Document of The World Bank

Public Disclosure Authorized FOR OFFICIAL USE ONLY

Report No. 47877-ME

INTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT

INTERNATIONAL DEVELOPMENT ASSOCIATION

AND Public Disclosure Authorized INTERNATIONAL FINANCE CORPORATION

COUNTRY PARTNERSHIP STRATEGY PROGRESS REPORT

FOR

MONTENEGRO

FOR THE PERIOD FY07-10

Public Disclosure Authorized March 20,2009

South East Europe Country Unit Europe and Central Asia Southern Europe and Central Asia International Finance Corporation Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization. I I Date of Last Country Assistance Strategy: May 15,2007

CURRENCY EQUIVALENTS (Exchange Rate as of February 17,2009) Currency Unit = Euro (EUR) EUR 1.00 = US$1.2774 US$ 1.00 = EUR .7830 GOVERNMENT’S FISCAL YEAR January 1 - December 31

AAA Analytical and Advisory Assistance GEF Global Environment Facility APL Adaptable Program Loan GRSF Global Road Safety Facility German Technical Cooperation BEE Business Enabling Environment GTZ BES Bureau for Education Services Agency CAS Country Assistance Strategy HIF Health Investment Fund CEM Country Economic Memorandum HBS Household Budget Survey Canadian International Development IBRD InternationalBank for CIDA Agency Reconstruction and Development International Development CPS Country Partnership Strategy IDA Country Partnership Strategy Association CPS-PR Progress Report IFC International Finance Corporation European Bank for Reconstruction IMF International Monetary Fund EBRD Instrument for Pre-Accession and Development IPARD EC European Commission Assistance for Rural Development Energy Community of South East KAP Podgorica Aluminum Plant ECSEE Land Administration and Europe LAMP European Credit Transfer and Management Project ECTS Ministry of Agriculture, Forestry Accumulation System MAFWM EIB European Investment Bank and Water Management Montenegro Education Reform MDG Millennium Development Goal MEW Montenegro Energy Efficiency Project MEEP Electric Power Company of Project EPCG Montenegro Environmentally Montenegro MESTAP Emergency Stabilizationof Sensitive Tourist Areas Project ESESP Electricity Supply Project Montenegro Institutional Energy Sector Management MIDAS Development and Agriculture ESMAP Assistance Program Strengthening Project Multilateral Investment Guarantee ESW Economic and Sector Work MIGA EU European Union Agency EUR Euro MoES . Ministry of Education and Science Food and Agriculture Organization MOF Ministry of Finance FA0 Montenegro Health Systems of the United Nations MSHIP FDI Foreign Direct Investment Improvement Project Foreign Investment Advisory Montenegro Sustainable Tourism FIAS MSTDP Service Development Project Financial Sector Reform and Public Expenditure and Financial FIRST PEFA Strengthening Initiative Accountability Assessment Financial Sector Assessment Public Expenditure and Institutional FSAP PEIR Program Review Public-PrivateInfrastructure FY Fiscal Year PPIAF FYR Former Yugoslav Republic Advisory Facility GDP Gross Domestic Product PPP Public-Private Partnership 1 FOR OFFICIAL USE ONLY

Pension Systems Administration TSU Technical Services Unit PSAIP Project United Nations Development UNDP Report on the Observance of Program ROSC Standards and Codes United States Agency for USAID Stabilization and Association International Development SAA Agreement USD United States Dollar SME Small and Medium-Sized Enterprise SOE State-Owned Enterprise TA Technical Assistance

World Bank IFC Vice President Shigeo Katsu Jyrki I.Koskelo Country Director Jane Armitage Shahbaz Mavaddat Task Team Leader Elisabeth Huybens George Konda

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

.. 11

TABLE OF CONTENTS

I. RECENT POLITICAL AND ECONOMIC DEVELOPMENTS ...... 1 I1. PROGRESS IN CPS IMPLEMENTATION...... 4 A . PROGRESS ON CPS OUTCOMES TO DATE ...... 4 B. IDA/IBRD LENDING PROGRAM ...... 7 C . STATUS OF THE PORTFOLIO ...... 7 D. ANALYTICAL AND ADVISORY SERVICES (AAA) ...... 7 E. PARTNERSHIPS ...... 8 F . IFC OPERATIONS ...... 8 G . LESSONS LEARNED...... 9 I11. CPS PROGRAM GOING FORWARD ...... 9 A . LENDING PROGRAM AND ENVELOPE...... 9 B. ANALYTICAL AND ADVISORY SERVICES ...... 11 C . IFC ACTIVITIES ...... 11 D. RISKS AND MITIGATION MEASURES ...... 12

TABLES Table 1: Montenegro .Macroeconomic Performance. 2006 .20 10 ...... 2 Table 2: Status of Base and High Case Lending Indicators...... 5 Table 3: Planned and Revised Lending Program (FY07-FY 10) ...... 10

ANNEXES Annex 1: Revised Results Matrix for FY07-FY10 CPS Progress Report ...... 13 Annex 2: CPS Outcomes ...... 19 Annex A1: Montenegro At-A-Glance ...... 24 Annex B2: Selected Indicators of Bank Portfolio Performance & Management ...... 27 Annex B3: IBRD/IDA Program Summary ...... 28 Annex B3 IFC Investment Operations Program ...... 29 Annex B4: Summary of Nonlending Services ...... 30 Annex B5: Social Indicators ...... 31 Annex B6: Key Economic Indicators ...... 32 Annex B7: Key Exposure Indicators ...... 34 Annex B8: Committed and Disbursed Outstanding Investment Portfolio (IFC) ...... 35 Annex B8: Operations Portfolio (IBRD/IDA and Grant) ...... 36

Map of Montenegro ...... 37

... 111

COUNTRY PARTNERSHIP STRATEGY PROGRESS REPORT FOR MONTENEGRO

1.This Country Partnership Strategy Progress Report (CPS-PR) assesses progress in implementing the FY07-FY 10 Country Partnership Strategy (CPS) for Montenegro, discussed by the Board on May 15,2007 (Report Number 39800-ME). To date, the Government has made significant progress against CPS goals and portfolio performance has been strong. Whereas most of the CPS resources have been committed, this Progress Report proposes a lending program for the remainder of the CPS period that maintains some flexibility in the context of the ongoing international financial crisis and economic slowdown.

1.RECENT POLITICAL AND ECONOMIC DEVELOPMENTS

2.hthe two years following independence in June 2006, Montenegro achieved its principal short-term state-building goals, including adopting a new Constitution and ratifying the Stabilization and Association Agreement (SAA) with the European Union (EU). The Presidential elections of April 2008 confirmed the pro-independence majority and strengthened the position of Prime Minister DukanoviC and his coalition Government. The next parliamentary elections were held on March 29, 2009. Montenegro ratified the SAA in late 2007 and approved an ambitious 2008-12 National Program for Integration @PI) in early summer 2008. The Government made progress on adopting related policies and reforms, and authorities aim to implement all obligations delineated in the SAA to be considered for membership by 2012. Montenegro formally submitted its application for EU membership on December 15,2008.

3 .High capital inflows have fueled strong economic growth and high overall budget surpluses. Yet they render the economy vulnerable to declining international liquidity and worsening investor sentiment. Continued implementation of the privatization and structural reform agenda, low taxes and a business friendly environment, and expectations of greater European linkages energized economic activity. In 2007, foreign direct investment (FDI) was strong and credit to the private sector, mostly awarded by the local branches of foreign banks, rose by 176 percent. These capital inflows supported rapid expansion of activities in construction, retail, and telecommunication, resulting in real GDP growth of 8.6 percent in 2006, and 10.7 percent in 2007, greatly exceeding the average growth rate during the four years preceding independence. They also sustained a large current account deficit that widened from 24.1 percent of GDP in 2006 to 29.3 percent of GDP in 2007; and an inflation rate that rose from 2.1 percent in 2006 to a projected 9.1 percent in 2008. The economic boom translated into higher fiscal revenues, which-together with policies aimed at containing expenditure-helped drive an overall fiscal surplus of 6.4 percent of GDP in 2007.

4.The external economic environment deteriorated markedly in 2008 and 2009. According to the most recent World Bank projections, the world economy will contract by 1.7 percent in 2009, while the euro zone and Russia, both key to Montenegro’s economy, are expected to contract by 2.7 and 4.5 percent, respectively. The pricing of emerging market risks has changed dramatically, with the spread between the Emerging Markets Bond Index (EMBI+) and US Treasury bills rising from 239 basis points at end-2007 to 712 basis points as of February 17, 2009. As a consequence, monthly capital flows toward developing countries fell sharply from US$472 billion in January 2007 to US$3 12 billion in August 2008.

5.In the wake of the global economic slowdown, the country is likely to see a decline in growth as capital inflows decelerate, real estate prices fall, the demand and price for aluminum drop, and tourism weakens. As Table 1 illustrates, real GDP growth is expected to fall considerably. Government projections predict a drop in growth from 10.7 percent in 2007 to 5.0 percent in 2009 and 2010, while IMF projections depict a more somber 2.0 percent growth rate over the latter years. Output at the aluminum smelter was recently cut after international prices for aluminum fell by more than one-half since mid-2008. FDI and external bank credit are drying up. As these financed the high level of imports during the boom period, the current- account deficit is forecast to narrow considerably. External debt is nevertheless expected to increase, largely because of increased government borrowing and government guarantees extended to public enterprises and banks. Given the increasing reliance on the VAT on imports as a source of fiscal revenue, tax receipts are expected to decline, and an overall fiscal deficit is projected to arise.

Table 1: Montenegro - Macroeconomic Performance, 2006 - 20101

I External Public Debt (% GDP) I 31.3 I 24.7 I 29.2 I 32.4 I 37.4 I I Total External Debt (% GDP)3 I 43.7 I 65.5 I 77.2 I 80.7 I 85.5 I I Public Sector ShareofExternalDebt I 71.6 I 37.7 I 37.8 I 40.1 I 43.7 I I Net Int’l Reserves (US$ million) I 310.3 I 490.3 I 445.2 I 201.6 I 53.5 1 Source: Central Bank ofMontenegro, WBAMF staff estimates

6.The Government and the Central Bank have taken a number of steps to reduce the impact of the crisis on the financial sector. Several proactive measures introduced over the past few years have helped to mitigate some of the risks to the banking system. These include temporary credit ceilings, the introduction of a credit registry, as well as stricter capital, reserve

World Bank economic data and projections are consistent with the Montenegro IMF Staff Report for the 2008 Article IV Consultation; government data and projections are taken from Montenegro’s Economic and Fiscal Programme document for 2008-20 11. Government data is not available for all indicators. 2 Projections of economic indicators are subject to substantial variance in the current volatile economic climate. Because ofthe depreciation ofthe US dollar relative to the euro, GDP measured in dollars rose sharply in 2008. End of period and period average exchange rate effects distort the external debt ratip. In fact, the projected increase in external debt in 2008 is $863 million or 19 percent of GDP. ~ - ‘-- 2 and provisioning requirements. In addition, the Central Bank has continued to play a proactive role, introducing a comprehensive deposit insurance scheme for all accounts in October 2008.

7,Nevertheless, the risks to the financial sector have increased substantially in the past few months. The banking system, which is dominated by foreign banks, has seen a decline in support from parent banks. In conjunction with the gradual - but consistent - deposit withdrawals, amounting to 14 percent between October 2008 and January 2009, the banking sector is exposed to a decline in liquidity. The Government has taken steps to improve the liquidity situation, by both permitting one-fifth of mandatory reserves to be invested in interest-bearing government securities and guaranteeing loans from international financial institutions to be onlent to SMEs. However, as Montenegro does not have a national currency (the country euroized unilaterally in 1999/2000), there is no exchange rate risk or currency mismatch between deposits and credits. Still, with a substantial percentage of loans concentrated in the tourism and construction sectors, both of which are suffering due to the global economic situation, the system is likely to face an increase in non-performing loans.

&Montenegro’s creditworthiness has been affected by its external imbalances. Public debt fell from almost 44 percent of GDP in 2005 to 27.5 percent in 2007. The Restitution Fund is in the process of verifying the validity of 10,200 entered restitution claims, and the Government has legally capped related annual payments at 0.5 percent of GDP. External debt climbed from 43.7 percent of GDP in 2006 to 65.5 percent in 2007, with almost all of the increase attributable to private borrowing. Citing healthy budget policy and the exchange rate regime, Standard & Poor’s maintained Montenegro’s long-term sovereign credit rating at BB+ in November 2008, but confirmed the negative outlook introduced in April 2008 due to high external imbalances. With respect to IBRD exposure, the Montenegrin Parliament has ratified a tripartite agreement signed by the Governments of Montenegro and Serbia, as well as the Bank, regarding Montenegro’s assumption of €270 million in loans that had been made to the former Socialist Federal Republic of Yugoslavia. Montenegro subsequently pre-paid €60 million of IBRD debt in 2007. Nevertheless, on a per capita basis, IBRD’s exposure to Montenegro remains among the highest in the world.

9.Strong growth helped boost income and social indicators, but the global economic slowdown could reverse recent gains in wages and income. Per capita GDP grew about 9 percent in both 2006 and 2007, when it reached €4,088. Unemployment fell from 22.3 percent in 2004 to an estimated 11.9 percent in 2007, while average wages rose by 15.3 percent in 2006 and an estimated 33.2 percent in 2007. Poverty remained at about 10 percent between 2002 and 2006,4 but inequality and the depth and severity of poverty declined between 2005 and 2006.’ The fall-out from the global economic slowdown could halt or reverse these gains. The use ofthe euro has allowed for a full pass-through of lower energy and food prices in late 2008/early 2009 and this has buffered any early effects on the poorest. However, eventually employment and wages may fall and Montenegro’s social assistance programs would need to be considerably better targeted to contain the effect on the poorest. Currently, the bulk of social spending goes to

4Poverty rates for 2002 and 2004 were estimated at, respectively, 9 and 12 percent on the basis of a limited survey conducted by a private think tank. The 2005 and 2006 annual household budget surveys, which are considered more reliable and were conducted by the national statistics agency, estimated poverty at 11.3 percent. ’ See World Bank, 2008a, “Welfare Analysis in Montenegro Using the Household Budget Survey Series.” 3 pensions while the anti-poverty program reaches only 17 percent of the poorest fifth of the population compared to 34 percent in Albania and FYR Macedonia.

1I.PROGRESS IN CPS IMPLEMENTATION

1 O.The FY07-FY10 Country Partnership Strategy was designed to provide integrated, coordinated, and selective assistance to support Montenegro’s strategic goal of accession to the European Union. Lending and non-lending activities were programmed to capitalize on the Bank’s comparative advantages while supporting select parts of Montenegro’s medium-tern development agenda, as defined in the SAA and the country’s 2007-11 Economic Reform Agenda. CPS interventions were aligned with the Government’s three policy priorities: Priority I: Enhance Sustainable Economic Growth; Priority 11: Build Institutions and the Rule of Law; and Priority 111: Improve the Standard of Living of Citizens. Base case assistance under the CPS was to include US$19 million from IDA (FY07) and US$50 million from IBRD (FY08-10) channeled through seven projects, complemented by select technical assistance (TA), economic and social work (ESW), and GEF support. The high case was to include an additional US$20 million from IBRD in FY10. IDA financing was limited to FY07, reflecting residual uncommitted IDA funds from the FY05-FY07 CAS for Serbia and Montenegro, followed by a transition to IBRD financing given Montenegro’s middle-income status.

11.Progress in CPS implementation has been solid, but in the face of the uncertainty resulting from the international financial crisis and the ensuing global economic slowdown it is premature to determine whether the high case has been achieved and the original program remains relevant. Most base and high case lending indicators are achieved, but progress against the overriding creditworthiness criterion is mixed (see Table 2). A summary of progress on CPS outcomes is provided below, with a more detailed assessment provided in Annex 2. A revised results matrix in Annex 1 charts past and expected progress on key outcomes.

A.PROGRESS ON CPS OUTCOMES TO DATE

12.Priority I: Enhance Sustainable Economic Growth: Progress was made in public finance, labor market and energy sector reform. Authorities strengthened fiscal oversight of municipalities and state-owned enterprises. A new law on concessions was drafted and presented to Parliament and legislation was enacted to improve labor market flexibility. In the energy sector, a privatization plan for Montenegro’s electrical utility (EPCG) was approved and unbundling of EPCG’s business lines is under way. Electricity tariffs were raised on the Podgorica aluminum plant, and cross-subsidies between consumer groups in the tariff schedule are being eliminated. Under the FY02 Emergency Stabilization of Electricity Supply Project (ESESP), EPCG developed a new financial management system and installed 4,000 “smart” meters in pilot areas, reducing technical and non-technical losses from 15 to 50 percent in 2003 to below 10 percent in 2007. The Energy Community of South East Europe (ECSEE) Adaptable Program Loan (APL) 3, approved in FY08, is investing in telecommunication and electricity infrastructure and strengthening linkages with the regional power and telecom markets. The FY09 Montenegro Energy Efficiency Project (MEEP) is introducing technologies to improve

4 Table 2: Status of Base and High Case Lending Indicators

Base Case Lending Indicators Status High Case Lending Indicators Status

Continued satisfactory macroeconomic Improvement in overall creditworthiness, as performance indicated by, inter alia: - Continued moderate public debt to GDP Achieved - Measures to reduce public debt to 30% of Achieved ratio. GDP by 2012 remaining on track - Contain inflation to EU average range. Not Ach. - Continuedjscal surpluses. Achieved - Maintain prudentjscal policies. Achieved - Strengthenedjscal oversight of SOEs and municipalities with major SOEs obliged to Achieved Continued implementation of FSAP Achieved carryout audits oftheir 2006 balance sheets by recommendations internationally reputable auditors and local governments required to produce consolidated Continued energy sector reform 2006 balance sheets. - The unbundling ofEPCG completed in line Underway - Satisfactory resolution of restitution debt. Achieved with ECSEE Treaty requirements - Improvements in overall BOP performance, - Continued implementation ofphased tariff Achieved with the CAD moving to more sustainable levels Not Ach. increasesfor KAP, as agreed in SAC 2. and remaining fully funded by FDI. - A restructuring and privatization plan for Achieved - External debt indicators continue to improve. Not Ach. the energy sector agreed. - Further improvements in collections. Achieved Continued satisfactory portfolio performance - Social program to offset tariff increases for Achieved -No more than 1 unsatisfactory operation. Achieved low-income households agreed. Implementation of a robust and efficient Pension system continues to be put on more framework for handling private provision of sustainable footing infrastructure through PPPsiconcessions - Overall pension expenditures as a share of Achieved - Adoption of revised PPP legislation in Underway GDP continue to decline from baseline of accordance with international best practice. 10.4%. - Completion of independent feasibiliw studies Underway - Increase in collections ofpension Achieved for major highway corridors. contributions and introduction of integrated collection scheme. - Voluntary “Thirdpillar” scheme Achieved introduced in 2007 to supplement retirement savings.

Continued strengthening of environmental and Underway tourism planning

energy efficiency in public sector buildings with a view to developing a sustainable energy efficiency improvement program.

13.The Government took steps to promote environmental management and sustainable tourism development, particularly through infrastructure provision. With support of the FY07 Montenegro Sustainable Tourism Development Project (MSTDP), authorities initiated construction of a regional pipeline supplying water from Lake Skadar to the Municipality of Bar, and a background study was drafted on environmental protection of the Bojana Buna Delta. In complement, an FY08 GEF project began work to strengthen the environmental management of Lake Skadar to mitigate threats from untreated wastewater and economic development. Under the FY04 Montenegro Environmentally Sensitive Tourist Areas Project (MESTAP), solid waste management was substantially improved: two unsanitary disposal sites were closed; a landfill was constructed for Kotor, Tivat and Budva; and work is underway to build a new landill for Bar and Ulcinj. However, Bank lending appears to satisfy only a small portion of infrastructure needs on the coast. Further, achieving clarity among stakeholders on the proper balance between

5 environmental management and sustainable tourism development, particularly on the Bojana Buna Delta, has proven more complex and controversial than foreseen. The Bank is strengthening its dialogue with the Government and stakeholders to devise appropriate strategies to address these issues.

14.Priority 11: Build Institutions and the Rule of Law: The Government made headway in strengthening the financial sector and is striving to lessen the regulatory burden for businesses. Authorities are gradually adopting the recommendations ofthe FY06 joint WB/IMF Financial Sector Assessment Program (FSAP). The Government divested all financial sector holdings except a minor position in an insurance company, though privatization of this company’s stock is underway. With Bank TA, the Central Bank assessed banking sector risks and issued new prudential regulations. A catalogue offinancial sector legislative reforms needed to comply with EU standards has been updated at end 2008. Though the recent economic boom enhanced business activity, it also focused attention on business hurdles, including the high costs and time of licensing businesses and registering land. In response, the Government adopted a five-year work plan in July 2007 to develop the real estate cadastre, and approved a new national spatial plan in 2008. In this context, a joint WB/IMF technical assistance program shed light on key regulatory and policy constraints to business growth, leading to preparation of a government strategy on eliminating business barriers. The FY09 Land Administration and Management Project (LAMP) is providing complementary support to reduce the time and cost to register land, complete the real estate cadastre, and build the capacity oflocal and central institutions.

15.Priority 111: Improve the Standard of Living of Citizens: Authorities supported reforms to strengthen agriculture and rural development aligned with EU requirements. In 2007, the Government drafted a National Strategy for Sustainable Development and, in 2008, a National Forest and Land Administration Policy. A key related and overarching priority is updating agricultural standards to comply with the EU Instrument for Pre-Accession Assistance for Rural Development (IPARD), through which Montenegro will be eligible, once an official EU candidate, for sizeable inflows ofEU assistance for rural development. In this context, the FY09 Montenegro Institutional Development and Agricultural Strengthening (MIDAS) project aims to develop government capacity to disburse, track, and monitor IPARD funds, including through IPARD-compatible institutions and matching grants to farmers. Fully blended GEF financing will support complementary agri-environmental activities.

16.Efforts to reform the education and health sectors and pension system made good gains. The FY05 Montenegro Education Reform Project (MERP) provided assistance to strengthen education quality and assessment and sector planning and budgeting, leading to improved teaching and a drop in education sector arrears from 10 percent in 2005 to 1.3 percent in 2007. The FY04 Montenegro Health Systems Improvement Project (MSHIP) supported a comprehensive strategy to strengthen the primary healthcare system, which led to a revised primary health care benefit package, more patient choice in doctors, and steps toward development of a new payment system. In addition, appointment waiting periods were reduced and consultation times increased, though a recent patient survey suggests more efforts are needed to increase satisfaction with public health services. The FY04 Pension Systems Administration Project (PSAIP) helped strengthen administration and finances of the pension system, including introducing an integrated system for collecting contributions and enhancing capacity in pension

6 system modeling and policy analysis. A “third pillar” law was also approved permitting voluntary private pensions. As a result of reforms, the deficit of the pension system dropped from 2.5 percent of GDP in 2005 to 1.7 percent in 2007, partly attributable to collecting arrears and boosting the number of contributors.

B.IDA/IBRD LENDING PROGRAM

17.The lending program is generally on track. As envisaged, two projects in energy (ECSEE APL 3) and sustainable tourism development (MSTDP) totaling US$19 million were delivered on IDA terms in FY07. In FY08, a US$2.6 million GEF program supporting environmental management of Lake Skadar was approved. In FY09, two projects in land management (LAMP) and energy efficiency (MEEP) were approved with a total IBRD commitment of US$25.6 million and one project in agriculture (MIDAS) with a total IBRD commitment of US$15.7 will be submitted to the Board together with the CPS PR. Ongoing IDA lending from the previous CAS period includes projects in health (FY04 MSHIP), pension reform (FY04 PSAIP) and education reform (FY05 MERP). An FY02 energy project (ESESP) closed in FY07.

C. STATUS OF THE PORTFOLIO

18.Portfolio performance is sound. As of February 2009, the portfolio had eight active IBRD and IDA projects totaling US$68.6 million, and one GEF project for US$2.6 million. Progress against Project Development Objectives is generally positive: one highly satisfactory (MERP), two satisfactory (ECSEE APL 3, MHSIP), two moderately satisfactory (MSTDP and PSAIP) and one (MESTAP) moderately unsatisfactory. MSTDP’s moderately satisfactory rating was due to the lack of clarity on the Government’s plans for the protection of the Bojana-Buna Delta. The PSAIP faced procurement delays for software and hardware, though procurement processes are underway and contracts are expected to be completed soon. The moderately unsatisfactory rating for MESTAP reflects continued slow progress toward the development of a second landfill and joint-municipal solid waste management company; an action plan was agreed by the Government and the Bank but remains to be fully implemented. Disbursement ratios for FY07 and FY08 were, respectively, 21.5 and 18.5 percent.

D.ANALYTICAL AND ADVISORY SERVICES (AAA)

19.111line with CPS expectations, Bank non-lending assistance has provided policy advice on key fiscal and economic challenges. An FY07 Debt Sustainability Analysis assessed country debt under different reform and growth scenarios. The FY07 Report on Observance of Standards and Codes (ROSC) analyzed financial auditing and reporting standards against EU requirements, and recommended reforms integrated into a financial reporting strategy and a draft law on accounting and auditing. In this context, the current law on accounting and auditing was amended in late 2008 to achieve partial harmonization with EU legislation. An FY09 Public Expenditure and Institutional Review (PEIR) and Public Expenditure and Financial Accountability Assessment (PEFA) analyzed fiscal and economic risks and provided related policy advice. An FY08 Poverty Update helped build capacity in poverty analysis and monitoring, and described steps to build a new poverty line based on 2005 and 2006 annual household budget data. A joint assessment of Montenegro’s business environment was

7 conducted in late 2007 by IFC, MIGA, and the World Bank. With support of the World Bank’s Global Road Safety Facility (GRSF), an assessment of Montenegro’s capacity in road safety management was undertaken with a view to addressing high rates of accidents and motor vehicle fatalities. In FY08, the Swiss Consultant Trust Fund supported an assessment of the University of Montenegro’s progress on quality assurance measures and education standards under the BologndEuropean Credit Transfer and Accumulation System (ECTS), as well as a clinic on ECTS requirements.

E.PARTNERSHIPS

20.The Bank collaborated closely with international partners, particularly to support EU integration. MEW activities were complemented with support from the Canadian International Development Association (CIDA). CIDA and the Government of Finland also provided support to strengthen the capacity of the Ministry of Education and Science in conjunction with MEW activities. Energy sector reform under the ECSEE APL 3 reflected the aims of a larger partnership between South Eastern European countries to promote regional integration in line with the 2005 ECSEE Treaty. Under MSTDP, the European Bank for Reconstruction and Development (EBRD) and the World Bank are co-financing the regional water supply scheme to provide connections for six coastal municipalities. The FY09 MEEP will be closely coordinated with technical assistance from the German Technical Cooperation Agency (GTZ).

F.IFC OPERATIONS

21.As of December 31, 2008, IFC commitments in Montenegro total $US25.6 million. IFC invested €10 million in the Mall of Montenegro to support the development of a mixed-use shopping mall in Podgorica. This public-private partnership between a Turkish sponsor and the Municipality of Podgorica will introduce new retail standards and best practices, provide a model for local investors and property developers, and help catalyze foreign investment and private- public partnerships in service delivery. In addition, IFC has invested about US$190 million in regional projects to support micro and small businesses, the development of commercial property, IandfiWwaste management, and equity investments in Southeast Europe including in Montenegro.

22.With respect to advisory services, IFC is taking a leading role in helping the Government to restructure the energy sector and has entered into an advisory mandate for the Moraca river hydro-power generation projects. IFC is also advising the Government on one of its largest transport investments: the Bar-Boljare highway. IFC supported implementation of a sub-national competitiveness project in three pilot municipalities (Bar, Bijelo Polje and Niksi) to streamline business regulations and increase their transparency. IFC also worked with the Ministry of Justice to support the opening of a second Mediation Center in Podgorica. As part of this activity, judges were trained in mediation, and 110 cases with legal claims totaling €4.5 million have been successfully resolved. The Balkan Hotel Market Access Program is active and is contributing to opening Montenegro to the lucrative independent travelers’ market. Finally, IFC participated in a joint mini-diagnostic of Montenegro’s investment climate focusing on tourism and potential synergies with upstream activities. Officials subsequently approved an action plan, which is being implemented.

8 G.LESSONS LEARNED

23.Three principal lessons can be drawn from CPS activities in Montenegro. The first is the importance of country ownership and realistic project outcomes to project achievements. Bank projects that performed well, such as ESESP, MEW, and MSHIP, were buoyed by strong commitment from ministerial and other stakeholders, complemented by clear project objectives and achievable outcomes. Some parts of MESTAP and MSTDP, on the other hand, lacked clear and unified local leadership.

24. A second related lesson is that effective coastal management and sustainable tourism development, which entails infrastructure provision and environmental and spatial management, will require significantly more resources and dialogue to move forward. While the MSTDP and MESTAP made some headway in these areas, particularly in providing water and solid waste infrastructure, substantially more resources are needed to satisfy the infrastructure demands associated with the rapidly growing tourism sector. Greater in-country dialogue will also be needed to determine the right balance between competing goals of environmental management and tourism development. In hindsight, the Bank may have overestimated its potential impact through two small interventions.

25.A third lesson is the importance of providing clear and consistent guidance and support to new Bank clients, such as Montenegro, to overcome limited familiarity with Bank procedures. Though portfolio performance is strong, the Government’s lack of understanding of the Bank project cycle and requirements led to some delays in project approvals, and there was some concern about limited in-country capacity to implement Bank projects. The assignment of projects’ fiduciary processes to a single Technical Services Unit (TSU) within the MOF and staffed with consultants has proved to be a sound strategy. However, continual engagement with officials is necessary, beyond what is standard with more seasoned Bank partners. Gradually, capacity should be strengthened to devolve fiduciary responsibilities to line ministries.

1II.CPS PROGRAM GOING FORWARD

A.LENDING PROGRAM AND ENVELOPE

26.While the CPS country development goals continue to provide a sound framework for the Bank’s program, the international financial crisis and the ensuing global economic slowdown has injected uncertainty that needs to be met with program flexibility. Therefore, and taking into account that the majority of the CPS resources have already been committed, further lending will initially be limited to the base case of about US$50 million. If the macro- economic situation remains stable, conditions may be appropriate to proceed with about US$20 million in high case lending. On the other hand, should the fiscal and balance of payment situation deteriorate considerably, there would be room within the original CPS envelope for the Government to avail itself of development policy lending should it consider that desirable. The updated lending program for FY07-FY10 is detailed against the original plan in Table 3.

9 Table 3: Planned and Revised Lending- Program- FY07-FY10 (US% million) Original Base Trust Actual and Trust Case Lending IDA IBRD Fund Revised Lending IDA IBRD Fund

ECSEE APL 3 9.0 ECSEE APL 3 9.0 FY07 MSDTP 10.0 MSTDP 10.0

Total 19.0 Total 19.0

MSTDP Add. Fin. 5.0 GEF Lake Skadar 2.6 FY08 Land Admin. 10.0 GEF Lake Skadar 2.6

Total 15.0 2.6 Total 2.6

MEEP 10.0 Base Case FY09 MIDAS (Rural Dev.) 15.0 LAMP 16.2 GEF Tara Lim 5.0 MEEP 9.4 MIDAS 15.7 Total 25.0 5.0 /associated GEF 4.0 MSTDP Add. Fin. * 4.8 Improved Social 10.0 /associated GEF* 6.4 Services MSHIP Add. Fin. * 6.5 FYlO Transport Infrastructure 20.0 Total Base Case 52.6 10.4 (High Case) High Case Project 17.4 Total 30.0

* Loans will be contracted in Euros. US dollar amounts represent estimated project financing based on the interbank dollar to Euro exchange rate of .7830 on February 17,2009: MSTDP Additional Financing: €3.75 million plus €5.0 million GEF; and MSHIP Additional Financing: €5.1 million. Note: If, in the context of the unfolding global economic slowdown, the high case scenario does not materialize, and the Government opts to pursue Development Policy Lending, this would be possible within the CPS envelope. Loans presented in italics remain to be approved 27.Investment operations for the remainder of the CPS period include:

*Additional Financing for MSTDP (Base Case, US$4.8 million/US$6.4 million GEF): To provide infrastructure for tourism development, this operation will support the extension of a regional water pipeline scheme to the Municipality of Ulcinj and Velika Plaza. Blended GEF funding will support improved wastewater practices in Ulcinj, and activities to promote environmental protection ofthe Bojana Buna Delta.

*Additional Financing for MSHIP (Base Case, US$6.5 million): Additional financing for MSHIP will support the extension ofprimary health care reforms outside Podgorica, and the development of reforms for secondary and tertiary care. Activities will also support the development ofa hospital information system.

10 .High Case Project (US$17.4 million): The CPS may consider a high case lending operation aligned to key government priorities. Authorities have expressed interest in possible lending in higher education, including assistance to strengthen education quality in line with the BologndETCS system; environmental remediation, including clean-up of key industrial and hazardous waste disposal sites; or transport. Other areas may be considered based on ongoing government consultations.

B.ANALYTICAL AND ADVISORY SERVICES

28.Non-lending services will focus on helping the Government assess and contain the impact of the international financial crisis and global economic slowdown, as well as on preparing future investments in infrastructure. The FY09 Programmatic Poverty Assessment will provide support to evaluate ongoing social assistance programs. Together with the FYI0 Economic Policy Notes, this assessment will help the Government anticipate and assess the local fallout of the global economic slowdown and devise measures to mitigate its impacts, especially on the most poor and vulnerable. Through FY09 and FY10, grant assistance from the Financial Sector Reform and Strengthening Initiative (FIRST) will provide support to assess banking sector risks and update the regulatory framework for bank supervision in line with international standards. Support from the Institutional Development Fund (IDF) will help strengthen internal controls and processes within the Central Bank.

29.Grants from the Public Private Infrastructure Advisory Facility (PPIAF) will provide funding to analyze the institutional framework for road investments and assess possibilities for public- private partnerships and concessions. PPIAF will also support TA to the Podgorica Water and Sewerage Company to review options for upgrading and expanding water and wastewater services. In the power sector, funding from PPIAF and the Energy Sector Management Assistance Program (ESMAP) will support analysis of Public Private Partnership (PPP) options for new power generation facilities.

C.IFC ACTIVITIES

30.IFC will continue to provide support to strengthen the private sector and improve the business environment aligned with the goals of the original CPS. To attract private sector interest in infrastructure, Montenegro needs to set clear rules for an electricity market model, ownership, regulatory regime, and tariff policy-areas where IFC has a global expertise. Through its PEP- SE Infrastructure program, IFC will continue to provide advisory services to the Government to structure and execute PPPs in the power and transport sectors. In addition, IFC will consider supporting infrastructure projects through debt and equity financing. IFC is considering a pre- privatization investment in EPCG, which would help attract strategic investors. In tourism, IFC will continue its efforts to support private investors through financing and advisory services as well as invest in tourism-related infrastructure and ecologically sustainable projects. IFC is considering investing in one of the first large-scale tourism developments in Montenegro, which could potentially kick-start nautical tourism and help reposition the tourism industry on the high end of the market. IFC will continue to look for opportunities to support small and medium enterprises through loans to local banks or selective investments in well-performing local companies. As in other countries in the region, IFC will bring an array of advisory services, such

11 as its International Standards, Alternative Dispute Resolution, and Municipal Simplification programs, subject to adequate donor funding.

D.FUSKS AND MITIGATION MEASURES

31.The risks that were identified in the CPS are now overshadowed by the uncertainty emanating from the international financial crisis and the ensuing global economic slowdown. The CPS identified the following risks: (i)a “hard landing” of the economy; (ii)regional instability; (iii) capacity constraints and poor portfolio performance; and (iv) reduced commitment to reform due to continued economic exuberance. The current global environment has significantly exacerbated the risk of a “hard landing”. Economic exuberance has now reversed and the authorities may find policy choices very limited. Risks related to regional stability and capacity constraints remain relevant.

32.Economic risks: The depth ofthe fallout of the global economic slowdown on Montenegro’s economy remains highly uncertain and will depend on: (i)developments in the aluminum sector; (ii)the effect of the economic downturn in the EU and Russia on the demand for tourism; and (iii)the size of the slowdown in external flows and the related impact on the real estate and construction sectors. To mitigate against this risk and its consequences for the fiscal deficit and the balance of payments, the CPS-PR provides for program flexibility, leaving room for development policy lending should the Government consider that necessary. ESW, such as the Programmatic Poverty Assessment and Economic Policy Notes, will support further dialogue with authorities on policy options in response to the crisis, including measures to cushion the impact on the poorest and most vulnerable.

33 .Regional stability risks: Lingering uncertainties on KOSOVO’Sstatus-and the political consequences, both domestically and vis-a-vis Serbia, of the Government’s October 2008 decision to recognize KOSOVO’Sindependence-continue to present risks of regional instability that could impact Montenegro. However, the Government has kept lines of communications open and strived to forge strong political and economic relationships with its neighbors in the Western Balkans. Montenegro continues to take steps toward EU membership, which entails a commitment to greater regional cooperation. The Bank will continue to closely monitor regional developments.

34,Implementation risks: While portfolio performance has continued to improve, the Government’s relative unfamiliarity with Bank requirements still presents risks to project preparation and implementation. This risk is being mitigated by the recent opening of a Bank office in Montenegro, and repeated and comprehensive communication to clarify procedures for preparing and implementing Bank projects. Though the performance ofthe TSU in the Ministry of Finance has thus far been strong, the rapid growth of the number of Bank projects may strain its capacities. To alleviate these risks, TSU staffing will be strengthened and annual performance assessments will be undertaken to identify and address challenges.

12 Y c

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Annex 2: CPS Outcomes

Government Priority I:Enhancing Sustainable Economic Growth

Country Goal: Sustain Macroeconomic Stability and Maintain Sustainable Economic Growth

1.Recent macroeconomic performance was solid, though risks are increasing. Macroeconomic results, including in growth and fiscal outcomes, were favorable. However, the potential for reduced external flows, tightening credit, and a global slowdown poses considerable risks to the economy. In response, authorities have taken steps to improve fiscal and economic sustainability. The Government strengthened financial oversight of state-owned enterprises and municipalities, including establishing debt ceilings on municipal borrowing. The Government is establishing the stock of restitution debt, and approved a law that limits annual restitution debt payments to 0.5 percent of GDP. Officials are improving the efficiency of budgetary and fiduciary services, with some evidence of improved performance ofpublic procurement. To alleviate labor market rigidities, a revised labor law was enacted. To address pressing infrastructure needs, authorities are exploring options for privatization of state-owned enterprises and greater use of concessions. With Bank support, feasibility studies are underway to assess financing options for major transport corridors, including concession arrangements. Revised legislation on concessions and public-private partnerships has been presented to Parliament, but approval has been delayed due to disagreements on concession modalities, such as contract duration.

Country Goal: Strengthen environmental management and tourism planning

2.Progress was made in environmental management and sustainable tourism development, particularly in supplying infrastructure in coastal areas. The Government, supported by the FY07 Montenegro Sustainable Tourism Development Project (MSTDP), initiated work on a regional network of pipelines and pumping stations to supply water from Lake Skadar to the Municipality of Bar. Officials took steps to develop tourism sites, such as initiating the tendering process for a tourism facility in Velika Plaia, and strengthen environmental protection, including drafting a background study on the protection of the Bojana-Buna Delta. Dialogue was also initiated on the control of illegal construction. Additional financing for MSTDP, expected in FY09, will extend regional water connections southward to the Municipality of Ulcinj and Velika Plaia. GEF funding blended into this project will support development of an environmental management plan for the Bojana Buna Delta, and improved wastewater techniques in Bar and Ulcinj. In complement, an FY08 GEF grant is supporting strengthened environmental management of Lake Skadar, which faces environmental pressures from rapid development, untreated wastewater, and illegal fishing. The FY04 Montenegro Environmentally Sensitive Tourist Areas Project (MESTAP) helped authorities strengthen solid waste management in coastal areas: two unsanitary disposal sites were closed, a landfill was constructed for Kotor, Tivat and Budva, and work was initiated to build a new landfill serving Bar and Ulcinj. Authorities established a new municipal solid waste management company to operate the former landfill, and a similar company is being established for the planned landfill serving Bar and Ulcinj. Though much work has been accomplished in these areas, challenges have arisen. Officials from Kotor failed to approve a longer- term landfill in line with initial feasibility studies, leading to the early closure of this landfill. Progress on the Bar and Ulcinj landfill also stalled for several months in 2007 due to stakeholder disagreements on the landfill’s location and other modalities. However, disagreements were largely resolved, and all parties are moving forward according to a newly established timeline. Striking the right balance between

19 tourism development and environmental protection on the Bojana-Buna Delta, particularly concerning planned tourism investments in Velika Plaia and Ada Bojana, also proved to be more complex and controversial than expected. In response, the Ministry of Tourism and Environmental Protection is organizing meetings with stakeholders and the Bank to discuss pertinent economic and environmental trade-offs, with a view to resolving lingering issues and devising a way forward.

Country Goal: Improve the efficiency and sustainability of the energy sector

3 .Progress has been achieved in improving the efficiency and sustainability of Montenegro’s energy sector. A restructuring and privatization plan for EPCG was approved, and the sale of 22 percent of its capital is being prepared for tender. By the end of 2008, EPCG’s transmission and market operations are expected to be unbundled into a joint stock company, and by the end of 2009 separate joint stock companies are expected to be created for EPCG’s generation, supply and distribution operations. Tariffs for KAP, a large aluminum plant that consumes 40 percent of Montenegro’s ‘ electricity, increased by 120 percent between 2006 and July 2008. Reforms are underway to eliminate cross-subsidies in the tariff schedule between consumer groups, while a social safety net is being implemented to protect the most vulnerable. With support of the FY02 Emergency Stabilization of Electricity Supply Project (ESESP, which closed in FY07), EPCG established an automatic billing and financial management system and installed 4,000 “smart” meters in 2 1 pilot areas. These efforts have reduced technical and non-technical losses from 15 to 50 percent in 2003 to below 10 percent in 2007. EPCG plans to roll out an additional 100,000 meters to scale up this program. Under the FY08 Energy Community of South East Europe (ECSEE) Adaptable Program Loan (APL) 3, EPCG is procuring transmission and telecommunication equipment that will enhance the security of power supplies and efficiently integrate the electric grid into the networks of neighboring countries and the regional market. The FY09 Montenegro Energy Efficiency Project (MEEP) is financing new technologies to help improve energy efficiency in targeted public sector buildings (i.e., hospitals and schools) to provide a demonstrated basis for development of a sustainable energy efficiency improvement program.

Priority 11: Building Institutions and the Rule of Law

Country Goal: Improved regulatory environment for businesses, including land registration and secure property rights

4.The Government is launching renewed efforts to lessen the regulatory burden for businesses, particularly to improve land registration. Montenegro’s economic boom focused attention on the slow speed and high costs of licensing businesses and registering land. To address constraints, the Government adopted a five-year work plan in July 2007 to develop the real estate cadastre. In October 2008, a new spatial planning law was enacted that reorganized the Department of Spatial Planning and supported improved regulation of illegal construction, and authorities are working on associated bylaws and regulations. Technical and analytical assistance under the joint WB/IMF Business Enabling Environment (BEE) Doing Business Improvement program helped to identify regulatory and policy constraints in business and construction permitting, which led officials to prepare their own assessment and strategy: Eliminating Barriers for Development of Entrepreneurship in Montenegro. In addition, the Bank is preparing comments on the October 2008 spatial planning law. The FY09 Land Administration and Management project (LAMP) will support complementary reforms to reduce the time and cost of registering property rights and acquiring permits and licenses. The LAMP will also provide assistance to complete the real estate cadastre and provide capacity building at the central and municipal levels. 20 Country Goal: Improve the financial sector

5 .Progress has been made in strengthening the financial sector. Authorities have gradually adopted the recommendations of the FY06 joint WB/IMF Financial Sector Assessment Program. The Government has divested all financial sector holdings except for an insurance company, and work has begun to identify instruments that could provide short-term liquidity in the event of a natural disaster. With Bank support, the Central Bank has assessed banking sector risks and issued new prudential regulations, including updated provisioning requirements. The Government also commenced development of a catalogue of legislative reforms needed to comply with EU standards.

Priority 111: Improving the Standard of Living for Citizens

Country Goal: Enhance opportunities for rural and regional development

6.Authorities continued efforts to strengthen rural development, particularly to satisfy requirements of EU accession. In 2007, the Government adopted its National Strategy for Sustainable Development, and has since drafted the National Program for Food Production and Rural Development and the National Forest and Forest Land Administration Policy. The Law on Agriculture was also drafted and approved. Major components of these policies include updating agricultural standards and practices to comply with EU requirements, and building capacity to effectively harness grant monies under the EU’s Instrument for Pre-Accession Assistance for Rural Development (IPARD) mechanism. To support these aims, the FY09 Montenegro Institutional Development and Agriculture Strengthening Project (MIDAS) is strengthening the capacity ofthe Ministry of Agriculture, Forestry, and Water Management to disburse, track, and monitor rural development funds, including by developing an IPARD-compatible Rural Development Unit, and issuing matching grant payments to farmers aligned with the IPARD framework. The project is also providing assistance to develop an EU compatible food safety system. A fully blended GEF grant is financing complementary matching grants to farmers for agri-environmental investments.

Country Goal: Improved quality and efficiency of education services and raising education attainment

7.Education sector reform continued at a good pace (see Box 1). With Bank assistance, the Government strengthened teaching and learning through improved quality assurance and student assessment. Authorities established an assessment center, participated in the Programme for International Student Assessment (PISA), and developed a standardized exit exam for secondary school. Textbooks were revised and schools are being renovated. Planning and budgeting processes within the Ministry of Education and Science (MoES) and Bureau of Education Services (BES) were also strengthened, which helped reduce education sector arrears from 10 percent in 2005 to 1.3 percent in 2007.

21 Box 1: Bank Support of the Education Sector

The FY05 Montenegro Education Reform Project (MEW) is building capacity at the school and system levels, especially to improve teaching and learning and efficiently harness budgetary resources. The MEW has been highly successfbl in achieving these goals by developing and revising textbooks, promoting teacher training, strengthening capacity in national assessments and international benchmarking, and executing civil works.

To build capacity, the MoES has devolved responsibilities to other agencies. For example, the BES became an independent institution in January 2004. With support ofthe project, the BES developed mechanisms for quality assurance and systematic teacher training. Montenegro’s Ministry ofEducation and Science coordinated the country’s first participation in PISA in 2006, and is preparing to introduce the State Matura, a standardized secondary school exit examination that facilitates access to higher education.

The MEW helped improve monitoring and evaluation (M&E). A large scale workshop was conducted in May 2007 with a variety of implementing agencies and key actors to clarify questions and responsibilities related to M&E. BES data on school performance and project data also provide evidence of strong project-related impacts in the classroom.

Factors underlying project success include strong donor coordination via biannual meetings ofthe project Steering Committee, and the strong commitment ofthe Project Implementation Unit at the Education Ministry.

The Bank also supported analytical activities in the education sector. Responding to requests at the ministry and university levels, World Bank trust hnds supported TA on higher education financing (FY07), higher education quality assurance (FY08), and implementation ofthe Bologna European Credit Transfer and Accumulation System (ECTS) (FY08). The first activity included a high level workshop and the second and third hands-on workshops. All three trust hnd activities led to reports that were well received by ministry and university officials, and that provide excellent bases for the proposed FYlO Higher Education Project.

Country Goal: Improved quality, efJiciency and patient satisfaction of health service

8.Substantialprogress was made in improving the quality and delivery of primary healthcare services. With the support ofthe FY04 Montenegro Health Systems Improvement Project (MSHIP), the Government has implemented a comprehensive strategy to reform primary health care, contain rising costs, and strengthen management and monitoring tools. The Government defined a revised primary health care benefit package, updated healthcare standards, and developed a new payment system. A health information system was established linking primary health care centers to the Health Insurance Fund. Primary health care teams were initiated throughout the country, and the concept of choosing a primary and dedicated physician is being promoted to improve the quality and management ofcare. Some progress was also made on upgrading primary care facilities. Appointment waiting times fell to a more reasonable period (i.e. 73 percent ofpatients seen within 30 minutes in 2006) and physician consultation times increased to an appropriate standard (56 percent ofpatients seen for 11 minutes or more). Yet patient satisfaction could still be improved. Only 5 1 percent and 28 percent ofpatients in Podgorica reported complete or partial satisfaction, respectively, with primary health care services. To gather more information on health outcomes, a health and household survey and a patient satisfaction and assessment survey will be completed before the end ofthe project.

Country Goal: Improved Jiscal sustainability of the Montenegrin pension system and options for voluntary pension savings introduced

9.The fiscal health of the pension system was improved and options for private pension funds were introduced. Following enactment ofthe 2003 Pension and Disability Law, the Government continued 22 administrative and institutional reforms to improve the effectiveness and efficiency of the pension system. With support of the FY04 Pension Systems Administration Project (PSAIP), authorities supported an in-depth reform of pension system administration, which included introducing an integrated system for collecting contributions, developing a database for individual records, and enhancing capacity in pension system modeling and policy analysis. A third pillar law permitting voluntary private pension savings was approved, and Securities Commission staff were trained on supervising the voluntary pension system. Though administrative reforms are still ongoing, some improvements are evident. The days needed to process registrations at the Directorate for Public Revenues fell from 5 in 2004 to 3 in 2008, and the ratio of registrations processed at the Pension and Disability Fund within 15 days rose from 56 percent to 64 percent over the same period. Public expenditure on pensions rose slightly to 9 percent of GDP, but this is still below the CPS ceiling of 10.4 percent. The deficit of the pension system also fell from 2.5 percent of GDP in 2005 to 1.7 percent in 2007, partly due to collecting arrears in contributions and increasing the number of contributors.

23

CAS Annex A1

Europe & Upper Key Development Indicators Central middle Montenegro Asia income &e distribution, 2W7 (2007) Male Female Population, mid-ye ar (milions) 0.60 445 8 23 Surfacearea (thousand sq. km) 14 23,972 41,497 Population growth (%) -0.1 0.0 0.6 Urban copulation (oh of total copulation) 61 64 75

GNI (Atlas method, US$ billions) 3.2 2,694 5,750 GNI percapita (Atlas method, US$) 5,060 6,051 6,987 GNI percapita (PPP, intemational $) 11,780 11,116 11,868

GDPgrowVl(%) 10.7 6.6 5.6 10 5 0 5 10 GDP per capita growth (%) 9.7 6.7 5.1 pmmnt

(most recerd estirna, 20OO-2007J

Poverty headcount ratio at $1.25 a day (PPP, %) 5 1,000) Poverty headcountratioat$2.00 aday (PPP, %) 11 Under-5 morfalily rate (per Life expectancy at birth (years) 74 89 70 Infant mortality (per 1,ooO ive births) 9 23 22 601 Childmalnutdtion (% ofchildren under 5) 2

Adultliteracy,male(%ofages 15and older) 99 94 Adult literacy, female (% of ages 15 and older) 96 92 Gross primary enrolment, male(% of age group) 98 112 Gross primary enrolment, female (%of agegnxrp) 96 109

Access to an improved watersource (% of population) 98 95 95 Accesstoimproved sanitationfaclities(% of population) 91 89 83

Net Aid Flows 1980 1690 2000 2007

(US$ rnNions) Net ODA and dficial aid 96 Growth of GDP and GDP per capita (%) Top 3 donors (b 2006): Italy 23 2T Unitedstates 22 European Cammisdon 16

Aid (% of GNI) 3 .o Ad per capita (US$) 160 ~ ~ ~ ~ ~ I ~ ~ I I

Long-Term Economic Trends 0 ga 95 00 05 Consumerprices (annual %change) 23.0 6.3 GDP implicit deflator (annual % change) 20.2 18.1 *GDP -GDP prcapta Exchange rate (annual average, local per US$) 1.1 0.7 Terms of trade index (2Mx) = 100) 1980-90 1990-2000 200047 (averageannualgmMh %) Population, mid-year (mil ions) 0.6 0.6 0.7 0.6 0.2 1.3 -1.6 GDP (US$ millions) 982 3,846 4.7 (?A of GDP) Agriculture 12.5 10.1 4.7 Industry 23.4 20.4 4.7 Manufacturing 10.2 9.4 4.7 Services 64.3 69.7 4.7 Hwsehold final consumption expenditure 70.0 90.1 4.7 General govt fhai consu mption expenditure 21.9 25 .O 4.7 Gross capial formation 22.4 28 .O 4.7

Exports ofgoods and services 36.8 47.5 4.7 importsofgoodsandservices 51.1 79.5 4.7 Gross savings 19.6 2.2

Note: Fguresinitafcsareforyearsotherthan thosespecmed.2007 data areprelmnary .. indicatesdata arenotavalabb. a. Aiddata arefor2006.

Development Economics, Development Data Grwp (DECDG). 24 Montenegro

Balance of Payments and Trade 2000 2007 ~overnanceindicaton,200Oand 2007 (US $ rnilions) - Total merchandise exports (fob) 23 1 903 Total merchandise impmts (cif) 460 2,739 Voice andaccomtabilty Netttadain goodsandservirm -140 -1,233 pollical stabilty Current account balance -2 7 -1,128 as a % d GDP -2.7 -29.3 Regrlabry qualty Rule of Workers' remittances and law compensationof employees (recepts) COltml OfCaNptl3n

Reserves, induding gdd 52 4Eo 0 25 50 75 1w 12007 Countws percantle ra& (0-100) Central Government Finance 02000 higtwvduesimrytrrtwrstngs (% of GP) Some KaufmmPKraay-Mastrum. WOdd Bank Current revenue flnciud hg grants) 45.4 Tax revenue 27.9 Current ewenditure 18.6 Technology and Infrastructure 2000 2007 Overall surplusldeficit 6.4 Paved roads (%of total) Highest mtghal tax rate (%) xed ineandmoblephone individual 15 subscribers (per 100 people) ,, 166 Corporate 9 Hgh technologyexports (Oh of mnufacturedexports) External Debt and Resource Flows Environment (US $ rnllions) Total debtoutstanding and disbursed 615 2,520 Pgriolltural land (% of landarea) Total debt service 3 86 Forest area (%of land area) Debt reief (HIPC, MDRI) - - Natimly pfoteUedareas(% oflandarea)

Totaldebt(%ofGDP) 53.1 65.5 Freshwater resources percapita (cu. meters) Total debt service (% ofevcrts) Freshwaterbithdrawal(%of internal resources)

Foreign direct investment (net infbws) 0 719 02emissions percapita (nit) Podfdb equity (netinflows) 0 7 GDP per unit of energy use (2005PPP$ perkg ofolequivalent) Composition oftoal exbrnal debt 2007 Energyuse percapita(kgofoii equivalent)

(US$ m'llon s)

IBRD Total debtoutstandingand dsbursed 269 Disbursements 0 Principal repayments 114 Interest paynents 16

IUSmlhorrs IDA Total debtoutstandingand disbursed 59 Disbursements 7 Rivate Se bor De vel on ment 2000 2008 Total debt service 0

Timerequired tostartabushess(days) - 21 IFC fiscaly yea^ Cast tostata business (% of GNI per capita) - 4.4 Total disbursed and outstandhg portfolio 16 Time reauired toreaisterpmpertv (daw) - 86 ofwhich IFC wnaccount 18 Disbursementsfor IFC ow account 0 Rankedasa major constiant to business 2000 2007 Pottloib sdes, prepayments and (%of managers surveyed who agreed) repaymentsfor IFC ownaccount 1 n. a. n. a. MlGA Gross exposure - Stock market capitalization (%of GDP) .. 106.4 Bankcapital to asset ratio (%) .. 10.4

Note : Fgures in ita iw are f or years other than those speded. 2 W7 data are preliminary. 3/6/09 .. hdicatesdata arenotavailable. -indicatesobsewtion isnotapplicable.

Development Economcs, Development Data Group (DECDG).

25 Millennium Development Goals Montenegro

Wih selected targets to achieve between 1990 and 2015 (estimate chest to date shown, +/- 2yearS)

Goa I 1: halve the rates Rr extreme povetty and malnutrltion 1990 1995 2000 2007 Poverty headcount iatk at $1.25a day (PPP, %of population) Povertv headcount iatk at national wvertvline (oh d population) Share dincomeorconsumptiontothe poorestqunitik(%) Prevalence of malnutrition (Oh of chilclren under 5) 2.2

Goal 2: ensvethatckildren are able to compieteprimaryschoolinp Primary schd enrdknent (net, %) Primarv camletion iate (% of relemnt aae aroup) Secondary school enrollment (gross, Oh) Youthliteracyrate(%of peopleages 1624)

Goal 3: eliminategenderdisparltyin education and empotterwomen Ratiod girls to boys in primaryand seccndaryeducation(%) Womenempb~dinthenonagricultuialsector (Oh dnmagricultuial employment) Proportion ofseats held by wmen in national parlament (Oh) 9

Goal 4: reduceunderd mortality by two-thirds Under4 mMdityrate (per 1,000) 16 14 13 10 lnfantmortalityiate(per 1.000live births) 15 12 11 9 Measksimnunization(pmpation ofoneyear dds imrmnized, Oh) 90

Goal 5: reducematemal mortalii by thrwqovths Maternal mortalityratk (modeled estimate, per 100,OOOlivebirths) Births attended byskilled hedth staff (% oftotal) 99 Contraceptie prevalence(% of wmen ages 1549)

Goal 6:haltand begin to reversethespread ofHlVlAlDS andothermajw dseases Prevalence of HIV (%of population ages 1549) Incidence d tubecubsis @er 100, MM people) 32 Tuberculosis cases detected under DOTS (Oh)

Goal 7:halve the proportion d peoplewithcut sustainable access to basic nwds Access to an improved water source (%of population) 98 Access to improved santation facilities (% of population) 91 Forest area (% of total land area) Natimaly protectedareas(% of tdallandalea) CO2 emissons (metrictons percapita) GDP perunitdenergyuse(wnstant2005 PPP $perkgofoilequivalent)

Goal 8:develop a global partnership for development Telephone mainlines (per 100 people) 58.9 Moble phonesutecribers(per1W people) 107.2 Internet users (per 1 OOpeople) 46.6 Personal computers (per 100 people)

:ducation indicatas (%) deasles immunization(% of lyear olds) ICT indlcators (per 100 people)

51 180 - 160. -- la. 1M ' 1w. 80- 60. 25 40. 20- '~-IIo> , , , , , , , , 1990 1995 zwo 2006 &Primryneterrdlmntralo (..)

*Ratiiofgdsto bo/Slnpnm8y& OMortenego OEurope& Cmtral Asla secordary ducatim (..)

Note:Figuresinitalcsareforyearsotherthan thosespeded. ..indicatesdataare not avdaie. 3/6/09

Developmnt Ecmomcs, Development Data Group (DECDG). 26 CAS Annex B2 Selected Indicators* of Bank Portfolio performance & Management As Of 2/13/09

Indicator 2007 2008 2009 Portfolio Assessment Number of Projects Under Implementation a 5 6 8 Average Implementation Period (years) 2.4 3.0 2.8 Percent of Problem Projects by Number a,c 20.0 16.7 12.5 Percent of Problem Projects by Amount 20.6 16.3 8.3

Percent of Projects at Risk by Number a*d 20.0 16.7 12.5 Percent of Projects at Risk by Amount 20.6 16.3 8.3

Disbursement Ratio (%) e 33.3 29.5 36.3 Porifolio Management CPPR during the year (yesho) No Yes No Supervision Resources (total US$ thousands) 535 440 ... Average Supervision (US$ thousands/project) 61 89 ...

Since FY Last Five Memorandum Item 80 FYs Proj Eva1 by OED by Number 2 2 Proj Eva1 by OED by Amt (US$ millions) 24.3 24.3 % of OED Projects Rated U or HU by Number 0.0 0.0 % of OED Projects Rated U or HU by Amt 0.0 0.0 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Banks portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year.

27 CAS Annex B3: IBRD/IDA Program Summary As Of Date 2/17/09

Proposed IBRD Base-Case Lending Program

strategic Implementation b Fiscal year Pmj ID US$(M) Risks (HAUL) (H/M/L) SUSTAINABLE TOURISM DEVELOPMENT FYO9 ADDITIONAL FINANCING 4.8 M M MONENTEGRO HEALTH SYSTEMS IMPROV. FYO9 ADDITIONAL FINANCING 6.5 M M Result

Overall Result 11.3

28 CAS Annex B3: IFC Investment Operations Program

2006 2007 2008 2009

Commitments (US$ml Gross* 15.68 0.00 Net* 15.68 0.00

Net Commitments bv Sector l%) Wholesale and Retail Trade 100% 0 Total 0 0 100% 0

Net Commitments bv Investment Instrument (%I Loan 50% Quasi loan 50% Total 0 0 100% 0

* IFC's Own Account only

29 CAS Annex B4: Summary of Nonlending Services As Of Date 2/1/09

Completion Cost Product FY (US$OOO) Audiencea Objectiveb

Recent completions Public Expenditure and Institutional FY06 Review Update 200.6 KG,PD,PS Fiduciary Assessment Follow-Up FY06 27.4 KG,PD,PS Financial Sector Assessment Program FY07 ... KG,PD , PS Debt Sustainability Analysis TA FY07 27.2 KG,PD,PS Report on the Observance of Standards FY07 92.4 and Codes KG , PD, PS Poverty Update FY07 73.9 KG,PD, PS Business Environment TA (FIAS) FY08 31 .O KG,PD,PS Public Expenditure and Institutional FY 09 Review 280.2 KG,PD,PS Public Expenditure and Financial FY 09 165.7 KG,PD, PS Accountability (PEFA)

Trust Funds Quality AssurancelECTS (Swiss CTF) FY08 44.8 G,B, PD KG,PD, PS

Underway Programmatic Poverty Assessment FYO9 ... G,B.PD KG,PD,PS Transport Sector Work FYlO 63.4 G, B KG,PD, PS

Trust Funds AlbaniaIMontenegro Lake Skhoder FYO9 G,B KG,PD, PS Integrated Ecosystem Mgt. (GEF) ... Health System (CIDA) FYO9 686.6 G,B KG,PD, PS Montenegro Early Warning Toolkit for FYlO 228.0 G,B KG,PD,PS Assessing Bank's Risk Profiles (FIRST) ROSC Country Action Plan (FIRST) FYI0 ... Road Safety Management Review (GRSF) FYI0 445.9 G, B KG,PD, PS

Planned PPP Options of Electricity Generation FYI0 ... G,D,B KG,PD,PS Country Economic Memorandum FYlO ... G,B.PD KG,PD,PS Programmatic Poverty Assessment FYlO ... G,B.PD KG,PD,PS

Trust Funds Podgorica Water and Sewage TA (PPIAF) FYI0 ... G KG,PS Power Sector Generation (PPIAF/ESMAP) FYI0 ... G, D, B KG,PS

a. Government, Donor, Bank, Public Dissemination. b. Knowledge Generation, Public Debate, Problem Solving.

30 CAS Annex B5 Montenegro Social Indicators- Latest single year Same regionfincome group Europe 8 Upper- Central middle- I9s 0435 I99085 2000-06 Asia income POPULATION Total population, mid-year (millions) 0.6 0.6 0.6 460.5 811.3 Growth rate (% arnual average for period) 0.0 1.2 -1.8 0.0 0.8 Utban popdation (% of population) 63.8 75.0 Total fertility rate (births perwoman) 2.3 1.8 1.6 1.6 2.0 POVERTY (% of population) National headcount index Urban headcount index Rual headcount index INCOME GNI per capita (US$) 4,130 4,815 5913 Consumer price index (2000=100) 139 132 Food price index (2000=100) INCOMECONSUMPTION DISTRIBUTON Giri index Lowest quntile (% of income or consumption) Highest quntile (% of ircome orconsumption) SOCWL INDICATORS Public expenditure Health (% of GDP) 6.2 4.1 3.6 Education (% of GDP) 4.2 4.1 Net primary school enrollment rate (% of age group) Total 91 94 Male 91 94 Female 90 93 Access to an impraved water source (% of population) Tot a1 92 93 Urban 99 98 Rural 80 78 Immunizationrate (99 of children ages 12-23 months) Measles 90 97 94 DPT 90 95 95 CHld malnutrition (% under 5 years) Life expectancyat birth (years) Total 74 76 74 69 70 Male 72 72 72 65 67 Female 77 79 77 74 74 Mortality Infant (per 1,000 live births) 12 9 22 22 Under 5 (per 1,000) 14 10 26 26 Adult (1559) Male (per 1,000 popdation) 171 298 26 0 Female (per 1,000 popdation) 84 122 137 Maternal (modeled, per 100,000 live births) 43 97 Births attended by skilled health staff (%) 99 95 94

Note: 0 or 0.0 meaw zero or less than half the mit shown. Net enrollment rate: break in series betwen 1997 ad1998 due to charge from ISCED76 to ISCED97. Immunization: refels to children ages 12-23 morths who received vaccinations before one year of age or at any time before the survey. Wodd Development lndicaton database, World Bank- 11 April 2008

31 CAS Annex B6 Key Economic Indicators

Actual Prelim. Prdecdons 2005 2006 2007 2008 2009 2010 2011 2012 National Accounts (as % of GDP) Gross domestic product” 100 100 100 100 100 100 100 100 Agri cu it ure 10 10 11 10 10 10 11 12 Industry 21 20 20 20 19 19 19 18 Services 69 69 69 70 70 71 70 71

Total Consumption Gross domestic investment 18 25 28 27 22- 21 22 22 Government investment 4 5 7 7 11 10 10 IO Private investment (incl. increase in stocks) 14 20 21 20 11 11 12 12

Exports GNFSb’ 44 49 47 43 45 47 50 51 Imports GNFS~) 61 79 80 76 69 64 62 64

Gross domestic savings 9 1 -1 -4 0 6 11 11 Gross national savings” 9 5 2 -1 4 IO 15 15

Memormdum items Gross domestic product (US$ millat current prices) 2,255 2,696 3,846 4,9 88 5,124 5,397 5,763 6,3 18 GM percapita(US$, Atlas method) 3540 41 80 5060 6200 72OO 7840 8460 9010

Real annual growth rates (%, calculated from previous years prices) Gross domestic pmduct at marketprices 4.2 8.6 10.7 7.5 2.0 2.0 4.0 4.5 Gross domestic income 3.6 3.6 9.1 5.2 7.2 9.8 9.7 5.2 Real annual per capita growthrates (YO,calculated from previous years prices) Gross domestic product at marketprices 3.5 9.0 9.8 6.4 1.7 4.8 6.4 4.6 Totdl consumption 3.5 9.0 9.8 6.4 1.7 4.8 6.4 4.6 Private consumption 3.5 9.0 9.8 6.4 1.7 4.8 6.4 4.6

Balance of Wyments(US%millions) 0.43549 0.49372 0.47473 0.43013 0.44665 0.46986 0.49548 0.51277 Exports GNFSb’ 982 1,331 1,826 2,145 2,289 2,536 2,856 3,240 Merchandise FOB 572 787 903 973 1,015 1,099 1,208 1,354 ~mportsGNFS~) ,3 77 2,133 3,059 3,803 3,513 3,448 3,597 4,053 Merchandise FOB ,211 1,861 2,739 3,305 3,052 2,996 3,125 3,522 Resource balance -395 -802 -1,233 -1,658 -1,224 -912 -74 1 -813 Net curent transfas 182 113 81 106 108 113 122 134 Current account balance .I91 -650 -1,128 -1,564 -1,127 -809 -634 -695 Net private foreign direct investment 473 586 719 833 667 458 461 442 Total foreign loans(net) 161 439 1,235 1,061 370 448 402 367 Other capital (ne< incl. errors & ommissions) - 303 -178 - 758 -556 90 - 97 - 229 - 113 Change in reserve8 - 140 - 197 -67 226 0 0 0 0

Memorandum item Resource balance (% ofGDP) -17.5 -29.7 -32.1 -33.2 -23.9 -16.9 -12.9 -12.9 Realannual growth rates (YROO prices) Merchandse exports(F0B) Pnmary Manufactires Merchandtse imports (FOB)

32 CAS Annex B6 Key Economic Indicators (continued)

Actual Prelim. Prgectiotw 2005 2W6 2007 2008 2W9 2010 2011 2012

Pubticfinance(as% of GDP at market prices)" Current revenues 40.7 45.4 43.9 40.2 37.3 36.7 36.6 Current expenditures 18.7 18.6 19.9 19.8 19.7 19.2 18.7 Cwent surplus (+) /deficit (-) 22.0 26.8 211 .O 20.4 17.6 17.5 17.9 Capital expenditure 5.1 6.7 7.4 10.7 10.1 10.0 9.8 Foreign fmancing 0.5 -2.9 0.6 0.2 0.3 0.2 0.0

Monetary indicators WGDP 27.2 43.0 72.3 61.7 61.6 60.0 62.0 Growth of M2(%) 87.2 119.7 -0.1 5.0 1.8 10.7 13.4 Private sector credit growth / 99.2 102.4 108.7 1 18.0 259.3 90.0 90.0 total credit growth (%)

Price indicies (YROO=lOO) Merchandize export price indec Merchandize importprice index Merchandize terms oftrade index Real exchange rate (US$LCu)' 7.4 3.6

Real interest rates Consumer price index (% change)g 1.8 2.0 6.3 6.4 3.2 3.0 2.9 3.5 GDP deflator (% change) 9.0 18.1 9.4 2.8 -0.5 0.3 3. 1 a) GDP at factor cost b) 'GNFS" denotes"gods and nonfactor senices" c) Includesnet unrequired transfers excluding official capital grants. d)Includes useofIMFresources. e) Conmlidated generalgovernment 0 "LCU' denotes "localcurrency units". An increase in realexchange rate denotesdepreciation g) Retail price index by 2002; since 2003 CPI

33 CAS Annex B7 Key Exposure Indicators

Actual PreL Projections Base Case Indicator 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total debt outstanding and 1,178 2,520 3,850 4,135 4,613 5,001 5,436 disbursed (TDO) (US$m)a

Net disbursements (US $m)" 1,342 1,330 285 479 388 43 4

Total debt service (TDS) (US$m)a 386 487 7 03 897 1,028 1,092

Debt and debt service indicators (YO) TDO/XGS~ 81.8 131.8 169.8 173.8 175.4 169.2 162.3 TDO/GDP 43.7 65.5 772 80.7 85.5 86.8 86.0 TDS/XGS 20.2 21.5 29.6 34.1 34.8 32.6 C oncessional/TDO 6.9 3.6 2.5 2.4 2.2 2 .o 1.9

IBRD exposure indicators (%) IBRD DS/public DS 44.7 85.4 462 31.9 30.7 29.2 31.7 Preferred creditor DS/public DS (%)" 77.5 88.3 73 2 53.3 55.7 55.0 59.8

IBRD DS/XGS 1.3 6.8 1 .o 1.1 1.0 0.8 0.8 IBRD TDO (US$m)d 250 26 9 25 9 2 56 257 259 25 3 Of which present value of guamntees (US$m) Share of IBRD portfolio (YO) 0.2 02 0.2 0.2 0.3 0.3 0.2 IDA TDO (US$mId 44 59 65 71 76 78 79 a. Includes public and publicly guaranteed debt, private nonguamnteed, use ofIMF credits and net short-term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. d. Includes present value ofguarantees.

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IBRD 34825 19°E MONTENEGRO

SELECTED CITIES AND TOWNS NATIONAL CAPITAL RIVERS

MAIN HIGHWAYS a n ri D MAIN ROADS BOSNIA AND To HERZEGOVINA Priboj RAILROADS Cehoti na To OPSTINA (MUNICIPALITY) BOUNDARIES To GradacGradac Priboj Foca INTERNATIONAL BOUNDARIES PljevljaPljevlja

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To Mostar Ze a v t RozajeRozaje IvangradIvangrad GvozdGvozd v KapaKapa KolasinKolasin VelimljeVelimlje MorackaMoracka v ‘ (2227(2227 m)m) PPetroviPetrovicietrovic´i NiksicNiksic v MatesevoMatesevo VilusiVilusi v AndrijevicaAndrijevica MorakovoMorakovo MedurijecjeMedurijecje To KomoviKomovi To Dubrovnik GrahovoGrahovo (2656(2656 m)m) Dakovica

Z MurinoMurino e a LijevaLijeva RijekaRijeka t c a a r o PelevPelev PlavPlav M To CrkviceCrkvice DanilovgradDanilovgrad Dubrovnik GusinjeGusinje SpuzSpuzv RisanRisan v BioceBioce Herceg-Herceg- PerastPerast NoviNovi TivatTivat KotorKotor PODGORICAPODGORICA

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JULY 2006