1. Western Balkans and Europe 2020 - Supporting Convergence and Growth
Jane Armitage, Country Director
and Regional Coordinator for South East Europe
WORLD BANK
March 2011

2. Outline Post-crisis macroeconomic framework
Structural reforms for smart, sustainable, and inclusive growth
Competitiveness
Governance and rule of law
Social sectors
The World Bank’s engagement

3. Two years after the crisis started...
The legacy of the crisis continues though economies are slowly improving
Growth collapsed but is recovering tentatively, especially through growing export demand
Private capital inflows fell sharply but very recently are beginning to trend upwards and formerly unsustainable CADs have shrunk sharply
Fiscal deficits spiked in most countries but have begun to moderate as a result of a expenditure adjustments
However, domestic demand remains weak and improvements in employment and poverty reduction remain elusive

4. Growth rates declined sharply and GDP shrank in most countries but there is now a gradual return to growth…

5. The momentum of poverty reduction slowed considerably…

6. Fiscal consolidation needed for macro sustainability, but…
Ageing populations and increased longevity putting pressure on pension and health systems
Need for reformed social safety nets with improved targeting to alleviate budgetary pressures and reduce payroll tax disincentives for employment creation
Competitiveness requires greater access to higher education and improved quality at all levels
Major infrastructure improvements needed in environment of reduced private finance

7. I. Promoting Growth and Competitiveness

8. The Region is improving ranking on “Doing Business”, but key areas need attention…
Most difficult areas are construction licenses, property registration and contract enforcement
Reforms are not that difficult: FYR Macedonia climbed from being 94th in 2006 to 38th in 2011

9. Lack of infrastructure is a major bottleneck for businesses in the Western Balkans…
% of firms indicating transport is a major obstacle to doing business
% of indicating electricity is a major obstacle to doing business
Energy
MONTENEGRO
BiH
SERBIA
Source: Doing Business 2011 9

10. Lack of infrastructure cont’d
Irrigation and Water Resources
Western Balkan countries have strong potential for agricultural production which is unrealized due largely to inadequate irrigation (most countries are net importers of food but could be net exporters with adequate irrigation)
Absence of River Basin Management Plans, inhibits balanced multi-purpose river use and leads to controversy (e.g. hydropower vs agriculture)
Major vulnerability to floods (e.g. Dec. 2010, 6 casualties) due to inadequate dike protection, lack of maintenance, no integrated planning, poor cost recovery
Going forward, climate change will continue to restrict areas that can produce rain- fed crops
Urban Water and Sanitation Services
Although coverage is generally good in the Western Balkans, services are unreliable affecting growth in key high-potential and water intensive industries such as tourism and food processing
Water and sanitation are generally publicly funded putting pressure on limited budgetary resources in many instances
Lack of adequate policy framework – low tariffs, weak collection rates and non-revenue water-- inhibits private sector investment

11. Transport Infrastructure
Roads:
Total road network in the SEE countries covers over 100,000 kms
of which core network is 6,000km
Road quality remains poor despite investments in the SEETO ‘Core Network’
All Western Balkan countries rank in the bottom half in a world economic forum ranking of 139 countries
Rail:
Western Balkan countries are in the bottom half of rankings for quality of rail infrastructure among 116 countries
Serbia, Bosnia and Herzegovina, and Albania are among the bottom quarter
Port and inland waterways :
The inland water transport network in SEE has been neglected for far too long
nearly no expenditure on Sava or Tisa since 1990

12. Better transport infrastructure is critical for Economic Development in the Western Balkans…
The small size of the Western Balkan countries, and their favorable location vis-à-vis the EU market, underline the importance of trade facilitation for growth and poverty reduction, but:
Road infrastructure below European standards: raises costs of trade
Broader trade and logistics environment (transport services, border-crossings etc.) is also weaker than in EU-10 region
Overall objective for transport sector development is to reduce ‘economic distance’ to the main markets
A reduction in economic distance requires:
improved physical infrastructure
improvements in the institutional framework
improved logistics
multi-modal development strategy

13. Improving Transport: Priorities for Action
Address increasing demand for road transport through continued development of the SEETO core regional road network
Prioritize improved management of existing infrastructure through:
better maintenance and establishment of professional management systems
Focus on enhancing logistic chains and clearance procedures to reduce delays to international transport
Revitalize the rail network through:
rehabilitation of track to return line speeds to design speed,
rolling stock rehabilitation rather than major upgrade in speed,
further institutional reform.
Improve financing sustainability through:
Efficiency improvements and increased cost recovery
Effective partnership with the private sector
Ensure environmental and social sustainability:
Improve road safety
Reducing disbenefits (air pollution, noise etc…) through appropriate pricing
Include environmental social cost in determining mode choice

14. Energy use in the Western Balkans is massively inefficient and investment needs are huge…
SEE economies are characterized by high energy intensity and low energy efficiency:
Conventional power generation structure, import dependent, and emerging severe shortages;
National market generally dominated by one state owned generator and is subject to high losses (commercial and technical)
Regulated tariffs cover costs but are generally low and insufficient to cover cost of new investments
Energy generation is dirty, heavily dependant on petroleum and coal
Meeting development and EU2020 goals will require
Huge investments: billion Euro over next 10 years
Adoption of regional investment strategies
Addition of new generation capacity and replacement of old plants
Development of gas and renewable resources in conjunction with revamping of tariffs structures

15. Energy (cont’d)
Regional integration is critical for energy security but must overcome the following challenge
Lack of market price penetration to final consumers and no publicly available and trusted “reference price” for electricity
Close relationship between incumbent generator and incumbent supplier which impedes open, competitive market
Difference between regulated tariffs across countries are too low to allow market based investments in generation
Market participants, regulators, and authorities have little or no experience of electricity market operation
Perceived instability of energy policy constrains private involvement
Strategic focus of Bank’s engagement in energy in the Western Balkans is
Development of regional energy market (transmission, rehabilitation of generation, dam-safety)
Promotion of energy efficiency and renewable resources
Improvement of energy supply and infrastructure (including new generation) through PPP approaches
Implementation of strategies for global and local environmental improvement

16. Western Balkan water and sanitation systems generate high water and financial losses…
Generally high water and sanitation coverage masks weaknesses
aging infrastructure results in high physical losses
outdated water pumps translate into high energy costs
continuity of service dips as low as 8 hours per day in some countries
wastewater treatment limited with negative externalities
Lack of operations & maintenance management & budgeting:
accelerated depreciation of assets
service disruptions
Utility financial performance is weak:
high Non-Revenue Water & low collection rates
overstaffing
inability to attract private sector financing
Private sector participation
low tariffs make concessions non-viable
political interference undermines pricing
weak regulatory oversight and enforcement

17. Water and Sanitation Sector: Priorities for Action
Update Water Sector Legislation and Regulations to align with EU Directives
Harmonize National Water and Sanitation Sector Strategies with EU Policies
Link water supply distribution to water resource management goals
Promote energy efficiency and water demand management
Initiate utility reform programs
Consolidate utilities to achieve better economies of scale
Institute utility performance contracts against realistic benchmarks
Set performance standards for utilities
Support utility staff training and certification programs
Devise subsidy programs that better target the poor:
Wind down subsidies to poor performing utilities (perverse incentives)
Target subsidies to the poor through social assistance programs
Improve data collection and information systems:
Empower regulatory oversight agencies to enforce reporting of sector data
Standardize indicators and performance measurement
Mainstream third-party verification of disclosed data

18. Despite tremendous potential, agricultural productivity is relatively low…
Agriculture represents 9-20% of GDP
Half the population (and most of the poor) lives in rural areas
Agriculture has enormous potential: abundant land and low-cost labor, favorable climate, and proximity to EU Market
Productivity is low: small farms, fragmented value chains, poor logistics, inadequate infrastructure, and low skills
Need for shift from subsistence
producers to commercial farms
Align policies to access
EU agriculture funds
Prepare for climate change

19. Irrigation – Essential tool to generate income and jobs…
Agriculture is % of countries’ GDP and 20-50% of jobs -- given major un- and under-employment it is critical to maintain agricultural employment
Climatic conditions impose use of irrigation and drainage to produce marketable valuable crops (vegetables, fruits, grapes, oil seed crops, etc.)
Climate will become drier and warmer  limits rain-fed agriculture, expands need for irrigation
Investment needs in rural infrastructure amount to €5-6 billion.
Most irrigation systems out of operation or vandalized, many drains not maintained. Most countries now prioritize modern agriculture including irrigation and drainage; plus bulk water supply (reservoirs, groundwater).
World Bank focus in Agriculture/Rural Water:
Institutional reform: (1) establish Water User Associations, (2) ensure market access for agriculture products, (3) realistic water fee to be paid by farmers, (4) partnership with local govt.
O&M costs plus on-farm equipment to be paid by farmers, but “public good” investment in main reservoir, pump, piping, for the moment from national budget
Combine irrigation, drainage, water storage, in river basin management

20. Improving water use and mitigating impacts of climate change…
Climate change has contributed to increasing frequency and severity of floods throughout the Western Balkans
Flood protection infrastructure is inadequate and poorly maintained
Water management will be more critical over next 2 decades as Western Balkans become subject to more intense but less frequent rainfall
Households and businesses need protection from the high cost of flood damage
Key emphases of World Bank strategy:
Provision of affordable insurance against losses from flooding and other catastrophic risks (Western Balkan Catastrophe Risk Insurance Fund)
Early warning system, river flow forecasting, improve hydromet data system
Localized emergency reconstruction and relief
Better integrated planning of structural and non-structural measures, including
recreation of floodplains
Securing the supply of bulk water, including dams and reservoirs bulk water canals, pumping stations
Support river basin management in line with EU Water Framework Directive, including analysis of trade-offs between environment, hydropower, other uses

21. II Governance: Governments are by and large gradually becoming more efficient, effective and transparent

22. EU Accession is Driving Clear Governance Improvements in the Western Balkans
Western Balkans have made clear progress in key governance indicators in recent years
But still lag the EU10 and Turkey in terms of governance quality
Rule of law and control of corruption are the weakest aspects of governance
Qualifying for decentralized management of IPA funds is a key driver of PFM reform

23. The rule of law has improved, but lags EU-10, Croatia, and Turkey
WBI Rule of Law (percentile rank)
Rule of Law (WBI Indicators, 2009)

24. Corruption in Courts is Down…
BEEPS : % of firms saying that bribes in dealing with the courts are frequent

25. Progress in government effectiveness is slow and uneven
WBI Government Effectiveness (percentile rank)
Government effectiveness WBI Indicators, 2009

26. The Western Balkans have seen a sharp drop in bribe incidence, but still fare worse than the EU-10
BEEPS : The % of firms reporting that bribes are frequent has dropped sharply

27. Procurement capacity is still weak and corruption is a concern
Public Financial Management and Procurement Systems are improving gradually, but reforms still needed…
PEFA assessments show that PFM systems are now more efficient, effective, and accountable
PFM reforms have improved budget planning, allocation, implementation and review
Procurement capacity is still weak and corruption is a concern
EU acquis and certification requirements for decentralized management of IPA funds (PIFC standards) are very strong incentives

28. III. Social Spending Challenging Balancing Act: Improving Social Protection, Education and Health w/tight budgets
Quality,
Coverage
Efficiency,
Cost Recovery,
Targeting
Social & Financial Sustainability
Increasing Needs:
Increased poverty & unemployment (crisis)
Demographic changes
Converging to EU standards
Fiscal constraints:
Large fiscal deficits and increasing public sector debt (crisis)
Social Sectors = large share of public spending
Growing pensions deficits

29. Pensions: Demographic => Fiscal Crisis
Aging population
(Doubling by 2050)
Shrinking
Workforce
(Fewer contributors) =
Rising Pension
Deficits +
Population Structure in 2005
Population Structure in 2050

30. How Can Countries Prepare for the Demographic Crisis?
Raise retirement ages, particularly for women
Reduce early retirement exemptions
Index pensions to inflation only
Start preparing for elderly
without pension rights

31. Social Safety Nets: Increasing Needs with Tighter Budgets
Dual challenge
Higher unemployment + poverty => increasing needs.
Tighter budgets given fiscal situation
Reform priorities: Focus limited spending on the most “needy”
Shift away from “rights-based” benefits that largely go to the non-poor (e.g., war veterans benefits in BiH, Croatia, Kosovo)
Strengthen targeting (adopting means-testing)
Eliminate filters which cause disincentives to work and exclude working poor

32. Education Sector Challenges
School rationalization: demographic shifts have left too many schools, with too many staff
Improve quality and increase participation in international standard testing
Increase access to poor and minorities (e.g.Roma)
Skills mismatch with labor market needs
For higher education: pursue sub-regional approach to quality assurance, links to businesses, compliance with Bologna Process, and cost recovery

33. Health Sector Challenges and Reforms
Cost pressures due to structural trends (e.g. technology, pharmaceuticals)—plus high rate of exemptions exacerbate mismatch between benefits and revenues
Health Insurance Funds lack capacity to allocate resources efficiently
Informal Out-of-Pocket expenditures are increasing (impact on poverty)
Reform priorities: enhance efficiency and equity in a fiscally constrained environment
Define Benefits Package, using evidence-based decision making in selecting interventions
Link Payment to Performance
Rationalize Infrastructure shifting resources to primary care
Strengthen Institutional Capacity
Tackle structural Cost Pressures (e.g. revising pharmaceutical pricing and reimbursement policies)

34. World Bank Engagement In Western Balkans

35. The World Bank Group is Active in the Region
Over 20 years experience in the Western Balkans
Total Lending US$7.3 billion
Pipeline of projects FY US$2.5 billion
Our work reinforces and supports the EU accession process
Significant country presence and sectoral knowledge

36. World Bank Lending to Western Balkans
Total Lending – US$ 7.3 billion
Does not include IFC lending

37. World Bank Lending to Western Balkans
Pipeline of projects – FY (US$ 2.5 billion)
Does not include IFC lending

38. Analytical and Advisory Assistance (AAA)
AAA , including non-lending technical assistance (NLTA), is central to World Bank program;
AAA services to Western Balkans average USD 3-5 million annually;
US$46 million provided since FY2000;
Does not include IFC AAA

39. Country Specific and Regional AAA Recently Completed and Underway
ALBANIA: Country Governance and Anticorruption, Accountability for Better Governance, Public Expenditure and Financial Accountability, Social Protection TA, Country Economic Memorandum (CEM)
BOSNIA AND HERZEGOVINA: Pension Technical Assistance, Report on the Observance of Standards and Codes on Fiscal Transparency, Public Expenditure Review (PER)
KOSOVO: Country Economic Memorandum Follow up; Transport ; Comprehensive Water Sector Assessment; Environment Policy Note, Transport Sector Review
FYR MACEDONIA: Comprehensive Water Sector Assessment, Higher Education, Green Growth and Climate Change, Science/Technology TA, Labor TA, Energy Policy Note
MONTENEGRO: Public Expenditure and Institutional Review Follow up, Transport Sector Work, Public-Private Partnerships for Electricity
SERBIA: Pension TA, Innovation Promotion, Capital Markets, CEM, Education, Policy Notes on Growth
REGIONAL: REPARIS (The Road to Europe: Program of Accounting Reform and Institutional Strengthening); Programmatic Financial Sector Development; Study on Science, R&D and Innovation; Public Financial Management; Programmatic Poverty Assessment and Gender Monitoring; Labor market, Education Skills and Social (MILES), Energy Efficiency and Renewables.