and Commerce in cooperation with the civil service management body, should develop (amend existing) legislation which introduces transparent and equitable pay and implementation o f that legislation should commence. 86. It is expected that by the end o f the program, by consolidating multiple salary supplements into the base pay, the size o f the base pay should reach at least 75-80 percent o f the total take-home pay and adequately reflect the value o f the position as measured by views o f staff in annual public official surveys. Further, incontrast to the current situation, information on public sector pay in will be centrally available for review and analysis through the development o f a central financial management information system (under the Public Financial Management (PFM) project). C. Improving the Strategic Allocation of Public Resources 87. Efficient governments allocate public resources to policy priorities to attain decisive impact with government programs. Moldova has been strengthening its resource allocation processes by introducing an MTEF and expanding the coverage o f sectors included inthe MTEF. In2006, the Government included agriculture inthe MTEFresource planning in addition to the existing health, education, and social protection sectors. This priority responds to the sectors relevance to the poverty reduction strategy. For the first time, the 2007-2009 MTEF i s expected to have a technical annex on public investment spending. Thus, Moldova has increasingly focused its public expenditure planning, thereby facilitating the more effective allocation o f resources to EGPRSP objectives. As part o f PRSCl, the MTEF framework will be approved by the Government and submittedto Parliament for information inadvance o f the 2007 budget. 88. The Government realizes that the effectiveness o f the MTEF process can be improved if the policy priority framework i s agreed in advance o f the MTEF planning. Therefore, under PRSC2, the Government has agreed to strengthen the central policy coordination capacity to facilitate Government's agreement on the policy priority framework early in the MTEF process. Currently, the Ministry o f Economy has developed a policy unit charged with coordination o f implementation o f the EGPRSP. This unit has introduced quantitative monitoring indicators and prepares a report for the Parliament o f implementation o f 30 EGPRSP objectives. Similar policy capacity i s being established in six line ministries. The Government agreed that the policy prioritization function should be raised from the administrative level to the Cabinet level. This will allow for the development o f political consensus on policies and help turn the budget into a more effective anti-poverty policy instrument. 89. The Government has already committed to establishing a central policy unit directly reporting to the Cabinet o f Ministers (in the Government Strategy o f Central Public Administration Reform). The Government has now committed itself to establishing a similar policy unit inthe Government Apparatus. It i s expected that under PRSC2 the Government will develop and adopt a legal framework underpinning policy coordination. By PRSC3, the policy unito ftheGovernment Apparatus will have reachedits operational capacity necessaryto prepare a proposal on policy framework to be approved by the Cabinet of Ministers as a guiding document for MTEF. In the meantime, the Ministry o f Economy i s acting as a policy coordination center for EGPRSC and EU-related priorities. As the capacity o f the Central Policy Coordination unit in the Government Apparatus reaches adequate level, they will provide strategic and day to day support to the Cabinet policy decision-making. 90. K e y to the improved allocation o f public resources i s the effective and efficient management o f public investment. While there has been improvement in public investment management processes inrecent years, much work i s left to be done. Inparticular, there i s a need to better integrate externally financed projects, centralized investments, and other sources o f public investment into a single common public investment program, as part o f the MTEF process, with a common procedure for the identification, prioritization, preparation, and appraisal o f projects. Public investment decisions also need to be better supported by economic feasibility studies that elaborate on the economic rationale for investment projects, their projected impact, and whether the outcomes are achieved at lowest cost. To improve the allocation o f scarce public resources and sharpen the strategic focus o fpublic investment, PRSC2 and PRSC3 will support, on a pilot basis, the Government efforts to implement new procedures for public investment decisions. 91. By the end o f the three-year PRSC program, the strategic focus o f annual budgets will be improved by the stronger linkage between the MTEF and annual budget laws. Moldova should also expect to see increased use and awareness o f economic cost-benefit analysis in the public sector leading to improvements in the quality o f public investment projects selected for funding. 92. Restructuring Public Expenditures. Since 2000, the Government has placed a heavy emphasis on increasing social spending - pensions, social assistance, education, and health spending comprise over 65 percent o f total general government expenditures. With fiscal resources scarce, improving the efficiency and targeting o f social spending, particularly in the education and health sector, will be required if the government i s to achieve the growth and poverty reduction objectives o f the EGPRSP. Sustained economic growth will also require more pro-growth public investment spending, particularly on the transportation infrastructure, and an improved allocation o f agriculture spending to enhance long runcapacity inthat sector. 31 C.1Agricultural Spending 93. Since 2001, farm restructuring has stalled, with approximately 50 percent o f agricultural land being used by large, corporate farms that are largely unreformed since the Soviet collective farm period. These corporate farms are less efficient than individual farms, and often operate at a loss. To spur growth and poverty reduction in agriculture, the natural process o f land flow to the more efficient individual farms should be re-energized. This process i s currently being blocked by government efforts to preserve corporate farms through policies and public expenditures that allow the accumulation and writing o f f o f debt and channel subsidies to large farms. By removing these blockages, the PRSC will facilitate continued farm restructuring. It will also help to create the fiscal space necessary to provide the growth enhancing public services and investments required to increase the competitiveness o f the new class o f independent family farmers. 94. Over recent years, the size and variety o f product- and input-specific subsidies to the agricultural sector have been growing rapidly. This i s often done without apparent strategic planning or prioritization in line with the EGPRSP and MTEF. The subsidy programs also vary from year to year, and actual amounts allocated from the budget can be changed rapidly and can vary significantly from plan. For example, subsidies under the Agricultural Support Fund(ASF) alone grew from MDL 36 million in 2004 to MDL 180 million in2005 (compared to a budgeted amount o f MDL 60 million), and increased again in the 2006 Budget to MDL 220 million. This represents an increase o f over 500 percent. Inaddition, the nature o f subsidies has changed over time. While the ASF began by providing credit subsidies that were open to all farmers, more recent subsidies such as those for Machinery Technology Stations (MTS) and plantation o f vineyards and orchards are geared towards large, usually corporate or cooperative farms. For 2006, the Agricultural Support Fundincreases Government participation in "picking winners" by subsidizing the production o f specific crops, such as sugar beet and tobacco, where Moldova probably does not have a comparative advantage, and which are primarily grown by corporate farms. The majority o f subsidies for 2006 (MDL 145 million) will go towards the purchase o f inputs like fertilizers and pesticides. Such programs do not have a track record o f supporting long-term growth. The Government recognizes the need to reduce such subsidies and use the resulting fiscal space to increase investments in sustainable growth-enhancing measures such as development o f standards, research, extension, agricultural education and training, and investment inmarket infrastructure. 95. Under PRSC1, the Government has refrained from providing any debt relief for agricultural enterprises/producers, except in the case o f one-off relief for firms undergoing privatization. This will force the large, corporate farms that are inefficient and poorly managed to restructure. The Government has also removed all restrictions on access to subsidies and supports based on farm ownership structure or size, which will reduce the current bias towards large farms, increase opportunities for individual farms, and further promote restructuring. 96. For PRSC2 and PRSC3, Government will begin restructuring o f agriculture expenditures by significantly increasing expenditure on growth-enhancing services, as a percentage o f total agriculture expenditures, over the next three to five years and by reducing the corresponding share o f subsidies. Within the diminishing expenditure share for subsidies, priority will be given to measures that demonstrably enhance the long-run productive capacity o f the sector by supporting the creation o f long-lived assets, for example, new vineyards, orchards, new genetic livestock strains, etc. The share o f purely recurrent subsidies, such as product or 32 input subsidies, will be correspondingly reduced. Further, Government will develop and begin implementing an Action Plan to streamline and modernize the agricultural research, training, and education system that will include: international benchmarking; rationalization requirements; and examination o f land and funding needs. Government will also undertake an evaluation of the existing anti-hail rocket system (which now consumes a large portion o f the Agriculture budget) and alternative measures. 97. At the end o f the PRSC program, the share o f subsidies in total agriculture expenditures will be substantially reduced (from 43 percent of the budget in 2006 to 30 percent inthe 2009 budget). Correspondingly, within the subsidies category, the increase inthe share o f capitalhnvestment expenditures will increase to 90 percent o f total subsidies by the 2009 budget. C.2TransportationInfrastructure 98. The rapid deterioration o f Moldova's transportation infrastructure over the transition period has significantly increased the cost and reduced the quality o f transportation services with a particularly strong impact on the country's poor. The deterioration in public infrastructure i s particularly noticeable in the road sector, where over 86 percent o f the national road network has passed the economic lifespan and some 27 percent i s in need o f urgent rehabilitation due to very bad technical condition. Currently, the annual budget for road maintenance represents only about ten percent o f the needed expenditure. The State Road Administration (SRA) within the Ministry o f Transport and Communications still operates based on the Soviet model, with no clear separation o f planning, procurement, and supervision o f road works. The present overall situation i s hindering the development o f a strong private road construction industryand impeding the efficient use o f the scarce state budget resources for road maintenance and rehabilitation. While the volume, cost, and schedule o f works are defined by contractual agreements between SRA and contracting companies, the efficiency o f these companies i s limited due to the lack o f competition inthe contract award process, and also due to the absence o f a clear linkage between results andpayments. 99. PRSCZ will support the EGPRSP objectives o f improving the effectiveness o f road works contracts for maintenance, repair, and rehabilitation through the preparation o f a road sector strategy that will include a reform o f road financing, introduction o f participation of road users inthe oversight o f road maintenance financing, and increased competition inthe execution o f road maintenance, repair, and rehabilitation contracts. Under PRSC3 the above mentioned transport strategy and related legislation on road financing reform will be approved and adopted bythe Government. 100. By the end o f the PRSC program the actual funding for road maintenance, repair, and rehabilitation included inthe MTEF (to at least $50 million) will be significantly increased and [some percentage of] civil works contracts will be awarded competitively. C.3 Spending on Education 101. Moldova's public expenditure on education, currently 7.3 percent o f GDP in 2005, is comparable to OECD and upper-middle income countries. However, there are a number o f inefficiencies and inequities confronting this sector. In terms of access, Moldova i s lagging behind many o f its neighbors. Inequities between income groups are acute, with the problem even more pronounced ifone makes the distinction betweenurban and rural students. 33 102. Inefficiencies, mainly resulting from the slow adaptation o f education expenditures and norms to changing demographics, are reflected in the fall in average studentheacher ratios over recent years. Similarly, the average school size i s lower than a few years ago with large variations in school sizes across the country and between urban and rural areas. A continuing anomaly in Moldova's education system i s the large number o f non-teaching relative to teaching staff (non-teaching staff represent 37 to 48 percent o f total staff compared to 27 percent in OECD countries). Another example o f inefficient spending is high heating costs in education - the result o fthe highprice o f energy on localmarkets, but also the poor insulation o fmost school buildings and the large amount o f space per student. While the number o f students in each school i s falling, the size o f school buildings remains the same with average space utilization expected to fall to 50 percent by 2010. 103. The inefficiency inthe public finance o f education is partly due to the methodology for allocating budgets to schools. There i s little wrong with the per capita financing formula used, which i s essentially one o f "money follows the student", with per-student allocations coming from the state budget. The problem i s that school directors are not allowed to use their allocation flexibly - the amount that they must spend on salaries i s determined by the number o f teaching hours in their school which i s inturn determinedby the number o f classes (however few students they may contain). Insome schools with very small classes, the salary bill (based on the number o f classes) thus exceeds the total allocation (based on the number o f students). Inmany schools, the high wage bill leaves little or no public money for furniture, materials, repairs, etc. The formula funding system is generating signals but they cannot be acted on. As a result, rayons, mayors and schools have to search for ways to make up for the shortfall, including mayor and village budget resources, local taxes, and extra-budgetary revenues, and the growth o f "unofficial payments" from individuals i s tolerated. 104. To improve education quality and reduce the urban-rural gap, the government program aims to start optimizing the school network and increasing efficiency o f spending. At present, a school mapping exercise i s being conducted to provide a solid information-base for improved resource planning. For PRSC2, based on the completed school mapping exercise, a strategy to optimize school networks will be developed. The strategy will, among other things, identify schools for optimization, define efficiency target indicators, and pilot a new funding formula. For PRSC3, the Government will begin implementation o f the optimization strategy covering at least 20 percent o f identified schools and allocating school budgets under the revised fundingformula to pilot schools. 105. By the end o f the PRSC program, studentkeacher ratio, studenthon-teacher ratios, and the share of expenditures on non-wage quality related items (e.g. textbooks, learning equipment, teacher training, etc.) will have increased inpilot schools. C.4.Spendingon Health 106. Moldovan health sector was pushed into reforms as a result o f the economic crises o f end 1990s, which saw public health expenditure fall to 2.9 percent o f GDP in 1999-2000 and real public health expenditure per capita to US$lO, much below regional averages. The Government responded to financial crisis by closing unnecessary health infrastructure, and emphasizing more cost-efficient service delivery at primary care settings. Public health expenditure increased to 4.3% o f GDP in2005, the Government has initiated a public investment program to modernize hospital equipment, and has spent more on primary care with the 34 assistance o f donor funding (IDA, Dutch and Japanese Government). The reform agenda however i s still incomplete and has not yet achieved the original aims o f equitable coverage o f the country with good quality primary care. The current set-up o f health service delivery by Rayon Health Authorities, providing both primary as well as hospital care, allows for cross- subsidies to hospitals from revenues intended for primary care services, weakening primary care and covering inefficiency in the hospital sector. The number o f vacancies in rural health centers i s continuously high, with 10-25% vacant family practitioner positions based on the current norm o f 1500 persons per doctor. Direct contracting with autonomous primary care providers would increase efficiency and transparency inthe health sector. 107. The increase in public health expenditure is mainly due to the launch o f health insurance in2004, with the Government contributing for non-working population groups such as the pensioners, children, and students. The health insurance coverage i s estimated at 83-84% o f residents, but rayonhealth authorities provide considerably lower estimates at 60-75%. The main coverage gaps are among the rural population and urban self-employed, both connected to contribution collection capacity. Therefore, although the Government contributes to the health insurance scheme for the non-working population, there i s still considerable risk o f poverty to cost of illness among the rural population and the self-employed. 108. The Government intends to pursue reforms to increase equity and efficiency in the health sector. In support o f this objective, under PRSC2 and PRSC3, the Government will maintain at least 30% allocation to primary care from the Health Insurance (HIC) budget. Further, under PRSC2, the Government will (a) prepare a procedure for direct contracting with primary care centers, and (b) will develop a strategy for increasing health insurance coverage, including measures for strengthening collections and information campaigns on insurance benefits. Under PRSC3, the H I C will contract at least 5% o fprimary care providers directly. D. Public Procurement 109. Given the fact that most countries spend from 5 to 15 percent o f their GDP on public procurement, the World Bank and international and bilateral donors firmly believe that establishment and maintenance o f an efficient public procurement system can help achieve substantial savings in public expenditure in Moldova. The Bank has been actively involved in supporting public procurement reform in Moldova since 1997 when, with the assistance o f the Bank, a law was enacted on Procurement o f Goods, Works, and Services for Public Needs (No. 1166-XI1 dated April 30, 1997). Since then the Bank has remained engaged in assisting the Government improve public procurement, most recently through an IDF Grant to the public procurement agency. Throughout this time a steady improvement in some aspects o f public procurement has been observed while at the same time a distinct deterioration inthe institutional framework has occurred. 110. Under PRSCl, competition for public procurement contracts was increased with a significant drop in the number and value o f public procurement contracts awarded using sole source and a steady increase in the number and value o f contracts awarded through open tendering. However, there i s still some progress that can be made to reduce the amount o f restricted tendering. 35 111. Under PRSC2, the Government will address the pressing need to reform the institutional framework by reestablishing the Public Procurement Agency as an independent entity under the Cabinet o f Ministers, responsible to the Prime Minister. This will be coupled with a steady increase in the human resources o f the Agency from the present 7 persons to a maximum target o f 35 persons by the time o f PRSC3. At the same time, the Agency may establish a moderate regional presence with small offices in the north and south o f the country. The newly reestablished Agency should develop a clear Action plan covering 2006-2010 (ratified in time for PRSC2) which should cover items such as: development o f the Agency, development o f a national training and certification program with at least 80 persons trained by PRSC3. 112. By the end o f the PRSC program, the level o f sole source procurement and open tendering will remain below 10 percent and will rise to at least 70 percent, respectively. If additional effort i s made to increase open tendering to 75 percent by the end o f the PRSC program, then Moldova could become rated "A" under the PEFA Indicator-19 (Competition, value for money and controls inprocurement). Pillar 111: Strengthening Pensionand Social AssistanceSystems A. CompletingPension System Reform 113. Although the administration o f the social insurance system has improved in the last three years, outstanding issues still need to be addressed. The 1999 reform o f the pay-as-you-go pension system has met some o f its short-term objectives, such as makingpension payments on time, in-cash (as opposed to in-kind),and without the need for budget transfers. Pensionreform, however, remains incomplete and the general pension law (1999) i s not being fully implemented. The EGPRSP lists the following four areas as major unfinished business: (i) financial stability o f the (pension and social insurance) system; (ii) fragmented and non-uniform pension legislation; (iii)significantand,inmanycases, unfairredistributionofresourcesamongdifferentcategories o f insuredpersons; and, (iv) relatively low levels o fpensions and indemnities. 114. The 1999 reform law mandated that pension payments be made based on actual paid contributions rather than on stated wages to reduce uncertainties o n revenue-expenditure gap, increase transparency, and improve equity. Nevertheless, this reform objective has not yet been completed. Originally, the contribution-based pension payment was planned to start in January 2005. While the National Social Insurance House (NSIH) has progressed in developing the IT system, supported by the Social Protection Management Project, the contribution data entry into the system has experienced significant delays. More than a year after the original target date, 75 percent o f the needed data has been entered. Although the recently initiated scheme o f submitting contribution data through electronic formats i s an indicator o f positive progress, the contribution-based pension payment i s not likely to start until after January 2007. 115. Other major issues in Moldova's pension system include the pension privileges for certain categories o f the population and certain sectors as well as agricultural pensions. Privileged pensions are in effect for several groups in the population, including the military, prosecutors, civil servants, Chemobyl liquidators, and members o f Government. These pensions are considerably higher than those received by general pensioners. These special pensions are received by roughly only 2 percent o f old-age pensioners but amount to about 14 percent o f public expenditures. Although the Government has not introduced new categories o f privileged 36 pensions, eligibility criteria have been somewhat loosened during the recent years. Because the beneficiaries o f the privileged pensions are socially and politically influential, phasing out o f the privileges has been difficult. Consequently, the privileged pension expenditures are increasing. 116. Issues relating to agncultural pensions are even more complex. There i s a substantial redistribution from non-agricultural workers to agricultural workers. Currently, agricultural workers contribute 20-22 percent o f their wages to the pension scheme while their pensions amount to nearly half o f all old-age pension expenditures. This problemwas not solved through the 1999 pension reform, even though agncultural pensions were reduced to 85 percent o f those o f non-agricultural workers. Contributions for agricultural workers are set at a very low level. 117. To continue pension reforms, the Government plans to: (i)implement the contribution-based pension payment benefits; and (ii) unify the pension system for all types o f pensioners (non-farmers, farmers and privileged). Under PRSCl, the Government has: (i) reduced data entry back log o f individual contribution so that 100 percent o f 2005 contribution data submitted to the Pension Fund has been entered into the computerized contribution database; and (ii) developed an agricultural pension reform strategy. 118. For PRSCZ, (i) the pension law will be amended to enable pension payments to be made based on individual pension contributions; and (ii) the Government will adopt a strategy to unifythe pensionsystem for all types o fpensioners (non-farmers, farmers andprivileged). Under PRSC3, the Government will begin: (i) pensions based on contributions registered in the paying individual accounts; and (ii) implementing the strategy to unify the pension system. 119. At the end of the program, (i)individual accounts will have been established for 100 percent o f all known pension contributors, meaning that all contribution data (declarations) received by the Pension Fund will have been entered into the computerized contribution database; and (ii)correlation between contributions and payments will have increased for all types of pensioners (targets to be determined during appraisal). B. Enhancing the Distribution Efficiency of Social Assistance Benefit 120. Today Moldova's social assistance system consists o f some 13 types o f cash benefits. The largest o f all i s the energy and housing subsidy called "nominal compensation", which is meant to be targeted towards the poor and vulnerable households. The total expenditure has averaged slightly above 200 million lei/year for approximately 250,000 beneficiaries. The "nominal compensation" transformed the former system o f privileges into a categorically targeted program focused on relatively more vulnerable population. In light of recent and projected increases in energy prices, this program could have a critical role in reducing the adverse shock on the poor and the vulnerable (A PSIA analysis on this impact has been undertaken). 121. One o f the major issues in Moldova's social assistance system is the targeting efficiency. "Nominal compensation" and all other social assistance programs employ some form o f categorical targeting. However, Type Iand Type I1errors both appear to be high. Over the last few years, it i s estimated that the poorest 20 percent o f the population have received only 6.6 percent o f total social assistance benefits. It was also estimated that roughly 45 percent o f the 37 benefits are received by the non-poor. Given the extent o f in-kind and informal income in Moldova, any type of income targeting is likely to lead to substantial errors o f inclusion; thus some type o f categorical targeting may be a necessity. Nonetheless, it i s still necessary to improve the targeting o f social assistance programs to ensure that they are focused on the poor and the vulnerable. 122. Another major shortcoming i s weak record keeping and information sharing across the various social assistance programs. At present, social assistance programs are administered by several government agencies, including NSIH, Ministry o f Health and Social Protection, Territorial Social Assistance Offices, and Territorial Social Insurance Offices, each o f which has independent beneficiary registries and payment databases. The existing arrangements make it very difficult to assess the overall impact and effectiveness o f social assistance programs to the government. They also make it more difficult for the poor and the vulnerable to access social assistance programs. 123. To improve targeting o f social assistance programs and gain efficiency in program administration, the Government's reform agenda focuses on: (a) developing and adopting a strategy for improved targeting for social assistance programs, in particular, the "nominal compensation" program; (b) undertaking a financial and impact assessment o f social assistance programs; (c) developing and implementing an information system for improved record keeping and information sharing; and (d) consolidatinglrationalizing the administration o f social assistance programs. 124. Under PRSC2, the Government will: (i) adopt a time-bound social assistance reform action plan for improved poverty targeting including converting some o f the categorical targeting to mean-tested ones, and (ii) design a unified database o f the beneficiaries o f cash-equivalent social assistance programs. Under PRSC3, the government will: (i) begin the implementation of the action plan; and (ii)start the installationo f the unified database. 125. By the end of the program, it is expected that the share o f poverty-targeted social assistance program budget inthe total social assistance program budget will have increased. VI. OPERATIONIMPLEMENTATION A. POVERTY AND SOCIAL IMPACT ANALYSIS 126. The PRSC team has endeavored to assess the likely distributional consequences of major policy reforms supported by the proposed credit on the welfare o f different stakeholders, with a special focus on the poor and vulnerable. While such policy reforms are aimed at promoting efficiency in the use of public resources, accelerating economic growth, and fostering poverty reduction, particularly in rural areas where the poorest households reside, adverse distributional consequences inthe short-run are nonetheless possible inat least three components o f the proposed operation. These include interventions aimed at achieving the following: (i) supporting the Government's efforts to maintain cost recovery energy tariffs by continuing to allow full-pass through o f energy price increases; (ii)implementing the strategy for optimizing school networks; and (iii) capping budget share o f expenditures on agriculture subsidies. Inlight o f these potential social consequences o f reform, recent analytics on the social impact o f rising energy prices, options for reform inthe education sector, and mitigation measures for easing the 38 reform process have informed the PRSC preparation process. The PRSC team has also been in close consultation with Government and other key stakeholders, along with the donor community, to discuss the preliminary findings from these analyses. 127. Raising energy tar$i to cost recovery levels. Allowing energy tariffs to rise to full cost recovery levels and facilitating a full pass-through to consumer o f recent energy price increases-while maintaining hard budget constraints on energy producers, suppliers, and consumers-can promote energy conservation, energy efficiency and investment in the modernization o f utility assets. The government has in place a social assistance system, including natural gas and energy compensation, to assist poor and vulnerable households. In 2005, about 2 percent o f GDP was allocated toward social assistance, with utility subsidies accounting for 40 percent o f this amount. And while cost recovery tariffs for natural gas have beeninplace since 2000, a lifeline tariff also covers monthly consumption up to 30 cubic meters. The budget for natural gas and energy subsidies has been increased in response to the price shock. The government has indexed its budget allocation for natural gas and energy compensation (including subsidies for firewood and charcoal) to offset the two rounds o f gas price increase and protect recipient households from the gas price shock in 2006. In particular, the government recently allocated 15.7 million lei in additional funding for gas and energy subsidies, to account for the recent increase innatural gas prices inJuly. 128. However, given that the Government maintains a categorical targeting system, in the short-run such a reform program may have unfavorable social implications. In the recent World Bank "Note on the Impact o f Energy Prices Changes inMoldova", which was deliveredto the Government and discussed at a press conference during the pre-appraisal mission, the analysis indicated that higher energy costs have had a significant impact on the poor since these consumers have little capacity to reduce already low demand inresponse to rising energy prices.' Further increases inthe cost of energy will certainly create additional pressure on the budgets of the poorest households. The note calculates that the likely fiscal cost o f protecting the energy consumption o f the poorest households i s within the current spendingenvelope. The PRSC team, drawing from the results o f this analysis and a chapter on social protection (in the forthcoming Public Finance Review), has also encouraged the government to develop better targeted social safety nets for the most vulnerable groups in the economy. A pilot program for means-testing i s currently underway. The impact on vulnerable groups will be monitored using quarterly Household Budget Surveys. 129. Optimizing the school network. The proposed operation supports an educational reform strategy that involves piloting the optimization o f the school network to promote more efficient use o f public resources in the education sector by decreasing the share o f non-teaching staff in total employment, lowering overhead costs, and bringing pupil-teacher ratios closer to international (e.g., OECD) norms. However, such an optimization program may generate fiscal savings that may be allocated toward quality-enhancing education inputs (such as textbooks), but may have important social consequences as well, at least in the short-run. For example, the program may lead to greater out-of-pocket payments for selected households or communities (e.g., to pay for commuting costs), particularly in the rural areas. There may also be nontrivial See Iaroslav Baclajanschi, LawrenceBouton, Hideki Mori, DejanOstojic, TarasPushak, and ErwinR. Tiongson, "The Impact ofEnergyPrice ChangesinMoldova", World Bank PolicyResearchWorking Paper No. 3960, July 2006. 39 public employment losses (and subsequent pockets o f political resistance against) associated with such a program. Inaddition, the reformprogram may need to take into account variations in local capacity for managing mergers, as this may lead to increases in geographic disparities in school quality. The forthcoming Moldova Public Finance Review on the education sector calculates the fiscal savings from such a strategy, but nets out the cost o f protecting the access to education services o f the poorest households by subsidizing commuting costs and the cost o f providing separation packages to retrenched staff. 130. Capping budget share of expenditures on agriculture subsidies. Government expenditures on agnculture are relatively low in Moldova compared to other countries in the region. Further, there i s little or no empirical evidence indicating that subsidies for agricultural inputs such as fertilizer, irrigation operations, energy, and pesticides have benefited the poor. Indeed, the Government's restrictions on these subsidies by farm size suggest that these benefits were received by larger (i.e. wealthier) farms. The proposed operation i s supporting the restructuringo f agricultural expenditures by redirecting expenditures on agriculture product- and input-specific and insurance subsidies towards growth enhancing measures, including agriculture services and capital expenditureshnvestment. With restrictions on farm size removed, these new expenditures will likely benefit small (i.e. poorer) farmers. B. IMPLEMENTATION, MONITORINGEVALUATION AND 131. The administration o f this credit will be the responsibility o f the Ministry o f Finance. To facilitate program implementation and the coordination o f activities, the Government has appointed an Inter-ministerial Steering Committee chaired by the First Deputy Prime Minister. This Committee is composed o f representatives o f key Ministers. The Steering Committee will be assisted by a Technical Committee comprising high level staff from various line ministries, including the Ministries o f Agriculture and Food Industries, Economy and Trade, Education, Finance, Industryand Infrastructure, Health and Social Protection, Transportation and Telecommunications, and the Moldova Customs Service. 132. A multi-donor supervision effort will be aligned with the existing government-led monitoring and evaluation system for the EGPRSP, the Moldova-EU Action Plan and the MTEF. The Steering Committee will be responsible for monitoring the PRSC program and all benchmark and outcome indicators. These benchmarks and indicators can be found inthe PRSC Policy Matrix in Annex 2. The specific benchmarks and outcomes to be monitored have been drawn from the Government's overall development program, thus providing significant benefits inreducing transaction costs for the Government. The overall reform effort will be reviewedby the Government in close coordination with regular multi-donor missions to ensure continued implementation o f the program within an adequate macroeconomic policy framework. Given satisfactory progress, Moldova's reform program will be supported by subsequent PRSCs under the programmatic lending framework, subject to the approval o f the Board o f Executive Directors. C. FIDUCIARYASPECTS 133. Pubic Financial Management (PFM). Strengthening public financial management is an important part o f the public sector reform component o f the EGPRSP. The PFM section o f EGPRSP largely incorporates recommendations o f a series o f diagnostic reports (Public Economic Management Report (PEMR), Country Financial Accountability Assessment (CFAA), 40 Country Procurement Assessment Report (CPAR)) produced in close collaboration with the Government. The priority areas o f activity under the Government PFM reform strategy include: (i) improvingpublic resource allocation by introducing modem budget preparation practices; (ii) strengthening financial discipline by modernizing the treasury system and budget execution procedures; (iii)improving public debt management to minimize debt service costs; (iv) improving fiscal administration and increasing the effectiveness o f financial controls; (v) increasing the efficiency o f budget management through introduction of an integrated financial management information system; (vi) harmonizing the budget and fiscal legal framework with EuropeanUnion standards. 134. The progress achieved in implementation o f the strategy by the end o f 2005 i s captured in the PFM performance report based on the PEFA (2006) methodology through a multi-donor effort. The overall conclusion o f the report i s that weaknesses in the current PFM system in Moldova are mainly due to institutional capacity issues typical for a country in transition. The fiduciary risk assessment annex to the report notes that Moldova remains a high risk country but has good chances to improve its rating to "medium" risk provided ongoing reforms are implemented effectively and efficiently. The progress achieved in the main areas o f PFMreforms and the remainingweaknesses are summarizedbelow. 135. Budgeting. The Government has been undertaking noticeable efforts to consolidate the budget formulation process to address the PEMR and CFAA findings on its fragmentation. The Law on budgetary system and budgetary process was amended in 2004 to introduce the concept o f National Public Budget". The MTEF, introduced in 2002, has a three year time horizon and i s updated annually on a rolling basis. It integrates with the national public budget framework approved by the Government at the inception phase o f the annual budget cycle. Extra-budgetary means and extra-budgetary funds (amounting to less than 10% o f Central Government budget) are integrated in the MTEF and the annual budget documentation. The PRSC supports further development o f the strategic focus o f the MTEFthrough establishment o f a central policy unit to support the Cabinet o f Ministers in defining medium-term policy priorities. The remaining weaknesses inthe budgeting area noted inthe PEFA report include the need to maintain adherence to the existing budget calendar and improve expenditure planningat the line ministry level linking it to sectoral policy priorities. Further strengthening o f budget formulation methodologies i s a component o f the PFMproject currently under implementation. 136. Internal controls over the budget execution. Moldova has made important progress in developing the national treasury system. Controls over budget execution have been significantly strengthened through gradual expansion o f the treasury coverage that started in 1997 with the state budget only and has now expanded to include the budgets o f territorial administrative units, extra budgetary funds and means, and the revenues o f the social and health insurance budgets. Expenditures o f the latter two budgets, as well as the donor financed contributions to investment projects, however, remain outside the treasury operations. This i s an area requiring further improvement in the treasury coverage. The PEFA report identifies a number of weaknesses related to treasury operations. The proper model of the treasury single account is missing at the moment and i s being developed under the PFM project, and also being monitored by the IMF under the new PRGF program. The PEFA report also points to a need for loThe national public budget is composed of: (i)Statebudget; (ii)State Social Insurancebudget; (iii) budgets of adminishative- territorial units; (iv) funds for compulsory insurance for medicalassistance. 41 further improvements in cash management and forecasting. Until 2006, no regular cash forecast updates were prepared, but the practice was improved this year through introduction o f monthly updates (part o f the CAS high case triggers). The solution still has to be found on the mode o f communication o f the cash availability information to the spending units that could prevent them from creating unfunded commitments and generating arrears. Improvements are also required in monitoring o f arrears, as information on the arrears' age profile i s unavailable. All o f the above weaknesses are being addressed under the PFM project. PEFA report also notes the relative weakness o f the treasury controls over payroll expenses, which i s relying primarily on integrity o f accounting staff o f spending units (since the payroll function i s performed by each individual spending unit using either manual calculations or separate isolated IT modules, payroll lists are not reconciled with personnel data). The FMIS being designed under the PFM project envisages a pilot payroll module as a first step inaddressing the weakness. 137. Procurement. The 2003 CPAR concluded that the public procurement system was weak and needed substantial strengthening. Single Source Tendering (SST) was happening "far too often, often in contravention o f the procurement law". In 2001, it was reported that 67 percent o f all contracts used SST. CPAR recommendations formed the basis for the improvements undertaken by the Government in the procurement domain in the last several years (part o f the CAS high case triggers). The Public Procurement Law was amended and the Public Procurement Agency was authorized to register contracts before they can be processed by treasury, with particular attention paid to SST cases. As indicated by the PEFA report, based on the data for 2004-2005, the SST practice has been significantly reduced (SST cases accounted for 8 percent o f the total number o f contracts and 10 percent o f their overall amount in 2005), while the percentage o f contracts awarded usingopen tender procedure reached 22 percent o f the total number o f contracts and 57 percent of the overall amount in 2005. With the assistance o f the Bank IDF, the new Public Procurement law was drafted (but i s still to be approved) to bring Moldova closer to the international standards in this area, and capacity building activities for public procurement agency and spending units were conducted.'' There remains, however, a concern about the sustainability o f the progress achieved, related to the lack o f clarity on the status o f the Public Procurement Agency. Its recent merger with the Agency for Material Reserves, Public Procurement and Humanitarian Aid has created a direct conflict o f interest undermining the independence o f the public procurement function.l2The PRSC program supports measures to improve public procurement through: (i) enactment o f the new Public Procurement Law13, including provisions for independent Public Procurement Agency; (ii) further decreases inthe number and value o f contracts under SST, and increases inthe number o f contracts and value o f contracts awarded by open tender. 138. Accounting and reporting. The Government i s preparing for important changes in public sector accounting and reporting in the context o f the PFM project. The new integrated budget classification and chart o f accounts system i s being developed on the basis o f the `I The main activities supportedby IDF Grant were: (a) Creation of Agency's and spendingunits' capacity through TA and training:(i)trainingof Agency staff in English; (ii) developmentof trainingcurriculumfor professionalprocurement,to be providedin local institution; (b) Developmentof legislativeframework in procurementaccordingto WTO requirements;(c) Computerizingof public procurementfunctions, including using of internet for publishingandaccessingof informationrelatedto public procurement:(i) web-sitedevelopment; (ii) developmento fperformancemeasurementmethods; and (iii) developmentof nationaldatabase relatedto performanceofpublic procurement. ''Thismerger was part of the inceptionphaseof the Governmentprogramofpublic administrationreform, which started with reorganizationof centralgovernment agenciesand personnelcuts. l 3Draftedwith IDF assistance. 42 GFS2001 standards to be launched with the new FMIS.The existing budget classification, which i s broadly compliant with GFS 1986, i s expected to be in use at least until 2008. There i s an ongoing program to replace, within the same timeframe, the multiple versions o f the chart o f accounts currently in use by different levels o f budget entities with a unique chart o f accounts compliant with cash-based IPSAS. The Ministry of Finance is also developing a strategy to introduce accounting standards for the public sector and sequence accounting reforms. It i s expected that in the medium-term the Government will maintain cash-based accounting for the treasury and modified cash based accounting for the budget institutions. The new FMIS will enable the Government to produce consolidated financial statements showing financial position o f the Government, and not only the budget execution reports, as i s the practice at the moment. 139. Internal auditing. The internal auditing function o f the Government i s at an early stage o f its development. Small internal audit units have been established in the Ministry o f Finance (MOF), State Tax Service, Customs and National Social Insurance House. In addition, there i s a Control and Revision Service (CRS) under the Ministry o f Finance. Inmost cases, the CRS i s performing ex-post verification o f budget execution. Development o f the modem internal audit function within the Government is a component o f the PFMproject. 140. External auditing. PEFA report mentions that the Court o f Accounts (COA) at present i s largely carryng out transactions level testing. Audit methodologies require hrther improvements despite introduction o f a number o f internal manuals and guidelines following the 2003 CFAA. Modem audit concepts were introduced into the Court o f Accounts Law through 2005 amendments. PEFA report observes the need for the Parliament to pay sufficient attention to the audit reports. The current system o f nominating members to the top management body o f the COA does not guarantee independence and i s prone to political influence in the working o f the COA. The Court o f Accounts has indicated its willingness to develop into a modem external audit institution along the EUcounterparts. Technical assistancehas been offered by the Swedish and British national audit offices to support the implementation o f the COA Strategic Development Plan. 141. PFM reforms and immediate measures needed to strengthen public financial management framework. Weaknesses in public financial management system are well understood in Moldova and a broad PFM reform program is under way. Major assistance i s already being provided by the Bank through the PFM Project, co-financed by SIDA and the Dutch Government. The PFM project i s supporting improvements in: (i) budget preparation and budget execution methodologies; (ii)accounting and reporting; (iii)development o f Financial Management information system and cash management; (iv) internal auditing; (v) building sustainable domestic capacity for PFM related training. In coordination with the PFM project, DFID is providing support to the strengthening o f the MTEF process, and TA for the Court of Accounts i s beingplanned by the donors. Several highpriority reform measures are included in the IMF's PRGF and the proposed PRSC (as indicated in the sections above). The existing instruments already mobilized through a concerted multi-donor effort appear to be sufficient to support the critical PFM agenda. No additional fiduciary risk mitigationmeasures are considered necessary for the present PRCS operation. 43 D. DISBURSEMENT AUDITING AND 142. Disbursement and Funds pow. The proposed Credit, SDR 6.8 million (US$10 million equivalent), will follow the Bank's disbursement procedures for development policy lending. The Credit will be disbursed in one tranche immediately upon effectiveness and is not tied to any specific purchases and no procurement requirements will be needed. The funds will be deposited at the existing treasury USD a c c o ~ n t 'opened by Ministry o f FinanceIState ~ Treasury with the NBM, which forms part o f the official foreign exchange reserves. The government will utilize the proceeds o f the credit in foreign currency for crediting the local currency equivalent into the treasury single account for financing budgeted expenses. If, after depositing the Credit proceeds, the proceeds are used for ineligible purposes, the Bank will require the recipient to refund the amount directly to the Bank, in which case the Bank will cancel an equivalent un-disbursed amount o f the credit. 143. Accounts and Auditing. The administration and accounting o f the Credit proceeds will be the responsibility o f the State Treasury 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 credit disbursements were in accordance with provision o f the Financing Agreement. Such accounts and records will be maintained in a form acceptable to the Bank. The proceeds o f Credit deposited at the treasury account with NBM will be used for converting into local currency 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 Operation will be subject to ratification by Parliament before it becomes effective. The MOF, with the assistance o f the NBM, will maintain records o f all transactions under the Operation in accordance with sound accounting practices. Within 30 days of the NBMbeing credited, the MOF will provide to the Bank a confirmation that the amount o f the Operation has been credited to an account that i s available to finance budgeted expenditures. 144. The IMF had conducted a Safeguards Assessment (SA) o f the National Bank o f Moldova (NBM) in 2002 and noted that general quality o f the financial reporting at NBM i s satisfactory. The Safeguard Assessment identified a few weak areas including: (i) lack o f an a independent supervisory board and audit committee; (ii) accountingpolicies for calculation weak o f distributable profit to the Government; (iii)vulnerability o f NBM loans to governments becoming impaired; and, (iv) lack o f properly functioning internal audit department. The NBM has made major efforts in establishing a modem internal audit department. NBM financial statements have received unqualified (clean) audit opinions from international auditors for the past three years in a row. The management letters issued by the auditors in 2004 and 2005 did not contain any significant internal control issues. In view o f this, there are no additional fiduciary safeguards considered necessary as far as management o f the deposit account i s concerned. E. ENVIRONMENTAL ASPECTS 145. The PRSC team has made an effort to assess and address the likelihood o f significant effects o f policies supported by the PRSC on the environment, natural resources, or forests including assessment o f the government's systems for reducing adverse effects and l4Usedfor receivingsupport from donors and for makingexternal payments. 44 enhancing positive effects. There are three areas o f the proposed PRSC that may require further attention with respect to environmental issues. These are policy interventions aimed at implementing the following: (i) reducing the regulatory burden; (ii)removing agricultural export restrictions; (iii) passing the full cost o f energy price increase to customers; and (iv) introducing cost-benefit analysis inpublic investment planning. 146. Reducing the regulatory burden. The PRSC supports ongoing efforts to reduce the regulatory and administrative costs o f business regulation and promote private sector development and boostjob creation. The PRSC builds on the Government's recent enactment o f the "Guillotine" law mandating a comprehensive review o f business executive regulations, leading to the identification o f regulations that are no longer necessary or do not have legal basis. This exercise has had a limited impact on environmental regulation so far. Of the 99 regulations identified by the Guillotine process for elimination, only [four] are related to environmental regulations, most of which were found to have inadequate legal basis. As the Government moves forward and implements next stage o f the regulatory reform strategy, it i s not clear how the new requirement will impact the environmental licensing system, if at all. The PRSC team, along with the Competitiveness Enhancement project will monitor the likely impact, including any unintendedconsequences, o f the next stage o f the regulatory reformprogram. 147. Removing agricultural export restrictions. The PRSC i s encouraging the Government to adopt a number o f measures to develop agricultural markets by liberalizing agricultural exports. In principle, the increased profitability of agnculture activity may lead to the so-called "extensification" or encroachment o f previously forested lands for agriculture production. It may lead to "intensification" with rising use o f harmful fertilizers and pesticides leading to soil degradation, water run-off, and a general degradation o f water quality with attendant health impacts. 148. On the other hand, there are offsetting developments and ongoing programs as well as institutional safeguards that mitigate potential environmental effects o f "extensification." First, the Forest Code and several environmental laws in place prohibit the transfer o f forest lands for agriculture production. Moreover, a number o f ongoing projects financed by the World Bank are serving to mitigate the likely effects o f increased agricultural activity. For example, among the components o f the Bank's "Persistent Organic Pollutants (POPS) Stockpiles Management and Destruction Project" are those aimed at institutional strengthening, the modernization o f current legislation (Le., those related to the Stockholm Convention), and the introduction o f broader chemical safety approach inthe country consistent with EuropeanUnion legislation. The project also has a special activity under Component 2 (Prevention o f new Stockpiles o f Obsolete Pesticides) that aims to provide support in promoting best practices in Pest Management in crop production, including Integrated Pest Management. Furthermore, the "Renewable Energy from Agricultural Wastes GEF Project" i s promoting the use o f biomass for heat-in place o f fossil fuel-through the efficient use o f primary agricultural wastes. The project aims to demonstrate (by installing demonstration biomass units technologies used in neighboring countries) practical and efficient use o f agricultural wastes, such as cereal wastes, typically burned on the field. Furthermore, the GEF "Agricultural Pollution Control Project" i s expanding the use o f environmentally-friendly agricultural practices by farmers and agricultural enterprises to reduce nutrient discharge from agricultural sources to the Danube River and Black Sea. Between 1990 and 2002, Moldova also experienced modest rates o f reforestation (about 600-700 ha annually) Between 2002 to 2006 it has also afforested by about 7,000 hectares 45 annually, thus extending the forest cover by about 35,000 hectares. Moreover, the program managed by the WE3 PCF's "Soil ConservationProject" i s aimed at helping restore to productive use some 20,000 hectares o f degraded agricultural lands. 149. Raising energy tarus. The World Bank i s recommending an increase in domestic gas tariff in response to the recent increase in the price o f imported natural gas and to pass the full cost o f the increase to consumers. This measure, by allowing energy prices to reflect their real cost, is aimed at encouraging consumers to save energy and use energy more efficiently. In the short-run, however, such price increases are likely to have distributional effects. The rising cost o f energy may have substantial health and environmental consequences, as households consume cheaper, and often dirtier, sources o f fuel. For example, the elevated use o f dirty fuels may degrade air quality and pollution may in turn lead to the deterioration of population health. Moreover, widespread burning o f wood promotes deforestation. It may then contribute to the loss o f critical environmental functions provided by forests and trees. 150. The World Bank i s supporting two measures aimed at mitigating the likely environmental effects o f households switching to dirty fuel. First, the World Bank i s encouraging the Government to improve the targeting o f energy subsidies to shield the poorest households, the same households more likely to switch energy sources, from the impact o f rising energy costs. Second, a number o f ongoing projects supported by the Community Carbon Development Fundmanaged by the World Bank are promoting energy conservation (Energy Conservation & Emissions Reduction) and the development o f less expensive, and cleaner, heating systems involving some 240 communities (Biomass Heating inRural Communities Project). 151. Introducing cost-benefit analysis in public investment planning. The PRSC i s strengthening the capacity to carry out public investment planningby gradually introducing cost- benefit accounting. While major infrastructure investments may indeed have environmental impacts, the rationale for introducing economic analysis to the planning process and into environment impact assessment procedure i s to assess the broader costs o f any major public investment, including its longer-term environmental costs. F. R I S K S 152. The risks for this operation include (i) fiduciary risks; (ii) implementation capacity at the central and decentralized level; (iii)external shocks; and (iv) political economy risks. 153. Fiduciary risks remain high and should be monitored. The Government's continued efforts to strengthen public financial management and procurement systems are reducing fiduciary risks with regard to the use o f public funds, but they remain high. To mitigate the risk, the Government must continue to push forward on implementing the recommendations and reform measures outlined in the most recent CPAR, CFAA, Public Finance Review (PFR) and PEFA. The PRSC program, as well as the Bank's and donor's work in these areas, i s providing assistance to the Government inthis endeavor. 154. Implementation Capacity is a medium risk. The Government has limited institutional capacity which could delay the implementation o f the reforms. For instance, should PRSC resources be used to finance higher capital spending, as indicated by the Government, most line ministries have limited capacity for the systematic selection and appraisal o f projects, 46 implementation, and evaluation. This may lead to the sub-optimal allocation o f budgetary resources. To mitigate these risks, all the reform areas benefit from Bank and donor-supported TA and capacity buildingprograms or investment operations (see Box 2). 155. Destabilizing external shocks are a high risk. Moldova and Russian state oil firm Gazprom may reach an agreement to increase Moldova's gas prices to European levels o f $llO/mcm in early 2006, up from $80/mcm in the previous three years. Negotiations with Gazprom would lead to still higher gas prices (up to $160/mcm in2006 and potentially higher in the coming years). As noted in the PSIA section, the increase in natural gas prices may have significant poverty and fiscal implications. Inparticular, this raises the cost o f energy consumed by households and enterprises. The burden o f the price increase may fall disproportionately on the poor and on households with limited alternative sources o f fuel. The price increase also creates two sources o f budgetary pressures. First, it raises the cost o f energy procured by government. Second, it leads to pressures for increased energy subsidies and transfers limiting resources available for investment spending. Under this operation, the Bank i s promoting reforms to improve the efficiency o f the energy sector. The Bank, along with the IMF and other donors, has some flexibility in the amount o f PRSC financing to respond, if needed, to external shocks. 156. Political economy risk may delay key elements of the program. Moldova's past uneven commitment to policy reform creates some uncertainty that the Government will implement some o f the more politically challenging reform items on the EGPRSP agenda and that a stop-and-go cycle for reform may once again emerge. However, recent progress on implementing the reforms underlying the high case triggers, and a visible political commitment to the EGPRSP and EU-Moldova action plan give some comfort that the reform agenda laid out inthose strategies will be pursued. Inaddition, the EGPRSP participation process has created a strong national consensus for the reform program. Similarly, Moldova's EU aspirations are widely shared among the population. 157. The close linkage between the PRSC-supported reform agenda and substantial donor assistance (DFID, SIDA, the Netherlands and EU) planned for Moldova i s a mitigating factor. The Government has also prepared the Letter of Development Policy, spelling out its own reform agenda (see Annex 1). In a number of sectors where the resistance to reform by vested interest i s expected to be strong, such as agriculture, road maintenance contracting, social assistance, and pensions, the operation i s bolstered by coordinated donor advocacy for trade and Private Sector Development reform, proposed Bank and donor projects (Le. road rehabilitation), and the government's own champions o f pension and social assistance reform. 47 ANNEX 1 GUVERNUL GOVERNMENT OF THE REPUBLIC11 MOLDOVA REPUBLIC OF MOLDOVA ChiSinBu LETTEROFDEVELOPMENTPOLICY Mr.PaulWolfowitz President The World Bank 1818 HStreet, N.W. WashingtonDC, 20433 Moldova's Reform Program for Economic Growth and PovertyReduction Dear Mr.Wolfowitz: The Economic Growth andPovertyReductionStrategy (EGPRSP) representsthe supreme policy framework for a medium term sustainable development of the Republic of Moldova and the achievement of the Millennium Development Goals (MDGs). The strategy sets out objectives and priorities, achievement of which is feasible in a medium term, but is also necessary to fulfill global long term objectives that come out of provisions of the Government's Plan of Activities "Revival o f the Economy- Country Revival," the EuropeanUnion- Republicof Moldova PlanofActions, and correspondto standards and practices generally acceptednationally, as well as internationally. These objectives are: i) sustainableand sociallyorienteddevelopment; ii) countryreintegration; iii) Europeanintegration. Inorder to achievelongterm developmentobjectives inadynamic and efficient manner the Governmentwill direct its mediumterm efforts towards fidfilling the following goals: Casa Gu\eniului. Go\ emrnent House, MD-2033, Chiyniu, Telefon Fax MD-2033, Chisinau, Republica hloldo\a -373-22-250101 -373-21-242696 Moldova(Rep ) 2 i)sustainableandcomprehensiveeconomicgrowth; ii)povertyandreductionininequality, extendingparticipationofpoorin the development ofthe economy; and, iii)humanresourcedevelopment. The poverty reduction support credit aims to support the Government in the implementation o f the EGPRSP. Given that EGPRSP and the European Union - Moldova Action Plan are in the final implementation phase, the Government intends to revise and adjust both of these strategic documents. The current EGPRSPwill be extendedto 2007 by updating the policy matridactionplan and estimate costs. At the same time, the Government will initiate work to update and extend the EGPRSP together with the programming process under the EU- Action Plan for 2008-2010period. A. BACKGROUND I.PovertyProfileandPovertyTrends Since 2001, the Republic of Moldova has seen important progress in ensuring and maintaining a strong economic growth. The GDP increasedby more than 30 percent, while the rate of absolute poverty fell by 41 percent, reaching the level of 29 percent in 2005. Nevertheless, GDP per capita remains low, and living standards are far inferior to those in the EuropeanUnion. Poverty and a lack of competitive employment opportunities have triggered massive labor migration, and this phenomenonhas given rise to new social and macroeconomic problems. Remittances, estimatedat about 30 percent o f GDP, stimulate consumptionbut at the same time complicate the conduct of monetary and foreign exchange policy. Migrationalso serves to erode the tax base. However, despite all efforts made within the program of general reforms, Moldova remains, by any standard, to be a poor country, i s positioned on the 113" place out o f 177 countries, according to the 2004 Human Development Report, having aHumanDevelopment Index (HDI) at 0.68 1(data from 2002). The poverty profile of Moldova is conditioned by economic, but also partially demographic factors, including: (i)low productivity o f labor in the farm sector; (ii)insufficient developmentofregionaleconomies; (iii)agrowingnumberof persons supported by the active population (Le. pensioners); (iv) low levels o f pensions and social allowances; and, (v) significant differentiation of wages among various sectors of the economy. In 2005, poverty is also spread out unevenlywith the highest poverty incidence being in small towns (48.5%), while poverty in rural areas is slightly lower (42.5%). Poverty in big cities is the lowest (14.7%). 3 Poverty kept on falling inurban centers, but inthe rural areas, where 63% o f the country's population lives, it grew during 2004 and 2005. The high poverty incidence in rural areas is determined by stalled farm restructuring and lack o f progress in "individualization" o f agriculture, inadequate public support for the emerging class of family farmers, the difference inprices for farm and non-farm products that ensued from the liberalization of prices, the relatively low productivity o f labor and small incomes o f persons employed inagriculture. 11. Source o fEconomic Growth The revival o f the national economy has been accompanied by an exacerbation o f the disequilibrium between the size o f internal demand and the volume of production. The growth rate o f final consumption in the 2000-2002 period was twice as large as the GDP growth rate. As a result, the size of final consumption for each o f these years exceeded the GDP by 1-3 percentage points. The main factor responsible for the rapid growth in consumption has been the growth in household consumption resulting from an increase in the sizes o f pensions, salaries, allowances and compensations, as well as the massive in flux o f remittances. Although the net effect on the GDP - growth o f imports counterbalanced by higher growth of consumption - was still positive, the sustainability of such model is questionable. Therefore, the challenge is to evolve to an investment-led growth model. Growth rates and the results o f economic development will depend to a great extent on the environment surrounding enterprise and investment activities, both at national, as well as local levels. For the medium term, the Government will undertake measures to improve substantially the investment and business climates by promoting a stable, transparent and efficient regulatory policy, by developing competition and supporting small and medium businesses. This will mobilize the economy's investment potential, made up o f remittance accumulations, resources o f the banking sector and the shadow economy, concessional official development assistance, as well as foreign direct investment. Inorderto changethe paradigmandquality ofgrowth, it isnecessaryto mobilize new resources and factors o f growth, by attracting a considerable volume o f investments, first o f all inthe processing industry and in infrastructure, so as to diversify the economy and replace labor force export with export o f service and merchandise. 4 1II.Creating Fiscal Space Public investment in Moldova is low. In order to increase public investment, without undermining macroeconomic stability or increasing the already large share of Government expenditures as a percent o f GDP, fiscal policy will need to remain tight. The Budget will need to focus on ensuring efficiency of public expenditures, as well as on redistributing existing resources from programs o f smaller importance to priority programs that have a substantial impact on economic growth and poverty reduction. Resources will be allocated among sectors based on an analysis o f sector expenditure programs, taking into account factors o f strategic influence over the development of sectors, as well as possibilities to streamline expenditures in some sectors identified within the mediumterm expenditure framework. IV. SoundMacroeconomic Framework FiscalPolicy Over the last years few years, fiscal policy has remained tight. In 2005, the surplus o f the general government grew to about 1.6 percentage points o f GDP, due to additional revenues, and the necessity to accumulate resources on a special account aimed at reducing arrears on external debt to Paris Club creditors. Starting from 2005 the Government also accumulated sufficient resources to start to repaying credits previouslyreceived from the National Bank o f Moldova (payments inthe amount of Lei 127 million, or 0.3 percent of GDP, were made in2005). The budgetary process has been improved as a result of the implementation o f our Medium-TermExpenditure Framework (MTEF), and by preparingestimates o f the national public budget, including the state budget and local government budgets, the state social insurance budget and the compulsory medical insurance budget, as well as special funds. In order to broaden the tax base, VAT exemptions have been eliminated on agriculture, as well as on the import and supply o f pesticides and fertilizers, equipment, technology and complimentary parts. The VAT rate on medicines has been increased from zero to 8 percent. External Debt Policy Inthe absence of external financing for the budget, external debt service became a serious burden for the budget, reaching 40 percent of the total state budget revenues (2001). Throughout 2003-05, the general government reported primary surpluses o f about 2% percent of GDP, and Moldova's external debt indicators improved significantly. Robust economic growth over this period as well as prudent limits on external borrowing allowed the Government to reduce the ratio o f public and publicly-guaranteed debt from 79 percent o f GDP in2000 to about 33 percent of GDP in2005. 5 ParisClub creditors agreedon 12May 2006 with the Government ofMoldovato a restructuring of its external debt in accordance with the so-called "Houston Terms". This agreement followed the International Monetary Fund's approval of Moldova's arrangement under the Poverty Reduction and Growth Facility on 5 May 2006 insupport o f the Government's ambitious reform program. As aresult of this restructuring, expendituresaimedtowards externaldebt service beforethe Paris Club throughout the implementationof the program signed with IMF fell fiom $149.9 million to $60 million, thus contributing towards a better economic outlook andproviding additional fiscal space for the reform agenda. Monetary andExchangeRatePolicy The key challengeof monetary policy during 2005 was managingthe pressure of foreigncurrency inflows. These inflows were mainly associatedwith remittances sent by Moldovan workers from abroad, which put considerable pressure on the level of inflation and the exchange rate. During most of 2005 there was upward pressure on the leu, and it took considerable effort on the part of the NBM to bring inflation back down from near 15 percent inthe first part of the year to 10 percent by end-year. This was achieved despite strong growth in energy sector prices. With energy prices continuing to rise in 2006 inflation pressures are expectedto mount. The NBMproposedan amendment to its main law by moving towards inflation targeting and away fiom the dual objective of prices as well as exchange rates. This reinforcesthe floating exchange rate regime, by which the NBMintervenes only to smoothout excessivevolatility inthe exchangerate. During2005 the real effective exchange rate of the leu registered an appreciation of 2.4 percentage points, relative to December 2004. Reserves grew by almost $130 million in 2005, reaching2.2 months ofprospective imports at end-December. At the same time, Moldova's external vulnerability continued to grow. Largely owing to the external shocks coming from higher energy prices as well as the recent wine exports ban from the Russian Federation, the trade balance deteriorated by almost 9 percentage points of GDP in 2005 and continued to worsen into the first half of 2006. This calls for an urgent diversification of Moldova's export markets which remain limited at the moment, reflecting continued dependence on traditional CIS markets. In 2005 the CIS absorbed about 51 percent of total Moldovan exports (comparedto only about 30 percent went to EU markets) out of which the wine exports to Russian Federation accountedfor almost aquarter. 6 B. KEY PILLARSOF THE PROGRAM I.GENERALSTATEMENT The economic growth fiom past years occurred in the background o f a slow economic restructuring, o f a fall inthe rate o f industry growth, especially of the processing sector. Rise in the final consumption and the gross capital accumulation is determined to a great extent by the flux o f incomes coming from citizens o fthe Republic o f Moldova working abroad and partially by the increase in salaries. Given these conditions in the situation o f low level of investments, vulnerability to external factors, the outlook o f a sustainable growth and poverty reduction may become uncertain if urgent actions are not undertaken to redress the situation. These actions would include among other: (i) optimization actual o f the business climate; (ii)improvement in the management o f state assets, and (iii)promotion o fthe public-private partnership. The low level o f public expenditures targeted towards financing capital investmentsinhibits opportunities for a future economic growth. Inthis context, it is necessary to establish a tax regime that will allow for the generation of resources that will be targeted towards public investments. The results following the implementations o f several programs of social assistance are rather insufficient, especially given an inefficient allocation o f public resources. The lack o f financial resources makes it impossible to satis@ the demand for social services, thereby causing an expensive widely covering institutional support. The government is aware that the present system for social assistance needs revision, so that the poorest parts ofthe population are protected andconcomitantly, a fiscal sustainability o fthe system is ensured. Starting with the motivation to adopt important and radical changes, the Government undertook the management and implementation roles, with support from the poverty reduction support credit, inthe realization of a program based onthe following major pillars: (a) improving the investment climate; (b) improving the efficiency andmanagement o fpublic sector resources and (c) strengthening social protection systems. I. Improvingtheinvestmentclimate For the medium term development period, the main target i s to ensure significant improvement o f the investment climate so as to create accelerated growth opportunities of private internal and external investments. The major objectives o f the state policy in this area are macroeconomic stability and the promotion public sector reform including that o fthe regulatory fi-amework. 7 Along with the main objectives o f the general policy, it is envisioned that other mediumterm tasks will also be accomplished towards improvingthe investment climate, such as: (i)improvement o f the legislation to protect the rights o f investors and creditors; (ii) limit the barriers to investment activities; and, (iii) improve the incentive-based tax regime for local and foreign investors. An important element in the improvement of the investment climates resides in the fight against corruption. As a rule, enterprise activities are most affected by corruption. It is recognized that corruption i s very expensive for entrepreneurs. To a large extend, corruption affects economic agents inthe process of obtaining licenses and when undergoing various inspections. The poor population from the rural area i s also affected as such, especially the population running commercial activity. The Government believes that eradication o f corruption i s a crucial condition for ensuring the continuation in economic growth and poverty reduction. The Government approved a set o f legislative and normative documents aimed to provide a legal framework which would prevent and fight against corruption. An extensive list o f anti-corruption measures i s envisaged in the National Strategy o f prevention and fighting o f corruption and in the action plan for the implementation o f this strategy. Objectives of this strategy are correlated with actions, which are intended to be implemented by the Government within Threshold Program to meet eligibility conditions for "Millenium Challenge Corporation" find. A. Regulatory framework reform Regulatory reform - which was initiated by the Government in 2004 and continued throughout the year 2005 - aims to create open, flexible, and low-cost business opportunities inorder to promote investments and business innovations. Only such conditions can offer the possibility for the Moldovan economy to rapidly adjust to new market risks and opportunities, and thus the possibility to ensure competitiveness o fthe localproduction. This reform, which represents a compIex and a long-term effort, presumes two major phases: (i)deregulation and streamlining, and (ii)consolidation o f capacities for good regulation within Government institutions. Duringthe years 2004-2005, some actions were undertaken for the first phase, namely: (a) simplification and centralization of the licensing procedures, (b) optimization of the registration procedure, (c) diminution o f conflicts of interest between inspectors and the function of checking conferred to control agents. The Law on the revision and streamlining o f the normative framework regulating enterprise activity (the regulatory guillotine) was drafted and implemented, which led to a significant reduction in the number o f normative acts regulating enterprise 8 activity, as well as for the reduction in costs surrounding authorization documents. The Law on Basic Principles and Mechanism for Enterprise Activity Regulation was adopted by the Parliament. This starts the next new phase o f reform, representing a higher level o f revision o f legislation, namely revision of laws and decisions o f the Parliament. Regulatory reforms provide necessary but not sufficient conditions for establishment of more competitive enterprise sector inthe Republic o f Moldova. Global markets have become increasingly stringent in terms o f product quality and performance. Conformity with international standards such as IS0 9000 has become a de facto requirement for external market access. Upgrading the framework for measurements, standards, testing and quality (MSTQ) i s a necessary first step in gaining access to the foreign markets and boosting competitiveness. WTO membership andthe EU/Moldova Action Plan, which underlines European integration, placed strong accent on the necessity o f upgrading the MSTQ system. The Government started developing a three-fold strategy focusing on: (i) upgrading existing MSTQ institutions to international levels (including obtaining relevant international recognition), (ii)improving existing services and introducing new MSTQ services (all based on demand from Moldovan producers), (iii)promoting use o f MSTQ services by enterprises to improve quality and conformity with international standards; and (iv) development o f capacity with regard to supervision o f production quality and consumer protection in line with the European Union practices. Significant improvements in the legal MSTQ framework have already taken place, with a number o f important laws adopted. B.Improving trade facilitation Improvement o f the investment climate also involves simplification and streamlining o f procedures for border crossing and Customs clearance. That includes reduction in the number o f documentary and physical controls, which can lead to better export competitiveness, attraction o f foreign investment and better integration inthe global economy. With support from Trade and Transport Facilitation in Southeast-Europe project, the Customs Service o f the Republic o f Moldova has already made important steps towards reducing clearance time and promoting trade. In this context, starting from January 2006 the Customs Service initiated the implementation o f risk analysis and selectivity, with the goal to improve results and efficiency o f clearance procedures. The system will be augmented by the 9 introduction o f post release audit. That is expected to lead to simplified and rationalized Customs procedures while increasing the detection o f irregularities and thus compliance on equal conditions by the business community. The whole process will enable the Customs Service to reduce the frequency o f physical inspectiono f imported goods and substantially reduce import clearance time. In April 2006, the Risk Analysis Unit within Customs Service started to introduce into the selectivity module o f the Automated System for Customs Data (ASYCUDA) World Informational System the first risk criteria that were established following various analysis and studies performed. The Customs System switched to selectivity during the process o f Customs clearance. All external economic transactions are examined through ASYCUDA World to evaluatethe risk factors andpossible impact on the economy. Development of a sustainable reporting system will be an important element in the monitoring o f performance at border crossings and during Customs clearance. The Customs Service plans to implement a "single window stop" principle for document processing both at border crossings and at the inland clearance terminals. The implementation o f the "single window stop" principle was initiated by the Customs Service at its main terminal o f Chiqingu, starting fiom April 2006. This involves submission of Customs documentationat the entry/ reception points and their return at the moment o f merchandise physical control; that eliminates contact of the Customs officer with the economic agent, and thus reduces in frequency o f corruption. Elimination o f duplication o f procedures, by reducing the number of agencies present at border crossing points, will also contribute to greater efficiency and improved trade facilitation. The performance indicator o f the ongoing project of Trade and Transport Facilitation in the Southeast Europe is reduction of the average time needed for import clearance as well as for the border crossing entry time to 30 minutes. C.Developrnent o f agricultural markets The largest real sector of the national economy, which i s also directly dependent on the investment climate, is agriculture. This sector has an important role to play both in poverty reduction - because it is the main occupation o f a large part o f the population on the poverty threshold, but also because it serves as an importantsource for industrydevelopment and export growth. The growthrate of the agricultural sector remains modest. During2001-2005 the volume o f agricultural production only increased by 16 percent. Agriculture remains the sector yielding the lowest productivity and labor remuneration 10 indicators. Contributing with 18% to GDP (nearly 30% when agroprocessing i s included) and offering jobs to about 45% o f the labor force, the low productivity and insignificant growth rates in the agricultural sector have negative implications for the growth perspectives for the economy. The poverty rate is highest among farmers and farm workers (at the level of 45-50% in 2005), which despite some improvements in earlier years, started growing again in 2003. The recent poverty estimates for the Republic o f Moldova clearly shows that the poverty rate among farmers and farm workers has increased in last two years (2003-2005) by at least 12percentage points. The Government is committed to promoting sustainable economic growth, in the agricultural sector in particular, by enhancing sector competitiveness and encouraging private initiatives and investments. The Government reconfirms its commitment to implement sound agricultural policies and support all types o f farm structures that exhibit efficiency and productivity enhancements towards developing a competitive and profitable agricultural and rural economy, operating on market principles. These market principles include no minimumprices or fixed prices o f any kind; no designated buyers; no export restrictions; no licensing requirements for import or export; no determination o f landto be planted under particular crops or production levels to be achieved; and no government institutions assigned to administer the production or processing of any crop. The Government recognizes the Land Code as a fkndamental piece o f legislation framing land relations inthe country, and reaffirms its commitment to respect a land code that adheres to market-oriented principles, namely that it: (a) clearly defines and protects landowners' rights; (b) provides for the enforcement o f real property rights through efficient institutions and effective courts; (c) facilitates and supports secure transactions o f property rights, backed by formal contract procedures, and provides a court system that settles any disputes in a timely manner; (d) provides for property rights information to be available to all persons who request it; (e) puts restrictions on transactions only under exceptional circumstances in conformity with existing legislation; (f) facilitates registration and transactions at low cost with minimum fees and taxes in the shortest possible time after application; and (g) protects land as a resource on environmental and health grounds. One of the main challenges facing the sector is the problem o f low producer prices. A critical step needed to address this problem i s increased market access for producers and enhanced competitiveness o f the sector. In the context o f agricultural export liberalization, the Government has canceled the legal requirement regarding the export o f grains taking place exclusively through the Universal Commodity Exchange. This requirement not only places a constraint on cereal exports, but also favors the big players on the domestic cereal market, 11 thus reducing the competition and pushing down the producer prices. A Decision, No. 946, removing this compulsory requirement was adopted by the Government on 18tho f August 2006. It is expected that this action will contribute to reducing the gap between the domestic producer prices and the international parity prices for cereals and oilseeds by at least 25% by 2009 (as measured by the 2006 Nominal Rate o f Protection (NRP) compared to the 2005 W).To explore this issue further, the Government, inconsultation with the World Bank, has developed the terms ofreference for a study on improvingthe stabilization o f cereal prices on the domestic market. The Government assumed the responsibility to implement an Action Plan (to follow the approval o f the Agricultural Strategy for the period 2006-2015) that would include, inter alia, (i)liberalization of the import regime for seeds and seedlings, (ii)improving certification and standardization system for agricultural products, and (iii)development and dissemination o f a Market Information System to inform farm producers on a regular basis about market opportunities and trends, both domestically and in major regional markets (such as Romania and Odessa). The Government believes that these three issues are of major importance for the future development and efficient finctioning o f agricultural markets in Moldova, as well as for the creation o f a competitive and profitable production sector. Moldova farmers pay more for inputs relative international markets. Liberalization o f these markets is a Government priority. Specifically, the Government is committed to undertaking a set of measures for the liberalization o f the present import regime for seeds and seedlings and plant materials, by improvingand streamliningthe national regulatory system for the registrationo f new varieties, acknowledging the fact that a free and quick access o f Moldovan farmers to new advanced technologies is a precondition for the domestic agricultural products to achieve a higher competitiveness on global markets. Following the implementation of these agreed measures aimed at liberalization ofthe seed market, it is expected that the number o f newly registered varieties in the Republic of Moldova will increase in the next years (until 2009) by at least 25%. Over the longterm, the Government will work towards adopting the EUregistry o f plant varieties to enable its farmers to have access to the best available international technology that is embodies in these varieties. In the meantime, farmers access to the best international technologies should be enhanced by a reform o f the Moldovan plant variety registration system involving a significant reduction in the evaluation period; a reform o f the composition o f the National Council to exclude interested parties from membership; and by the establishments o f an independent appeals mechanism for rejected applications. The Government acknowledges the importance of harmonizing national legislation with European and international standards, especially given the 12 current critical need to enter new markets that are more stable and more secure than the traditional ones. This will also require changes in institutions and approaches, as well as significant investment. Towards this end, the Government has already begun the implementation o f the National Program for the development o f technical regulations. The Ministry o f Agriculture and Food Industry (MAFI), as the party responsible for developing the 31 Technical Regulations related to agricultural and food products, has managed to approve so far 12o fthose, the remaining 19 to be drafted and approved by the end o f 2006. Credit is an essential input to agricultural production, and it i s currently a major constraint for farmers. The Government has been working with the World Bank through the Rural Investment and Services Projects (RISP Iand 11) to increase farmers' access to credit by supported rural Savings and Credit Associations (SCAs). These SCAs - covering more than 530 associations and 96 thousand members - can contribute to the sector's fbture growth and development. Further, SCAs give access to financial services for a large part o f the population, which do not have access to traditional services of the banking sector. Despite the accomplishments obtained, the system o f associations faces a series o f important challenges, such as a great number o f small associations, an unsustainable support system, and an outdated legal fkamework. The rapid growth in the size o f member deposits and the inefficient supervision of association activities also represent major challenges for the system. To ensure the long-term sustainability o f the SCAs, it will be necessary to improve the legal and regulatory environment for their supervision. The Government, therefore, will soon finalize the draft law on savings and loan association, based on the most successfbl international practices. Establishment o f a new legal, regulatory and supervisory framework will ensure a favorable environment for a prudent and sustainable growth o f the system of associations, will contribute to the development o fbusiness, andthus to a rise inincomes andpoverty reduction, especially inthe rural areas. D.Reducing energy vulnerability Reducing the vulnerability o f Moldova to external energy price shock is a serious challenge facing the Government. Rising energy prices, particularly the increase inthe price of natural gas, have reemphasized the need improve energy efficiency and to diversify types o f energy and sources of energy supply to Moldova. Without improvements in energy efficiency and diversification o f energy supplies, the rising energy prices may have a significant negative impact on the already low level o f competitiveness o f local production, as well as the livingconditions o fthe population. The Government recognizes that a sound tariff policy is key for the improvement of energy efficiency and the diversification o f energy supplies. Therefore, the Government will help ensure that tariffs for natural gas, electricity and heat are 13 gradually adjusted to the full cost recovery level for all categories of consumers. It will also help ensure that cash collection ratios are maintained above 90% for natural gas and above 95% for electricity. If successfully implemented, these measures would help attract investments in energy efficiency projects in the public and the private sector causing the reduction o f energy intensity o f economy. The tariff policy will be also a cornerstone o f an energy efficiency program which the Government will develop and implement to help improve financial viability o f energy enterprises, including Termocom. The Government will revise the existent legal and regulating framework, to the aim of adopting and implementing an Action Plan for ensuring legal conformity o f gas and power markets in Moldova with norms established by the Energy Community of the South-Eastern Europe. In addition, focus will also be placed on drafting new normative acts in non-regulated areas - thermal energy, renewable energy sources, and adoption of the National Program for capitalizing renewable energy sources by the year 2010. 11. Increasing efficiency and improving management of public sector resources The general objectives o f the medium and long term tax policy is based on the following principles: (i) ensure stability and predictability of public revenues; to (ii) ensurefiscalequity; (iii)tostimulate economic activitybyrationalizing to the system o f tax incentives, so as to preserve those incentives that are targeted towards supporting economic growth and poverty reduction. At the same time, the conclusion o f the evaluation of public expenditures and financial responsibility shows that the relationship between actual expenditures and the budget is sound, as a result o fthe revenue surplus following the positive economic evolution and improvement in the tax administration. In general, the control and monitoring of the budget execution are goodandare accompanied by well-established procedures. At the same time, we are aware that Moldova's system o f internal control and audit no longer meets the requirements o f effective financial management at the organizational level. The Government plans to establish a system o f internal control and audit compatible with EU requirements for Public Financial Internal Control ftamework. Although the system o f public procurement is improving, the need for improving awareness, practice, and enforcement ofprocurement legislation is significant. Improving access o f the population, first o f all o f the poor, to basic medical services through primary medicine development, to qualitative educational services, consolidation ofthe financial stability inthe social insurance system, as well as streamlining o f the social service delivery system by targeting these services towards the most poor, represent the main challenges facing the Government in the upcoming medium term. The policies proposed through the 14 credit for poverty reduction are aimed to improve efficiency and resource management inthe public sector. The Republic o f Moldova has undergone major and radical changes over the transition period which, along with integration into international structures, demand that the public administration in general and the Government in particular adapts to new requirements. The Government has assumed the leadership in implementing a reform o f the central public administration as one of its priorities. This reform will contribute to increasing the country's international competitiveness by establishing an efficient administration, capable o f attaining policy objectives adopted by the country's leadership. A. Meritocratic civil service The objective o f the reform that started o f f in the second half of 2005 is to establish a modern and efficient system o f central public administration, in accord with the European Union's principles of good governance. The reform implies the transformation and modernization Moldova's public administration through the reorganization o f the central public administration, optimization o f the decision-making process, and establishment o f a professional civil service. The Concept o f the Public Service Personnel Policy, approved by Parliament (resolution No.1227-XV o f July 18 2002) envisages introduction a competitive, merit-based system for staff recruitment and selection in the civil service. This would ensure objectivity and transparency in the hiring o f personnel in public autorities which, in turn, would lead to better professionalism. These objectives have not lost their importance today and the Government i s hlly committed to the implementation o f the stated objectives. In the context o f the mentioned Concept, the Government approved a Regulation which establishes the manner in which contests to select candidates for vacant civil service positions are organized and held, as well as the method of conflict resolution inthe respective area. Inthe absence o f effective enforcement o f merit principles, the adherence to this Resolutionstill gives concerns to the Government. To ensure that civil servants are competitively selected the Government, based on the results o f the functional review o f the Governmental Apparatus, will set up a civil service management structure, responsible for the implementation and monitoring o fthe civil service reform. Inorder to create a professional group o f permanent civil servants that would be responsible, accountable, impartial, efficient, and accessible by citizens, the following objectives are to be accomplished: - designing a new system o f classification and grading of civil service - strengtheningthe central coordinationo fhumanresources management; positions; 15 - improving a system of financial and non-financial incentives for civil servants. To achieve the mentioned objectives, the Implementation Plan for the Strategy for Central Public Administration Reform (SCPUR) provides for a series o f actions to be realized over 2006-2008. One of these actions provides for the drafting in the second half of 2006 of the L a w on Civil Service and Statute of Civil Servants. The draft law will, among other issues, include provisions regulatinghiring for public service and merit-based promotionof civil servants. After the adoption of the respective law, the Government will design, adopt and implement new legislative provisions regulating human resources in the civil service. B. Implementing a transparent and uniform remuneration system for civil servants The Government has already taken some measures to the conditions of civil service remuneration, as well as of persons responsible for technical maintenance o f public authorities. The base salary levels were raised (the share of the base salary in the total salary increased from 22% to 55%), while several increases and supplements were reduced or annulled altogether. The process aimed to improve the incentive-yielding system for civil servants will continue throughout the next two years. In the first semester of 2007 especially, a system for civil service remuneration will be drafted, which will consolidate the existing allowances and supplements into the base salary in line with the new classification and gradation of civil servants. The variable part of the monthly salary shall be comprised ofperformance bonuses. C. Improvingthe Strategic Allocation o fPublic Resources The preparation o f the MTEF in Moldova as a tool for medium-term strategic planning during the last five years underpinned the reform of methods and procedures regulating budgetary planning. The budgetary legislation was amended to ensure that the MTEF is an indispensable part of the budgetary cycle. The MTEF serves as a strategic framework for the national budget and facilitates the process of preparation and examination of the annual budget. The implementation of MTEF has increased transparency and improved understanding of the budgetary process within the Government and the civil society. The MTEF for 2007-2009 is based on an analysis o f sectoral expenditure programs.It provides for a better correlation between sectoral policy priorities stipulated inthe EGPRSP and other srategic documents and process o f resource - - allocation. It was also based on a detailed analysis of expenditure programs, 16 including strategic expenditure planning in four pilot sectors: education, health protecton, social assistance and the farm sector, which, given the set out objectives, determine the reform actions within the programs, with implication on budgetarymanagement andperformance indicators inthe respective areas. The MTEF includes a technical note on the analysis of public investment expenditures, as well as related medium-termpriorities. Ininfrastructure sectors, the priority will be given to the sectors with greater social and economic impact. For the following three years, the priority sectors for investment will be road and transport infrastructure, the energy network, water supply and sewerage. These areas are considered o f priority in the context of Moldova's integration with European structures as well. The Government will establish a unit for strategic planning within the Government Apparatus, which will be responsible for advising the Government on medium-term policy priorities and for the methodological coordination o f strategic planningunits inpilot-ministries. The MTEF for 2008-20 10 will reflect a cost-benefit analysis o f major investment projects with internal financing for two sectors o fthe national economy. Startingwith the MTEF for 2009-2011,the Government, following a proposal by the strategic planning unit, will adopt an annual resolution, which will set out priority sectors within medium-term expenditure policies. D. Agricultural Spending The Government recognizes the need to re-think and streamline the agricultural spending, since the current system has showed to exhibit a number o f weaknesses and shortcomings. Thus, within the current system the small farmers, which have proved over the years more productive than the large ones, often lack state financial support. In addition, most government programs are targeted at product- and input-specific subsidies, which have a short-sighted effect and do not promote sector growth. Therefore, the Government is committed to re-direct agricultural expenditures towards growth- and productivity-enhancing activities and long-term capacity improvements. The need to create incentives to restructure agricultural enterprises, and promote the individualization o f agriculture and better use o fresources is also on the Government's agenda. The Government recognizes that practices involving cancellation or accumulation o f farm debts are counter-productive and do not stimulate financial discipline. For this reason, the Government will undertake the necessary measures to exclude such subsidies starting next year (2007). Exceptions to the general rule will be made only for old debt o f those state farms that undertake privatization and restructuring will be taken on a case by case basis. The Government is aware that the development o f agricultural services (including extension, training, education, research, marketing, infrastructure 17 services, such as wholesale markets, cooling storages, packaging units, etc.) plays an important role in competitiveness enhancement process o f the farm sector. The second component o f agricultural expenditures, called subsidies, will be reduced year by year: in2007 the share of subsidies will drop by 3 percentage points, and in 2008-2009 by 5 percentage points o f total agricultural expenditures. Subsidies are, in turn, divided in two categories: recurrent subsidies (amounts allocated to specific agricultural products/inputs) and investment subsidies (plantation o f vineyards, orchards). Within the limit set for subsidies (as a share o ftotal agricultural expenditures), the investmentcomponent will increase, while the recurrent one will reduce with the objective of reaching the ratio o f 90%/10% by the year 2009, the biggestpart pertaining to investment subsidies. The Government agrees that setting equal rules o f the game within the state supported schemes i s an absolutely necessary condition allowing establishing equal opportunities for all producers - regardless o f the farm ownership structure, legal form or size o fthe enterprise/farm- and eliminating inefficiency- yielding distortions within the sector. This objective will serve as a basic principle in the development of any future state-supported program in agriculture. In addition, the eligibility criteria that are currently in place for various state support programs will be revised towards eliminating/amending the provisions that allow for a subjective approach or non-transparent procedures for public resource allocation. At the moment, a thorough assessment of the existing research, training and education system i s required. Inthis context, a separate study will be carried out to investigate this important topic, and the help of the WB in the field of international benchmarking will be particularly useful. In addition, the Government will carry out an evaluation o f the anti-hail rocket system currently applied in Moldova, and based on the cost-benefit analysis will decide on the continuatiordtermination o f the current system. The study will also contemplate some alternative system(s) suitable for the Republic o fMoldova. E. Transport Infkastructure According to the agenda o f EGPRSP objectives for the year 2004-2006, the reform o f road transport infrastructure includes the implementation o f a program o f commitments stop the degradation of the road network and start its gradual reconstruction, create a sustainable system for sector financing, modernize the technical evaluation o f roads, and negotiate with international financial institutionsto obtain credits for projects aimed at rehabilitating the national roads ofEuropean importance. The country's road network infrastructure has considerably deteriorated during the transition period: of the total 3,325 km o f national roads, 87% have passed 18 their economic lifespan and some 30% are in a very bad technical condition. About 95% of the road network is paved, but most of these roads do not correspond to the technical standards. Creationo f a sustainable andtransparent system o f road financing i s a priority on the agenda of central and local public administration. To that end, the Government plans to invest more in the sector - including through increased annual budget allocation - while focusing on road maintenance and repair to reduce the backlog on national roads in poor condition. At the same time, the Government will address the existing spending inefficiencies in the sector through gradually improving the management capacity o f the State Road Administration and clarifying its role and functions, and improving the competition in the award o f road maintenance and repair contracts. The Government is also considering developing a partnership with the private sector, including foreign companies, to rebuildand manage national roads. Implementation o f modern systems for road technical evaluation and for the optimization of maintenance and repair processes will be addressed by the strategy for transport infrastructure management and financing which the Government intends to draft throughout the following year. Based on the adopted strategy and regulations on sustainable and transparent road financing, the Government will substantially increase available financing for road maintenance. F. EducationSystem Policies regulating the education system represent one of the most important factors inthe development o f the human capital, which inits turn constitutes one of the pillars at the base of economic growth and social cohesion inthe country. Acknowledging the important role that education has and considering constitutional provisions, as well as other commitments, the Government o f the Republic of Moldova formulated the following general objective in EGPRSP: Ensuring access to quality education and ensuring the efficient and sustainable finctioning o f the education system in a way, which facilitates its role in developing humanresources and the economy. Inthe same time, one o fthe main MDGfocuses on "achieve universalprimary education." Education expenditures have declined compared to the 1990s (reaching 7,3% o f GDP for 2005),but are still higherthanthe OECD average (4.9%). The system is characterized by inefficient use of financial, human and material resources. Allocation o f public finances to schools i s regulated by a formula o f unit financing leustudent. Various expenditure requirements, however, limit the flexibility o f use o f the education budget.. The greatest portion o f education spending is on teacher salaries (more that 60%) and on utilities (about IS%), 19 with quality related expenditures constituting only about 10% of education budget. The education expenditures per pupilvary significantly among institutions, by 2- 3 times. The ratios of pupilheacher and pupilhon-teachers are low. The lack o f didactic materials and the lack o f modern means of teaching lead to reduction o f the quality o f studies, having a negative impact on the level of assimilation o f newinformation. Another issue is the widening social inequality inMoldova, which contributes to reduced access to education of vulnerable social groups. There are significant differences regarding access to education o f children from rural and urban localities. The completion ratios o f rural students in secondary and higher education is 76% and 6%, respectively. This compares with 81 % and 29% for students from urbanlocalities. Inorder to improve the quality o f education and to reduce the gap betweenthe urbanandrural village, the Government setthe objective to optimize the network o f schools and to increase efficiency o f public resources spending. For these, the process o f mapping institutions o f general education was completed, which includes more than 150network and economic-financial indicators. Based on the school mapping exercise for general education institutions, measures will be taken for the optimization of the institutions inrural areas. By the end o f 2009, it i s planned to reorganize 20% o f schools identified as candidates for optimization. School mapping also will help with definition of basic package o f free education services. Inaddition, existingfinancingformula will be revised for schools -pilotedunder the project called "Quality education in rural area o f Moldova". Combined with school autonomy and optimization o f schools networks, this revision will contribute to improvement o f quality by increasing efficiency, in this way providing resources for increasing salaries for teachers and increasing o f quality related expenditures, as didactic materials, equipment and professional trainings. G. Health Sector Reform The health care sector is in the process o f being reformed, the mandatory health insurance was introduced starting with January 1, 2004. In the first years o f health insurance, the two lowest income quintiles however have not received the same benefits as other quintiles due to large share of uninsured people in those groups. The main goal o f the Government regarding the healthcare sector reform program, mentioned in EGPRSP, is to increase access of the population, and, especially, o f the poor, to basic health services through the development of primary medical care. There is evidence that the health care insurance, which provides fiee o f charge services on the basis of the Uniform Program has improvedpopulation's accessto healthservices. 20 This objective is consistent with the existing disease burden, which largely affects the poor and according to international experience prevention measures have a very effective impact on health, especially, in case o f poor family. Another objective o f health care reform is improve efficiency in the use o f financial, human and material resources within the health protection system, through a continuous rationalization o f the hospital sector and implementation o f mandatory insurances for medical assistance in order to maintain financial stability. The present health care organization, whereby primary care and hospital services are provided by the same legal entities, allows for subsidizing o f hospital services from budgets that are planned for primary health services, thereby weakening the primary health services and concealing inefficiencies in the hospital sector. Inorder to resolve these gaps, the Governmentwill take measures that will allow direct contracting o f primary health centers. The Government will preserve at least 30% o f allocation for primary health assistance from the budget o f health insurances andwill draft a strategy aimed to broadenthe span o fhealth insurance coverage. The health insurance company will directly contract at least 5% o f primary assistance providers and, following the implementation o f the strategy for insurance coverage, health insurance will include 85% o f the residential population. H.PublicProcurement Creation and maintenance of an efficient system of public procurement can help secure substantial savings o f public expenditures. For these feasons, since 1 January 2005, was initiated the decentralization o f the system o f public procurement, which clearly delineated attributions and responsibilities in the process o f public procurement o f goods, works and services for public money. This measure led to increasing o f transparency in the process o f public procurement, through posting announcements, publishing relevant information, results, reports, template documents, projects etc, both in the Public Procurements Newsletter, as well as on the web. There were also held meetings with potential providers, were granted necessary methodological support to specialists involved in public acquisitions, was published the Guide for Public Procurements (a manual containing all instructions, including standard documentation that i s necessary to initiate and perform procedures o f public procurement). Control over the procedure o f one source procurement was made tighter. The Regulation on the List o f forbidden providers (entrepreneurs) participating in the process o f public procurement was approved by Decision o f the Government, which provides method o f setting up 21 and monitoring the list o f forbidden providers who do not honor their contractual commitments, with an eventual exclusion of those from public procurement procedures for a certain period oftime. In order to adjust the legal framework regulating public procurement, the Government, drafted the new Law on public procurement, which envisaged establishment of an Independent Agency for Procurement, with the corresponding staff and budget, in accordance with central public administration reform. The draft o f the respective law will be submitted to the Parliament for examination and approval by the end o f this year. To facilitate eventual implementation o f the newly adopted law, it is planned to draft a plan o f action for law execution. 111. Strengtheningsocial protection systems A. Completing the pension reform The pension system started to face common problems to Central and Eastern European countries during the 1990s. The revenues from contributions diminished as a result of low tax compliance and the decrease in the number o f working people. Moreover, the fragmented pension legislation which comprises numerous pension facilities violates the principle o f "social equity" and undermines people confidence inthe pension system. The 1999 Reform of the pension system accomplished its set-out medium term objectives: timely payment o f pensions in conditions of limited budgetary transfers. Despitethis, however, the pension reform stays to be incomplete, while the pension law has not yet been hlly implemented. Although the Law on 1999 reform provides that pension payments be made based on actual contributions that are paid, and not based on salaries declared, the National House for Social Insurance has been substantially lagging behind with the introduction o f data on contributions. The Government took measures so that 100% o f the declarations made by insured persons inthe year 2005 and presented by 1 April 2006, was included in the state Register for individual evidence by June 1 2006. The Government is committedto keeping the contributiondatabase up-to-date. Participation in the system o f social insurance by persons employed in the agricultural sector remains to be a problem, as the means accumulated from their contribution payments do not cover even a third of expenditures necessary for pension payments. At present, employees of the agricultural sector contribute with around 6% o fthe BSSI (the budget of state social insurances) revenues, but benefit from 53% of it. It is proposed to solve this situation through the 22 implementation o f the Strategy on reforming the pension system for persons employed inthe agricultural sector, and also innon-wage sector (self-employed), which provides for switching to the principle of paying income contributions in fixed sums, with possible subvention by the state. The respective strategy is already drafted and is now being coordinated with the relevant institutions. Inorder to continue reform inthe pension sector, the Governmentplansto draft a strategy aimed to unify the pensions systems for all categories o f retired persons (non-farmers, farmers and privileged persons), and also to amend the pension Law, so as to allow for payments based on individual social insurance contributions. B. Increasing the distribution efficiency in the system o f social assistance benefits The results o f social assistance programs evidence a rather high level of inefficiency, especially due to the fact that resources have not been allocated correspondingly. The main objectives for social assistance focus on ensuring optimization o f the social payments system, by targeting them towards the most poor and focusing on social groups facing situations of risk and the successful transition from a categorical to a means-tested system. The EGPRS also includes, as a base element, measures aimed to increase efficiency in the social assistance system, targeted towards the most vulnerable population. To this aim, the Government has already approved the Concept for increasing efficiency in the social assistance system, by pointing out a series o f conceptual items, such as the Plan o f actions for increasing efficiency and method o f payment o f nominal compensations. Based on these, the pilot project for testing the mechanism for payment o f nominal compensation was launched, which will include testing o f revenues from families o f nominal compensation beneficiaries, which will serve as basis for switching to a system where social assistance (first o f all, nominal compensations) will no longer be given by categories, but depending on the necessity and total revenues o f the fmily/person. Inthe same time, the Government will adopt an additional plano factions aimed to implement the reform o f the social assistance system, which will include concrete measures for updating the legal and normative framework, as well as for the creation o f a single individual account for paying all social payments. The Government is committed to develop a plan that establishes a timeline for social assistancereform inorder to introduce improved targeting for poor, which would ensure the transition from a categorical to a means-tested system and the implementation o fthis time-bound actionplan. Maintenance o f registers in an unsatisfactory manner, the insufficient dissemination o f information among various programs of social assistance, as 23 well as management o f the social assistance program by several governmental agencies make it difficult for the Government to evaluate the general impact and the efficiency o f the social assistance program. In this context, the Government will draft and implement an information system aimed to ensure better maintenance ofregisters andto disseminate information more widely. Finally, let me assure you that my Government i s determined and committed to continue with the necessary actions and reform to improve the performance in priority areas such as improve governance, infrastructure, education and social service and give a new impetus to private sector development aiming to deliver a higher quality o f service to Moldavian citizens, ensuring a sustained growth perspective for the country. Iam sure that my country can rely on the continuous support of the World Bank and yours personally, VASILE TARLEV PRIMEMINISTER 3 ss 3 s3 ANNEX 3: FUNDRELATIONS NOTE Page 1o f4 EXTERNAL Public Information Notice RELATIONS DEPARTMENT International Monetary Fund 700 lgthStreet, NW Public Information Notice (PIN) No. Washington, D. C. 20431 USA FOR IMMEDIATE RELEASE IMF Concludes 2005 Article IV Consultation with the Republic of Moldova On May 5, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultationwith the Republic of Moldova.' Background Economic growth has continued to be robust, although the drivers of growth-household consumption and construction-remain heavily dependent on inflows of remittances (now equal to some 30 percent of GDP), as well as strong wage growth. Real GDP growth in 2005 was over 7 percent, as it has been since early in the decade. Inflation has gradually abated. After peaking at over 14 percent in April 2005, it fell to 10 percent (year-on-year) in December, despite a sharp pickup in energy prices in mid-2005. Fiscal policy has remained tight. The general government posted a cash surplus of about 1.7 percent of GDP in 2005, about twice the level of 2004, and considerably tighter than the deficit predicted in the revised 2005 budget (% percent of GDP). The main factors driving this fiscal performancewere better-than-expectedValue Added Tax revenues, delays in implementingforeign-financed project investments, disbursement of a grant from the European Union on December 29 for which expenditures had been included in the 2006 budget, and some spending restraint on the part of the government. Under Article IV of the IMF'sArticles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters,the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the Executive Board discussion based on the staff report. 1 ANNEX 3: FUNDRELATIONSNOTE Page2 o f4 Monetary policy was tightened in 2005, despite continued strong inflows of remittances. Sterilization efforts were stepped up in the second and third quarters before easing in the fourth quarter, as the balance of payments weakened in light of higher energy prices and the National Bank of Moldova (NBM) moderated its foreign exchange purchases. The NBM's balance on sterilization operations rose from an average of 1.Ipercent of GDP in 2004 to an average of 2.9 in 2005, reaching 3.5 percent of GDP at end-February 2006. As a result, reserve money growth slowed during the year, falling to 16% percent at end- September, before rising seasonally in December.At the same time, broad money growth remained strong (at 35 percentfor the year as a whole). Lending and deposit rates have remained high, despite plentiful liquidity on the T-bill and interbank markets. Financial sector soundness indicators have remained generally strong, reflecting partly strong economic performance of the recent years. Moldova appears to follow an asymmetric, managed floating exchange rate regime. Since early 2004, it would appear that downward pressure is accommodated while upward pressure is absorbed by the NBM through purchases of foreign exchange. The leu appreciated in real effective terms in 2004, but with a weaker balance of payments and lower inflation than in key trading partners, this tendency leveled off in 2005. Reserves have grown as well, doubling in dollar terms since end-2003, though as a share of imports they remain modest at about 2.2 months. The trade balance deteriorated significantly in 2005, owing in large part to the impact of higher energy prices. Energy (particularly fuel oil) imports rose in value terms by about 50 percent in 2005 (to about 5 percent of GDP), while export growth slowed modestly. The structural reform agenda has been reinvigorated by Moldova's aspirations for closer integration with Europe. The European Union-Moldova Action Plan, signed in February 2005, provides, along with the authorities' Economic Growth and Poverty Reduction Strategy Paper (EGPRSP), a road map for advancing a broad reform agenda, including in areas public administration, public expenditure management, and management of state enterprises. Executive Board Assessment Executive Directorswelcomed the strong economic growth and significant poverty reduction in recent years, the moderation of inflation, and the strengthened fiscal position, and commended Moldova'sauthorities for their commitment to structural reforms and balanced macroeconomicpolicies.At the same time, they noted that growth has been fueled mainly by domestic spending, which was financed by workers' remittances. Directors agreed that maintainingmacroeconomicstability in light of robust inflows of remittances while diversifyingthe economy and bringing povertyfurther down remain the key challenges going forward. They also stressed the importance of improvingthe business environment to support greater private sector investment and thus to help reverse the large migration of labor and strengthen the external position. Directors commended the authorities for their disciplined macroeconomic policies and considered that the short-termfiscal stance constituted an appropriate balance between the objective of supportingdisinflation and meeting the need for larger public investment and 2 ANNEX 3: FUND RELATIONS NOTE Page 3 of 4 social spending. Looking ahead, most Directors encouraged the authorities to repeat the fiscal over performance of recent years, though some Directors favored devoting revenue in excess of budgeted amounts to poverty reduction and infrastructure spending if the macroeconomicenvironment permits it. Directorswelcomed the authorities' efforts to modernize public sector management to improvethe efficiency of government operations. They observed given the large size of the government, that the public administration reform currently underway should lead to a leaner, more focused, and transparent government structure. While Directors welcomed the decision to fully pass through energy price changes, they expressed concern about the large increases in public sector wages in 2006 and urged the authorities to ensure that the wage profile remains consistent with priorities identified in the mediurn-term expenditure framework. Directorswelcomed the decline in inflation during 2005. Nevertheless, they noted that inflationarypressures remain, particularly in light of the increasing energy prices and the tightening labor market, and urged the authorities to be prepared to tighten monetary policy. Directors also encouraged the authorities to permit greater exchange rate flexibility to minimize risks to the disinflation path and facilitate the economy's resilience to balance-of- payments shocks. In this context, they welcomed the authorities' decision to amend the National Bank law to establish price stability as its key objective and stressed that this legislative change needs to be matched by steps in monetary policy implementation. Directorswelcomed the authorities' renewed push for structural reforms and underscored their importance to sustain the economic revival and maintain external competitiveness. They stressed the importance to improvethe environment for private initiative and investment also by reducing licensing and registration requirements and other administrative barriers and strengthen the legal and institutional framework and governance.They encouraged the authorities to accelerate implementation of the structural policies envisaged in their Economic Growth and Poverty Reduction Strategy (EGPRSP) to encourage investment, reverse the current emigration trend, and use the strategy to make progress in achieving the MDGs. Directorsalso noted that the EU-Moldova Action Plan- which is consistent with the EGPRSP-will serve as a useful roadmap for the ambitious reform agenda. Directors noted that financial sector stability indicators were largely positive, but urged the authoritiesto address remaining vulnerabilities. They emphasized the crucial importance of financial sector development to underpin economic and employment growth. Directors considered that Moldova's financial sector, and the economy more broadly, would benefit from a presence of reputable international banking institutions. In this context, they welcomed the authorities' intention to privatize Banca de Economii. Directors also commendedthe authorities for strengtheningthe AMLEFT framework and their objective of bringing it in line with best practices over the medium term. Directors welcomed the sustained improvement in Moldova's external debt position and expressed hope that Moldova will be able to normalize its relations with Paris Club creditors and restructure its stock of arrears in the near future, underscoring that this would facilitate access to fresh donor financial support. ANNEX 3: FUND RELATIONS NOTE Page 4 o f 4 Directors were encouraged by Moldova's subscription to the Fund's Special Data Dissemination Standard as an important step to further improve transparency, timeliness, and comprehensivenessof economic and financial data. Public Information Notices (PINS)form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINSare issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINSare also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. Republic of Moldova: Selected Economic Indicators (Percentchange: unless otherwise indicated) Production and Prices NominalGDP (in MDL millions) 27,619 32,032 36,755 42,585 Real GDP growth 6.6 7.4 7.1 6.0 Consumerprices (endof period) 15.7 12.6 10.0 9.0 (In percentof GDP) Public finance (general government) Overall balance(cash) 0.2 0.8 1.7 -0.8 Primarybalance 2.3 2.7 3.0 0.6 (Percentchange: unlessotherwise indicated) Money and credit Broadmoney (M3) 30.7 37.7 35.0 29.4 Creditto the economy 44.4 22.2 35.0 25.6 External sector Currentaccount balance(in percentof GDP -6.8 -2.7 -5.6 -5.4 Total external debt (in percent of GDP) 88.7 63.8 54.7 51.3 Total debt service (in percentof exports of goods and services) 19.8 21.3 20.2 14.5 Gross official reserves(in millionsof dollars) 302 470 597 750 Sources: Moldovanauthorities; and Fundstaff estimates. 4 Page 1of 3 ANNEX 4. Moldova at a glance 6/17/06 11 Lower Key Development Indicators Europe8 Central middle Moldova Asia income Age dlstrlbulion, 2005 (2005J Male Female Population,mid-year (millions) 4.2 473 2,475 Surfacearea (thousandsq. km) 7674 34 24,238 39,946 Populationgrovdh (%) -0.3 0.1 0C-04 Urban population (% of total population) 1.o 46 64 49 50.54 40.44 GNI (Atlasmethod,US$ billions) 3.2 1,945 4,746 3634 GNI percapita (Atlasmethod, US$) 880 4,113 1,916 2C-24 GNI per capita (PPP,international$) 2,150 9,142 6,313 10.14 0.4 GDP growlh (%) 7.1 6.0 6.9 15 10 6 0 5 10 GDP per capita growth (%) 7.4 5.9 5.9 percent (most recent esfimate, 200&2005) Povertyheadcountratio at $1 a day (PPP, %) 22 2 I Povertyheadcountratioat $2a day (PPP,%) 64 16 Under4 mortality rate (per 1,000) Lifeexpectancy at birth (years) 68 69 70 Infant mortality(per 1,000 liveblrths) 23 28 33 Child malnutrition(% of children under5) 5 12 I " 1 Adult literacy,male (% of ages 15 and older) 99 99 93 Adult literacy, female (YOof ages 15and older) 98 96 85 Gross primaryenrollment,male (% of age group) 95 105 115 Gross primaryenrolirnent, female (% of age group) 94 102 113 Access to an improvedwater source (% of population) 92 92 82 Access to improvedsanitationfacilities (% of population) 68 85 57 1880 j895 2000 2W4 Moldova rnEurope & CentralAsia Net Aid Flows 1980 1990 2000 2005 a (US$ millions) Net ODA and official aid 10 123 118 Growth of GDP and GDP per capita (%) Top 3 donors (in 2004): UnitedStates 9 35 33 15 T Sweden 0 2 7 Germany 0 2 6 Aid (% of GNI) 0.4 9.4 4.0 Aid per capita (US$) 2 29 28 Long-Term Economlc Trends 90 85 00 05 Consumerprices(annual% change) 31.3 13.1 GDP implicitdeflator (annual% change) 13.5 27.3 7.3 --6GDP -GDP percapita Exchangerate (annualaverage, localper US$) 0.0 12.4 12 6 Terms of trade Index (2000= 100) 100 115 188040 1990-2000 2000-95 (average annualgrordh %) Popuiation.mid-year (millions) 4.0 4.4 4.3 4.2 0.8 -0.2 -0.3 GDP (US$millions) 3,593 1,288 2,917 2.7 -9.6 7.1 (% of GDP) Agriculture 36.1 29.0 17.0 -11.2 1.4 Industry 36.7 21.7 24.5 -13.6 8.9 Manufacturing 36.0 16.3 17.3 -7.1 7.7 Sewices 27.2 49.2 58.5 0.7 6.4 Householdfinal consumptionexpenditure 57.5 91.4 91.6 9.9 10.2 Generaigov't final consumptionexpenditure 15.1 10.3 15.5 -12.4 7.0 Gross capitalformation 24.9 23.9 29.8 -15.5 8.4 Exportsof goods and services 48.2 49.8 52.4 0.7 16.1 Imports of goods and sewices 50.6 75.4 93.9 5.6 16.3 Gross savings 56.1 16.3 24.7 Note: Figures In italicsare for years other than those specified. 2005data are preliminaryestimates...indicatesdata are not available. a. Aid data are for 2004. b. GNI per capita excludesTransnistria. DevelopmentEconomics, DevelopmentDataGroup (DECDG). Page 2 of 3 Moldova Balance of Payments and Trade 2000 2005 (USS millions) Governance Indicators., 2000 and 2004 Total merchandise exports (fob) 477 996 Total merchandise imports (cir) 793 7,817 Voice and accounlabilily Net trade in goods and seivlces -331 -1,211 Political slabilily Workers' remittances and compensation of employees (receipts) 179 920 Regulatory quality Current account balance -98 -285 Rule of law as a % of GDP -7.6 -9 8 Control of corruption Reserves, including gold 218 597 I 0 25 50 75 100 Central Government Finance 02004 Country's percentilerank (0.100) 02000 higher valuesrmpiy teneri8dgi (% of GDP) Revenue 27.4 29 3 Tax revenue 14.7 16.4 Expense 28.9 27.1 Cash surplusldeficit Technology and Infrastructure 2000 2004 -1.5 0.4 Paved roads (Ohof total) 86.1 88.2 Highest marginal tax rate (%) Fixed line and mobile phone Individual subscribers (per 1,000 people) 169 391 Corporate High technology exports (% of manufactured exports) 4.1 3.7 External Debt and Resource Flows Envlronment (US$ rnil/tons) Total debt outstanding and disbursed 1,693 1,868 Agricultural land (% of land area) 77 77 Total debt service 151 248 Foresl area (% of land area, 2000 and 2005) 9.9 10.0 HlPC and MDRl debt relief (expected;flow) - - Nationally protected areas (% of land area) 1.4 Total debt (%of GDP) 131.4 72.0 Freshwater resources par capita (cu. meters) 237 Total debt service (% of exports) 18.1 12.2 Freshwater withdrawal (% of internal resources) 231.0 Foreign direct investment (net inflows) 127 81 CO2 emissions per capita (mt) 1.5 1.6 Portfolio equity (net inflows) 3 -2 GDP per unit of energy use Cornpositlon of total external debt, 2004 (2000 PPP $per kg of oil equivalent) 2.0 1.9 ISRO. 185 Energy use per capita (kg of oil equivalent) 672 772 US$millions Private Sector Development 2000 2005 Time requiredto start a business (days) 30 Cost to start a business (% of GNI per capita) -- 17.1 Time required to register property(days) - 48 Ranked as a major constraint to business (% of managers surveyedwho agreed) Cost of financing . .. 41.3 Tax rates .. 37.8 uross exL Stock market capitalization (%of GDP) 30.4 22.1 Bank branches (per 100,000 people) Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates ..indicates 8/11/06 data are not available. -indicates Observationis not applicable. Deveiopment Economics. Development Data Group (DECDG). Page 3 of 3 Millennium Development Goals Moldova With selected targets to achieve between 1990and 2015 (estmate closestto date shown, +/- 2 years) Goal 1: halvethe r a t e e r $1 a daypo@y andmalnutrition ~~1990 1995 ~ 2000 2004 Poverty headcount ratio at $1 a day (PPP, % of population) 7 3 c2 21 8 Povertyheadcount ratio at national poverty line (% of population) 62 4 48 5 Shareof incomeor consumption to the poorest qunitile (%) 78 Prevalenceof malnutrition (%of children under 5) 3 Goal 2: ensure that children are able to complete primary schooling ~~ Primaryschool enrollment (net,%) 89 89 66 Primarycompletionrate (% of relevant age group) 94 90 91 Secondaryschool enrollment (gross,%) 80 83 63 Youth literacyrate (% of people ages 15-24) 100 100 Goal 3: eliminate gender disparity in education and empower women Ratioof girls to boys in primary and secondary education(%) 105 99 102 Womenemployedin the nonagricultural sector (% of nonagriculturalemployment) 49 51 53 55 Proportionof seats held by women in nationalparliament(%) 5 9 22 Goal 4: reduce under-5 mortality by two-thirds Under-5mortalityrate (per 1,000) 40 44 37 26 Infant mortalityrate (per 1,000 live births) 30 34 29 23 Measlesimmunization(proportionof one-year olds immunized,%) 92 99 87 96 Goal 5: reduce maternal mortality by three-fourths ~ Maternalmortalityratio(modeledestimate,per 100,000 live births) 36 Birthsattendedby skilled health staff (% of total) 99 Goal 6: halt and begln to reverse the spread of HIWAIDS and other major diseases __ Prevalenceof HIV (% of populationages 1549) 1.1 Contraceptiveprevalence ("hof women ages 1549) 74 62 Incidenceof tuberculosis(per 100,000people) 64 138 Tuberculosiscases detected under DOTS (%) 40 59 ~~Goal 7: halve the proportion of people without sustainable access to basic needs - ~~~~~~~~ Access to an improvedwater source (% of population) 92 Access to improved sanitation facilities(% of population) 68 Forestarea (% of total land area) 9.9 10.0 Nationallyprotected areas (% of total land area) 1.4 C02 emissions(metric tons per capita) 5 5 2.6 1.5 1.6 GDP per unit of energy use (constant 2000 PPP$ per kgof oil equivalent) 2.2 1.5 2.0 1.9 Goal 8: develop~aglobal partnership for development ~~~ Fixed line and mobile ohone subscribers (Der 1,000 Deoole) .. ~~~~~~~~~~~ . 106 131 169 391 I , , Internetusers (per I,000 people) 0 0 12 96 Personalcomputers(per 1,000people) 2 15 27 - Youth unemployment (% of total labor force ages 15-24) 15.2 Educatlon Indicators (%) Measles immunization (%of I-year olds) ICT indicators (per 1,000 people) 125 1w - 500 1w- 75 - 400 ~ I 3w 4 ~ 75 - 50 - - 200 - - I 25 - 100 i 1998 2wo 2wz zw4 0 - 0 1990 1995 zow 2004 20w 2002 2004 --O-Primary net enrollment ratio +Ratio of girls to boys in primary& Moldova fixed +mobilesubscribers secondary education ~ -Europe & Central Asia JInternetusers Note: Figuresin italics are for years other than those specified. .. indicatesdata are not available. 8/11/06 DevelopmentEconomics, Development Data Group (DECDG). 27°00' 27°30' 28°00' 28°30' 29°00' SWEDEN Baltic LATVIA Sea LITHUANIA l l l l l l l RUSSIAN l l l Moghiliov- l l l l FED. l l l l l l l Podolski RUSSIAN l l l l l l BELARUS FEDERATION l l l l l l l l l l POLAND l l l l l l l l l l Ocnita l Dnester GERMANY l l Briceni l CZECH UKRAINE l l REP. l SLOVAK REP. l l l l l MOLDOVA l l AUSTRIA HUNGARY l l l ll l l l l l Donduseni l . 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