The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) Project Information Document (PID) Concept Stage | Date Prepared/Updated: 25-Aug-2021 | Report No: PIDC31822 Jun 17, 2021 Page 1 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) BASIC INFORMATION A. Basic Project Data OPS TABLE Country Project ID Parent Project ID (if any) Project Name North Macedonia P176366 Building Effective, Transparent and Accountable Public Financial Management Institutions in North Macedonia (P176366) Region Estimated Appraisal Date Estimated Board Date Practice Area (Lead) EUROPE AND CENTRAL ASIA Oct 04, 2021 Dec 16, 2021 Governance Financing Instrument Borrower(s) Implementing Agency Investment Project Financing Republic of North The Ministry of Finance of Macedonia the Republic of North Macedonia, Public Revenue Office Proposed Development Objective(s) To strengthen the efficiency, transparency and sustainability of public expenditure and increase the effectiveness of revenue administration. PROJECT FINANCING DATA (US$, Millions) SUMMARY-NewFin1 Total Project Cost 18.20 Total Financing 18.20 of which IBRD/IDA 18.20 Financing Gap 0.00 DETAILS -NewFinEnh1 World Bank Group Financing International Bank for Reconstruction and Development (IBRD) 18.20 Jun 17, 2021 Page 2 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) Environmental and Social Risk Classification Concept Review Decision Low Track II-The review did authorize the preparation to continue Other Decision (as needed) B. Introduction and Context Country Context 1. The Republic of North Macedonia is a small upper-middle-income country in the Western Balkans that aspires to achieve the living standard of the European Union (EU). North Macedonia's population, about 2 million, is aging and prone to emigration. Nearly 25 percent of the population lives in the capital, Skopje, and close to 40 percent live in rural areas. In 2019, North Macedonia's gross domestic product (GDP) per capita was US$6,042, about one-sixth of the average for EU member states. Its GDP per capita in purchasing power standards stood at EUR11,530 in 2018, 39 percent of the EU-27 average. 2. North Macedonia’s economy was converging with the EU before the pandemic-induced crisis: its average annual GDP per capita growth of 2.9 percent in 2000–2019 exceeded the 1.6 percent average for the EU during the same period. The country has made considerable progress in reducing poverty and inequality: the percentage of the population living below the upper-middle income poverty line of US$5.50 per day has decreased to 17 percent from about 35 percent in 2009 on the account of labor market improvements, higher labor earnings, and steady remittances. Yet, the productivity growth has been low and even negative, and economic growth relied primarily on the accumulation of capital since the 2009 global financial crisis. In 2017, growth almost stalled due to political instability and a freeze in capital investments that required careful reconsideration and even renegotiations. 3. The outbreak of the COVID-19 pandemic swiftly plunged the economy into the deepest recession in almost three decades. Real GDP contracted by 4.5 percent in 2020 (compared to the pre-crisis 2019 growth of 3.2 percent). Private consumption, the main driver of growth in the past, experienced a marked decline of 5.6 percent year over year as a result of containment measures and low consumer confidence. Investments also declined by more than 10 percent on average, and external demand plummeted. An increase in government consumption by over 10 percent partly alleviated the decline as the fiscal stimulus ramped up to protect jobs and firms. Except for agriculture, information and communication, and real estate, all other sectors declined. This has led to a fall in employment, although Government response measures partially alleviated the crisis impact. The combined effect of lower labor incomes and remittances increased poverty to an estimated 18 percent in 2020 (at US$5.5 a day in 2011 purchasing power parity), wiping out the gains made since 2018. 4. The pandemic has had an adverse effect on the fiscal accounts and public debt. North Macedonia entered the COVID-19 crisis in a relatively solid fiscal position with a gradually declining deficit and stable public debt since 2017. In response to the pandemic, the Government implemented five sets of anti-crisis measures estimated at 8.4 percent of GDP.1In 2020, the general government deficit tripled to 8.2 percent of GDP, while public and publicly guaranteed debt 1These include: (i) wage subsidies and social security contributions; (ii) deferment of the advance payment of corporate and personal income tax for the companies in the tourism, transport and food and catering sectors and other companies affected by the confinement measures; (iii) moratorium Jun 17, 2021 Page 3 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) exceeded 60 percent of GDP, the highest level in recorded history. Given the extended pandemic, a sixth stimulus package is being discussed. 5. Growth is expected to rebound to 3.6 percent in 2021, but downside risks are high. This scenario assumes accelerated vaccination by mid-2021, no further lockdowns in 2021, and recovered external demand. The policy response focus needs to increasingly move from relief to building resilience and restoring sustainability. 6. The country needs to accelerate structural reforms. Even before the COVID-19 crisis, productivity was among the lowest in the Western Balkans, and even declining. 2 Following the resolution of the country name dispute with Greece in 2019, the opportunity for accession to the North America Treaty Organization (NATO) and the EU opened up. The recent NATO membership3 as well as the possible launch of the EU accession negotiations should provide an impetus for structural reforms that will boost productivity and strengthen investors’ confidence over the medium term. Governance reforms, including of public finance management, are part of the new government’s4 reform agenda, and infrastructure, both publicly and privately funded, remains a priority. 7. Climate mitigation and adaptation are priorities for the Government, given that North Macedonia's economy is vulnerable to the impacts of climate change. North Macedonia ratified the Paris Climate Agreement in February 2018. In April 2021, it further increased its nationally determined contribution, now aiming to reduce greenhouse gas emissions by 51 percent compared to 1990 levels (previously having targeted a 30 percent reduction from business as usual levels).5 Due to the extensive use of fossil fuels for electricity production across the country, there is significant potential for climate change mitigation through investments in renewable energy and energy efficiency improvements. Additionally, the effects of climate change and the country’s geography make it prone to river flooding and extreme temperatures, with a high incidence of both, especially since 2012. A major flood disaster, like the one that hit the country in 2015, could derail economic growth, affect critical infrastructure, cause losses in agricultural incomes, and disrupt rural livelihoods. The annual damage to critical infrastructure from climate-related hazards could be more than three times higher by 2080 than today. As temperatures rise and precipitation becomes more variable, droughts will particularly affect southern and eastern parts of the country and jeopardize agricultural production and water quality in these regions. Digitalization of government services and processes, as well as ensuring disaster recovery solutions for government systems are thus a priority. Sectoral and Institutional Context 8. Over recent years, slow economic growth and inconsistent fiscal policies have adversely affected North Macedonia’s fiscal outcomes, and the country is currently facing important challenges in bolstering the economy’s resilience to external shocks. Fiscal slippages are not a new problem - in the past decade, supplementary budgets were frequently issued, pro-cyclical fiscal policies adopted in an attempt to boost growth even further, and publicly guaranteed on loan repayments, partial credit guarantees, and (iv) tax rate cuts, exemptions and free-value added tax (VAT) weekends, shrinking the already low revenue base. On social assistance, the government provided one-off financial assistance to vulnerable groups, high-school and university students, tourism vouchers for low-wage earners, and relaxed the Guaranteed Minimum Income eligibility criteria. 2 World Bank (2018), North Macedonia: Systematic Country Diagnostics. 3 On June 12, 2018, the Governments of North Macedonia and Greece signed the Prespa Agreement, aimed at resolving the long-standing name dispute. The Parliament in Skopje endorsed the necessary constitutional changes in January 2019 and the new name ‘Republic of North Macedonia’ was introduced on February 12, 2019. On March 27, 2020, North Macedonia became the 30 th member of NATO, while on March 30, 2020, the EU decided to open accession talks with North Macedonia. Negotiations, however, have not been launched yet. 4 Appointed in August 2020. 5 https://www4.unfccc.int/sites/ndcstaging/PublishedDocuments/The%20Republic%20of%20North%20Macedonia%20First/Macedonian%20enhanc ed%20NDC%20(002).pdf Jun 17, 2021 Page 4 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) debt grew to reach more than 60 percent of GDP in 2020 (above the safe long-term limit).6 The urgency of addressing these issues, however, has recently been underlined by the increased expenditure needs associated wit h the country’s COVID-19 response and the increasingly constrained fiscal situation brought about by the pandemic. Appropriate regulatory, institutional and systemic frameworks for public financial management (PFM) covering both the expenditure and the revenue sides, together with a strong enabling environment that ensures the incentives and coordination needed for the reform’s success, are critical to addressing the long-term, core underlying issues which are currently contributing to North Macedonia’s current challenges in fiscal and public financial management. Challenges on the expenditure management side 9. Public expenditures in North Macedonia could significantly improve in their efficiency, sustainability and transparency. Since 2009, public spending in North Macedonia has become more rigid and less efficient, leaving the Government with less flexibility to reallocate resources to priority items and sectors with greater economic impacts. General government arrears were reduced from 3.5 percent of GDP in 2017 to 2.42 percent at the end of 2019. However, due to the impact of the COVID-19 crisis, in 2020 they increased to 2.65 percent of GDP as local governments accumulated arrears, and their persistence is indicative of continuing issues related to the absence of effective commitment controls, contributing to inefficiencies in treasury management and the need for short-term financing actions. Other challenges associated with overall fiscal governance and public financial management include a missing link between strategies/policies and prioritization of budget allocations; the prevalence of off-budget structures that impact the comprehensiveness of the budget; difficulties in producing credible medium-term fiscal strategies and monitoring fiscal risks and contingent liabilities; and weaknesses in accounting and government financial reporting. The lack of an integrated financial management information system (IFMIS) also poses important challenges, including inefficiencies in the processing of payments for invoices; current manual processes create significant delays in many sectors (in some instances, these delays are longer than a month).7 10. The Government’s ambition to scale up on-budget public investments from 2.6 percent of GDP in 2019 to 4 percent by 20228, 9 is not currently supported by the necessary legal and institutional public investment management (PIM) framework. To fully materialize the benefits of such a scale-up, the Government needs to address structural bottlenecks to the efficiency of its investments. Weaknesses include the lack of a consolidated national investment strategy or plan that includes the costing of major infrastructure projects, regardless of levels of government or financing sources; the absence of a single pipeline of appraised projects ready to be prioritized and compete on a level playing field for budgetary resources; the execution of project selection and prioritization without using standard and comparable methodologies across sectors; and the lack of central oversight over the entire public investment portfolio (a role currently not provided for by the legal and regulatory framework), preventing the Ministry of Finance (MoF) from clearly identifying cost overruns and project delays, and taking corrective actions in a timely manner.10 Additionally, although the country has some experience with public-private partnerships (PPPs)/concessions (an important part of the PIM agenda for addressing public infrastructure needs), especially at the municipal level, current regulatory, institutional and human 6See Modernizing the Framework for Fiscal Policy and Public Debt Sustainability Analysis (https://www.imf.org/external/np/pp/eng/2011/080511.pdf). The authors suggest 49 to 58 percent of GDP as a safe long-term debt limit. For North Macedonia—a small open economy with limited policy space and significant vulnerabilities—the safe limit is likely to be at the lower end of 49 percent. 7 A PEFA analysis is ongoing and the results will provide additional insights when available. 8 Fiscal Strategy of the Republic of North Macedonia for 2020–22 9 The off-budget capital spending for road infrastructure adds an additional two percentage points of GDP. 10 Isabel Rial, Eduardo Aldunate, David Gentry, Simon Groom, Di Hai, Antonia Viyachka, and Bojan Shimbov, North Macedonia Public Investment Management Assessment, IMF, April 2020. Jun 17, 2021 Page 5 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) capacity gaps have impacted the performance of the existing portfolio. The Ministry of Economy (MoE) is currently working on a new PPP and Concessions Law, harmonizing it with international best practice and the EU acquis Communautaire, and is also in the process of developing the necessary by-laws, guidelines, methodologies and trainings11 (with World Bank support under the Strengthening the PPP Regulatory Framework and Policy Advisory Services and Analytics (ASA) (P169110). The PPP framework and processes will need to be integrated with the PIM system (which is being developed) and project implementation tools for contracting authorities, including guidelines and manuals for contract management and standard contracts, developed, in order to ensure a consistent, strategic and cost-effective infrastructure pipeline. 11. In addition to concerns related to fiscal sustainability, there are also important issues associated with ensuring the environmental sustainability and climate informed nature of public expenditures. The high level of the fiscal deficit compounded by COVID-19 related challenges has translated into weakened resilience to physical climate risks and constrained capacity for climate action that will hinder a green recovery. Responding to this situation is complicated by the fact that, currently, in North Macedonia, climate change is not covered as part of the policy setting, budget planning and execution process in a coherent and comprehensive way. Costs from climate change or contributions from climate smart policies are not integrated into PFM processes. Public investment management prioritization and selection decisions, as well as overall budget planning and preparation do not consider climate change as one of the factors in the decision-making process, complicating efforts to track climate-informed expenditures and their results. 12. Similarly, there is a need to enhance systems to track allocations for gender equality and improve the transparency of the publicly available data on budget (development, adoption and implementation) for gender equality. The country currently lacks the legal framework (the existing budget law does not include gender budgeting) to integrate gender into budgeting decisions, an important input for generating data and analytics to support informed dialogue on opportunities for gender inclusion. 13. Fiscal transparency challenges are also significant. Measures of the country’s budget transparency show that it has remained below its 2010 level since 2012. 12 In 2019, North Macedonia scored 41 out of 100 on the Open Budget Index, signaling that it only makes limited information available and scoring below the global average of 45.13 It scored 0 out of 100 on public participation in the budget process, and the legislature and supreme audit institution were found to provide only limited oversight (scoring 54 out of 100) of the budget process. These challenges are also apparent in the results of the 2015 PEFA and 2018 Fiscal Transparency Evaluation, which in spite of advances in areas including publication of the medium-term macro and fiscal framework, fiscal risk assessments and public debt and guarantees,14,15 also highlighted areas for improvement regarding fiscal transparency and accountability. 14. While recent progress is poised to contribute to greater fiscal transparency, several areas of improvement remain. In 2018, Parliament approved the Law on Reporting and Monitoring the Liabilities (Official Gazette 64/2018) to identify and monitor arrears of the general government and state-owned enterprises outside of the general government. The law mandates the use of a new arrears reporting system and the quarterly publication of reported arrears by entities, 11 The development of a new single electronic PPP system, including a PPP registry, is also needed, but not contemplated within the scope of the proposed Project. 12 World Bank, Public Finance Review: FYR Macedonia, June 29, 2018 13 https://www.internationalbudget.org/open-budget-survey/rankings 14 EU, Public Expenditure and Financial Accountability 2015, https://www.pefa.org/country/macedonia 15 IMF, Fiscal Transparency Evaluation 2018, https://www.imf.org/en/Publications/CR/Issues/2018/10/29/Former-Yugoslav-Republic-of- Macedonia-Fiscal-Transparency-Evaluation-46317 Jun 17, 2021 Page 6 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) group of entities, types of expenditures and clients.16 This has helped MoF to start clearing arrears and work on preventing the creation of new ones.17 Other advances include, among others, the publication of detailed data on public debt through the javendolg.open.finance.gov.mk tool since February 2020, and the launching of the Fiscal Counter tool on the home page of the MoF’s website in March 2021, providing regularly updated information on the realization of revenues, expenditures, capital expenditures, and government debt.18 However, areas for improvement remain, including: i) publication of central government financial liabilities and foregone revenues from tax expenditures19; ii) encouraging independent evaluation of fiscal forecasts; iii) publication of the total costs of investment projects and methodological guidelines for the appraisal of large projects along with their assessments and sharing information on the costs and performance of public investments; and iv) publication of citizen budgets on time and together with the budget proposal being submitted to Parliament. Challenges on the revenue management side 15. Recent assessments have also highlighted important performance gaps in tax administration, which affect the effectiveness of revenue collection,20 and further compromise the country’s fiscal situation. North Macedonia’s tax to GDP ratio (26 percent in 2018, including mandatory social security insurance) remains one of the lowest in Europe, below both the EU (41.2 percent) and the Organization for Economic Cooperation and Development (OECD) averages (33.9 percent), mainly as a result of the large informal economy (estimated at 38 percent of GDP in 2016). 16. The World Bank’s DIAMOND assessment of North Macedonia’s Public Revenue Office (PRO) helps to identify the most important gap areas and opportunities for improvement. The assessment, carried out in September 2020, covers both strategic dimensions of the tax administration as well as an analysis by business areas, and helps identify a number of areas of opportunities for improvement which would support revenue generation and make tax compliance easier for taxpayers, especially for businesses. These include, inter-alia, strengthening the compliance risk management framework and the audit program (e.g., developing risk-based audit selection criteria for all taxpayers, increasing the use of third-party data, and reallocating more resources to audit); developing a comprehensive voluntary compliance strategy; reintroducing a dispute resolution process; and ensuring an accurate picture of the PRO's total stock of arrears and the existence of measures to address arrears older than twelve months. It also recommended strengthening the enterprise/institutional risk management framework and enhancing the PRO's business continuity plan to build on lessons learned from the COVID-19 pandemic; developing an updated workforce planning strategy and filling key vacant positions in the Large Taxpayers Office (LTO), arrears management and audit; moving towards a performance-oriented budget; building capacity in international taxation; and finalizing the development, testing, and deployment of a new integrated information technology (IT) system that supports all core tax administration functions. 17. These findings are aligned with the IMF’s February 2020 Tax Administration Diagnostic Assessment Tool (TADAT). The TADAT identified weaknesses, including the fragmentation of the tax IT system (which does not provide whole of taxpayer view and consistent quality of services); the need to improve the strategic execution of Compliance Risk 16 Supported by the World Bank DPO P171851. 17 The existing Treasury system was established in 2007. In order to enhance the monitoring of arrears, the Budget Department established a separate application where all budget users (including municipalities) and State-owned enterprises report their arrears periodically since 2017. 18Other advances include the incorporation of municipal transactions into the Open Finance portal dataset since June 2020; the publication of enterprise-level data on public and state owned companies’ revenues and expenditures as well as the execution of local governments’ budgets since October 2020; and increased coverage of the financial operations on public enterprises and trade companies included in the Government’s recent Fiscal Strategies. 19 First such report has been produced by the MOF in 2021 with the support of the EU Twinning partners and is pending publication. 20 The World Bank Tax Development of Implementation and Monitoring Directives (DIAMOND) 2020 and IMF Tax Administration Diagnostic Jun 17, 2021 Page 7 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) Management (CRM) across the PRO; the need for operational activities, including audit, to be sufficiently directed by risk assessments; the absence of an independent administrative review process; deficient management of value added tax (VAT) reporting and refund processes; inadequate management of large taxpayers; and suboptimal use of data and taxpayer input for management decisions. Challenges Related to Reform Management and Behavioral Change 18. Addressing these challenges in public expenditure and revenue management is not simply a technical issue that can be addressed solely through the “right� combination of laws, systems and tools; inherent in new laws and systems is a set of changes in behavior that need to occur in order for their full effectiveness to be achieved. Experience around the world shows that PFM reforms are complex, with technical solutions often falling short due to the persistence of stakeholders’ pre-reform behaviors, necessitating an integrated and adaptive approach to change management in order to generate support across the wide range of affected stakeholders. In North Macedonia, stakeholder engagement surveys conducted in the Ministry of Finance and Ministry of Information, Society and Administration during the preparation of the new Organic Budget Law (OBL, discussed further below) revealed several issues which could pose challenge to the implementation of planned expenditure reforms, including a conservative culture with low appetite for risk, human resource capacity constraints such as uneven tacit knowledge of public administration and use of technology, and the need for institutional arrangements which improve coordination and arbitration between stakeholders. Similarly, constraints related to human resources were also highlighted in the DIAMOND assessment of revenue management. An integrated approach to Public Financial Management reform 19. The Government’s current reform programs set out its plans for addressing these issues by enhancing the PFM system across the entire PFM cycle. The 2018-2021 public financial management (PFM) reform program specifies seven priorities: (i) an improved fiscal framework, including fiscal rules and a fiscal council, (ii) revenue mobilization, (iii) planning and budgeting, including a revised Organic Budget Law, medium-term and program-based budgeting, (iv) budget execution, including the introduction of an integrated financial management information system (IFMIS), (v) enhanced transparency in government reporting, (vi) internal control, including an enhanced legal and methodological framework improved, and (vii) external control and parliamentary oversight. Looking ahead to the period between 2021 and 2025, the Government will organize its fiscal policy around three platforms, which build on the ongoing PFM reform program: (i) fiscal consolidation, (ii) the strategy for economic recovery and sustainable growth (Smarter Growth), and (iii) a public investment plan. In December 2020, it also adopted the Five-Year Strategy for Tax System Reform 2021-2025, which aims to ensure greater fairness in taxation, better revenue collection, encourage investment and innovation, greater tax responsibility, higher tax transparency, higher quality of services, digitalization and green taxation. The Government is also now starting to update the PFM Reform Program for 2022-2027. 20. As part of the associated expenditure reform efforts, the Government is in the process of updating critical legal frameworks that will introduce significant changes in institutional roles and responsibilities, processes and relevant information systems. Key to this effort has been the development of a new OBL that will address current shortcomings in PFM by providing a comprehensive legal and institutional framework for the PFM system and new processes, in line with international good practices and the country’s needs and reflecting prioritized areas of reform identified through ongoing engagement between the World Bank and the Government since 2018 under the Organic Budget Law Technical Assistance ASA (P168027). The draft law, which was approved by the Government in January 2021 after a series of discussions with stakeholders including a public consultation event in October 2020, is currently under the review of the Legislative and Regulatory Committee and the Financing and Budget Committee of Parliament. The Parliamentary approval process is Jun 17, 2021 Page 8 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) expected to be completed in the coming months, and preparation of the relevant implementing legislation is currently ongoing, with support from the World Bank and the Instrument for Pre-Accession Assistance (IPA) twinning project. 21 21. The OBL’s implementation will require changes to the entire PFM framework, including adjustments to institutional structures, secondary regulations, processes, and systems, and affect management and staff practices across the whole public sector. In particular, implementation of the IFMIS will be key to the success of the OBL’s broader implementation and strengthening the Ministry of Finance’s performance of core PFM functions including budget planning and execution, public debt management, monitoring of public investments, data analytics, and business intelligence. This process also offers the opportunity to fill an existing gap and integrate climate change and gender considerations into the budget process and the associated systems. Having been advancing on assessing PFM processes and systems, comparing IFMIS implementation options, and preparing the detailed requirements in line with the reform priorities since 2019 together with support from the World Bank under the Organic Budget Law Technical Assistance ASA (P168027), the Government is now ready to progress to implementation. 22. Within the tax administration, the institutional reforms laid out in the PFM Reform Program 2018-21 and Tax System Reform Strategy (2021 -2025) are being operationalized through the PRO’s Strategic Plan 2021 – 2023. The plan sets out three strategic programs of the tax administration: (i) strengthening administrative capacities, (ii) protecting against tax fraud and reducing the size of the gray economy, and (iii) mobilizing tax revenue. One of the key activities envisaged is the deployment of a new integrated information technology (IT) system to support core tax administration functions and replace the existing information systems that are outdated, fragmented, incomplete and too rigid to keep up with the legal changes and core tax administration functions. Following a review of the detailed design and business processes, supported by the EU and IMF, in 2019, the PRO began developing the Integrated Tax Information System (ITIS). The system’s core modules (Registration, Filing and Service Management, Accounting, Payments, and Refunds, Debt management, Assessments, Legal, and Audit) are expected to be fully operational in 2022. In line with the findings of the World Bank’s recent assessment of the PRO’s IT strategy, complementary improvements in IT related to data warehousing, business intelligence tools, and e-invoice and e-commerce modules have also been identified by the PRO as priorities, and building from support to the preparation of the associated technical requirements, the Government is also ready to progress on their implementation.22 23. On both the public expenditure and revenue sides, the successful implementation of these public financial management reforms will require strengthening inter-institutional coordination, cooperation, and collaboration, and effective change management and communication strategies. The stakeholder engagement analysis and strategy developed during the preparation of the OBL identified initial stakeholder capacity and engagement needs as well as coordination, cooperation and collaboration constraints whose addressing would be critical for the reform’s successful implementation. Given change management’s cross-cutting implications, implementation of the OBL and the IFMIS (as a part of that strategy) will require strengthening MoF’s capacity to foster a high-level of inter-institutional coordination, 21 The World Bank through the Good Governance and Investment Climate Reform (GGICR) TF has been providing technical assistance on preparation of the OBL and its selected secondary legislation. These are Delineation and Register of Public Entities, Budget Liquidity Planning, Budget Classifications, Procedures for entering into commitments and registering pre-commitments and commitments, Guidelines for the organizational units for financial matters of the budget users, Rulebook on the terms, rules and procedures of cash management of the TSA system. The remaining 23 by-laws will be drafted as part of the ongoing EU IPA TF activities. 22 The ongoing Bank ASA Supporting the Public Revenue Office IT system Design (P175799) which is expected to be completed in June 2021, will support the PRO in developing technical specifications for data warehouse, business intelligence tools, and e-invoice and e-commerce modules. This ASA will also focus on analyzing and assessing the robustness of the PRO’s IT Strategic Plan and system development approach. This analysis will help provide advice and assistance to adjust the existing plans if needed, confirm the areas of direct support requested by the PRO, and inform the preparation of this lending operation. Jun 17, 2021 Page 9 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) cooperation, and collaboration with entities across Government as well as strategies to address resistance to changes in procedure from the rank and file, and to provide middle management with improved control over the pace and scope of reforms. Similarly, the MoF currently lacks the technical capacity for oversight of the public investment portfolio, and there are significant institutional and capacity risks to implementation of the new PPP/Concessions framework and the development of a successful pipeline of projects. In terms of revenue administration, capacity building and advisory assistance are also needed to improve PRO’s tax administration capacity. Given the extensive scale of planned reforms, and in order to maximize their impacts, comprehensive change management and communication strategies oriented both inwards towards the public administration as well as externally towards citizens will be critical for building support for reforms and strengthening state-society relations. Listening to taxpayers – and particularly to businesses - will also be critical for increasing the probability that tax administration reforms are able to be successfully implemented, helping to not only expand the system’s tax base and increase tax revenues, but also to enhance taxpayer confidence, reduce costs for compliance and enhance the business climate. Relationship to CPF 24. The November 2018 Systematic Country Diagnostic (SCD) (Report No. 121840-MK) emphasized the continued need to improve fiscal sustainability and identified several supporting policy actions including increasing the transparency and accountability of government decision-making, reinforcing the efficiency of public spending and increasing tax compliance and tax progressivity, which are well-aligned with the proposed Project’s focus. In particular, the SCD noted that public spending efficiency reforms could yield savings for North Macedonia equal to more than 13 percent of total public spending, and highlighted possible policy responses including adopting management guidelines requiring all public investment projects be subject to cost-benefit analysis, readiness assessment, and alignment with sector strategies and medium-term budget plans, as well as including all costs expected throughout the entire project cycle in budget plans to avoid backlogging maintenance. On the revenue side, the SCD recommended efforts to modernize the tax administration and increase voluntary taxpayer compliance, noting that working at the nexus between the quality of public services, enforcement of rules, and fairness (non-selective application of rules) would help shrink the informal economy. 25. The Country Partnership Framework (CPF) for the Republic of North Macedonia 2019-2023 (Report No. 135030- MK) identifies Strengthen[ing] Fiscal and Public Finance management as a key objective (Objective 4) within Focus Area 3 – Sustainable Growth: Enhance Sustainability and Build Resilience to Shocks. In particular, the CPF highlights support to the introduction of the new OBL among its areas of engagement. The proposed Project, with its project development objective (PDO) of strengthening the efficiency, transparency and sustainability of public expenditure and increasing the effectiveness of revenue administration, and particular engagement on the implementation of the OBL, is well-aligned with the CPF’s Objective 4. Over the medium to long term, the Project is expected to contribute to the Focus Area’s broader goal of reducing risks to fiscal sustainability and boosting resilience to fiscal shocks, as well as to the strengthening of the Government’s ability to effectively provide public services, underlying Focus Area 2’s emphasis on expanding skills and opportunities for the most vulnerable. C. Proposed Development Objective(s) To strengthen the efficiency, transparency and sustainability of public expenditure and increase the effectiveness of revenue administration. Key Results (From PCN) Jun 17, 2021 Page 10 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) 26. Proposed indicators to capture achievement of the project development objective (PDO) include: i. Reduction of central government arrears (measurement TBD) (efficiency of public expenditure) ii. Required time for the processing of payments through IFMIS and Treasury Single Account interface is reduced (efficiency of public expenditure) iii. Increased comprehensiveness of the general government reporting that includes critical extra-budgetary funds measured based on the PEFA PI6 indicator (transparency of public expenditure) iv. Increased taxpayer satisfaction with PRO services, disaggregated by gender (effectiveness and transparency of public expenditure) v. Climate change considerations integrated into project screening (percent of approved projects addressing climate change mitigation or adaptation) (sustainability of public expenditure) vi. Decreased VAT gap (percentage) (effectiveness of revenue administration) vii. Increase in net tax assessed per audit (effectiveness of revenue administration) Data availability for these and other possible indicators will be explored further during preparation. D. Concept Description 27. Reflecting the objectives of the Government’s 2018-2021 PFM reform program and building from the recent World Bank advisory support to the development and preparation for the implementation of the new OBL,23 the strengthening of the regulatory and institutional framework of PPPs,24 as well as the development of system modernization requirements to support the implementation of tax reforms,25 the proposed Project aims to strengthen the efficiency, transparency and sustainability of public expenditure and increase the effectiveness of revenue administration in North Macedonia. This will be pursued through a comprehensive approach to strengthening both the expenditure and revenue sides of the public financial management cycle that takes into account both fiscal and climate change sustainability. In particular, it contemplates: (i) support to public expenditure management reforms and the development of the IFMIS, and (ii) strengthening of tax administration processes and systems in the PRO. These advances will be supported by activities focused on regulatory and institutional reforms, systems modernization, and capacity building. Given the importance of change management and strategic stakeholder engagement within the reform agenda, related activities will be an integral part of the proposed operation. Component 1: Supporting Public Expenditure Management Reforms 28. The objective of this component is to support the implementation of PFM reforms by strengthening institutional capacity and improving the processes and technology platforms in line with the new OBL, including the introduction of an IFMIS in North Macedonia to replace existing information systems. These activities are key to establishing the foundations for the implementation of the OBL and improving the efficiency, transparency and sustainability of public expenditure. Subcomponents include: Implementation of adjustments to legal frameworks (subcomponent 1.1), Development of GovTech solutions to Support PFM reforms (subcomponent 1.2), and Institutional structures and enabling environment (subcomponent 1.3). Component 2: Strengthening Tax Administration Practices and Systems in PRO 23 Technical Assistance on the Organic Budget Law together with the IFMIS Solutions, P168027 24 Technical Assistance, Strengthening the PPP and Regulatory Framework and Policy in North Macedonia, P169110 25 Supporting the Public Revenue Office IT System Design, P175799 Jun 17, 2021 Page 11 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) 29. This component will aim to strengthen operational effectiveness of PRO operations with focus on strengthening its tax compliance management system and selected management functions. Subcomponents include: Improvements in the effectiveness of revenue management (subcomponent 2.1); Enhancing and expanding PRO’s tax revenue management information systems (ITIS) (subcomponent 2.2); and Strengthening of PRO management functions (subcomponent 2.3). Component 3: Change Management, Coordination and Project Implementation Support 30. This component aims to address current challenges in inter-institutional coordination, cooperation, and collaboration; institutional capacity; and state-society relations which will impact the extent to which public expenditure and revenue management activities are able to be effectively implemented, and will provide support for project management and implementation, stakeholder engagement and change management activities, and donor coordination and integration of the Project’s work with other ongoing and future assistance programs in these areas. Subcomponents include: Operationalization of change management, stakeholder engagement and communication (subcomponent 3.1) and Staffing and operation of a Project Implementation Unit (subcomponent 3.2) Legal Operational Policies Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Areas OP 7.60 No Summary of Screening of Environmental and Social Risks and Impacts . There are no environmental impacts with the project. The most important social issues would be the proper engagement of all interested parties and informing the general public. . CONTACT POINT World Bank Mediha Agar, Alberto Leyton Senior Public Sector Specialist Borrower/Client/Recipient Republic of North Macedonia Implementing Agencies Jun 17, 2021 Page 12 of 13 The World Bank Building Effective, Transparent and Accountable Public Financial Management Institutions in N. Macedonia (P176366) The Ministry of Finance of the Republic of North Macedonia Daut Hajrullahi Head of IT Department daut.hajrullahi@finance.gov.mk Public Revenue Office Marjan Mihajlovski Head of Sector for International Cooperation marjan.mihajlovski@ujp.gov.mk FOR MORE INFORMATION CONTACT The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-1000 Web: http://www.worldbank.org/projects APPROVAL Task Team Leader(s): Mediha Agar, Alberto Leyton Approved By APPROVALTBL Practice Manager/Manager: Country Director: Massimiliano Paolucci 26-Aug-2021 Jun 17, 2021 Page 13 of 13