1. Fiscal Space for Infrastructure Borrowing in South-Eastern Europe Brussels, September 21, 2005

2. Background and Objectives SEE-7 countries are contemplating significant new borrowing for infrastructure investment, based on bilateral and multilateral funding. SEE-7 countries are contemplating significant new borrowing for infrastructure investment, based on bilateral and multilateral funding. What key issues need to be kept in mind when evaluating proposed borrowing/investments? Is there ‘fiscal space’? What key issues need to be kept in mind when evaluating proposed borrowing/investments? Is there ‘fiscal space’? The analysis is indicative, does not address the quality of individual projects, and must be supplemented by more detailed analysis by each Government,… The analysis is indicative, does not address the quality of individual projects, and must be supplemented by more detailed analysis by each Government,… …but strongly suggests a need to carefully consider macro/fiscal constraints when planning/proposing new investments. …but strongly suggests a need to carefully consider macro/fiscal constraints when planning/proposing new investments.

3. Fiscal Space “The availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of its financial position”. “The availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of its financial position”.

4. Several macroeconomic trends show clear improvement… From 2000 to 2003, public debt/GDP was cut in all countries except Croatia, sometimes substantially. From 2000 to 2003, public debt/GDP was cut in all countries except Croatia, sometimes substantially. Achieved through stronger policy efforts, real appreciation, and (sometimes) debt restructuring. Achieved through stronger policy efforts, real appreciation, and (sometimes) debt restructuring. A general downward trend in fiscal deficits reflects government commitment to fiscal responsibility. A general downward trend in fiscal deficits reflects government commitment to fiscal responsibility.

5. …but many challenges remain High government spending/GDP (BiH, Croatia, SaM) High government spending/GDP (BiH, Croatia, SaM) High public debt/GDP (Albania, BiH, Croatia, SaM) High public debt/GDP (Albania, BiH, Croatia, SaM) Large external debt/GDP (Bulgaria, Croatia, SaM) Large external debt/GDP (Bulgaria, Croatia, SaM) High current account deficits (all countries) create large external financing needs (10-18% of GDP) High current account deficits (all countries) create large external financing needs (10-18% of GDP) Future loan terms hardening while grants declining Future loan terms hardening while grants declining Pre-EU accession/integration costs Pre-EU accession/integration costs Risk of macro instability in the event of reversal/decline in anticipated flows Risk of macro instability in the event of reversal/decline in anticipated flows Managing vulnerabilities requires sustained macro adjustment/reform, with the burden falling on fiscal policy Managing vulnerabilities requires sustained macro adjustment/reform, with the burden falling on fiscal policy

6. Adjustment will lead to reduced financing needs ‘Base case’ scenarios assume continuation of fiscal discipline and other reform efforts. ‘Base case’ scenarios assume continuation of fiscal discipline and other reform efforts. Indicative projections by World Bank staff, with reference to IMF projections. Indicative projections by World Bank staff, with reference to IMF projections. Outcomes assumed necessary to keep the economies on a path of sustainable growth. Outcomes assumed necessary to keep the economies on a path of sustainable growth. Envisage still high but reduced financing needs in the medium term (10-16 percent of GDP) Envisage still high but reduced financing needs in the medium term (10-16 percent of GDP)

7. Planning starts at the project and sectoral level... High quality infrastructure investments will be crucial for growth. High quality infrastructure investments will be crucial for growth. Ensuring quality requires careful project evaluation/public investment planning, sound sectoral policies/regulatory framework, and (in multi- country projects) good cross-country cooperation. Ensuring quality requires careful project evaluation/public investment planning, sound sectoral policies/regulatory framework, and (in multi- country projects) good cross-country cooperation. Indicators of reform progress still show that much remains to be done in the infrastructure sectors Indicators of reform progress still show that much remains to be done in the infrastructure sectors

8. …but also needs to consider macro/fiscal constraints Prudent economic management demands analysis of the impact of new borrowing on macro sustainability Prudent economic management demands analysis of the impact of new borrowing on macro sustainability Investments should fit into (still substantial) overall financing limits Investments should fit into (still substantial) overall financing limits Borrowing beyond these limits could raise the current account deficit and debt to levels which send alarm signals Borrowing beyond these limits could raise the current account deficit and debt to levels which send alarm signals Resulting damaging perceptions of macro performance could in turn reduce investment and borrowing by the domestic private sector Resulting damaging perceptions of macro performance could in turn reduce investment and borrowing by the domestic private sector

9. Creating fiscal space for high quality public investments Cutting wasteful current spending. Cutting wasteful current spending. Dropping planned public investments with clearly lower rates of return. Dropping planned public investments with clearly lower rates of return. Enhancing the overall efficiency of public spending. Enhancing the overall efficiency of public spending. Enhancing the financial sustainability of the sector receiving investments through deeper reform and restructuring. Enhancing the financial sustainability of the sector receiving investments through deeper reform and restructuring. Scaling back/phasing investments. Scaling back/phasing investments.

10. Conclusions To achieve desired growth, investments must be subjected to: rigorous evaluation rigorous evaluation strong supporting reforms/ regulatory framework strong supporting reforms/ regulatory framework enhanced cross-country cooperation enhanced cross-country cooperation These considerations become more important with the currently limited fiscal space/external borrowing limits. These considerations become more important with the currently limited fiscal space/external borrowing limits. To avoid compromising fiscal adjustment and increasing external vulnerability, any foreign financing will need to fit into such limits. To avoid compromising fiscal adjustment and increasing external vulnerability, any foreign financing will need to fit into such limits. Domestic budgetary resources will need to finance an increasing share of public investments. Domestic budgetary resources will need to finance an increasing share of public investments. The same considerations ultimately apply to public- private partnerships. The same considerations ultimately apply to public- private partnerships.