Document of The World Bank
Public Disclosure Authorized FOR OFFICIAL USE ONLY
Report No. 40716-UA
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
Public Disclosure Authorized AND
THE INTERNATIONAL FINANCE CORPORATION
COUNTRY PARTNERSHIP STRATEGY
FOR
UKRAINE
FOR THE PERIOD FYO8-FY11
Public Disclosure Authorized November 8,2007
Ukraine, Belarus and Moldova Country Management Unit Europe and Central Asia Region
International Finance Corporation Central and Eastern Europe Department Public Disclosure Authorized
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The date of the last Country Assistance Strategy was October 23,2004
CURRENCY EQUIVALENTS Currency Unit = Hryvnia (UAH) July 2007: US$=UAH5.05
FISCAL YEAR Government of Ukraine: January 1- December 3 1
ABBREVIATIONS AND ACRONYMS
AAA Analytical and Advisory Activities BEEPS Business Environment and Enterprise Performance Survey CAS Country Assistance Strategy CAS CR Country Assistance Strategy Completion Report CEM Country Economic Memorandum CIDA Canadian International Development Association CIS Commonwealth of Independent States CPAR Country Procurement Assessment Report CPPR Country Portfolio Performance Review CPS Country Partnership Strategy CTP Center for Tender Procedures and Business Planning DPL Development Policy Loan EBRD European Bank for Reconstruction and Development EC European Commission ECA Europe and Central Asia EIB European Investment Bank EMBI Emerging Market Borrowing Index ESW Economic and Sector Work FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FTA Free Trade Agreement GATT’s General Agreement on Tariffs and Trade GDP Gross Domestic Product GoU Government of Ukraine IBRD International Bank for Reconstruction and Development IEG Independent Evaluation Group IFC International Finance Corporation IMF International Monetary Fund ISR Implementation Status and Results MICs Middle Income Countries MIGA Multilateral Investment Guarantee Agency MoF Ministry of Finance NATO North Atlantic Treaty Organisation NBU National Bank of Ukraine NGO Non-governmental Organization FOR OFFICIAL USE ONLY
OECD Organisation for Economic Co-operation and Development PAL Program Adjustment Loan PAYG Pay As You Go PEFA Public Expenditure and Financial Accountability PFM Public Finance Management Reform project PIUS Project Implementation Units PPPS Public Private Partnerships PTAP Programmatic Technical Assistance Partnership PTP Power Transmission project SAMP Social Assistance Modernization project SIAM Social Insurance Administration Modernization project SIDA Swedish International Development Association SME Small and Medium Enterprise SOEs State owned Enterprises STATCAP Statistics Capacity Building SWAPS Sector-Wide Approaches TB Tuberculosis TFP Total Factor Productivity TIMMS Trends in International Mathematics and Science Study TRIMS Trade-Related Investment Measures TRIPS Trade-Related Aspects ofIntellectual Property Rights UEFA European Soccer Association USAID United States Agency for International Development VAT Value-Added Tax WBG World Bank Group WBI World Bank Institute WTO World Trade Organization
IBRD IFC Vice President: Shigeo Katsu Declan Duff Country Director: Paul Bermingham Jerome Sooklal Team Leader: Martin Raiser Oksana Nagayets
This CAS was prepared by a core team that included Anush Bezhanyan, Olena Belch, Julia Smolyar, Katia Petrina, Zoran Anusic, Igor Oliynik, Hermann von Gersdorff, Paul0 Correa, Alexander Pankov, Natasha Kapil, Hormoz Aghdaey, Vitaliy Bigdai, Dejan Ostojic, Dmytro Glazkov, Alexander Kaliberda, Alexei Slenzak, Matthias Grueninger, Svetlana Budagovska, Maria Koreniako, Tetyana Komashko, Jana Kunicova, Viktoria Siryachenko, Oleksiy Balabushko, Rush Piontkivsky, Pablo Saavedra, Munaver Sultan Khwaja, Luis Alvaro Sanchez, Anna Wielogorska, Dmytro Derkatch, Suzy Yoon, Yulia Snizhko, Iouri Loutsenko, Cathy Summers, Sergiy Kulyk, Ivan Velev, Florentin Blanc (IFC), Sanjar Ibragimov (IFC) and Aliona Voloshina (IFC’r.
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.
TABLE OF CONTENTS
EXECUTIVES~Y ...... i
I. COUNTRY CONTEXT...... 1 A . Economic Context ...... 1 B. Recent Social Developments ...... 3 C . Recent Political Developments ...... 7
I1. RECENTECONOMIC DEVELOPMENTS AND RISKS ...... 9 A . Recent Economic Growth - Drivers and Prospects for Sustainability ...... 9 B. Maintaining Macro-Economic Balance ...... 11 C . Key Risks to the Outlook ...... 14
I11. UKRAINE’SDEVELOPMENT CHALLENGES ...... 16 A . Sustaining Growth and Improving Competitiveness ...... 16 B. Public Finance. Public Sector Reform and Improved Public Service Delivery ... 17 C . Governance and Public Support for Reform...... 19
IV. GOVERNMENTRESPONSE ...... 21
V . WORLD BANKGROUP STRATEGY ...... 24 A . Lessons Learned from the 2003-2007 CAS ...... 24 B. Operational Principles and Rules of Engagement ...... 28 C . CPS Pillars and Objectives ...... 31 D. Operational Activities by Pillar ...... 33 E. Results, Monitoring and Evaluation ...... 41 F. Consultation Process...... 44
VI. RISKS AND RISK MITIGATION...... 45 A . Implementation Risks ...... 45 B. Credit Risks ...... 48 Tables:
Table 1: Main Macroeconomic Indicators. 2000-2006 ...... 2 Table 2: Key Social Indicators, 2005 ...... 7 Table 3: Medium-Term Economic Projections for 2007-2010 ...... 14 Table 4: Common Reform Areas in Government Programs, 2000-2007 ...... 22 Table 5: The CPS Programs by Pillar and Typology ...... 32 Table 6: The Transition from Extensive to Intensive Growth - Pillar 1 Themes ...... 35 Table 7: CPS Activities in FYO8 and FY09 ...... 43
Figures: Figure 1: GDP Growth Rate. 1991-2006 ...... 1 Figure 2: EBRD Average Transition Indicator. 199 1-2006 ...... 2 Figure 3: Poverty Rate in Ukraine. 2000 -2005 ...... 3 Figure 4a-d: Ukraine Poverty Rates...... 5 Figure 5: Natural Gas Prices by Type of User ...... 6 Figure 6 a-b: The Structural Transformation of Ukraine’s Economy ...... 11
Boxes: Box 1: Poverty in Ukraine: Concepts vs . Perception...... 4 Box 2: Recovery from the Transition Crisis and the Impact of Reform...... 13 Box 3: Euro 2012 ...... 17 Box 4: The Recent Evolution of Public Procurement...... 19 Box 5: Portfolio Performance and the Investment Lending Review ...... 26 Box 6: Operational Approach to Governance in the CPS ...... 36 Box 7: Portfolio Monitoring and Implementation: Agreed Services Standards ...... 47
Annexes: Annex 1: Key Development Challenges ...... 50 Annex 2: Governance and Anti-Corruption Agenda ...... 60 Annex 3: CAS Completion Report (FY04-07) ...... 76 Annex 4: IEG Recommendations from the Country Assistance 2003-2007 Evaluation and Management’s Response ...... 127 Annex 5: CPS Principles and Operational Framework for Selection of Programs ...... 128 Annex 6: Donor Engagement by Areas ...... 133 Annex 7: Results Matrix ...... 134 Annex 8: Country Partnership Strategy - Public Consultations ...... 147
Annex Tables: Annex A2: At a Glance Table Annex B2: Selected Indicators of Bank Portfolio and Management Annex B3: IBRD/IDA Program Summary Annex B3: IFC Investment Operations Program and MIGA Annex B4: Summary of Nonlending Services Annex B5: Social Indicators Annex B6: Key Economic Indicators Annex B7: Key Exposure Indicators Annex B8: Committed and Disbursed Outstanding Investment Portfolio Annex B8: Operations Portfolio (IBRD/IDA and Grants)
2 EXECUTIVE SUMMARY i. Ukraine is a lower middle income country, with a Gross Domestic Product (GDP) per capita of US$1940 in 2006. It is the second largest country of the former Soviet Union with a population of46 million. ii. Since 2000, Ukraine has enjoyed a strong economic recovery, with growth at around 7.5 percent per year on average. Structural change has started but remains incomplete. Ukraine continues to lag behind the European Union (EU) accession in terms of economic reform. An important benchmark may be reached soon with the World Trade Organization (WTO) accession. iii. Rapid economic growth has facilitated a sharp decline in poverty in recent years. Poverty has fallen sharply from 31 percent in 2001 to 8 percent in 2005. Ukraine has enjoyed one of the fastest rates of poverty reduction in the Europe and Central Asia Region (ECA) since the onset of economic recovery in 2000. However, in spite of this achievement, the public’s satisfaction with their material well-being remains low. iv. Ukraine’s macroeconomic framework on the whole remains adequate, but the authorities will need to be vigilant in the face of potential external shocks or political spending pressures. Under the Bank’s base-case medium-term macroeconomic forecast, growth is maintained at around 5-6 percent per annum, with moderate inflation and external as well as fiscal imbalances. External shocks would require policy adjustment to safeguard Ukraine’s improvements in external creditworthiness. v. Despite frequent government changes and significant political volatility, the basic vision of economic development for the country is broadly shared between all main political forces. The development vision includes a commitment to closer integration with Europe and with the world economy at large. vi. Ukraine is receiving increased attention from international partners, in particular from Europe. The EU has started negotiating a deep Free Trade Agreement with Ukraine, and collectively the European institutions are now by far the largest provider of financial assistance. vii.This Country Partnership Strategy (CPS) builds on an analysis of Ukraine’s key development challenges. To sustain growth into the future, specifically, Ukraine will need to address three key challenges: (i)the improvement in competitiveness, (ii)the reform of public finance and the public sector to improve service delivery and make growth socially inclusive, and (iii)tackling weaknesses in governance. viii. In response to these challenges, the CPS proposes a two-pillar framework of support. The first pillar will aim to improve Ukraine’s competitiveness through investments in public sector infrastructure (in particular transport and energy efficiency), advisory services and advocacy work to improve the business climate, technical assistance and access to credit lines to strengthen the financial sector, and global knowledge sharing to promote innovation and technology adoption, as well as to ensure that Ukraine benefits from the framework for international carbon trading and makes a contribution to emission reductions. The second pillar will seek to improve public services by targeting greater efficiency in spending, and using improvements in public sector financial management as an entry point into public sector reforms more generally.
ix. Governance and Anti-Corruption efforts will cut across both pillars of the CPS. A key problem for Ukraine is the lack oftrust in public sector institutions, and the resulting low expectations trap: the public expects little from the state, but is in turn not willing to make much of an effort to advocate for improvements either. The Bank’s approach will concentrate on building demand for better governance, whilst continuing to seek opportunities to strengthen public sector institutions where sufficient client ownership and policy consensus exists.
x. The International Finance Corporation’s (IFC) activities will be a key element of the Bank Group’s strategy. The IFC will support the achievement of target outcomes in the first pillar through investments to support modernization of the private sector, and through selected investments in municipal and public infrastructure. The IFC will also look for opportunities to help mobilize private funding for the modernization of public services. The IFC’s expanded advisory services will be a key component of the Bank Group’s non-lending interventions.
xi. Three principles underlie the operational approach in this CPS: (i)selectivity, (ii) flexibility and (iii)partnerships. These principles are directly derived from the lessons of experience in the previous CAS. The Bank will adopt a programmatic approach, choosing a selected number of areas for support, with the range ofinstruments adapted to the degree of client ownership, development urgency and the Bank’s own comparative advantage in relation to other donors. A selection of programs across the two main pillars has been identified for the first two years ofthe CPS. Beyond this, the CPS retains the flexibility to adjust both the selection of program and the range of instruments to changing client demand, development needs and evolving development partnerships.
xii. The CPS lays particular emphasis on non-lending activities. Recognizing that in several critical reform areas, there is not yet a national consensus around reform priorities or a well-defined reform roadmap, the Bank will invest in advocating for and building capacity to implement policy changes through non-lending activities and advisory services. To make room for this enhanced non-lending focus, the Bank will target improvements in the performance of the investment lending portfolio, aiming at fewer, larger and more effective interventions. ... xm. The CPS proposes a lending range of US$2-6 billion over four years, with annual lending levels modulated by a series ofperformance benchmarks. Specifically, the Bank will monitor the maintenance of an appropriate macroeconomic framework, overall progress in structural reform, and progress in improving the implementation of the
.. 11 existing portfolio as key performance benchmarks determining the size of financial allocations. The maintenance ofan appropriate macroeconomic framework will be a pre- condition for access to Development Policy Lending (DPL). Consequently, the share of DPL in the total allocation would increase from zero at the bottom of the lending range towards 40 percent in the middle of the range and potentially higher at the top of the range. xiv. The Bank Group is strongly committed to harmonizing its assistance with country systems and coordinating its activities with other development partners. Although collectively the donor community contributes only marginally to Ukraine’s own investments, the transactions costs for Ukraine of dealing with external donors remain high. The CPS proposes to address this issue by continuing to work towards the greater use of country systems, where appropriate, and by advocating for policy change and building capacity, where country systems fall short of acceptable standards (e.g., in public procurement). Over time, the Bank aims at channeling an increasing share of its resources through the Ukrainian budget, potentially against agreed performance targets, and together with other donors (e.g. through Sector Wide Approaches - SWAPS). xv. The CPS is tied into a results framework which will serve as the main tool for joint accountability during implementation. Annual Country Portfolio Performance Reviews (CPPRs) are planned at which an annual results report will be jointly reviewed and discussed. The Country Team is investing considerable resources into strengthening capacity for results, in particular to address the challenge of how to adjust the results framework to the principles of flexibility, as well as how to reflect the role of advocacy work. xvi. The Bank would appreciate guidance from the Executive Directors on the following questions: Are Ukraine’s development challenges appropriately identified in the CPS and does the two-pillar structure ofsupport provide an adequate response?
0 Are the principles ofthe CPS of selectivity, flexibility and partnership and the resulting selection ofprograms appropriate? Is the lending range acceptable and are the benchmarks modulating between the levels oflending adequately defined?
0 Is the results framework realistic and provide for sufficient accountability?
... 111
I. COUNTRY CONTEXT A. ECONOMICCONTEXT 1. Ukraine is a lower middle income country, with a GDP per capita of US$1940 in 2006. It is the second largest country ofthe former Soviet Union with a population of 46 million.
2. Ukraine suffered one of the steepest declines of any of the successor states of the former Soviet Union, with GDP falling to 45 percent of the 1991 level by 1998 (Figure 1). Structural reforms were initially hesitant with Ukraine lagging considerably behind Russia in the liberalization of markets, privatization of state assets and the foundation ofmarket-based institutions.
Figure 1: GDP Growth Rate, 1991-2006
15.0- .... .__...... I......
10.0 ".ll""I1 ...
...... _._ .... .- .. - ..
t .. .. 3' I I .. .20.... $0.. s$9 . + 4 o;, 8 ...... % 0s os
......
11"111 ...... l.."_.""......
...... -......
1 -t- Ukraine ?h- CIS ECA i 3. Since 2000, however, Ukraine has enjoyed a strong economic recovery, with growth at around 7.5 percent per year on average (Table 1). The period of recovery was initiated by a sustained reform effort that began during the government of Prime Minister Yushchenko, now Ukraine's President, and continued under subsequent governments. Macroeconomic stability was established, key industries were privatized and the process of legislative and institutional reform was begun. Economic recovery has benefited from the significant excess capacity in industry, as well as from a favorable external environment, and an initially strongly undervalued currency. Trade expanded rapidly, while at the same time, its geographical orientation changed gradually towards Europe and other markets outside the former Soviet Union. Russia remains Ukraine's largest single trading partner, however.
4. Structural change has started but remains incomplete. The services sector has become more important, while agriculture has declined as a share of GDP and employment. The industrial sector remains large and dominated by capital-intensive branches such as iron and steel and industrial chemicals. However, catalyzed by the steep rise in the price of imported energy from Russia since 2005, Ukrainian manufacturing is undergoing a process of investment-led modernization. A particular feature of Ukraine is the size of its government sector. At over 40 percent of GDP, it is uncharacteristically large for a lower middle income country. Over half of total employment remained in the public sector as of2004'.
Table 1: Main Macroeconomic Indicators, 2000-2006 I 2000 I 2001 I 2002 I 2003 I 2004 I 2005 I 2006 I Real GDP (change in percent) 5.9 9.2 5.2 I 9.6 12.1 I 2.7 I 7.1 Real Industrial Production (change in percent) 13.2 14.2 7.0 I 15.8 12.5 I 3.1 I 6.2
Nominal GDP (in billions of USD) 31.3 I 38.0 I 42.4 I 50.1 I 64.9 I 86.1 I 106.5 GNI per capita (USD, Atlas method) 690 1 720 I 780 I 970 I 1260 I 1520 I 1940
5. Ukraine continues to lag behind the EU accession in terms of economic reform, although it has caught up with the ECA average (Figure 2). Since 2000, steady but gradual reform progress has been made, but frequent government changes, and the lack of a strong external anchor have been important constraints. An important benchmark may be reached in 2007 with WTO accession. Figure 2: EBRD Average Transition Indicator, 1991-2006
3.0
25:;=: 2.025:;=: 1.5 " 1.0 -
0.5 - 0.0
Source: EBRD
6. Ukraine has one of the largest informal sectors among the transition economies. The shadow economy is estimated at around 50 percent of official GDP2. This has
Ukraine Jobs Study. Fostering Productivity and Job Creation, World Bank Report No.32721-UA, February 2006.
2 significant implications for economic diagnostics. For instance, ratios ofkey variables to GDP, such as government spending, or the size of the financial sector, would tend to be over-estimated. By the same token, trade data tends to suffer from under-reporting, due to transfer pricing (for exports) and customs evasion (for imports). If the underlying trade dynamics are different than officially reported, this would affect underlying GDP growth rates as well. Furthermore, if the dynamics of the informal sector are different than those in the formal sector, real incomes may follow a different pattern than suggested by official statistics. Aside from affecting the reliability of economic diagnostics, the large informal sector is a symptom of pervasive governance problems and reflects the significant obstacles businesses and individuals face if they seek to operate according to the existing formal rules.
B. RECENTSOCIAL DEVELOPMENTS 7. Rapid economic growth has facilitated a sharp decline in poverty in recent years. Poverty has fallen sharply from 31 percent in 2001 to 8 percent in 20053 (Figure 3). Ukraine has enjoyed one of the fastest rates of poverty reduction in ECA since the onset of economic recovery in 2000. However, in spite of this achievement, the public’s satisfaction with their material well-being remains low (Box 1). Figure 3: Poverty Rate in Ukraine, 2000 - 2005
I 2000 2001 2002 2003 2004 2005 1 Source: Ukraine Household Budget Survey, World Bank
8. Generous increases in social transfers have significantly contributed to reducing poverty. Real average pensions increased by 34.8 percent in 2004 and another 28.9 percent in 2005. Pension increases, and to a much smaller extent a rise in child benefits, explain around one-third of the decline in poverty over the 2004-2005 period. However, these measures have pushed the size ofthe Pay As You Go (PAYG) pension system to 14 percent of GDP in 2005, one of the highest ratios in the world. Generous social transfers are financed by high payroll taxes of about 35 percent which burden businesses, stimulate under-reporting of wage income, and hurt Ukraine’s long-term competitiveness.
’ Schneider and Enste, 2004. According to estimates ofthe Ministry of Economy the informal sector was 39 percent of GDP as of2006. Ukraine: Poverty Update, World Bank Report No. 39887 - UA, June 2007.
3 although the majority of the population How Ukrainians feel about remains dissatisfied with their current making ends meet standard of living, a public opinion poll conducted by the Kyiv International Institute of Sociology, also suggests that households are more able to buy enough food to eat (see figure). Individual perceptions of well-being would seem to lag behind falls in the poverty rate. Nevertheless, the dynamics shown in the chart are consistent with the Bank’s findings that over recent years, Ukraine made huge progress in poverty 2001 2002 2003 2004 2005 alleviation. World Bank (2005). Ukraine Poverty Assessment: Poverty and Inequality in a Growing Economy. Report no. 34631-UA, Source: KIIS World Bank: Washington, DC, December.
9. Households with many children are particularly vulnerable to poverty (Figure 4). The incidence ofpoverty is close to 30 percent in households with six or more members, more than three times the national average. In contrast, the incidence of poverty is not higher than average among pensioners, confirming the positive effect that the recent increases in pension payments have had. The numbers presented here differ from Government estimates, according to which, overall poverty remained constant during 2001-2005, and poverty in families with many children, as well as among pensioners, fell
4 by 3.6 percentage points and 4 percentage points, respectively. Although the unemployed have a higher incidence of poverty, in absolute terms, the majority of the poor live in households headed by the employed or by pensioners. Returns to education have been increasing in Ukraine, and so the incidence of poverty is declining in more educated households, an effect that has become steeper over time.
Figure 4a-d: Ukraine Poverty Rates a. by household size b. by household head's education, 2005
(Ibwrtyh=1813u4y inpmiagg&) (I'o\c.n) line-1313 UAH. in perccnrnge poinu)
...... *..*I .__^ _^^_^.^^
1 2345 6 7crm Hxdddsizz(nnt.rofp$e) 0' Level ofeducation equtv
e. by age group, 2005 d. by status of head of household I (Pmmylin: 1813UAH,in~pom, ......
16T .. _.I._ ...... I ...... I i ". 'I HYENfc 153 ...... I I* I !I bdwj 154 * I' ...... Wm, 7.8 l.l"-_l" ...... I! ,,
-.---I___.-- I__- \b!wgfalm
1 ii
0 00 20 40 6.0 80 10.0 120 140 160 180 05 6-14 15-19 2024 25-29 3034 35-39 4044 4149 5054 55-59 6Q(rl 65+ nsesroupl In-pards I Sources; Ukraine Household budget survey, World Bank
10. The doubling of household energy tariffs between 2005 and 2007 has created a significant social challenge. From January 2006, import prices for Russian gas increased by 53 percent and by another 35 percent in January 2007. Consequently, household tariffs for gas and power were also raised substantially (Figure 5). The size of the increase has raised concern about its potentially negative social impact. However, calculations carried out by the World Bank suggest that because even the poor do not spend a very large proportion oftheir income on energy, a doubling of energy prices from the levels at the end of 2005 would raise poverty by only 1.7 percentage points. Moreover, it would cost only US$63 million to restore all those that had become poor as
5 a result ofenergy price increases to a spending level just above the poverty line, provided social assistance was perfectly targeted.4.
Figure 5: Natural Gas Prices by Type of User -~___ (h UAH perzcubic meters)
800
700
600
500
400
300
200
100
0
Sources: Ukraine Householdbudget survey, World Bank
11. Ukraine spends a high proportion of GDP on health and education and this is reflected in universal access to primary and lower secondary education and to basic healthcare (Table 2). However, quality is variable, and spending patterns are highly inefficient. In education, inequality of access widens significantly at the upper secondary level, and is also prevalent in pre-school education, which negatively affects poor children's educational outcomes. In health care, inequalities in access are determined both by significant variations in the quality of service between rural and urban locations, and by the prevalence of significant informal payments, which may reach a level similar to total public spending on healthcare. Moreover, public health is underdeveloped and health risks from lifestyles, environmental hazards and communicable diseases are high. Consequently, Ukraine scores low for its level of income on key demographic indicators, such as life expectancy and male mortality rates.
Ukraine: Poverty Update, World Bank Report No. 39887 - UA, June 2007.
6 Table 2: Key Social Indicators, 2005 rn inwwne: UkraineIhasia KaTaldStanIX2-i oM9) Healthexp3&m,total(%ofGP) 6.50 6.00 3.80 6.58 11.31 cM-of-pockethealthsrpayhture(%ofpi~~manhealth) 90.50 76.70 1#.# 82.08 37.52 mlicSpdq OneJAratlW total (OYOofm) 6.39 2.31 FdQrate, total (bllth perm) 1.2 1.29 1.75 1.57 1.66 Life eqxctaqatb~&fde o..s> 73.97 72.4 71.85 74.02 82.29 Life eqxctaqatw de(yam) 62.23 58.87 60.91 64.67 76.41 Mxtalitymte, adult, fde(per 1,ooO fdeadults) 150.23 173.33 151.57 135.7 PqXllaton&(dO! -0.77 -0.51 0.88 0.06 0.64 Source: WDI * Data on total health expenditures and out ofpocket payments are for 2004
12. A particular social challenge is Ukraine’s demographic profile. Ukraine is forecast to lose around 25 percent of its population by 2025 as a result of still relatively high mortality rates and very low birth rates5. Moreover, because of low retirement age, employment rates are low in spite of recent improvements in the labor market. As a result, Ukraine’s dependency ratio (i.e., the ratio ofUkraine’s non-working to its working population) was already high at 44.6 percent in 2005. As Ukraine’s population ages, the overall costs ofproviding care to the elderly will also increase, perhaps by as much as 5.2 percent of GDP by 2020. Ukraine will need to increase its retirement age, improve employment prospects for those workers that have been discouraged from looking for work through training and re-training, and potentially open its labor market to migrants if it is to stem the increase in the dependency ratio. Reforms of the pension system, professional training and old-age care, are also urgent to handle the rising costs of an aging society.
C. RECENTPOLITICAL DEVELOPMENTS 13. Ukrainian politics in the recent past has been quite volatile. During the period of implementation ofthe previous CAS from 2003 to 2007, Ukraine had no fewer than four different Governments. Presidential elections in 2004 led to a political shift, as the chosen successor to former President Kuchma and current Prime Minister, Mr. Yanukovych, lost against Mr. Yushchenko, who retains the Presidency to date. The shift in power, often referred to as the “Orange Revolution”, was associated with a significant increase in political freedom, reduced state control over the media and the emergence of a vigorous national political debate (see Section I11 and Annex 2 on the governance agenda).
14. Important constitutional issues remain unresolved, which has given rise to additional political tension. Part of the political compromise that facilitated a re-run of the 2004 presidential elections and the victory of Mr. Yushchenko, were amendments to the constitution that transfer significant powers to the Parliament. However, the amendments leave considerable ambiguity on respective roles of the Government, the
World Bank. From Red to Gray, 2007
7 Presidency and the degree of independence of the Judiciary. These ambiguities have been a source of tension between the Presidency and the Government, in particular, following the return to power of Mr. Yanukovych as Prime Minister, after his Regions Party emerged as the largest party from the parliamentary elections of March 2006.
15. Tensions came to a head in April 2007, with the President dissolving parliament, leading to early parliamentary elections on September 30, 2007. The ruling coalition of the Party of the Regions, the Communists and the Socialists was unable to retain its majority. As ofmid-October 2007, no decision had been taken on the formation ofa new governing coalition, with many possible combinations actively discussed. Among the more plausible options is the return to power of former Prime Minister Yulia Timoshenko, backed by a coalition of her party with the pro-presidential faction Our Ukraine - National Self-Defense. Another government change would fit into the pattern of frequent government turnover observed in other Eastern European countries, where incumbent governments have found it characteristically difficult to stay in power.
16. Despite the continuous power struggles, the basic vision of economic development for the country is broadly shared between all main political forces. The development vision includes a commitment to closer integration with Europe and with the world economy at large, exemplified by the progress made in the WTO accession, and to the further deepening of structural reforms as the key to sustained economic growth. This basic vision has survived the frequent changes in government since the turn of the millennium and is reflected in the sequence of government programs adopted since the European Choice agenda launched by former President Kuchma in 2003.
17. Despite significant political risks going forward, a compromise remains more likely than a protracted political stand-off. The economy has taken the recent political uncertainty in its stride and the major business interests which are strongly represented in all branches of executive and legislative power have little interest in a drawn-out political conflict. While it would be desirable for Ukraine to re-establish constitutional clarity and work to strengthen the rule of law and the trust in state institutions, the base case assumption for the current strategy is a continued muddle-through scenario, in which the political system generates enough compromise to move forward gradually and sometimes inconsistently, whilst avoiding reform reversals or a protracted crisis. The nature of political risks and mitigation measures is discussed further in Section VI of this document.
18. Ukraine is receiving increased attention from international partners, in particular from Europe. The EU launched a new framework agreement with Ukraine in late 2006, a key provision of which is the negotiation of a “deep” Free Trade Agreement following WTO accession. This goal is supported by all the dominant political forces in Ukraine and is likely to provide the strongest anchor to economic policy during the period of implementation of this CPS. In the political arena, the EU Ukraine Action Plan foresees the further strengthening of the rule of law, political and
8 media freedoms. The EU has evaluated progress on all dimensions positively at the end of the first year ofthe Action Plan in late 2006. Taken together, the European institutions, comprising the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the European Commission (EC) is by far the largest donor to Ukraine. Ukraine has also qualified for assistance from the Millennium Challenge Corporation, although the size and timing of support remains somewhat uncertain. Russian commercial interests are developing strongly. Overall, the international environment is expected to remain supportive to greater economic integration.
11. RECENT ECONOMIC DEVELOPMENTS AND RISKS
A. RECENT ECONOMICGROWTH - DRIVERS AND PROSPECTS FOR SUSTAINABILITY 27. Ukraine has consistently exceeded expectations of economic growth over the period 2000-2007. Growth averaged 7.5 percent, and per capita incomes in US$, according to the Atlas method, increased from US$700 in 2000 to US$1940 in 2006.
28. Two factors contributed to this phase of economic “recovery”. First, the financial stabilization and introduction of economic reforms in 2000 effectively hardened budget constraints, bolstered confidence in the Government’s macroeconomic management and in the country’s fledgling financial sector, and created the legal and institutional basis for market-based exchange.
29. Second, the real exchange rate depreciation, following the 1998 financial crisis in Russia and the availability of ample spare capacity in Ukrainian industry, created conditions where the returns on investment and entrepreneurial initiative were unusually high. Both factors together shifted the incentive structure towards formal economic relations and away from the rent-seeking predominant in the 1990s. The result was the emergence of Ukraine’s particular brand of capitalism built on strong domestic financial industrial groups, which originated thanks to close and often non-transparent links to political power brokers, but which were increasingly acting as the motors of economic recovery and growth.
30. Ukraine’s transition path to date has two weaknesses: First, the sources of recovery and export revenues are highly concentrated in heavy industry, in particular ferrous metallurgy. Ukraine’s economic performance is thus vulnerable to a shift in terms of trade against the metals sector in particular. Ukraine’s high degree of energy inefficiency is also a main source of vulnerability. Unlike other Eastern European countries, Ukraine’s trading patterns were still heavily oriented towards Russia and commodity-based, whereas Ukraine’s peers are increasingly developing intra-industry trade links with Europe and the Organisation for Economic Co-operation and Development (OECD) countries, thereby gradually managing to move up the value chain6.
Ukraine’s Trade Policy, World Bank Country Study, November 2005.
9 31. Second, the political economy that has facilitated Ukraine’s recovery may be a potential obstacle for further and deeper structural reform, if the dominant domestic capitalist groups use their political clout to block further liberalization and competition from foreign investors as well as domestic new entrants. However, to protect and further grow their wealth, the domestic groups need to clean up their corporate act and might thereby act as catalysts for a general shift towards greater transparency7.
32. Nonetheless, there are signs of diversification and modernization of production that support a moderately robust outlook for Ukraine’s economy, at least over the short- to medium-term. Among the most important developments in this regard since 2004 are: The significant inflow of Foreign Direct Investment (FDI) in 2005 and 2006, buoyed by the re-privatization of the country’s largest steel mill (Khryvorizhstal) to a strategic investor (Mittal Steel) and the sell-off of strategic stakes in some of the country’s major banks by the financial industrial groups (Figure 6a). In western business circles, the “Orange Revolution” put Ukraine on the map and investment interest is significant, including in industries such as retailing, food processing, light industry, car manufacturing and supplies. The transformation of Ukraine’s banking sector and signs of improvement in corporate governance practices in the large domestic financial industrial groups has provided access to finance to a large proportion of Ukrainian businesses and households on an unprecedented scale (Figure 6b). This has relieved constraints on investment and allowed companies to undertake long-delayed modernization of their plant and equipment. Access to capital has allowed Ukraine to adjust very rapidly to the large energy price shock imposed by the two step increase in gas import prices from US$62/tcm in 2005 to US$l3O/tcm today. There is also micro-economic evidence that Ukraine, during the past 6 years, has undergone a significant degree of restructuring, driven in particular by the entry ofnew firms, and that this has contributed to rapid productivity growth as it did a decade earlier in Eastern Europe’. More work is needed to understand the implications of these findings and the greater competition among large business groups for Ukraine’s “insider economy” and the extent to which they are reflective of a greater degree of dynamism and restructuring than had been suggested by previous analyses.
’World Bank Country Economic Memorandum (CEM), 2004 * ECA Productivity Study, forthcoming.
10 a. Nominal FDI, USD million b. Share of foreign capital in Ukrainian banking system and the ratio of deposits to GDP
50
40
30 s 20
10
2000 2001 2002 2003 2004 2005 2006
--e+- Share of foreign capital in the statutory capital of banks, ?LO (left scale) --t Deposits to GDP, % (right scale) 2000 2001 2002 2003 2004 2005 2006
Source: National Bank of Ukraine
33. Ukraine’s economy may thus be more resilient and robust than had earlier been anticipated. As GDP has recovered to only three quarters of its 1991 level, there would appear to be ample additional spare capacity that with some additional investment could easily be brought on stream. Ukraine’s low effectiveness in using its existing assets (both physical and human) is at the same time an opportunity for entrepreneurs that promises high returns even when the business climate remains far from perfect, as long as there is macroeconomic stability and sufficient certainty about property rights.
34. However, Ukraine will need to deepen structural reforms sooner or later in order to sustain growth at rates of 6-7 percent per annum which would be required to converge towards the income levels in Eastern Europe (where growth is in the 5 percent range). In the short run, structural reforms may not be a binding constraint on growth, but unless reforms are accelerated today, growth over the medium-term will suffer. Box 2 below illustrates the non-linear relationship between structural reforms and growth in an economy recovering from a deep fall in output.
B. MAINTAININGMACRO-ECONOMIC BALANCE
27. While growth prior to 2004 was export-led, since 2005, domestic demand has been the main driver. This has led to deterioration of the current account from a 10.6 percent of GDP surplus in 2004 to a 1.5 percent of GDP deficit in 2006. Such a massive turn-around in the savings-investment balance has raised concerns that Ukraine may be pursuing unsustainable macroeconomic policies and needs a combination of fiscal tightening and greater exchange rate flexibility to allow external balance to be restored. Pre- election promises of further increases in public sector wages and transfers underline
11 the concern that Ukraine may be over-heating. Moreover, cost-push factors (including the partial pass through of higher gas import prices to consumers and higher food prices following a poor 2007 harvest) and rapid monetary growth have lifted inflation to 14.4 percent year-on-year in September 2007. Even excluding energy price effects, the Consumer Price Index (CPI) has increased significantly over the past year.
28. Domestic demand remains supported by high wage settlements, partially fuelled by the public sector. Private sector wage settlements remain high with annual increases close to 27 percent in July 2007, and recent budget amendments will push the minimum wage up by 20 percent in 2007. These high settlements may reflect growing inflationary expectations. However, real wage growth has slowed considerably, particularly if measured against producer prices, and with further increases in utility prices, consumption growth is likely to further abate.
29. The widening current account deficit is easily financed by private capital inflows. In 2006, Ukraine attracted a total of US$14 billion in net debt inflows, in addition to US$5.2 billion in FDI, together amounting to 18 percent of GDP. Some of this money is flight capital returning from abroad and thus reflects the fact that Ukraine is now using some of the savings it accumulated in earlier years. Indeed, given Ukraine’s investment needs in order to achieve income convergence, an excess of investment over domestic savings and the corresponding inflow of foreign capital is warranted. Given current conditions, the International Monetary Fund (IMF) estimates that Ukraine could sustain a current account deficit in the range of 4-6 percent of GDP. Ukraine’s fixed investment to GDP ratio is estimated at 24 percent for 2006, which is still too low to allow incomes to converge.
30. Fiscal policy has been restrained in aggregate but the composition of spending remains biased towards consumption and transfers. Fiscal deficits have declined from 4.4 percent of GDP in 2004 to 1.3 percent of GDP in 2006, staying well below budget projections. While public consumption expenditures as a share of GDP have increased significantly since 2004, as wage and pension payments were hiked, tax revenue has been equally buoyant, boosted by improved collections, the tightening oftax loopholes and strong import-related Value-Added Tax (VAT) performance. However, by raising the tax burden on producers and redistributing the revenues to consumers, the authorities have contributed to the fall in private savings.
12 Box 2: Recovery from the Transition Crisis and the Impact of Reform The Figure below illustrates the interaction between initial output decline and the contribution of .eform to economic growth. A country has two available steady state growth paths, depending on he depth of structural reforms (which may be thought of as raising both steady state income hrough an increase in investment and the long-term rate of productivity growth - i.e., shifting the yowth path up and making it steeper). Because of an initial exogenous output decline, the :ountry is below both steady state paths at point A. Even if Ukraine accelerates reforms at that ioint, the benefits become apparent only after point B.
Output Decline and Recovery and the Impact of Reform on Growth
Ukraine may still be at point “A” Inc ne level
t
3 1. Ukraine’s macroeconomic framework on the whole remains adequate, but the authorities will need to be vigilant in the face of potential external shocks or political spending pressures. The Bank’s base-case medium-term macroeconomic forecast provides for a gradual slow-down in the pace of expansion of domestic demand and a corresponding stabilization of external deficits and declining inflation rates. This assumes the absence of a negative external shock and the continuation of gradual, if sometimes inconsistent, economic reforms.
32. Growth is expected at an average of 5.5 percent per year in the medium-term (Table 3). The key assumptions underlying these projections are as follows: (i) growth will continue to benefit fi-om bringing under-utilized resources into production even if structural reforms proceed at modest pace; (ii) a protracted political stand-off will be avoided;
13 CPI, percent change eop 12.2 9.6 8.3 7.4 Current Account Balance, percent GDP -3.9 -6.1 -7.0 -72 Terms of Trade, percent change 4.8 -3.7 -2.4 -1.4
Budget revenues, percent GDP I 41.0 40.5 39.9 39.2 Budget expenditures, percent GDP 42.9 42.9 42.5 41.7 Fiscal balance, percent GDP -1.9 -2.4 -2.6 -2.6 Public and Guaranteed Debt, percent GDP 14.8 15.5 16.4 16.9 c. KEY RISKS TO THE OUTLOOK
33. The key risk to the outlook is the combination of a larger external shock with a significant tightening of Ukraine’s access to international financing. In such a case, an exchange rate correction might be required, together with a significant tightening of fiscal policy. This would temporarily slow growth, as domestic demand declines and exports respond with a lag to exchange rate adjustment. Under a malign external scenario, there would also be the need to deepen structural reform to return to current growth rates, as Ukraine would need to reassure international investors that it remains an attractive destination for capital. The authorities would need to show determination to force restructuring in the banking sector and prevent bank failures to translate into quasi- fiscal liabilities. Ukraine’s current reserves of relatively “easy growth” would become more quickly exhausted.
34. Developments during the summer of 2007 have highlighted these risks. Triggered by concerns over the fall-out from the sub-prime mortgage market in the United States, liquidity tightened significantly in international markets between mid-June and early August. This led to rising risk premia and falls in equity markets worldwide.
14 In Ukraine, too, equity markets have declined somewhat after record gains, and bond spreads have widened, but reserve accumulation by the National Bank ofUkraine (NBU) has continued and liquidity in the banking system remains high. It is too early to assess the full implications of recent developments, and while Ukraine boasts significant strengths in terms of its macroeconomic fundamentals, it would be vulnerable if a protracted global downturn were to reduce metal prices at the same time as external financing became more expensive. Negative developments in other financial markets in the region, in particular in Russia, could also be a source ofcontagion.
35. Second order risks to the outlook are rooted in Ukraine’s volatile political environment and in the possibility that the authorities would react inappropriately to a changing external environment. Following the dissolution ofparliament in April, there has been a gradual re-pricing of Ukrainian risk in international markets, which accelerated over the summer. This reflects market perceptions of political instability as an additional risk factor, particularly if this was to lead to inappropriate policies, such as rising fiscal deficits or delayed reactions to exogenous shocks. However, for reasons mentioned in the preceding section, both risks are mitigated by the interests and political influence of big domestic business in the maintenance of macroeconomic and political stability.
36. Should Ukraine be faced with an exogenous shock, adjustment would be complicated by the recent build-up of a strong foreign exchange exposure in the economy, intermediated by the banking system, While banking sector assets and liabilities are reasonably well-matched, many borrowers, particularly Ukrainian households, are not hedged against a possible exchange rate devaluation. The NBU’s de facto peg against the US dollar has arguably reduced these borrowers’ perceptions of exchange rate risk and thus fuelled the process of dollarization. This puts the NBU in a dilemma: in case of an external (or political) shock, there may be pressure on the exchange rate, but a large correction would in turn cause difficulties for many banks. How it reacts depends on whether it sees the shock as temporary and manageable or whether it is permanent and requires adjustment.
37. The NBU intends to move towards greater exchange rate flexibility but has left the timeframe open. Central bankers point to the current political instability, the potential negative implications of initial exchange rate appreciation driven by balance of payments inflows on competitiveness, and to the need to develop further the market conditions for an active monetary policy (including by increasing the circulation and liquidity of government securities and the development of a yield curve) as arguments against a rapid change in the monetary framework. However, in the event of a negative external shock, the NBU is expected to react.
15 38. It is also likely that fiscal policy would be supportive of any required adjustment and expenditures (most likely on capital spending) would be reduced to prevent an increase in the fiscal deficit. Despite the risks Ukraine faces, the maintenance of macroeconomic stability remains the base case scenario. The present strategy modulates lending levels and access to DPL against the maintenance of an adequate macroeconomic framework as detailed further below.
1II.UKRAINE’S DEVELOPMENT CHALLENGES
39. This CPS builds on an analysis of Ukraine’s key development challenges. As argued above, Ukraine’s impressive recent economic performance is due to a combination of factors, including progress in key dimensions of building a market economy, the degree of the country’s initial output decline, and the good fortune of a highly supportive international environment. To sustain growth into the future, however, Ukraine will need to address three key challenges: (i) the improvement in competitiveness, (ii)the reform ofpublic finance and the public sector to improve service delivery and make growth socially inclusive, and (iii)tackling weaknesses in governance. These challenges are briefly outlined below. A more detailed assessment can be found in Annex 1 (on economic development challenges) and Annex 2 (on governance challenges).
A. SUSTAINING GROWTHAND IMPROVINGCOMPETITIVENESS 40. The drivers of recent growth in Ukraine are temporary - the foundations for sustained growth over the medium- and long-term still need to be laid. After 15 years of independence, during which the country’s inherited capital stock has undergone little modernization, the need for increased investment and depreciation of existing assets is high. This poses significant challenges to both the private and the public sectors.
41. Moreover, given demographic trends, Ukraine will require large productivity improvements if it is to finance the costs of an aging population. Growth in total factor productivity has been the predominant source of growth in all ECA countries since the start ofreform and this is likely to remain the case going forward. While to date total factor productivity (TFP) growth has been boosted by rising capacity utilization and the reduction ofhidden unemployment, particularly in industry, these relatively “easy” gains from defensive restructuring are not likely to be available for much longer.
42. A combination of challenges needs to be addressed to achieve growth and improve competitiveness going forward:
0 Ukraine needs to become better at adopting new technologies and nurturing the skills and institutional environment to promote innovation and technological adaptability and thus shift production towards higher value added goods.
16 The business climate needs to be improved to encourage private investment and increase competition on the domestic market, including by reducing subsidies to State-Owned Enterprises (SOEs) and promoting a level playing field.
0 Financial markets need to deepen further and regulation needs to improve to contain financial market risks. Ukraine needs to address behind the border obstacles to transit and trade in order to benefit fully from recent progress in trade liberalization and the prospect ofimminent accession to the WTO. Ukraine needs to increase the energy efficiency of its economy and thus reduce its vulnerability to further import price shocks, as well as modernize the energy sector itself to make it more efficient and competitive.
43. A new challenge, but also a unique opportunity to improve Ukraine’s image and attractiveness for investors, is the Euro 2012 Football Championships, which Ukraine was awarded to host jointly with Poland. This decision will have a major impact on infrastructure investments in the country and has the potential to attract significant private investment for the modernization oftransport, municipal infrastructure as well as the tourism sector in the next five years. Box 3 discusses current organizational arrangements and key challenges.
Box 3: Euro 2012 Between 800,000 and 900,000 spectators are expected to visit Ukrainian stadiums for the Euro 2012. Around 200,000 tourists are anticipated and their additional spending may total UAH 1 billion (US$0.2 billion) or 0.2 percent of 2006 GDP. Direct spending on the renovation of stadiums and on additional security measures may amount to around UAH 10-15 billion (US$2-3 billion), with government spending needs estimated at around UAH 8 billion (mainly for security and for the renovation of the Kyiv Olympic stadium). In addition, Ukraine has to invest in infrastructure which is not directly related to football, such as creating 30,000-50,000 hotel beds, reconstructing airports, building roads and modernizing railroads. The precise requirements imposed on Ukraine by the European Soccer Association (UEFA) are not known, and reliable cost estimates are difficult to obtain. Nonetheless, it is clear that the Euro 2012 is likely to swallow a considerable share of the public investment budget and may in addition catalyze significant private investment. The potential positive impact on growth, private investment and the long-term modernization of Ukraine is important, but the risks of overly costly and misguided investments and of macroeconomic imbalances resulting from the surge in spending or implicit and explicit government guarantees are also significant.
B. PUBLIC FINANCE,PUBLIC SECTOR REFORM AND IMPROVED PUBLIC SERVICE DELIVERY
44. While the private sector has begun the process of modernization, public sector reforms as a whole are lagging behind. Ukraine has managed to establish macroeconomic stability and to harden budget constraints. It also continues to generate sufficient tax revenues to support a large public bureaucracy and deliver an important range of public services and social transfers. However, the scope and size of government
17 comes at the cost of a high tax burden, pervasive red tape, low quality in the delivery of public services, limited capacity to prioritize and the crowding out of critical public investments by the size of government consumption.
45. Ukraine’s public sector is one of the largest among other lower-middle income countries, yet the quality of service delivery is regarded as highly deficient by its population. As around 42 percent of GDP, public sector spending in Ukraine is around twice as high as in comparable middle income countries in Asia and Latin America. Education spending at 6.5 percent of GDP is above the OECD average. Public health spending is lower at 3.7 percent of GDP, but may be twice as large again once out of pocket payments of the population are taken into account. Yet, in recent survey evidence, Ukraine ranks near the bottom of all countries in ECA in terms of public perceptions of the quality of health and education services.’ Similarly, the PAYG pension system swallows around 14 percent of GDP, but replacement rates are low, and decreases with rising incomes, reducing compliance incentives.
46. In contrast to large and rising public consumption and transfer spending, public capital spending is low and badly prioritized and managed. Subtracting state transfers to SOEs capital spending has ranged barely above 2 percent of GDP in recent years, less than half the level in the new EU member states and around one fifth of the level in East Asia. High consumption spending and wasteful subsidies to SOEs crowd out public investment, but even the limited investment that does take place suffers from a highly discretionary, unpredictable and poorly executed capital budgeting process.
47. Ukraine has made significant improvements in public financial management, but retains key weaknesses in public procurement, management of state-owned enterprises and medium-term budget planning. A recent Public Expenditure and Financial Accountability (PEFA) assessment found Ukraine outperformed many of its peers on the credibility, predictability, and execution of its budget. However, the same assessment also identified key weaknesses in public procurement (see Box 4), management of the quasi-fiscal activities of state-owned enterprises, and the consistency ofthe budget with medium-term strategic priorities.
48, The strong performance of Ukraine’s budget system nonetheless provides an important entry point to the reform of public services, by emphasizing the potential for quality enhancement at no additional cost if current internal rules and processes are reformed to allow for greater incentives to improve efficiency. This will need to include strengthening the role, autonomy and accountability oflocal government. lo
Life in Transition Survey, EBRD and World Bank, 2007. loThe Public Finance Review, Volume 11, in preparation elaborates on this point in detail.
18 Box 4: The Recent Evolution of Public Procurement In 2005, Ukraine spent more than US$4 billion, around 5 percent ofGDP, on public procurement. The existence of regulatory framework that guarantees a transparent, competitive and thereby cost-effective process is thus of considerable importance for the country. Until late 2004, Ukraine’s public procurement system underwent a process of gradual improvements, with the number of tenders conducted on an open basis, increasing from 7 percent Gust under 50 percent of total value) in 2002 to 26 percent (69 percent of total value). Sole- source contracts were correspondingly reduced to 10 percent of the total (15 percent of value). A series of amendments to the public procurement law in November 2004, June 2005, December 2005, and December 2006 have seriously diluted and fragmented government procurement authority. Important functions have been transferred from the Authorizing Agency in the Ministry of Economy to the Center for Tender Procedures and Business Planning (CTP), a Non- Governmental Organization (NGO), not subject to the same controls routinely imposed on bodies of public administration. The CTP officially holds patents and copyrights for numerous bidding documents, including standard bidding documents nearly identical to those of the World Bank, which it sells to bidders against a fee. Market participants complain of pressure by the CTP to use their copyrighted documents and to pay for questionable services, including commissions on successful bids. Moreover, the fully decentralized public procurement system has created significant capacity problems among procuring entities. Market participants complain about insufficient access to information, unclear bidding documents, insufficient time to prepare bids, unjustified cancellation of tender procedures, and frequent delays in contractual payments. Such practices have discouraged competition and given rise to significant governance concerns. Supervisory functions are another major concern, Supervisory functions were transferred by legal amendments in 2005 from the Authorizing Agency to the control and revision unit of the MoF and the Accounting Chamber, creating conflicts of interest, since the procurement entities were now supervised by the same bodies that also audit them. In December 2006, further legal amendments created a Special Control Commission. However, the decisions of the commission can be challenged by the CTP in court, further enhancing the powers of this non-government body. The need for Ukraine to fundamentally overhaul the present system and return to the path of harmonizing its public procurement rules with acceptable international practice is increasingly recognized. It is a trigger in the World Bank’s DPL program and also a condition for Ukraine to receive budget support from the EC. A new draft law has been prepared and it is to be hoped that it would be adopted soon in the new parliament, taking into account international best practice. Source: Country Procurement Assessment Report (CPAR) 2006, updated March 2007. c. GOVERNANCEAND PUBLIC SUPPORT FOR REFORM
49. Governance weaknesses are at the root of many of the reform challenges listed above. Ukraine continues to rank poorly on comparative indicators of governance, although it has improved notably since 2004. Transparency International’s Corruption Perceptions Index ranks Ukraine 99th out of 163 in 2006. However, improvements are notable since 1998, a fact that is also confirmed by enterprise surveys such as the Business Environment and Enterprise Performance Survey (BEEPS). Annex 2 contains a more comprehensive governance diagnostic.
19 50. In part as a result of political instability and pervasive corruption, people’s confidence in public institutions is very low. Ukrainians display among the lowest level of trust in public institutions in ECA. At the same time, people’s expectations of what the state should deliver remain high - individual or collective initiatives to address local issues such as the quality of schools, health services, or municipal and housing services remain hesitant, albeit growing significantly from a very low base. While most people support the move to a market economy and democracy, in Ukraine this has not yet translated into acceptance of a reduced role of the state and greater personal responsibility’ ’.
5 1. Strong vested interests have so far blocked serious administrative reforms, and the judiciary does not serve as a guarantor of people’s rights. Byzantine bureaucratic structures and a politicized civil service in all important senior positions have tended to slow down decision making processes, make them more opaque and subject to frequent revisions when key personnel changes. This has complicated efforts to modernize public institutions. The large World Bank portfolio in support of these efforts has disbursed slowly. The judiciary is perceived to be corrupted, while a lack of investment and training of court staff further serve to undermine the credibility of the courts. People and businesses generally seem to have little recourse to an objective third party if their rights have been infringed upon, all the more so if the infringement has been committed by a public official.
52. As a result, Ukraine finds itself in a low-equilibrium accountability trap. People’s trust in the state is low and their willingness to support the move towards greater individual responsibility is muted because they feel the state is not reciprocating with efforts to improve the quality of services. This creates a significant challenge for reform: the analysis presented above suggests that improvements in public services will need to come primarily from a reform in financing arrangements and greater local accountability. Yet, these reforms are not priorities for the majority of the population, while the corresponding staffing and structural changes are likely to run into the resistance of interest groups.
53. This diagnosis suggests that efforts to improve Governance and Anti-Corruption (GAC) will require advocacy to generate greater understanding of and demand for reforms that increase the accountability of the public sector and stimulate greater private initiative. The strategic implications for the Bank are that the attempt to reform state institutions, through investment lending projects with the central government, needs to be complemented with greater efforts to stimulate demand for good governance. This is spelled out in greater detail in Annex 2.
I’ Life in Transition Survey, EBRD and World Bank, 2007.
20 IV. GOVERNMENT RESPONSE
54. A broad political consensus exists in Ukraine around deepening international integration, maintaining macroeconomic stability, strengthening the functioning of markets, improving the quality of public services and broadening social inclusion. This consensus has remained at the core of government policy throughout recent political changes. It was reflected in the “European Choice” program of President Kuchma, on which the previous strategy was built, as well as in the “Meeting the People” program of the Tymoshenko government that assumed power following the victory of President Yushchenko in the elections of 2004. The same themes are also articulated in the draft medium-term program prepared by the coalition government between the Regions Party, the Socialist Party of Ukraine and the Communist Party of Ukraine. Table 4 compares the main pillars of these three strategic documents by programmatic themes. This demonstrates the consensus that exists around key themes, such as improving the business climate and promoting innovation, international integration and trade, reforming social assistance and pensions, and improving public services, in particular in the areas of health, education, and environmental protection.
55. More recently the authorities have paid greater attention to the modernization of physical infrastructure. In this, the authorities are responding to the investment needs and reacting to the dramatic increase in energy prices since the start of2006.
56. Maximizing Ukraine’s unique potential as a transit country is a top government priority going forward, Consequently, the government has provided ample room for external borrowing by Ukravtodor (the State Road Agency) and Ukrzaliznytzya (the State Railways) to finance upgrading of roads, complete electrification of the railway network and purchases of new rolling stock. The government also plans to upgrade several airports, attract private investment into its sea ports, and modernize its power transmission and gas pipeline network. The authorities are keen to attract private investment to these areas, and are working on legislation to facilitate this. The European football championship Euro 2012 is expected to provide a key impetus in this area.
57. Energy efficiency has become imperative as Ukraine moves closer to world market prices for imported gas. Apart from international financial institution (IF1)- financed investments in the generation and transmission system, the government is also re-launching privatization of distribution companies (initially by selling minority stakes) and promoting private investment to increase energy efficiency through tax incentives.
58. The municipal and housing sector is receiving particular attention. The government created a dedicated Ministry for Housing and Municipal Utilities in March 2007, is working on a new Housing Code, and has allocated significant sums in the 2007 budget and beyond for urgent rehabilitation and repair ofthe housing stock. The budget code continues to subject municipal borrowing to tight central control, but bond issues and guarantees to utilities by municipalities (which are allowed under the budget code), are nonetheless increasing in reflection ofthis emerging priority.
21 Table 4: Common Reform Areas in Government Programs, 2000-2007 Program “Stability, “Meeting the People Program”/ “Reforms for Competitiveness and Improved “EU Action Plan” prosperity”/ Livelihoods”/ State program of (2005-2006) “European Economic and Social Choice” (2000- Development” 2004) (2007I2011) Improved living standards and poverty Alleviating poverty and accelerating Achieving poverty reduction, including through pension growth reduction reform Promoting innovation and structural Adopting an infrastructure financing Supporting economic change, including through greater strategy and pursuing gradual competitiveness and energy security and efficiency, better convergence towards EU principles growth infrastructure, and building Ukraine’s and standards on electricity and gas transit potential. markets Implementing the European choice through regulation harmonization and increased trade
Trade promotion, including through Strengthening fiscal sustainability Moving towards creating and efficient export structure Europe and and extending cooperation with EU increasing- trade integration Establishing conditions to increase Improving institutionsiregulation for Improving fiscal investment through tax and budget business and consumer services. situation through fiscal reform, financial market development, transparency, fiscal and SOEs management improvement austerity, and debt reduction Promoting small and medium Improving social services and social Promoting enterprises (SME) and reducing cost of assistance entrepreneurial doing business activitv Improving quality of public services Improving human development
59. Improvements in the investment climate have been delayed due to political instability, but the agenda is expected to be resumed once a new government is formed. Key laws at a fairly advanced stage of preparation include a new Joint Stock Company Law, changes to the banking law and law on financial services that would force disclosure ofbeneficiary owners and move Ukraine towards consolidated and in a second stage risk-based supervision of banks and non-bank financial institutions. The adoption of a new inspections law confirms the commitment to reducing obstacles to business development. All of these legislative initiatives have roots dating back to the Orange Revolution and were in fact included in the matrix ofpolicy actions supported by the first DPL. A second DPL is being prepared in parallel with this CPS and confirms the continuity of the reform agenda. However, experience indicates that implementation of this agenda is likely to continue to be gradual and its sequencing not easily predictable. This calls for a flexible mode ofsupport in policy-based lending going forward.
22 60. The authorities are aware of the challenge to improve agricultural competitiveness, but the establishment of a functioning land market has been repeatedly delayed. WTO accession and the subsequent negotiations over a FTA with the EU are highlighting the need to modernize Ukraine’s agricultural and food processing sector to be internationally competitive. However, a key reform in this regard - namely the establishment of secure and tradable property rights over agricultural land - has stalled. l2
61. In the area of public finance and public sector reform, efforts going forward are likely to concentrate on tax and pension reform, as well as improvements in public financial management. The Government has adopted a tax concept that lays out the strategic directions oftax policy going forward and embraces the goal ofreducing the tax burden over time through improved compliance. A tax code embodying these strategic directives has been designed but its approval may be delayed. An additional challenge in improving compliance is pension reform. This was initiated in 2003, when a framework law introducing a second mandatory pillar to the pension system was passed, but progress stalled as the government struggled to cope with the impact of large minimum pension increases. The second pillar introduction is currently planned for 2009. Moreover, the unification of pension and other social insurance contributions is also planned, thus reducing compliance costs. Both measures would over time serve to increase compliance and allow payroll taxes to be reduced. In the area ofpublic financial management, a key initial step will be the reform of the state procurement system. A concept paper on public financial management reform has also been prepared and will serve as a basis for the Bank’s support in this area. Key policy measures are included in the DPL program, prepared in parallel with this CPS.
62. In the social sectors, the authorities have yet to articulate their reform strategies. Strategic planning capacity in the Ministries of Health and Education is weak, and reform initiatives have largely concentrated on improving working conditions by raising salaries of public sector employees. There is a National Health Reform strategy, which includes important concepts, such as the move towards preventive, primary care and towards greater financial autonomy of budget units in targeting health outcomes. The introduction of mandatory health insurance has also been discussed. In the education sector, efforts have concentrated on the introduction of standardized performance tests, and this may serve as a basis for a consistent effort to improve quality throughout the education system. However, implementation capacity in the line ministries is weak, and progress will, to a large extent, depend on changes in sector financing.
63. Institutional reforms, including reforms of the judiciary and of public administration, are high on the political agenda, but implementation remains uncertain. The weaknesses in Ukraine’s public administration and in the judiciary were
12 A legal framework for the establishment ofa unified registry of rights in immovable property and a land cadastre has been developed, but a consensus has yet to be reached over its implementation and the moratorium on the sale of agricultural land remains in place.
23 highlighted above. A civil service law has been drafted in compliance with EU standards, but its approval remains uncertain. Two presidential decrees outline the country’s vision on judicial reform. Yet without a resolution of the underlying constitutional issues, a fundamental reform of the judiciary seems difficult. Efforts are more likely to concentrate on improving material conditions in the judicial system, and modernizing the courts so as to lay a basis for more efficient operations and increased credibility in the eyes of the public. More generally, institutional reforms in the public sector have tended to lag reform measures designed to support private sector development. This pattern may continue.
V. WORLD BANK GROUP STRATEGY
A. LESSONSLEARNED FROM THE 2003-2007 CAS
The CAS Completion Report (CAS CR) 64. The CAS CR notes that the CAS was broadly aligned with the development priorities expressed in Ukraine’s “European Choice” agenda developed in 2003 (Annex 3). The robustness ofthis construction is apparent in the fact that the authorities and the Bank jointly agreed not to change the assistance framework during the mid-term review in 2005, although the Government had changed in the meantime following the “Orange Revolution” oflate 2004.
65. Ukraine, over the period of the 2003-2007 CAS, achieved or even exceeded many of the long-term development outcomes set as targets under the CAS. Growth exceeded projections, public debt levels declined, and Ukraine made significant progress in trade liberalization and financial sector development. The political changes at the end of 2004 brought significant improvements in media freedoms and the expression of political voices. In the social dimension, progress was mixed, as the significant reduction in poverty was not matched by similar progress in other social indicators.
66. The overall positive assessment notwithstanding, the CAS CR highlights the variability of results across pillars and areas of engagement. Thus work on macroeconomic stabilization, financial sector development and international integration was successful, whereas work to improve corporate governance and the environment for private sector development, was less successful. While poverty reduction was achieved as a result ofrising incomes, the much needed reform of social assistance and insurance systems advanced less rapidly than had been hoped for. Similar variability in outcomes is observed within the social sectors, with some progress in access to education but limited advances in the reform of health care, the containment ofthe HIV/AIDS and TB epidemics, or in improved quality of municipal services. The public sector governance agenda advanced in the area of public financial management, but stalled in public procurement and in the reform ofpublic administration.
24 67. This variability in outcomes is also observed across instruments. Many of the results achieved during the CAS period can be attributed to adjustment lending (initially the Program Adjustment Loan (PAL) program later transformed into the DPL program). By contrast, investment lending contributed only marginally to the achievement of results during the CAS period, both because investment lending operations naturally take longer to achieve results, but also because their implementation was highly uneven, with many projects experiencing preparation, effectiveness and implementation delays. The integration of investment lending into the results framework was incomplete. Recognizing the implementation problems in the investment lending portfolio, the Bank carried out an Investment Lending Review in 2005, the recommendations of which are being implemented (see Box 5).
68. The authorities have become increasingly aware of the need to improve the effectiveness of investment lending. Notably, a Working Group on improving the effectiveness of lending by IFIs was set up in the government in 2006. The Chamber of Accounts has also issued a report reviewing IF1 lending. It should be emphasized that several investment loans were completed rapidly and successfully during the previous CAS period, including Treasury-I, EDP-I, or Kyiv District Heating, to list a few examples (a full list is provided in Annex 3).
69. The CAS CR draws the following lessons from the review of outcomes and their variability during the 2003-2007 CAS implementation: Institutionally capable and committed counterparts support effectiveness. Weak institutions are less likely to implement agreements even if there is a high level of formal “ownership.” However, the capacity to implement is not fixed and can increase through strong political mandates, good leadership and institutional reform. Linkages across themes reinforce the effectiveness of interventions. For instance, improving payments and fiscal discipline has helped make further progress in the financial and the energy sectors. Opportunities for further strengthening of linkages are in public financial management (including inter- governmental fiscal relations) and the delivery ofsocial services.
Clear objectives are not enough to achieve results. Effectiveness requires not only a clear vision, including expected results, but an understanding of the remedies to remove the barriers to achieve them. The Bank must understand political economy constraints to implementation and work on reform roadmaps that allow it to overcome these constraints. A broad agenda risks wide variability of results. The 2003 CAS agenda was broad because it endeavored to cover most aspects of the government agenda. The price has been a wide variability of results. With hindsight, greater selectivity would have helped improve the quality of the overall delivery. Selectivity requires putting in place rules of engagement and enforcing them. Flexibility helps move in areas ofopportunity and drop slow-moving agendas
25 Box 5: Portfolio Performance and the Investment Lending Review During the CAS period, six new investment loans were approved and new commitments amounted to US$629 million, around half of the total. Disbursements however were only US$241 million, or around 21 percent of total disbursements. The total investment loan portfolio remained steady at between 11-12 operations, of which 3-4 were in problem status in each year of the CAS. Projects at risk thus accounted for around one third of the total, with commitments at risk rising through the CAS period to 46 percent in FY07 (largely because the single largest operation - the Rural Land Titling and Cadastre Development project - moved into the risk category in that year). Ukraine’s portfolio has consistently been one of the weakest in the region, with high risk levels, low disbursements, long preparation times, effectiveness delays and a large number of dropped projects. Under these circumstances it is not surprising that investment lending has not contributed effectively to achieving CAS results. To begin to address these challenges, the Bank carried out an Investment Lending Review in 2005. The 2005 Investment Lending Review proposed to: (a) restructure or cancel non-performing projects; (b) reduce the institutional complication of investment projects; (c) move to a greater use of country systems; (e) encourage the government to simplify its procedures, and (f) improve internal coordination within the Bank teams. The Bank and the government have advanced in cleaning up the portfolio of Bank projects through cancellations or re-programming. In addition, new operations have sharper objectives and are less institutionally loaded, which should make it easier to implement and evaluate results. Greater use of country systems is making progress by skfting disbursements under all projects with the central government to the treasury. Nonetheless, disbursement rates, although improving, remain low, and preparation and implementation times are well above ECA and Bank averages. The new performance standards developed jointly by the Bank and the authorities during the 2007 CPPWCPS are designed to address the persistent problems in investment lending.
0 Achieving results demands sustained efforts that combine the use of various instruments. Although there may be cases ofquick wins, in most circumstances, progress came about through a combination of intensive dialogue supported by analytical work and adjustment, and, in a few cases, investment. While there must remain room for exploration and innovation, this requires expectations to be properly managed.
70. Going forward, the CAS CR recommends greater selectivity in the choice of areas of engagement, whilst arguing for a thematic approach that recognizes synergies across interventions and directly addresses the trade-offs between client ownership and development needs. It therefore recommends a combination of interventions in areas with strong delivery potential with a presence in key strategic arenas, where progress has lagged and where this risks holding back development progress as a whole.
71. The report also urges the Bank to maintain flexibility, both across areas of engagement and across instruments, and suggests to program activities on a rolling basis. It recommends the greater use of Analytical and Advisory Activities (AAA) to build ownership in areas where reforms are slow-moving, both as background for the design of development policy and investment lending. Such AAA should also reveal
26 potential implementation obstacles prior to embarking on new lending commitments and thereby limit the variability ofresults.
72. With regard to investment lending, the CAS CR suggests moving towards clearer rules of engagement and performance standards to complement the attention on internal processes in project preparation on the Ukrainian side during the 2003-2007 CAS.
73. Finally, the report strongly encourages greater cooperation both across the World Bank Group (WBG) and with other donors, and recommends the Bank to intensify the dialogue on the challenges of transition with a broad group of stakeholders in Ukraine.
The Country Assistance Evaluation
74. The Independent Evaluation Group (IEG) evaluation of the Bank’s support to Ukraine from FY99 through FY06 echoes many of the findings of the Bank’s CAS CR. It evaluates the Bank’s assistance across three broad pillars: (i)Sustainable Economic Growth and Integration into the World Economy, (ii)Public Sector Reform, and (iii)Poverty Reduction and Comprehensive and Harmonized Human Development. The outcomes of the Bank’s assistance are rated moderately satisfactory overall, with a satisfactory, moderately satisfactory and moderately unsatisfactory across the three pillars. Within each pillar, ratings also differ across activities, highlighting the variability of outcomes across a broadly-based program. While the overall assessment of the IEG report is somewhat less positive than the Bank’s own assessment, the ranking of outcomes across pillars and activities is broadly consistent.
75. IEG further rates the institutional development impact of the Bank’s assistance as modest, in particular with reference to limited progress in the reform of public administration and remaining governance problems. Risks are regarded as significant and the report takes the view that Ukraine’s unexpectedly strong economic performance may not be sustained without a deepening of structural reforms and improvements in public and private sector governance. The IEG report confirms the positive impact that adjustment lending had on advancing the policy reform agenda in Ukraine, while noting that the breadth of engagement in investment lending may have reduced its effectiveness.
76. Going forward, the IEG evaluation makes the following recommendations. The Bank’s response to these recommendations is contained in Annex 4:
27 Strategy. The Bank strategy should strive for greater selectivity, focusing on public financial management, PSD, energy, and social protection, and within these areas, on improving governance and institutional development. Economic and Sector Work (ESW). The Bank should be placing greater emphasis than in the past onprivate sector development and infrastructure. Investment lending. A tighter alignment is needed between investment projects and the government priorities. In addition, the Bank should simplify investment projects and reduce their scale to match implementation capacity, and ensure line ministries’ engagement in project preparation, and also their more direct involvement in project implementation, avoiding off-line Project Implementation Units (PIUs). * Adjustment lending. A shift from broad, multi-sectoral loans to loans that are more narrowly focused and disbursed in a single tranche is appropriate for Ukraine, which would also provide the opportunity for follow up and deeper policy and institutional reforms.
B. OPERATIONAL PRINCIPLES AND RULES OF ENGAGEMENT
Operational Principles
77. Three principles underlie the operational approach in this CPS: (i)selectivity, (ii) flexibility and (iii)partnerships. These principles are directly derived from the lessons of experience in the previous CAS. They are also fully consistent with emerging best practice in Middle Income Countries (MICs).
78. In preparing this CPS, the Bank, together with the authorities, has developed an operational framework to select programmatic areas for its future engagement. The operational framework is presented in Annex 5 of this CPS. The framework proposes a typology ofprogrammatic interventions, including: (i) core programs - where the Bank would support government reform efforts through the entire range ofinstruments at its disposal; (ii) development programs - where Bank interventions would be targeted at developing a reform path, or complementing the efforts already under way by other donors (Annex 6 provides an overview over the activities of other donors); (iii) advocacy programs - where there is as yet insufficient ownership and public support for the necessary reforms and Bank efforts would consequently focus on creating greater consensus and demand for change.
79. The framework will be applied flexibly over the course of the CPS. An initial selection of programs for financial years 2008 and 2009 is proposed below. However,
28 the selection remains open to modification at a mid-term review, as reform priorities evolve, as the consensus in support of a reform path develops, and as the Bank determines its particular role in the concert of other donor support. The flexibility will also extend to support instruments, ranging from traditional investment lending, DPLs, through more innovative instruments, including increasing focus on performance-based budget support, and moving towards SWAPS.
80. A particular focus of the CPS will be on non-lending interventions, with particular attention placed on timeliness, dissemination and communication to achieve greater impact. Commensurately, the Bank will aim to deliver fewer, larger and better financial support operations, in order to make room for greater non-lending support in the Bank’s administrative budget. By implication, improvements in the performance of the existing lending portfolio will need to remain at the center of the Bank’s efforts during the CPS.
81. The framework also takes into account the specific role of the IFC. The IFC’s ability to work directly with private sector clients and its expanding advisory services, will allow it to provide significant support in areas where the private sector can act as a catalyst for reform. The CPS thus integrates the different comparative advantages of IFC, the Multilateral Investment Guarantee Agency (MIGA), the Foreign Investment Advisory Service (FIAS) and the International Bank for Reconstruction and Development (IBRD) into a coherent framework.
Lending Range and Benchmarks
82. Ukraine has greatly improved its external creditworthiness since the last CAS was approved. The public debt to GDP ratio has fallen to less than 15 percent of GDP; growth has been maintained at high rates, and inflation has remained at moderate levels. Fitch upgraded Ukraine’s Sovereign Long Term Foreign Debt Rating to BB- in January 2005 (upgrading the outlook to positive in October 2006), while Standard and Poor’s followed in May 2005. The OECD transferred Ukraine from the sixth to the fifth risk group in its classification of export credit risk in January 2007. These improvements have been reflected in growing international market access, and overall the appetite for Ukrainian risk remains reasonably strong despite a gradual re-pricing ofUkrainian risk in the international bond market since May 2007, in line with developments in other emerging markets.
83. The size of Ukraine’s economy in US dollar terms has tripled since 2000 and is set to continue to grow further. As with many other transition economies, Ukraine, over the medium-term, is expected to experience further real exchange rate appreciation.
84. Taking into account Ukraine’s substantial investment needs (estimated at US$lOO billion over ten years) and the significant growth of its economy since the last CAS, the CPS proposes a lending range of between US$2 to 6 billion over a four year period. The proposed lending range is around 30 percent higher than that provided
29 for in the previous CAS, which is, however, considerably less than the expansion of the US dollar GDP since 2003. At the same time, the Bank has not been able to fully utilize the base-case lending envelope during the previous CAS, on account ofdelays in meeting key policy lending conditionality and in investment lending preparation. Therefore, this CPS proposes a more flexible architecture with lending levels within the overall range modulated by progress in reforms, maintenance of an appropriate macro-economic framework and improvements in portfolio implementation and project preparation. In respect ofthe latter, it is expected that as the Bank consciously moves towards fewer but larger projects, with fewer investments in complex institutional reforms, project preparation and implementation will speed up considerably. Thus, in infrastructure, disbursement rates have tended to be above 20 percent as against 3-5 percent in projects supporting institutional reforms.
85. DPL is expected to decline in relative importance during the CPS period from up to half of planned total lending to around 40 percent. Access to DPL lending would be contingent on the maintenance of an adequate macroeconomic framework, as detailed below. Thus, at the low end of the lending range, the share of DPL lending would be zero, increase to around 40 percent in the middle of the range, and above that level, subject to stronger progress on reform and government demand. This implies a target size for DPLs in the middle of the lending range ofaround US$300-400 million per annum. The target size takes into account the current pace of policy reforms, which requires a re-calibration of the DPL program in terms of its ambition. Large but less frequent DPL operations could also be considered, but the strategic orientation for the CPS is to design a DPL program that is feasible to be implemented in annual sequences in order to maintain momentum and avoid the long delays in the previous CAS. This includes the possibility to move towards thematic DPLs in support ofthe two CPS pillars respectively, which would allow support to be concentrated and bundled in a particular area each year, with the two DPL series designed to alternate, but with the flexibility to move faster in one area than in the other. At the top of the lending range, two parallel DPL series in support of a comprehensive and deep reform program in both CPS pillars could be envisaged.
86. Key benchmarks to modulate the level of financial assistance would include:
0 Maintenance ofa satisfactory macroeconomic framework. The maintenance ofan adequate macroeconomic framework would be a pre-condition for access to DPL lending. In the absence of satisfactory macroeconomic policies, no DPL lending would be provided and the overall level of assistance would drop to the bottom of the lending range.
0 For Ukraine to move towards the top of the lending range, additionally, action to address current macroeconomic risks, by gradually introducing a more flexible exchange rate framework, improving financial sector supervision and reducing the share of consumption and transfers in the overall budget, while maintaining overall fiscal discipline and low public sector debt levels, would be key benchmarks.
30 Satisfactory progress in improving portfolio implementation. Reductions in project preparation times and increased disbursement rates would be key targets to permit lending to expand towards the top of the range. Conversely, should portfolio performance deteriorate further from current levels, lending would remain near the bottom ofthe lending range.
0 The degree of progress on structural reforms (including governance), which would be evaluated comprehensively, would also modulate lending levels. Naturally, without overall progress measured against a set of reform milestones and benchmarks defined in the accompanying DPL I1 document, the DPL program would not proceed and investment lending would also remain at the bottom of the range. Conversely, to progress towards the top of the lending range, successful implementation of DPL I1 and DPL I11 would be an important benchmark. c. CPS PILLARS AND OBJECTIVES
87. In response to the development challenges summarized in Section 111, this CPS proposes a two pillar strategy of support. The first pillar has the overall objective to contribute to sustained economic growth and improve the competitiveness of Ukraine. The second pillar’s objective is the reform of public finance and administration and the improvement ofpublic services. The choice of a two-pillar construction reflects the aim to maximize synergies across thematic areas and at the same time emphasize selectivity in the choice ofprograms.
88. The CPS emphasizes the strong links and synergies between increasing investments in infrastructure on the one hand, and improvements in the investment climate and in conditions for private businesses on the other. Improved infrastructure services have a direct positive impact on the investment climate. At the same time, improvements in the investment climate facilitate the attraction of private investment to address key infrastructure needs.
89. Similarly, the CPS emphasizes the links between reforming public finance and public administration and improvements in the quality of public services. Only if budgets are allocated in a way that rewards good performers, and spending units are given the authority to decide how to allocate money, and fiduciary controls are adequate to prevent inefficient spending or leakage of funds, can public services be improved. But ultimately, it is also true that only through improvements in public services will the state regain the credibility and authority that is key to reducing monitoring and enforcement costs and thus making the public sector more efficient. However, the approach chosen in this strategy is to use the reforms ofpublic financial management and the administration of social assistance and insurance as entry points into a dialogue on improving public service quality. This choice reflects the lessons learned that only through strong ownership at the level of the MoF can interventions aimed at improving service quality succeed.
31 90. Within these two broad pillars, ten programs have been identified based on the Bank’s existing activities and matched to key government priorities. The ten programs have been selected from a longer list with the help of the framework summarized above. Table 5 summarizes the resulting overall framework of assistance by each pillar and by grouping programs into core development and advocacy programs (see Annex 5). Programs are listed under the heading of the strategic goal underlying the program.
d environmental health
I .. I
91. The choice of core programs reflects the basic storyline of the CPS: financial assistance will be concentrated in areas where there is strong government ownership and demonstrated capacity to implement. This is the case in public infrastructure and, as demonstrated by the successful dialogue on fiscal stabilization and the creation of a State Treasury, in the management of public finances. In other areas, either government ownership or capacity to implement smoothly along a clearly defined reform path, remains to be fully developed. The specific activities planned over the next two years, as explained below, reflect and substantiate the allocation proposed here. Most investment lending is concentrated in the core programs, while AAA activities feature prominently in both development and advocacy programs.
92. In addition to the ten programs identified in Table 5, two additional programs are listed as cross-sectoral at the bottom of the table. The improvement of governance is a core corporate strategy for the WBG and this is reflected across the design of all
l3Please note, as per discussion in Annex 5, paragraph 3, that “Promotion of Innovation and Knowledge Economy” and “Deepening Financial Markets and Reducing Financial Risks” under Pillar 1 will be considered core programs for IFC and utilize a range of instruments, including investment lending.
32 activities in the CPS. Box 6 summarizes the operational approach to governance in the CPS. Details are provided in Annex 2. In collaboration with the IMF, the World Bank will continues to exercise close macroeconomic surveillance and provide assistance as required to maintain Ukraine’s solid macroeconomic record ofrecent years.
93. Several ongoing activities are not captured by the selection of programs made but are integrated under other program headings. The Bank’s work in support of land reform and agricultural competitiveness has been included under the heading of improved business climate and promoting innovation and knowledge economy. The latter also includes advisory work, on-the-jobs agenda and skill upgrading. The Bank’s support for judicial reform is part ofthe governance agenda, although this CPS is careful not to commit to ambitious outcomes in this area, given the lack of a clear political consensus.
D. OPERATIONAL ACTIVITIES BY PILLAR
Pillar 1: Sustaining Growth and Improving Competitiveness
94. The first pillar of the CPS brings together a diverse menu of interventions to improve Ukraine’s international competitiveness. The basic underlying theme is that to sustain growth, Ukraine needs to move from extensive growth, relying on cheap labor, the existing asset base and a commodity dependent structure of production and exports, towards intensive growth, based on improvements in labor productivity and growing export diversification. The key driver of this change is likely to be the growth in competition, through WTO accession,, improvements in the business environment, improved management of SOEs , and deepening financial markets to facilitate domestic entry and business growth. However, additional supporting measures by the state are required. These concern first and foremost improvements in infrastructure, in particular improvements in energy efficiency and in transport infrastructure, to reduce costs. In addition, the state must support economic diversification through policies that facilitate product and process innovation and technology adoption and that ensure a sufficient supply of skilled labor to make technological upgrading feasible. Key outcomes supported by the first pillar include GDP growth above 5.5 percent per annum, labor productivity growth in industry above 8 percent per annum, and growing export diversification.
95. In support of the transition from extensive to intensive growth the CPS gradually reorients frnancial and analytical support. Table 6 below shows the transition from themes ofthe previous CAS to the emerging new areas ofsupport. It also relates these to the main long-term development results targeted by the first pillar. The diagnostic and analytical basis for the existing extensive growth agenda were developed in the Country Economic Memorandum (CEM) 2004 and the Trade Study of 2005, as well as in a series of sector notes, in particular in the energy sector. The analytical basis for the forward looking agenda is yet to be fully articulated and a strong AAA investment is thus planned in the new CPS.
33 96. In support of this broad agenda, new investment lending operations in PYO8 and FYO9 are planned in the transport and energy sector. A Road Rehabilitation and Safety project (the key component of which is the rehabilitation of the Kyiv-Kharkiv highway) for US$400 million is under preparation for FY08. A further road transportation investment is under consideration for FY09 with financing in the range of US$200-400 million. Both projects are expected to contribute to reduced transportation costs, as well as improvements in road safety. A Power Transmission project (US$200 million) was approved in early FY08. Additional investments in Ukraine’s power generation and transmission system are planned in the range ofUS$200-300 million. The investments in the power sector are linked to a programmatic engagement, which aims to increase reliability of supply and reduce costs through greater competition, support growing integration of the energy sector with Europe, and create the conditions for increased private investment through improved financial sustainability. Investment requirements at the municipal level and in the context of the European Football Championships in 2012 are also potential candidates for WBG financing in FY09 or in future years ofthe CPS.
97. Policy reforms in support of improvements in the business climate, in the financial regulation, in the financial sustainability of the energy sector, and in the attraction of private investment into infrastructure, are supported by the DPL program. DPL 11, under preparation, supports prior actions in the area of trade liberalization, the liberalization of the telecommunications sector, the adoption of a new inspections law, the restructuring of energy debts, and the reduction in quasi-fiscal deficits in the energy sector. Future benchmarks and triggers in the DPL program support the reform of standards and technical procedures in compliance with EU regulations (thus directly supporting the negotiation of a FTA with the EU), the adoption of public private partnership (PPP) legislation to attract private investment in transport and other infrastructure sectors, the adoption of a new Joint Stock Company Law, the move towards consolidated and risk-based supervision for banks and non-bank financial institutions, continued efforts to raise energy prices and maintain collections in the face of import price shocks, and the enactment of a law making the energy regulator independent. Both loans are expected to be in the US$300-500 million range.
98. Improvements in governance are mainstreamed into pillar 1 activities. A planned Judicial Support project (FY08 - US$40 million) focuses on improvements in the physical condition of court houses and on the establishment of automated case management systems. While it is not expected to contribute to major reforms in the judicial sector, it may provide a basis to intensify the dialogue on judicial reform once greater political consensus has been established. This would be a key contribution to greater investor confidence. At the same time, a number of demand-side initiatives under the GAC agenda are planned. This includes the dissemination ofthe Faces ofCorruption Report in Ukraine and application to the Ukrainian reality. A key governance agenda is the management of SOEs. Subsidies and non-transparent management practices are distorting competition, creating significant quasi-fiscal losses and overall reducing
34 Ukraine’s competitiveness. While the Bank would like to see privatization advance, this may not be possible in the absence of a broader political consensus. Against this background, the management of SOEs becomes all the more important and would be expected to be an area ofengagement through both DPLs and non-lending.
99. Increasing energy efficiency is also a key goal from the perspective of reducing carbon emissions, in the light of increased global attention to climate change. The Bank’s current and forthcoming carbon funds, including the new Carbon Partnership Facility will look for opportunities to support emission reductions under the Kyoto protocol, Article 6, through the Joint Implementation framework, and Article 17, through the International Emissions Trading framework, as well as any future agreements on climate change. Because ofits initially highly energy inefficient structure ofproduction, Ukraine is one of the largest potential beneficiaries of international emissions trading, and the resulting revenues could potentially make a key contribution to modernizing Ukraine’s economy.
100. The objectives of the pillar are also supported by a substantial portfolio of existing projects in the power sector, in the financial sector and in land reform. A Second Export Development project is a follow-up operation providing credits to Ukrainian exporters through the banking system. In parallel, the Access to Financial Services project provides credit lines to Ukrainian banks to reach smaller borrowers, in particular, in rural areas and among smaller municipalities, as well as providing technical assistance to the non-bank financial regulator. A Rural Land Titling and Cadastre Development project is ongoing to assist in the creation of a competitive market for agricultural land and a State Tax Service Modernization project aims to reduce the costs of compliance for tax payers and thus improve the business environment.
Table 6: The Transition from Extensive to Intensi e Growth - Pillar 1 Themes Pillar 1: S daiaing growth and fmprov g competitiveness Foundations of growth: Emerging constraints for Key long-term development future growth results Macroeconomic 0 Infrastructure (energy 0 Sustained GDP, labor stability & transport) productivity and export growth Business environment 0 Trade logistics and Improved business climate and 0 Regulatory reform trade and transport transparency ratings Corporate governance facilitation 0 Reduced transport and logistics Financial stabilization Energy efficiency costs and market deepening Skills and labor market 0 Improved energy efficiency WTO accession and Innovation and 0 Increased investment ratio and international integration technology transfer, increased levels of FDI per knowledge economy capita Analytical basis: CEM Analytical basis: CEM 0 Increased private sector 2004, Trade Study 2005, (FY08/09), Knowledge involvement in infrastructure DPL I Economy Assessment 0 Deeper and more stable (FYO8), Jobs Study (FY06), financial sector Jobs Agenda TA (FY08/09)
35 Box 6: Operational Approach to Governance in the CPS Weak governance and widespread corruption pose a serious developmental challenge for Ukraine. However an internal review of the degree of vulnerability ofthe Bank’s portfolio to the country’s fiduciary risks has found that these can be mitigated to acceptable project levels. Three broad strategic recommendations follow: (i)The World Bank response to the GAC challenge must remain pragmatic and gradualist until new opportunities emerge; (ii)given the current implementation and institutional obstacles, as well as the lack of a broad-based political consensus, national-level governance reforms need to be addressed through efforts to strengthen the demand for good governance in addition to standard investment lending instruments; (iii)the GAC agenda should be implemented as cross-cutting themes through the WBG’s policy lending platform, and as design and implementation features in the investment operations for infrastructure and public service delivery. These strategic recommendations have the following operational implications for the WBG’s engagement in Ukraine: 1) Adjustment of the portfolio in the short- to medium-term towards capacity building of civil society and local stakeholders. The Bank will aim to scale-up successful pilots llke the People ’s Voice project and develop further the synergies with other sectors (housing, utilities, etc.). The Bank will propose new institution-building loans to the central government beyond those already in the pipeline only when it judges prospects for successful implementation are reasonable, with reference in the first instance to needed improvements of existing lending interventions in this area. 2) A significant amount of resources will be allocated to non-lending activities. The purpose of this work will be to strengthen and broaden demand for good governance. Among the vehicles to support this objective will be the tailoring to Ukraine’s context and dissemination of reports distilling international policy lessons, as the recent ‘‘Many Faces of Corruption”, as well as continuing work with NGOs and civil society. 3) The Bank will intensify its work with local governments, which are seen in some areas as more effective counterparts. Given that most government-provided public goods are delivered at the local level, such an approach may deliver results faster and propagate itself through demonstration effects. 4) The Bank will intensify efforts to move towards SWAPSand disbursements through the budget as a means to increase the effectiveness and efficiency of its assistance. As implied by PEFA indicators, disbursing through the budget in Ukraine appears to be relatively low risk and may generate benefits of greater country ownership, more efficient processing and ultimately deliver results more effectively. However, developing a roadmap toward this approach will require significant additional effort to strengthen strategic planning capacity in partner ministries and to align World Bank and country processes. 5) To mitigate fiduciary risks in Bank operations, the strategy envisions strengthening existing fiduciary standards, such as enforcing the Bank’s procurement rules, competitive bidding, as well as adequate supervision and attention to capacity building among project counterparts. Innovative ways to track money flows and build accountability mechanisms into project design such as Public Expenditure Tracking Surveys, stakeholder involvement in project governance or independent technical audits will need to be explored on a case-by-case basis taking into account resource constraints and the need to avoid adding additional complexity to project design in the Ukrainian context.
36 101. Under the first pillar, IFC will continue to invest directly in the real and financial sectors and provide a range of advisory services. IFC would contribute to the first pillar through direct investments targeting higher value added sectors as well as sectors that require improvements in energy efficiency and overall modernization of production, such as manufacturing and services, agribusiness, and associated development of logistics, freight, and warehousing industry. IFC would also contribute to upgrading the companies’ managerial and corporate governance practices through its advisory services on an individual company basis, where needed, and through a planned Comprehensive Advisory project on company internal controls. IFC would support the development of the financial sector by both investing in local banks and supporting the entry of regional players into the Ukrainian market, with a particular focus on such priority areas as energy efficiency, mortgage, SME, leasing, insurance and consumer finance. IFC would seek to develop innovative financing instruments that are commensurate with clients’ needs and those ofthe market as a whole, including potential support for securitizations, provision of partial credit guarantees and local currency financing. Advisory work in the financial sector would promote the standardization of housing finance practices across the industry, develop energy efficiency finance, and establish a framework for the development of agro-insurance. Additional support for the development of agribusiness would be provided through linkages programs for agribusiness supply chains. IFC is also looking to engage in pilot PPP transactions in a variety of areas and potentially assist in the post-privatization restructuring ofthe energy sector (subject to this being done transparently). IFC would expand its provision of sub- sovereign financing in Ukraine to address the development needs on municipal level and potentially contribute to the development of financial markets. This will include work on new financial instruments, including local currency financing.
102. MIGA will continue to support foreign investors through the provision of political risk guarantees. MIGA would support projects in the manufacturing and agribusiness sectors which promote the modernization ofproduction and contribute to the diversification ofthe economy. Also, MIGA would contribute to the development ofthe financial sector by continuing to support foreign strategic investors. In particular, MIGA intends to focus on investments which: i)improve SMEs’ access to finance, ii) increase the provision of specialized banking products, including leasing and mortgage financing, and iii)strengthen banks’ capitalization. The Agency would also explore opportunities to support capital markets transactions in Ukraine, including asset-backed securitizations. Further areas for potential involvement in Ukraine include the infrastructure and power sectors. MIGA could also play a role in promoting foreign direct investment in infrastructure at the sub-sovereign level.
103. Substantial non-lending assistance will complement financial support to the first pillar. Ukraine’s competitiveness agenda will be developed under a new flagship CEM to be delivered in FY09, but with earlier dedicated inputs on the Knowledge Economy (Knowledge Economy Note and Assessment FY08) and Labor Markets and Skills (Labor Market Policy Note FY08, TA and dialogue on skills FY08). Additional diagnostic work is planned in FY09 in infrastructure, with policy notes on the coal sector
37 and on the development of a gas market. A Trade and Transport Facilitation audit (funded under a Trust Fund from the Dutch government) is also planned in FY09, which would lead to the establishment of a performance measurement system along key transit routes during the same year. A Financial Sector Assessment Program (F-SAP) update, completed in 2007, takes stock of the remaining vulnerabilities and development challenges in Ukraine’s financial sector.
104. Significant technical assistance and advocacy work is planned to further improve the business climate. The IFC’s Business Environment project (FY07-1 l), under the Private Enterprise Partnership, will take a leading role in advising the government on necessary changes in business regulations, including in the important areas of certification, permits and licensing and inspections reform. In addition, the World Bank Institute (WBI), in collaboration with FIAS, will carry out a training program for public officials on selected topics in promoting innovation and investment in Ukraine. This will include detailed policy advice in the areas of PPPs, the design and implementation ofinvestment promotion regimes, including special economic zones.
105. The Bank’s regional studies and flagship reports will also contribute to the policy dialogue in support of the first pillar. Key reports in the coming year are the ECA Productivity Study to be disseminated in FY08, the World Development Report (WDR) on Agriculture (FY08), and the BEEPS planned in 2008.
Pillar 2: Public Finance, Public Sector Reform and Improved Service Delivery
106. The Bank has in the past attempted to improve public services through selected investment operations with individual line ministries. This approach has delivered mixed results at best, as the underlying financial and structural problems have not been resolved and insufficient drive and momentum from the MoF and other central government agencies has slowed down implementation.
107. In reflection of this past experience, the CPS proposes a shift in approach in support of the second pillar - using the reform of public finance as an entry point for the improvement of public service delivery. The aim is to use the ownership ofthe MoF behind the agenda of improving public financial management and increasing the efficiency of spending to structure a dialogue around changes in incentives, accountability frameworks and budgeting processes at the line ministry and local government level, without which improvements in service delivery will be difficult. In parallel with this central strategic orientation, the Bank will strengthen its AAA activities to stimulate demand for greater local accountability, encourage bottom-up initiatives, and advocate the need for structural changes in the delivery of public services, including a reduced role for top-down state control.
38 108. The second pillar supports the achievement of the following long-term development results:
Reduced overall size ofthe government sector. Reduced tax burden and improved tax compliance. Increased public capital spending, and greater alignment of public capital spending with strategic priorities. Improved social sector outcomes through increased efficiency of social sector spending. Reduced environmental and health risks and increased social awareness ofthese risks. Increased citizen satisfaction with the quality ofpublic services. Improved employment prospects, reduced poverty and improved targeting of social assistance.
109. Unlike in pillar 1, where investment lending accounts for a large proportion of the targeted CPS outcomes, in pillar 2, more emphasis is laid upon non-lending engagement and the results of the adjustment program. Maintaining high quality in the policy dialogue in this critical area is therefore a pre-eminent challenge for this CPS.
110. New investment loans in the pipeline for FYO8 and FYO9 in support of the second pillar include at the core a Public Finance Modernization project (PFM, US$50 million, FYO8). The PFM project is a key to the construction ofthe second pillar, since it will contribute to improve information systems across the entire PFM sector, including the MoF, internal audit and the Treasury, with associated links to the State Tax Administration and the State Customs service. This will facilitate budget preparation and execution. Moreover, a significant technical assistance component is planned to improve medium-term budgeting, debt management, and strategic planning. The project has been closely coordinated with a large group of donors providing additional technical assistance. A Dutch Trust Fund is being mobilized to support improvements in capital budgeting, including a large-scale training effort supported by WBI. In addition, Bank technical and advisory services will continue in the context ofthe Public Finance Review and follow-on fiscal work.
111. Additional new investment lending will be provided for the Social Insurance Administration project (SLAP, US$113 million FY09). This project lays the foundation for a more efficient administration of social insurance by unifying the current four social insurance funds under the auspices of the State Pension Fund. The project would also lay the foundation for the introduction of a second pillar to the pension system planned for 2009. The project is closely linked with the Social Assistance Modernization project (SAMP, approved FY06) which aims to reduce the cost of administrating social assistance.
39 112. The objectives of these investment loans are complemented and supported by the DPL program. The DPL I1 includes prior actions in the improvement of public financial management related to the overall fiscal envelope, the approval of a public financial management strategy, the management of SOEs, and the introduction of an independent testing system for secondary education (Trends in International Mathematics and Science Study (TIMMS). Future triggers and benchmarks relate to improvements in tax administration, inter-governmental fiscal relations, greater accountability and transparency of the state-owned enterprise sector, parametric changes to the pension system to improve its financial sustainability and creating the legal basis for the unification of social insurance contributions. There is therefore a close link between the core investment lending operations planned in support of the second pillar and the conditionality of the DPL in this area, In addition, the DPL supports changes in input norms in the health and education sectors, which would be key catalysts to improve financing and introduce greater incentives for efficiency in these two social sectors.
113. The Bank has been increasing its financing support to the modernization of municipal infrastructure with the approval in early FYOS of a US$140 million Urban Infrastructure project. This project aims to support investments into the rehabilitation ofmunicipal utilities through a financing umbrella. Additional investments with a similar construction (Municipal or Infrastructure Financing Fund) are planned in future years. However, a key challenge in this area is how to ensure that top-down allocations of financial support are consistent with and support bottom-up initiatives to improve municipal and housing services through the formation of housing associations and other citizen initiatives. There is also a great need to strengthen strategic planning capacities at the level of municipal and oblast authorities, which future projects at the local level will need to address. An important pilot in demand-side initiatives in this area is the People’s Voice project funded through a Canadian International Development Agency (CIDA) grant, expiring at the end of2007. A follow-on initiative is planned, and the Bank will allocate non-lending resources to support this work. Going forward, the objective is to bring bottom-up initiatives together with the financial support the Bank can provide through the central government. IFC is also planning support in this area through investments in PPPs at the municipal level and through its support to widen municipal access to financing. MIGA may also help promote foreign direct investment in infrastructure at the sub-sovereign level through the provision of guarantees. The WBG will collectively seek ways to expand the range of instruments it can offer to municipalities, including guarantees, local currency funding, pooled funding facilities etc. The advice of the Bank’s Treasury Department will be sought in this endeavor.
114. In the health sector, the CPS proposes a shift towards greater emphasis on advocacy to increase awareness of public health risks on the one hand, and a gradual move towards targeted budget support on the other. The existing portfolio includes a TB and HIV/AIDS Control project, which has faced significant difficulties in implementation, without apparently contributing so far to reducing the rate of HIV infections (greater success has been met by the aim to combat TB among the prison population). Public awareness of health risks from communicable diseases to lifestyle
40 and environment health risks is developing slowly, and hence demand for fundamental changes in the health care system is low. Most people seem to expect improvements largely as the result ofmore public spending. The CPS proposes to attack this challenge from two fronts. On the one hand, a significant increase in non-lending and advocacy work is targeted to increase public awareness and to contribute to a public debate about the state of health care and associated demographic and economic costs. On the other hand, using the undisbursed balance of the TB and HIV/AIDS Control project as a pilot, the Bank will attempt to move towards targeted budget support in the health sector. Bank financing would go through the budget and be directly linked to government funding for the HIV/AIDS action plan. Disbursements could be tied to performance measures, thereby piloting the move towards SWAPSin the social sectors. To make this possible, significant additional technical work by the Bank’s Human Development, Fiduciary and Public Sector Reform teams will be needed to develop corresponding procedures.
115. In the area of protecting the environment, the Bank’s approach will combine advocacy work to highlight the economic and social costs of industrial pollution with advisory services to support emission reductions and allow Ukraine to benefit from carbon trading opportunities. In an innovative activity, the Bank initiated a local environmental TA in the city of Zaporizhzhia to work on a local environmental risk management plan together with businesses, representatives of civil society, the media and the local administration. This model is intended to be expanded to other cities and potentially scaled up at the national level. In addition, the Bank will continue advisory work to ensure that Ukraine benefits to the maximum extent from the opportunities under the Kyoto protocol and any future international agreement on climate change to sell emission reductions and create an incentive for reduced industrial pollution.
116. In the education sector, the existing investment operation will continue to aim for improved access to quality secondary education. In addition, working with other donors and WBI on training of education policy makers, the Bank will focus its policy dialogue on the importance ofreforming national standards and independent attestation to improve the quality of education. No new investment loans are planned in this area for the time being, taking into consideration the substantial funds already allocated to the sector.
117. The lending and non-lending activities for FYO8 and FY09 are summarized in Table 7. Activities in future CPS years will be reviewed on a rolling basis and confirmed at the time ofthe CPS Progress Report (PR) at the end ofFY09.
E. RESULTS, MONITORINGAND EVALUATION
118. The ultimate success of the Bank’s strategy in Ukraine must be measured against the economic outcomes or results achieved. Ukraine has in the past tended to perform well on macroeconomic results, even if crucial policy milestones were delayed. At the same time, the extent to which this can be attributed to the Bank’s or other donors’ presence in Ukraine is difficult to fully ascertain. The CAS CR points out that the results
41 framework in the previous CAS did not take sufficient account of the investment lending portfolio. It also points out that in many cases, the monitoring and evaluation frameworks for individual lending operations need strengthening.
119. This CPS includes a results matrix (Annex 7), which will serve as the main accountability framework during implementation. The matrix links the WBG lending and non-lending activities to specific economic outcomes, and specifies target values for each outcome. These are then related to longer-term country level outcomes and to the obstacles that need to be overcome to meet these outcomes. There is a close correspondence between these obstacles and the analysis of development challenges in Section I11 and Annex 1 and 2 ofthe CPS.
42 Table 7: CPS Acti~ties in FY08 and FY09 Lei ling Non-lending (AAA)
FY OS FY09 FYOS + FY09 IBRD lending IBRD lending IBRD AAA PTP- US$200 mln PTP I1- US$200 CEM (2009, ESW) Road Safety - mln Agricultural Policy Notes (ESW, 2008) US$400 mln Second Transport Knowledge Economy & Competitiveness dialogue (2008, TA) DPL I1US$300 (road) project Labor demand and skills relevance (2008, ESW) mln US$400 mln FSAP (2008, centrally financed)
9 Judicial Support DPL I11 US$300- Capital Market Technical Assistance Partnership Program project US$40 mln 400 mln (PTAP, with USAID, 2008-201 0, TA) Hydropower I1US$ Local investment Dutch grant to NBU + Financial Sector dialogue (TA, 2008-10) 50 mln (EURO 2012) -US$ A&A ROSC follow-~p(TA, 2008) 300 mln Gas Market Note and Coal Policy Note update (2009) Trade and Transport Facilitation audit (Dutch TF, 2009) IFC investments, CF J and MIGA guarantees IFC, FIAS, WBI Direct investments in real and financial sector IFC BEE (PEP) IFC advisory services for agribusiness (production chains and agro-insurance) IFC advisory services for the financial sector (mortgage finance, energy efficiency) Competitiveness Capacity Bldg (WBI, FIAS, IFC and IBRD) Pill 2: Public Finance, Pub :Sector Reform and Improved Public Services FY08 FY09 FYO8+FYO9 IBRD lending IBRD lending IBRD AAA
PFM - US$50 mln 9 SIAP - US$ll3 mln IBRDAAA DPL I1-US$300 DPL I11 - US$300- PFR I1 (2008) mln 400 rnln Dutch Trust Fund on capital budgeting, PFM and Trade and UIP - US$140 mln Transport Facilitation (2008-20 10) Social Sector Financing (AAA, 2009) Housing and Municipal Utilities TA (linked with PVP follow-up, 2008) Health and Demography Advocacy work (2009) Environmental Partnership in Zaporizhzhia (TA, 2008) Poverty Update (2009, ESW) Kyoto TA (2008) IET Institutions and Green Investment Schemes TA (2008) IFC investments, CF J ind MIGA guarantees IFC, FIAS and WBI Investments in municipal utilities under PPP Training on capital budgeting and PFM (under Dutch TF) schemes Advisory services to municipal govts. in context of municipal Sub-national finance
IBRD AAA Macroeconomic monitoring (ongoing) Strengthening demand for good governance and anti-corruption Advocacy work (ongoing) Total Bank Budget and other sources for TA Around US$1.5 million in Bank budget and perhaps an equivalent amount in additional sources of funding
43 120. The matrix emphasizes that in key areas, the main results are expected to come from the implementation of the existing portfolio. Hence, continued attention to improvements in portfolio performance will be critical to achieving the target CPS outcomes. The greater selectivity of the CPS is expected to free up resources to help increase the impact of the existing portfolio - for instance by working on the public financial management agenda and thereby increasing attention of spending inefficiencies in the social sectors.
121. The need to remain flexible imposes modesty on the results framework. The Bank, in several instances, may not be able to commit more than improvements in selected enterprises or sub-sectors. This is especially true for IFC investments, which although intended to generate demonstration effects, cannot quantify such effects ex ante. The strong emphasis on non-lending support also creates a challenge for the results framework, although the cross-sectoral DPL program allows in many instances to link key diagnostics with policy reforms supported by policy-based lending.
122. Weaknesses remain in the monitoring and evaluation frameworks of existing projects and some changes will be necessary to align them more closely with the CPS. Moreover, capacity for monitoring and evaluation is weak, both in the central and line ministries. To support capacity building for monitoring and evaluation, the Bank can draw on one existing lending operation (STATCAP) and plans to apply for an Institutional Development Fund (IDF) grant.
F. CONSULTATIONPROCESS
123. The Bank team has conducted a series of consultations with different stakeholders on the design of the CPS. The basic principles ofthe CPS were presented to the authorities at the CPPR in March 2007, and the present draft was extensively discussed and reviewed with the authorities. Roundtable discussions were held in Kyiv during May and October 2007, with donors and with civil society, and the full CPS draft was posted on the Bank’s external website for three weeks in September-October 2007. The Bank also presented the same material to representatives ofall major political parties and conducted five regional consultations in Donetsk, Kharkiv, Lviv and Lutsk and Simferopol. In addition, the Bank team held informal discussions on different economic and political development scenarios and the role of the international community with a group ofindependent political analysts.
124. The consultation process held to date has confirmed significant support for the Bank’s approach. In particular, participants endorsed the principle of greater selectivity in the Bank’s interventions. The greater emphasis on infrastructure lending in the portfolio going forward was supported by other donors, although the Bank was requested not to abandon the social and institutional reform agendas. In response, the Bank clarified that it would change the mix ofinstruments but not the degree of engagement on social and institutional reforms and emphasized the importance of close donor collaboration in achieving impact fiom its non-lending interventions. Representatives of
44 civil society raised concern about governance and corruption in Ukraine and highlighted that there was some disillusionment with the reform process, which they felt had not translated into sufficient improvements in living standards and in the quality of service delivery. Civil society representatives strongly endorsed the emphasis in the CPS on stimulating demand for improved governance and urged the Bank to establish a forum and a platform for greater national debate on reform priorities, NGOs expressed great interest to widen their collaboration with the Bank in the implementation ofthe CPS and some expressed a view that the CPS should adopt the strengthening of civil society as a key objective in its own right. The independent political analysts cautioned that improvements in governance may continue to be slow given strong vested interests, and argued for a pragmatic approach that failed to raise unrealistic expectations. There was general agreement that financial support to the government, through lending operations, was most effective in areas where a national consensus on the need for reform had been reached.
125. Consultations with representatives from different political parties confirmed that there is no fundamental difference in economic vision and the commitment to reform. All those consulted welcomed the Bank’s continued engagement to support economic reform in Ukraine and felt the principles established by the CPS were adequate. A review of sectoral priorities also did not reveal major differences ofopinion in relation to areas of focus for the Bank. A detailed summary of the consultation process held to date is in Annex 8.
VI. RISKS AND RISK MITIGATION
A. IMPLEMENTATIONRISKS
126. Implementation risks in Ukraine are considerable. The track record of implementation, particularly in the investment lending portfolio, is poor. Ukraine has the lowest disbursement rates among any IBRD borrower, although there have been some significant recent improvements.
127. The main sources of implementation risk fall into three categories: (i)lack of ownership, (ii)cumbersome internal procedures which are inconsistent with World Bank procedures, and (E) policy delays or reversals.
128. Ownership: The capacity of Ukraine’s government for strategic planning remains relatively weak. The authorities have been making efforts to improve internal coordination, but strategic prioritization remains a challenge. In this environment, it is sometimes difficult to ascertain the extent of client ownership for a particular intervention. Yet, the Bank has in the past also been culpable of preparing lending operations at the request ofline ministries, without verifymg the extent ofsupport (and or political resistance) by power brokers in the central government agencies (Cabinet of Ministers, MoF, Ministry ofEconomy).
45 129. The current CPS imposes greater limits on the number of new projects being prepared, thereby forcing the authorities to coordinate more effectively. This has already been in evidence in preparation ofthe CPS, when the Government internally agreed to a clear sequence for the preparation and approval of three institutional reform projects in the lending pipeline: Court Modernization, PFM Reform and Social Insurance Administration Modernization. In addition, the Government clarified that they would not consider asking for support for civil service reform until 2010, which is consistent with Bank staff evaluation that the political consensus to push forward civil service reform does not yet exist. The recent improvements in coordination with World Bank assistance by the authorities are part of a general effort, as reflected in the elaboration of a Government Strategy for Cooperation with IFIs, adopted in 2006.
130. The CPS also aims for greater ownership of the AAA work and the planned Innovation Fund would be the strongest expression ofa new partnership where client co- determination of the focus areas for Bank advisory services would result in greater impact.
13 1. Cumbersome procedures: Ukraine has a bewildering array of internal procedures and every step in project preparation requires a consultative inter-ministerial process that can last several months. Moreover, IF1 projects with the exception of the DPL, are not included in the annual budget and hence each project requires ratification by the Rada, which again delays project effectiveness by several months.
132. The Bank and the government have started a dialogue on simplifying national procedures and moving towards the use of country systems on a selected basis, where fiduciary risks are thought to be manageable. As an initial success of this dialogue, the government recently passed a resolution mandating the disbursement of World Bank funds through the National Treasury. Moreover, the 2007 CPPR has committed both sides to clear service standards in portfolio monitoring and implementation (Box 7). An improvement in the disbursement rate to 12 percent and general portfolio performance standards are base case conditions ofthe CPS.
133. Policy delays or reversals: The pace ofpolicy reform in Ukraine has by and large fallen short of expectations. This has affected the sequence of DPLs, which have tended to take at least two years to prepare. The annual disbursement schedule foreseen in the CPS may thus be regarded as ambitious.
134. The risk is mitigated at least in part by a recalibration of the DPL program. Compared to close to 100 benchmarks and over 20 triggers in the PAL 2 program, DPL I1 contains only 8 prior actions and six triggers. Moreover, the DPL fiamework is flexible; triggers can be waived if reform progress is delayed in one area, but this is compensated by greater progress in another area. The recalibration of the DPL program is reflected in the smaller share that adjustment lending takes in the overall CPS envelope, and in the smaller size of each DPL relative to the size of the budget or the economy. Thus while the economy has tripled in size in US dollar terms since 2000, the average DPL size of
46 US$300-400 million is not much higher than the average size of previous adjustment operations.
135. Delays in the implementation of key legislation can also affect the preparation schedule of investment lending operations. To the extent possible, the DPL should shoulder this risk by taking on policy conditionality important to deliver investment lending results. However, in some cases, a legislative change is a pre-condition for an investment operation to be feasible. In such cases, a careful political economy analysis will need to be conducted to understand the risks associated with this policy conditionality and the preparation schedule may have to be adjusted or the project abandoned.
Box 7: Portfolio Monitoring and Implementation: Agreed Services Standards In March 30, 2007, the representatives of the Ukraine central government agencies and the World Bank liscussed the proposed new draft CPS for FY2008-2011 that will be based on new principles and ipproaches in cooperation as well as the World Bank project portfolio in Ukraine. :he meeting reviewed the status of the lending portfolio and agreed on the need to improve its ierformance. In order to achieve greater results of the Bank-financed Investment projects, the parties will nake every effort to apply to the investment projects the following performance standards: From commencement of work (decision of the Government on the expediency of a project) to signing the minutes of formal negotiations - 1 year; If there is a delay in such Government's decision, the two sides should discuss and decide whether there is a necessity in project preparation; The Ukrainian side will facilitate the international project agreements to become effective within 6 months after their signing; Projects under implementation but with insufficient implementation progress, and whose objectives are at risk of not being met, will be subject to consideration with regard to their restructuring, extension andor closure by mutual agreement, without prejudice to the rights ofeither side to make decisions individually within the framework ofrespective international project agreements. 2uarterly portfolio performance review meetings will be convened by the Ukrainian side and the Bank vhich will allow all project implementing entities and project implementing units involved in World Bank irograms to discuss project implementation. The Government and Bank management will meet at more enior levels as appropriate to discuss systemic or urgent matters. ireview of progress in the Bank's CPS and the overall performance of the Bank's programs will be held luring an annual Country Program Review. The World Bank, working closely with the Cabinet of llinisters and relevant ministries, will develop program- and project-level results indicators that will be nonitored and assessed as part ofthe Country Program Review. 'he parties will apply a systems approach to the country project portfolio, starting with the use of the State 'reasury to service all investment projects executed by the central governmental bodies and other budgetary agencies, which are approved by the World Bank after July 1, 2007 (World Bank's fiscal year ,008). In those cases when Special Accounts are still needed, such accounts will be opened exclusively in he local commercial banks or NBU. 'he parties will continue to optimize the procedures and shorten the period of processing documents by loth the World Bank and corresponding central government agencies.
136. Fiduciary risks are another important source of risk for the CPS. However, several recent diagnostic pieces allow the conclusion that these risks are manageable and the standard assistance mode through the central government remains a viable model for
47 Ukraine. An internal review of corruption risks was carried out in 2006 to analyze governance problems in Ukraine and how they affected fiduciary risks in the portfolio. This analysis came to the conclusion that although fiduciary risks in Ukraine were recognized to be higher on all important dimensions than in the EU accession countries or other large middle income borrowers, in practice, fiduciary controls in investment lending operations worked to acceptable standards. The Governance Annex (Annex 2) of the CPS explains how the Bank intends to go beyond standard fiduciary controls in addressing governance risks, although it should be acknowledged that additional demand side measures are likely to take some time to take effect and will be applied initially on a selected basis. Stronger fiduciary controls, as developed in the context of the Bank’s GAC, will additionally be required.
137. The PEFA assessment revealed significant strengths in budget execution, credibility and transparency. These achievements are encouraging and suggest that the Bank should over time move to disbursing financial assistance through the government budget. However, the PEFA assessment also highlights weaknesses in the capital budget and in the state procurement system. These two weaknesses should therefore be at the center of the Bank’s efforts to move towards a greater reliance on country systems as an explicit risk mitigation strategy.
B. CREDIT RISKS
138. Ukraine’s public sector debt levels are low and the country’s macro economy at present is reasonably balanced. Section I1 provided an analysis of Ukraine’s recent growth and macroeconomic performance and highlighted Ukraine’s considerable macroeconomic strengths and good fundamentals.
139. Nonetheless, several important macroeconomic risks exist, which will need to be carefully monitored in terms of their implications for Ukraine’s overall creditworthiness. The main risks from a macroeconomic perspective include:
Adverse terms of trade shock: With metal prices at record highs, the impact of rising energy import costs has been muted. Should this change, Ukraine would face widening current account deficit, reduced corporate profitability, and at least temporarily lower growth. Reduced access to international financing: Ukraine has benefited from a benign external environment in terms of both export prices and access to financing. Should portfolio preferences shift against emerging markets, Ukraine would be vulnerable both because ofthe reliance on external financing of its current account deficit, and perhaps more importantly, because of potential impacts on domestic financial sector liquidity. Liquid domestic assets are well in excess of scheduled private debt repayments, but a sharp curtailment ofliquidity could expose underlying credit risks in the financial sector. Rapid financial sector expansion and remaining weaknesses in regulation. While banking sector supervision has improved, there is still need for further
48 capacity building and greater transparency in the management ofbanking sector risks. In the non-banking sector, which has experienced fast growth from a low base, regulation remains very weak. This could exacerbate risks should a tightening ofliquidity or an unexpected sharp exchange rate devaluation expose underlying credit quality issues. Fiscal expansion driven by populist politics: Fiscal management to date has been conservative, but political instability has led to election promises that if fulfilled could be fiscally costly. Fiscal expansion would risk overheating the economy, with further rises in inflation, growing external imbalances and the potential risk ofa hard landing.
140. The above macroeconomic risks are mitigated by Ukraine’s past record of macro-management, which suggests policy will adjust in the face of negative shocks. Specifically, it is likely that in the face of strong negative terms of trade shock, the exchange rate would adjust, and fiscal policy would support the economic rebalancing. Should external conditions deteriorate more gradually, the NBU would have time to move towards a more flexible exchange rate regime, which it has indicated it will do over the medium-term. Ukraine’s experience at the end of the 1990s has moreover engrained a strong commitment to fiscal stability and aversion to too much dependence on external financing. Nonetheless, continued vigilance will be required to monitor Ukraine’s macroeconomic balance and any possible impact on creditworthiness of large adverse external shocks.
49
ANNEX 1: KEY DEVELOPMENT CHALLENGES A. SUSTAINING GROWTHAND IMPROVING COMPETITIVENESS 1. Ukraine needs to move up the value chain to gain market share in Europe and other developed markets and reduce the exposure to terms of trade shocks stemming from its current reliance on commodity-based exports. Ukraine’s exports are concentrated in metallurgy, chemicals and food products. The share of intermediate inputs in the production of these products is high and their prices tend to be volatile in international markets. The challenge is to adopt new technologies, and improve the quality of products, all the more so, since Ukraine’s wage cost advantage is likely to erode in coming years. Ukraine produces a relatively high number of patents and has a well developed research and development capacity, but it fails to turn this capacity into a significant stream of product or process innovations at the enterprise level. The country is weakly integrated into global production chains because oflow levels ofFDI. Despite high enrollment rates, university graduates struggle to find adequate jobs, while skill shortages in manufacturing are increasing, as many skilled workers have sought employment in Russia and Western Europe. 2. A variety of indicators highlight that much remains to be done to improve the business climate. The World Bank’s Doing Business indicators in 2006 ranked Ukraine 128th out of 175fh, with key weaknesses in the tax system, the protection of property rights and bankruptcy procedures. The OECD recently produced an index of product market regulation - an indicator that captures the degree to which markets operate fi-ee from state intervention and create conditions conducive to business development (Table A1 .1). While considerable progress has been made in the regulation of entry, the scope of government intervention remains very large. Ukraine must improve at fostering the survival and expansion of private businesses to generate the competitive dynamics that would stimulate greater innovation and foster sustained productivity growth. The continued dominance of state-owned enterprises or companies with close connections to government officials in key markets is one obstacle to greater competition. Although survey evidence strongly suggests that privatization increases firm level productivity, the privatization process has been effectively stalled in recent years. Corporate governance practices also fall well short of international standards, the antiquated company law dates back to 1991, while contradictions between the civil and commercial codes create vast scope for discretion in the interpretation of the legal fi-amework for private contracts and property rights.
I investment I I I I I 1 Source: OECD
50 3. The financial sector has undergone an important transformation over the past two years with the aggressive entry of foreign strategic investors, but still requires stronger regulation. Total banking sector assets have increased more than five times since 2000 and with bank credit to GDP standing at close to 50 percent, Ukraine is catching up with the countries in Eastern Europe. Table 5 shows that this expansion has happened at the same time as interest margins have come down and bank profitability has increased, pointing to the beneficial impact of growing competition. However, the financial sector faces important challenges. Regulation ofbanks and in particular ofnon- bank financial institutions, is still weak and not risk-based; the disclosure of ultimate beneficial owners is not mandatory for either banks, security issuers or non-bank financial institutions; and the capacity of the three financial market regulators needs ~trengthening’~. Moreover, loan books are not yet mature and the rapid pace of expansion is likely to hide underlying problems. Maturity mismatches and growing foreign exchange exposure to unhedged households are concerns”. Moreover, the strengthening of regulations of non-bank financial institutions and of the securities markets are key conditions for the success of a second pillar pension reform, currently planned for 200916.
4. A key step forward in structural reform have been recent legislative changes (at the end of 2006 and again in June 2007) laying the foundations for the accession to the WTO. With its accession to the WTO expected over the coming months, Ukraine would lock in important advances in structural reform and accept important rules concerning future policy, including: 0 Bind the import tariff reductions that it carried out during 2005-2007;
0 Reform ofcustoms procedures;
0 Allow foreign banks to establish branches in Ukraine, thereby further enhancing competition in the banking sector;
l4See the Programmatic Technical Assistance Partnership (PTAP) position paper on the development of capital markets, World Bank and the United States Agency for International Development (USAID), 2007. These findings are echoed by a Financial Sector Assessment Program (FSAP) Updated currently under preparation. See also Fitch Banking Sector Review, 2007. l6PTAP Position Paper.
51 Gradually reduce (or phase out) export duties on scrap metal and selected agricultural products; Gradually shift the mode of agricultural support from input and production subsidies (“amber and yellow box”) to measures supporting agricultural competitiveness, the environment and rural development (“green box”); this includes changes to the VAT regime in agriculture which would considerably reduce current tax expenditures in the sector; Accept limits on the kinds of investment support trade-related investment measures (TRIMS) that would be acceptable, including in the context of setting up special economic zone;
0 Accept a much stronger regime for the protection of intellectual property rights trade-related aspects of intellectual property rights (TRIPS); Reform its standardization, licensing and labeling regime to continue the harmonization ofUkrainian standards with International and European norms and remove any discrimination against importers; Adhere to the General Agreement on Tariffs and Trade (GATT’s) Art. 24 in joining any regional free trade area. 5. In parallel with the WTO accession process, the telecommunications market has been liberalized, penetration rates for mobile phones and the internet have increased dramatically, and tariff rates have begun to converge to European levels. 6. However, even after WTO accession, Ukraine will need efforts to reduce behind the border obstacles to trade and modernize its transport and logistics system to fully benefit from the opportunities of international integration. A recent comparative exercise ranks Ukraine 73rd out of 150 countries in terms of the quality of its transport and logistics. The assessment shows that Ukraine lags its peers in the areas of customs, the quality of transport infrastructure, the ease of shipment and ease of tracking, and the quality of logistics services. Timeliness and internal logistics costs are rated more favorably (Figures Al.l and A1.2). Major physical investments will be needed to improve the situation. Ukraine has passed a concessions law that lays the basis for PPPs in the transport sector, but this framework remains untested and a comprehensive law on PPPs is under preparation. The state-owned railways has also embarked on a multi-year restructuring program that foresees corporatization, tariff rebalancing and gradual disinvestment ofnon-core assets over the next five years.
52 Figure All: Logistics Perception Index - Ukraine vs. Regional Peers Overall LPI
Internal log costs
Ease of tracking Ease of shipment
Logistics serdces
1 --c Ukraine -t*- Russia -A- Romania Kazakhstan -"AC Poland 1 Note: The scores are from one to five, one being the worst performance for the given dimension. Source: World Bank Global Logistics Perception Survey, 2006
Figure A1.2: The LPI: A Clear Logistics Gap 4.5 4 3.5 3 2.5 2 1.5 1 8.5
Source: World Bank Global Logistics Perception Survey, 2006 7. The initial adjustment to the hike in gas import prices has been encouraging, but reforms need to continue to attract private investment, improve the efficiency of the energy sector, and exploit the opportunities for greater energy trade with Europe. Despite import prices rising by 53 percent, the quasi-fiscal deficit in the energy sector actually fell as a percent of GDP in 2006, as a result of strong domestic price adjustment. Collection rates have declined in 2007 as expected, and may fall short of the levels achieved in 2005-2006. Ukraine's industrial sector has reacted to the price increase by significantly increasing investment in energy saving, one of the factors behind the revival of investment demand in 2006. While financial discipline in the sector has been progressively strengthened, inherited debts are starting to be reduced, and progress in transparency has been made with the move to cash purchases for gas and
53 auctions for power exports, and an ambitious reform agenda remains: Ukraine needs to strengthen the independence of the energy regulator, persist with tariff adjustment, re- launch privatization in power distribution and create the conditions for the operation of a domestic wholesale market. Moreover, the coal sector urgently needs to be restructured and privatized and greater transparency is required in the gas sector. These reforms carry significant political sensitivities and thus the pace of their implementation is likely to continue to be carefully sequenced.
B. PUBLIC FINANCE,PUBLIC SECTOR REFORM AND IMPROVED PUBLIC SERVICE DELIVERY 8. The tax burden is high, tax administration is cumbersome, and the structure of taxation remains unbalanced. Tax compliance costs are high as reflected in a very low ranking on the Doing Business Indicator for paying taxes, as well as in surveys of domestic enterprises, such as the annual IFC SME (Table Al.3). The lack ofa risk-based approach to tax administration imposes a high burden of inspections on all tax payers, bona fide or not. The performance of the VAT suffers on the one hand from a lack of control over fraudulent VAT registrants and on the other from wide-spread arrears on VAT refunds for exporters that act as a significant tax on foreign trade and as a source for corruption. Significant scope for tax avoidance is provided by the simplified tax system, introduced in 2003, while new tax expenditures in the form of various investment promotion schemes currently under preparation raise additional concerns 17. The current government has been working on a new Tax Code that would consolidate existing legislation and that contains a number of improvements but its future has been put in doubt by the current political uncertainty.
Indicator Ukraine Region OECD
I I Payments (number) I 99 I 46.3 I 15.1 I Time (hours) 2,085 45 1.5 183.3
Profit tax (%) 12.2 11.2 20.0
Labor tax and contributions (%) 43.4 28.7 22.8
Other taxes (%) 1.8 10.8 3.4
Total tax rate (% profit) 57.3 50.8 46.2
17 Ukraine: Creating Fiscal Space for Growth - Public Finance Review, World Bank, 2006.
54 half of the total capital budget is accounted for by subsidies and transfers to SOEs of doubtful efficiency. Net of such transfers, public investment barely exceeded 2 percent of GDP in recent years, just half of the level in the EU accession countries, and between three and five times lower than public investment in the fast growing middle income countries ofEast Asia (Figure A3). 10. While capital spending is low and its strategic prioritization is weak, other elements of public financial management have undergone important improvements. A recent PEFA report highlights recent progress, in particular, in the area of budget credibility and execution, comprehensiveness and transparency, and accounting and reporting (Figure A4). The creation of a treasury and its integration within the MoF, as well as the incorporation of all extra-budgetary funds into the national budget, were key milestones in this respect. Ukraine also has a functioning and reasonably independent external audit institution, the Chamber of Accounts, which prepares regular and public reports on public spending. However, revenue and performance audits are not yet common and internal audits, in particular within individual spending units, remains underdeveloped. Key additional weaknesses pointed out by the PEFA report relate to strategic planning and prioritization, the capital budget process, the management and control of SOEs, and the quality of the public procurement system. The latter experienced an important setback over the course of the previous CAS which is summarized in Box 4. Figure A3. Decreasing Capital Expenditures and Public Investments (Fixed) in Ukraine 2002-2005 CompaaiIJw of Cspihl Tnnrlre to Spmdnp Imb adEnkrprnrr Cornposibon of capital expenditures in Ukraine lu pwm dCDP) "1
+NewEU
~ Members Average 3 1 "1 ~--~
-- 2002 2W3 2W4 2005 2002 2003 2004 2005
Sources: MoF; State Statistics Committee; Eurostat; OECD.
11. The 2001 reform of the Budget Code transferred responsibility for the management of social assets and the delivery of most public services, including health and education, as well as municipal utilities, to the local government level. However, the tax system remained essentially centralized, and thus a formula based block grant was instituted to equalize financial resources across regions. This reform in principle laid the foundation for decentralizing accountability for service delivery to the local government level. 12. However, overlapping responsibilities and the complexity of the inter- governmental financing formula have partially offset the potential positive impact of this
55 reform. Ukraine has 24 oblasts, 2 cities with special status, 1 autonomous republic, 490 rayons and around 30,000 rural towns and settlements. The lowest of these levels is responsible for the delivery of basic services, with some higher level responsibilities located at the rayon level. But in many cases, responsibilities are overlapping. Moreover, the formula determining the size of the inter-regional equalization transfers has grown more and more complex over time, reducing transparency and re-introducing the scope for negotiation and discretion in the determination of transfers. The lack of year-to-year predictability weakens incentives for multi-year planning and can result in unfunded mandates. 13. Rigid input norms have also limited financial and managerial autonomy in public service delivery at the local level. In both health and education, service providers are regulated by centrally imposed input norms, such as specific staff/student or personnel/patient ratios, or the constitutional prohibition against the closure of health facilities. These input norms conflict with the formula-based approach to financing, but take precedence, such that capital and operational maintenance budgets need to be correspondingly adjusted. This undermines any incentives for cost savings and strategic planning and leads to chronic under-spending on non-wage costs at the local level. Key reforms, such as the move from in to out-patient and from secondary to primary care in the health sector, are impossible without a revision of these rigid input norms. The unit costs of service delivery are high, while staff motivation is low given low salaries (due to overstaffing) and lack ofreal autonomy. 14. An increasingly urgent priority for reform is the housing and utilities sector. Most of Ukraine’s housing stock is old and in a state of serious disrepair. The same is true for municipal utilities. Technical and commercial losses are considerable, while inadequate tariffs undermine the utilities’ financial sustainability and incentives for improved demand management. Few meters are installed, except for electric power. The problems ofdeteriorating housing and utility infrastructure are related. While most ofthe apartments were privatized during the 199Os, the housing stock itself typically remains in municipal ownership. Municipalities contract with a public service monopoly (the so- called “Zheks”) to maintain buildings and undertake critical repairs. In the absence of competition, service standards are low, while apartment owners are provided with few incentives to look after communally-owned assets. In this situation, the increases in municipal tariffs for gas, district heating and water naturally meet strong resistance by households, who have little opportunity to save consumption without improvements in the state of communally-owned infrastructure and the installation of meters. Perhaps equally if not more importantly, the sad state ofthe sector is a cause ofsignificant health risks due to low water quality and failing heating supply in winter, and at the same time a cost to business due to the unreliability ofsupplies.
56 Figure A4: Ukraine’s Public Financial Management Performance a. UA vs. GDP Peers b. UA vs. Regional Peers
Budget Credibility 4.0h Budget Credibility
Comprehensimness & Comprehensiveness & External Scrutiny External Scrutiny Transparency Transparency
Accounting R Reporting Policy-based budgets Accounting & Reporting Policy-based budgets
Predictability & Control in Predictability R Control In Execlition Execution
Q Ukraine fa GDP cUS$ZWO >US$IOW /~aUkraine0 ECA-UA] Sources: MoF; State Statistics Committee; Eurostat; OECD. 15. Ukraine suffers from serious environmental and public health risks but people’s awareness of these risks remains low. Ukraine’s life expectancy at birth has remained stagnant through the process of economic recovery at 62 years for men and 74 years for women. These numbers are around 11 years and 7 years below averages in developed European countries and, for men, significantly below the average for MICs. Ukraine suffers from high levels of male mortality in particular, caused by increases in cardiovascular diseases and external causes of death (injury, accidents, and poisoning). Industrial pollution, as well as stress and unhealthy lifestyles (including tobacco and alcohol abuse), are chief causes ofhigh levels ofmortality. The costs ofpollution related mortality and morbidity in Ukraine have been estimated at UAH 13 billion (around 2.5 percent of GDP).” Moreover, Ukraine suffers from one ofthe fastest rates ofincrease of HIV/AIDS infections in Europe, while Tuberculosis (TB) is also a significant concern. The population has a relatively negative perception ofthe quality oftreatment received in the health sector (according to the Life in Transition Survey, 38 percent of respondents are either very unsatisfied or unsatisfied, compared to 25 percent in EU member states and 33 percent in the CIS MICs. However, awareness of public health risks is still low and improvements in Ukraine’s health status will require efforts to increase demand for better protection from, and policy attention to, issues ofpublic health risks. 16. The social insurance and assistance system is poorly targeted and not financially sustainable. While social assistance and, in particular, the PAYG pension system has been successfwl in contributing to reduced poverty in recent years (see Section I),the targeting of this assistance to the poor has been very weak. In 2005, around 35 percent of all social transfers, including pensions, were received by households which were not in the bottom two quintiles of the distribution (Table A4). While in the case of pensions, at least 45 percent of all payments were received by households in the bottom
’*E. Strukova, A. Golub and A. Markandya (2006), “Pollution Costs in Ukraine”, Working Paper 120 (2006), Fondazione EN1 Enrico Mattei, Milano.
57 quintile, in the case of gas or housing subsidies, this percentage amounted to only 14 and 9 percent respectively. In other words, these two transfer payments were strongly regressive. As argued further above, Ukraine could easily afford to compensate the poor for the recent increase in energy prices and thus mitigate the social costs of moving towards cost recovery and financial sustainability in the energy and municipal utilities sector. However, this would require reforming social assistance payments to improve targeting. An important initial step has been the unification of social assistance claims into one application and the creation of a unified database of all social assistance claimants. Key reform challenges in the pension system are summarized in Box A1 . Table A4: Distribution of Social Transfers across Quintiles of Net Consumption Expenditure in 2005 (Percentage point distribution over consumption expenditures net of social transfer Poorest . d Richest 1st 2nd 3d 4th Pension 45.7 20.2 13.3 10.6 Social assistance to families with children 22.7 26.6 23.7 15 .8 Social assistance to poor families 37.9 32.6 22.3 4.2 Housing subsidy 32.3 18.6 19.9 16.0 13.2 Liquefied natural gas 40.9 21.9 11.0 12.3 13.9 Total social transfers 44.7 20.6 13.7 10.7 10.3
58 BOX Al.1: KEY CHALLENGES IN PENSION REFORM Like many other countries in the region, Ukraine has a PAYG pension system with several problematic features. The Ukrainian system features a conventionally defined benefit formula with generous replacement rates, low retirement ages (60 for men and 55 for women), the full old-age pension entitlement based on 20 years of service for women and 25 years for men, and numerous early retirement provisions. High contribution rates to finance this system and caps imposed on maximum pensions to keep the system in balance have discouraged compliance and led to almost flat benefits. In 2004, significant increases in the minimum pension hiked pension spending from 9 percent of GDP in 2003 to 15 percent in 2005 and the resulting pension hnd deficit, reached 3.3 percent of GDP. Since then, parametric adjustments and a conservative indexation formula have reduced pension fund spending and closed the deficit. Compliance, as measured by the share of contributions collected from the declared wage bill, has also improved. Nonetheless, the PAYG system remains inefficient (due to incentives to under-declare incomes), unfair (due to negative rates of return for contributors over the long run- replacement rates are expected to fall from the presently 45 percent to 27 percent in the long run, while the contribution rate for wage earners is 34 percent) and unsustainable over the medium-term (due to demographic developments) In 2003-2004, a series of legislation was passed introducing a multi-pillar pension system, with a mandatory fully funded second pillar. However, introduction of the second pillar has been delayed because of a provision that it can only be introduced if the first pillar is in full balance. Specific arrangements, including contribution rates into the second pillar, administrative issues, financing of the transitional deficit, and the timing of the reform, remain to be clarified by additional legislation (the corresponding Law “On Implementation of Cumulative System of Obligatory State Pension Insurance” was passed in first reading in April 2007). One concern is that the Ukrainian capital markets may not be strongly developed enough to absorb a large inflow of pension fund investments. This requires improvements in the regulation of capital markets and increases in the supply of low-risk domestic government bonds in parallel with preparations for the introduction of a second pillar. The government has also reduced the planned rate for mandatory second pillar contributions to 2 percent, which will limit initial inflows into the system. In addition to ensuring the conditions for a successful introduction of a multi-pillar pension system are in place, Government faces the additional challenge to introduce parametric changes to the PAYG system to ensure its financial sustainability over the long-term and re-establish a connection between contributions and benefits to improve fairness and compliance. Key World Bank recommendations include: (a) increase in retirement age for women, (b) reduction of eligibility for minimum pension for working pensioners, (c) better minimum pension targeting, (d) differentiation of the minimum pension level, (e) introduction of regular contribution rates for those on simplified tax regime, and (0 reduction in early retirement provisions. Implementation of these measures would provide the opportunity for a moderate reduction in the contribution rate and a more generous indexation pattern in latter years. The Government foresees a gradual and sequenced approach to these reforms in parallel with the introduction of a multi-pillar system Source: World Bank, Creating Fiscal Space for Growth: A Public Finance Review, September 2006.
59 ANNEX 2: GOVERNANCE AND ANTI-CORRUPTION AGENDA
1. Executive Summary 1. This annex takes stock of Ukraine’s progress on governance and anticorruption, formulates strategic recommendations, and draws operational implications for the Bank’s engagement in Ukraine. 2. Extensive analytic work done in Ukraine by the World Bank and other development agencies concludes that corruption poses a major developmental challenge for Ukraine. Risks to the appropriate use of Bank resource transfers are among the highest in the region, but are also capable ofbeing mitigated. 3. In order to strengthen country outcomes in the area of GAC, the Bank’s strategic engagement will be guided by the following principles in the context of its new CPS: (i) The Bank response to the GAC challenge must remain pragmatic and gradualist, linked to the emergence of country-owned initiatives; (ii)given the obstacles experienced by the Bank in the implementation of institution-building investments, as well as the lack of a broad-based political consensus around GAC reforms, addressing national-level governance reforms through full-fledged investment lending is, under present circumstances, unlikely to deliver results; (iii)the GAC agenda should instead be implemented as a cross-cutting theme through the WBG’s policy lending platform, and as design and implementation features in the investment operations for infrastructure and public service delivery. 4. These have the following operational implications for the Bank’s engagement in Ukraine: (i) Adjustment of the portfolio in the short- to medium-term towards capacity building of civil society and local stakeholders. The Bank will aim to scale-up successful pilots like the People ’s Voice project and develop further the synergies with other sectors (housing, utilities, etc.). The Bank will propose new institution- building loans to the central government beyond those already in the pipeline only when it judges prospects for successful implementation are reasonable; with reference in the first instance to needed improvements of existing lending interventions in this area. (ii) A significant amount of resources will be allocated to non-lending activities. The purpose of this work will be to strengthen and broaden demand for good governance. Among the vehicles to support this objective will be the tailoring to Ukraine’s context and dissemination of reports distilling international policy lessons, as the recent “Many Faces of Corruption” as well as continuing work with NGOs and civil society. (iii)The Bank will intensify its work with local governments, which are seen in some areas as more effective counterparts. Given that most government-provided public goods are delivered at the local level, such an approach may deliver results faster and propagate itself through demonstration effects.
60 The Bank will intensify efforts to move towards SWAPS and disbursements through the budget as a means to increase the effectiveness and efficiency ofits assistance. As implied by PEFA indicators, disbursing through the budget in Ukraine appears to be a relatively low risk and may generate benefits of greater country ownership, more efficient processing and ultimately deliver results more effectively. However, developing a roadmap toward this approach will require significant additional effort to strengthen strategic planning capacity in partner ministries and to align World Bank and country processes. To mitigate fiduciary risks in Bank operations, the strategy envisions strengthening existing fiduciary standards, such as enforcing the Bank’s procurement rules, competitive bidding, as well as adequate supervision and attention to capacity building among project counterparts. Innovative ways to track money flows and build accountability mechanisms into project design such as Public Expenditure Tracking Surveys (PETS), stakeholder involvement in project governance or independent technical audits will need to be explored on a case-by-case basis taking into account resource constraints and the need to avoid adding additional complexity to project design in the Ukrainian context.
2. Governance and Anti-Corruption Challenges In Ukraine (a) Governance as a Developmental Challenge 5. Ukraine has seen noticeable improvements in governance over time. The greater degree of political competition, improvements in government legitimacy and the functioning of basic checks and balances lay behind these improvements. However, not all of these improvements have been sustained, suggesting that some of the measurements recorded in 2005 may have been due to the initial high expectations of positive change in the aftermath of the events that came to be known as the “Orange Revolution”. 6. Nonetheless, the process of improving governance has been gradual rather than radical even after 2004 and the results have been very uneven. While progress was made in several areas of government policy, including macroeconomic and public financial management, and in the degree of transparency and accountability of the public sector, improvements have been more limited in creating strong public institutions, including a functioning and independent judiciary, and a meritocratic and efficient civil service (see also CAS CR, Annex 3). As a result, such improvements have not translated into notable development outcomes in areas such as the business environment or the delivery of public services, Overall, the quality of governance still poses a major developmental challenge. 7. Citizens desire anti-corruption reform from the state at high levels, but personally are willing to do little to combat the status quo and uproot petty corruption. The relatively slow and uneven improvements in governance since the “Orange Revolution” have left an expectations gap with regard to the accountability of
61 elected officials.” Politicians are seen as corrupt and disrespectful to the rule of law; legislators’ allegiance is seen as mainly to their parties, and not to those who elect them; civil servants, including judicial officials, are perceived to be self-serving, corruptible and unaccountable to public interest. There is widespread cynicism and disrespect for public office and public goods. Despite improved regulatory quality, the regulation of the private sector is not perceived to be for public interest, or government policy to reflect broad-based public preferences; the Government is distrusted as a public agent and is regarded as captured by the big domestic business groups. 8. While all the main political forces stress their commitment to fight corruption, their incentives to undertake the political and institutional changes that would lead to a radical improvement are more limited. Vested interests within the bureaucracy but also among the domestic business groups are strong. These interest groups may support the GAC agenda if it plays to their advantage (e.g., in access to international capital markets), but have in the past resisted faster institutional changes. Therefore, a continued gradual, muddle-through scenario is considered most likely. Against this background, the Bank’s GAC activities should not rely exclusively on high profile top- down interventions, but should also seek to strengthen the demand for good governance fi-om below. (8) Dimensions of Governance and Anti-Corruption and Policy Initiatives 9. A comparison across dimensions of governance reveals that Ukraine lags in particular in the areas of control of corruption, the rule of law and the degree of political stability. By comparing the weight of governance concerns in various existing governance datasets2’, the areas which emerge as the highest priority for Ukraine are control of corruption, establishing property rights and enforcing contacts, and legal and judicial reforms, followed measures to safeguard independence of the media, public administration and civil service reform, and further improvement of the quality of public financial management (see Table A2.1).
19 Survey results on people’s trust in public institutions can be found in the Life in Transition Survey, carried out jointly by EBRD and the World Bank. The Bank also commissioned a background analysis of recent public opinion surveys prior to preparation ofthe CPS, on which the observations here draw. 2o A detailed comparison for Ukraine was conducted using World Bank Institute Governance Indicators, Freedom House, Corruption Perceptions Index - Transparency International and Business Environment and Enterprise Performance Survey (BEEPS) indicators.
62 Table A2.1: Ranking of Ukraine’s Governance Developmental Priorities
Priority Governance Dimension Specific Probfem Areas . Control of Corruption . Cross-cutting Rule of Law Property rights enforcement High . . . Political Stability/ No . Judicial framework/ Violence independence Media independence . Quality ofpublic administration Voice and Accountability Strengthening local governments Medium . . . Government Effectiveness . Efficiency of revenue mobilization (tax policy and administration) I Low I Regulatory Quality Source: Bank staff based on Transparency International, WBI Governance Indicators, BEEPS, and Freedom House. 10. Corruption is a significant obstacle for doing business. According to the Corruption Perceptions Index for 2007 (TI), Ukraine ranks 118th (out of 179 ’igure A2.1. Control of Corruption countries) placing it among the most corrupt countries in Europe and its immediate neighbors. Ukraine’s ranking compared to 2006 deteriorated by around 20 places, as other countries showed significant improvements. This is also confirmed by the 2007 WBI Control of EE 8 BALTICS Av Corruption rating (Fig&. 1). Middle- and high-level corruption is most frequently noted in relation to business licenses, permits, tax collection and customs. The 0 25 50 75 10 OECD2’ finds corruption in Ukraine to be Country’s Percentile RankftDO) 0 a significant obstacle to doing business for the past 15 years. Other surveys indicate that corruption exists in every public WGI, WBI, 2007 institution, including- law enforcement Source: bodies, the Prosecutor’s Office and the Judiciary, as well as local authorities. However, the World Bank and the EBRD BEEPS reveals some positive changes since 1999, both in the extent of petty corruption at the enterprise level and in the extent of capture of legislators and government officials by private interests (Table A2.2).
21 The Anti Corruption Network for Eastern Europe and Central Asia (ACN) of the OECD.
63 Ukraine CIS Countries 1999 2002 2005 1999 2002 2005 Bribe frequency 39.1 34.9 27.5 34.7 31.9 26.9 Bribe tax (in Dercentage of sales) n/a 2.2 1.5 da 2.0 1.4 Time tax (in percentage of sales) I n/a I 11.2 9.1 da 8.2 6.1 Impact of private payments to legislators I 43.7 I 4.7 3.5 30.2 3.0 3.1 Impact of private payments to government officials 36.9 5.2 3.7 26.4 3.4 3.2 Corruption as obstacle 24.2 27.8 22.6 29.8 19.5 17.3
*’The Commission consists of 18 high level officials (Ministers, and heads ofagencies), representing the Presidency, Prime Ministry, Parliament, Security Service, Foreign Office, Prosecution Service, the Ministry ofthe Interior, the Ministry ofJustice etc.
64 (c) Public Sector Governance Assessment 14. The governance of Ukraine’s public sector is hampered by limited capacity for strategic planning, overlapping and extensive administrative functions, the lack of a de-politicized, professional civil service, and constitutional ambiguities that have contributed to repeated political crises. Ukraine’s bureaucracy is large and the public sector consumes almost half ofofficial GDP. While Ukraine has maintained, through the painful transition process a relatively strong state and capable bureaucracy, it has so far failed to modernize most public institutions in line with the requirements of a market economy (with some notable exceptions such as the NBU). The civil service is poorly remunerated, appointments are not always made on a meritocratic basis, and frequent changes in senior positions have hampered planning and policy-making. While key public services are delivered at the local level, the framework for local government autonomy and accountability is weak and implementation of central policy decisions uneven. 15. Despite overall institutional weaknesses, Ukraine’s public sector boasts some notable strengths. In particular, Ukrainian public financial management institutions compare favorably with those of regional and lower middle-income peers.23 The budget is comprehensive and credibly executed, it is adequately discussed and reviewed by parliament, cash management is strong and fiscal risks are on the whole managed well. Weaknesses relate to the control of implicit fiscal risks in the non- budgetary public sector, including SOEs, the management of payroll, the auditing of revenues, and crucially, the management of public procurement. In addition, the government’s capacity for medium term budget planning, including prioritization of public investments, and the integration ofthe budget into a medium-term macroeconomic framework are under-developed. The coordination and management of donor assistance is poor. 16. Centralized internal financial control is adequately functioning in the present public administration; however, it does not yet meet EU standards. At present, two central institutions are involved in internal financial control: the State Treasury of Ukraine (STU) and the State Control and Revision Office (KRU). The STU carries out ex-ante control and ongoing controls on cash payments. These controls often do not guarantee sufficient financial discipline and there are still many breaches of laws and regulations. The system does not stimulate managerial responsibility and annually the KRU can only cover one-third ofthe total number ofstate budget entities. 17. External audit in Ukraine generally meets the requirements of international standards, in particular with regard to independence and audit remit. For ten years since it was established, the Accounting Chamber of Ukraine (ACU) has achieved substantial progress in all aspects of its activity, in spite of the difficult operational environment. However, further reform will require transforming the role of the body from a controlling to a financial management one. This will require strong political support at senior government level in a manner that will also assure its continued independence from the executive.
23 See Public Financial Management Performance (PEFA) report, 2006.
65 18. A particular concern in the government’s fiduciary framework is the procurement system. As described in detail in the World Bank’s recent CPAR (2006), following legal amendments in 2004, 2005 and 2006, the public procurement system has become fragmented, beset by conflicts of interest, and lacks oversight by the central government. New legal amendments have been drafted to address the concerns raised collectively by the donor community, but not yet adopted by the parliament. 3. GAC in the Bank Program and Fiduciary Risks Mitigation (a) The Bank’s Governance and Institutional Reform Effort 19. The limited effectiveness of past interventions to help address the GAC agenda, through assistance for institution-building, requires a recalibration of the Bank’s approach. The previous two CASs addressed key development constraints- institutional weaknesses and poor governance-and were consistent with the government’s objective^.^^ The Bank’s diagnosis about the centrality of the governance and institutional reforms was accurate and valid. The Bank’s effort reflected a broad agenda, supporting the demand and supply side of governance simultaneously, including strengthening civil society and improving accountability and transparency of the government. Progress has been slower than expected, partially because efforts to build new institutions take time, but also because the government’s willingness and commitment to deliver faster progress in this area were overestimated. 20. This suggests that the Bank’s institution-building efforts should begin by improving the implementation of existing lending operations and increasing the use of non-lending instruments to build greater demand for improved governance. The current portfolio in this area includes a State Tax Modernization project, and a Statistical Development project, as well as a Public Finance Management project and a Judicial Support project under preparation. In addition, there is one active operation and one under preparation to reform the institutions providing social assistance and security in Ukraine. 21. The progress achieved in public finance management to date may provide an entry point for public sector reform and improved governance. The Bank program supported significant PFM reform to improve budget operations and its outcomes have been recognized as positive. Modern budgetary institutions and practices (treasury, budget code) were established and the Bank’s effectiveness has benefited from the steady relations with the MoF. 22. Building on these achievements, the second pillar of the current CPS is built around the theme of Strengthening Public Finance. This builds on key analytical reports such as the CEM, a CFAA and CPAR (2006), the PEFA report (2006), and PFR (2006). These reports provided policy recommendations on public sector governance that were incorporated in subsequent lending operations. For example, PFR and the Public Financial Management project under preparation will assist the Government of Ukraine
24 Their consistent themes were: (i)achieving sustainable economic growth and integration into the world economy; (ii)restructuring the public sector, and achieving improved transparency and accountability; and (iii)poverty reduction, comprehensive human development, and reduction of regional imbalances.
66 (GoU) to use the budget as a strategic instrument of reform and to implement a Medium Term Expenditure Framework (MTEF). (b) Fiduciav Risks and Mitigation 23. The Bank’s FM monitoring consistently recognizes Ukraine as a “high risk” country that posses significant fiduciary risks. A Figure A2.2. All ECA-Ukraine Risk-Band significant portion (23 percent) of the active investment projects are rated “high risk” (see Fig. A2.2) compared with the ECA’s regional average (9 percent). An internal analysis High Risk by Bank staff of the Substantial Risk vulnerability of the portfolio to Moderate Risk corruption carried out in 2006 Low risk did not reveal project fiduciary ECA Ukraine risks to be at prohibitive levels. The analysis confirmed that on nearly every dimension of the anticorruption infrastructure, Source: RAPMAN-PRIMA as of October 2,2007 Ukraine compares unfavorably with the new EU members and with the group of large middle-income countries, while compared to other CIS countries, Ukraine compared favorably. 24. The Bank declared misprocurement only once, back in 1999, and one case has been recently referred to the Department of Institutional Integrity. Procurement post-reviews have mostly revealed relatively minor issues. Some projects are judged to be more vulnerable to corruption, and irregularities found in two projects appear to stem from bad management rather than fraudulent intent. The relatively strong performance of Ukraine’s public financial management in recent studies suggests that it is appropriate for the Bank to continue the process of increasingly aligning its project implementation arrangements with country systems, provided those areas identified as weak are addressed, and additional capacity is deployed in selected areas. The policy reversals in public procurement noted elsewhere in this report will prevent the Bank from significant use of country procurement systems for the time being. As a risk mitigation measure, all high risk projects identified by the fiduciary team will be subject to a joint fiduciary review (Le., FM together with procurement and disbursement) once during the lifetime of the project. 25. The Bank has supported the design of an internal control system, and is providing assistance to the GoU in redesigning the role of the two agencies with an external control mandate (the Accounting Chamber and the KRU) consistent with accepted EU principles. The challenge is to move beyond compliance to performance audits, which will require improvements in the government’s internal monitoring and evaluation framework and in strategic planning capacity. Recognizing that implementation is key for developing such capacity, the Bank will invite the Accounting
67 Chamber to conduct performance reviews on selected Bank financed projects during the period ofimplementation ofthe new CPS. 26. Additional efforts to improve fiduciary controls at the country level are needed, with a focus on public procurement, the governance and management of state- owned enterprises, and in strategic planning and capital budgeting. The 2006 PFR identified major constrains to proper capital budgeting in Ukraine. The Bank has been increasingly emphasizing, as a strategic objective the building ofdomestic ownership and reducing transaction costs by a gradual integration of its projects into country systems. However, to do so effectively will require advances in public fiduciary controls as well as the planning and execution ofthe public investment. 27. The Bank will continue to strengthen the assessment of procurement risks earlier in the project preparation cycle and mainstream participatory oversight in the procurement processes (see section 4(a) below); however, its longer-term goal will remain working with the Government and other donors on improving the national procurement system. This effort will be directed at meeting the internationally recognized standards for efficiency and transparency such as adopted by the Baseline Indicators Tool.25 4. Bank’s GAC agenda for Ukraine and Entry Points for 2008-2011 28. The overarching objective of the Ukraine country GAC activities will be to assist in developing institutions - national and local - which function on a participatory, fair, transparent, accountable, and efficient basis. The immediate objective is formulated to underpin and strengthen the implementation of the CPS (FY08 to FYI 1) aiming to sustaining high economic growth, improve competitiveness, public sector reform and service delivery. 29.The main points of entry will be through further enhancement of country systems in particular public financial management, integration of GAC in sectoral projects and programs, and through strengthening of the anticorruption measures in project design. Specifically, the Bank’s engagement on the three levels - project, sector and country - will be as follows: (a) Project Level: Mainstreaming Project Anti-Corruption Plans On a project level, the GAC work will focus on improved fiduciary controls in line with the corporate GAC agenda; pilots on using communications to address governance concerns; and exploring new accountability mechanisms in project design and implementation. Improving existing fiduciary controls will begin by identifying each project’s main vulnerabilities to corruption overall and separately for each major component. An improved management review process for fiduciary risks within the ECA Region will be
25 E.g. see the World Bank / OECD DAC procurement initiative adopted by the “Johannesburg Declaration” in 2004 and the 2006 OECDIDAC Benchmarking Tool under development which provides the methodology for application ofthe baseline indicators and associated compliance and performance indicators.
68 applied. A Fiduciary Committee established at the level of the country team a year ago will continue to address fiduciary risks and concerns. Additional training will be provided to the staff of implementing agencies. Opportunities will be sought where appropriate for more detailed anti-corruption activities focused on better standards, code of conduct, improved financial management, transparency, and enhanced public oversight. These activities will include greater transparency and accountability through the publication of project reports, and the active engagement of civil society and community members. New accountability mechanisms may include representatives of civil society groups attending public bid openings and contract signings; inviting civil society observers from local universities or other independent institutions; technical assistance to NGOs for monitoring government anti-corruption efforts; or establishing a working group to oversee progress of the anti-corruption reforms. Moreover, the Bank will explore strategic cooperation opportunities between project teams and EXT for the use of communication as an essential tool of increasing transparency on the use of Bank delivered resources. An example of innovative community monitoring mechanisms which could be adapted to World Bank lending operations is the People’s Voice project, active in currently six cities in Ukraine (Box A2.1). (b) Sector Level: A Focus on Risks and Opportunities for GAC in Infrastructure Existing analytic work shows that the sources and nature of corruption differ by sector. Bank engagement will therefore be adapted to respond to each sector’s GAC environment. In the area ofpublic service delivery, this will include local accountability mechanisms, as appropriate. Pilot programs are planned on advocacy work in health, housing and environment, which could be also expanded to education in later CPS years. Governance risks in infrastructure deserve particular attention, since the bulk of additional lending during the CPS period is planned in this sector.26 Corruption in infrastructure and related services is reported on all levels, from meter readers, paying extra for connections to jump a queue, to a “10-percent-rule” at ministerial level (grand corruption). Corruption in infrastructure affects negatively the quality and cost of infrastructure services; the public is robbed by being charged for low quality or non- delivered services or services it does not need. In addition to collusion among bidders, infrastructure projects are especially vulnerable to change order schemes and the use of inadequate and inferior materials. Efforts to mobilize private financing for the major new construction projects may lead to collusion between private investors and government officials and non-competitive solutions, adoption of overly optimistic demand projections, and the assumption of excessive commercial risks by public entities. Construction licenses and permits are among the biggest sources oflocal-level corruption
The most common causes for the high incidence of corruption in infrastructure are: (a) the scale of the fixed investments required; (b) procurement of large contracts procurement; (c) the presence ofnatural and artificial monopolies generating large rents; (d) the management of large equipment and civil works contracts by government agencies (licenses, permits and registration requirements); and (e) fixed investments vulnerable to expropriation.
69 BOX A2.1: PEOPLE’S VOICE PROJECT
The People’s Voice project is a technical assistance project (funded by the Canadian government) that has supported the facilitation of citizen engagement activities in six cities in Ukraine (Makiyivka, Chernihiv, Komsomolsk, Lutsk, Alchevsk and Kolomyya) with a focus on municipal governance and civil society development. The main thrust of the project has been to improve local service delivery by building the capacity of municipal officials to identify solutions to local problems that are identified through “citizen report cards”. The project has sought to develop standards, procedures, structures, and skills of local partners through the facilitation of a series of project activities (training, regional workshops, research, etc.) so that municipalities can become economically self-sufficient and so that various citizen engagement mechanisms can be sustained over time, including: creation of project stakeholder committees so that ideas are shared, areas of common interest are identified and future project planning is agreed upon by local partners; building of local research capacity of NGO partners so that they can conduct their own research and carry out the monitoring of service delivery; creation of focal points for citizen engagement, such as community foundations and condominium associations; and development and distribution of best practices, in the form of guidelines and publications, so that methodologies can be accessed as a resource throughout the country and replicated in other cities. Beyond the local results associated with the citizen engagement efforts, the project has brought about change in local service improvements, with three main themes having emerged involving both the vertical and horizontal integration of project activities and trends: (1) development of IS0 9000 systems; (2) reforms in the communal housing sector, and (3) modernization of the social assistance system. Many of these efforts are now being integrated in national policy efforts and adapted in other Ukrainian cities.
30. Governance risks in infrastructure deserve particular attention, since the bulk of additional lending during the CPS period is planned in this sector.27 Corruption in infrastructure and related services is reported on all levels, from meter readers, paying extra for connections to jump a queue, to a “10-percent-rule’’ at ministerial level (grand corruption). Corruption in infrastructure affects negatively the quality and cost of infrastructure services; the public is robbed by being charged for low quality or non-delivered services or services it does not need. In addition to collusion among bidders, infrastructure projects are especially vulnerable to change order schemes and the use of inadequate and inferior materials. Efforts to mobilize private financing for the major new construction projects may lead to collusion between private investors and
27 The most common causes for the high incidence of corruption in infrastructure are: (a) the scale of the fixed investments required; (b) procurement of large contracts procurement; (c) the presence of natural and artificial monopolies generating large rents; (d) the management of large equipment and civil works contracts by government agencies (licenses, permits and registration requirements); and (e) fixed investments vulnerable to expropriation.
70 government officials and non-competitive solutions, adoption of overly optimistic (see Box A2.2).
Box A2.2. ADDRESSINGGAC IN INFRASTRUCTURE Moving beyond deterring corrupt practices and towards devising preventive safeguards and actions, by improving client’s control frameworks, accountability environment and ensuring adequate FM system for implementation. “Ring-fencing’’ project risks is a limited solution - it is needed in particular cases but often is not sufficient to mitigate risks emerging from institutional weakness of project implementing agencies and the authorizing environment. The challenge here is to mitigate the risks of working through the country’s systems (FM, procurement, judiciary, property rights, contract enforcement) by strengthening these systems in the process. One of the key lessons from the Bank infrastructure program is that achieving this objective critically, depends on the selection of the project implementing agency based on its clear commitment to technical and governance excellence, and providing support under the project for capacity building in project management, procurement and FM. Finding innovative solutions in applying results-focused and participatory approaches and third party-monitoring to project preparation and implementation by working with a broad array of stakeholders and civil society. Engaging civic groups in social accountability mechanisms (control and oversight) in the sectoral policy reforms in energy and transportation and project implementation will strengthen the demand side for good governance. Lack of competition is one of the root causes of poor governance. In infrastructure, Government is often the sole provider of infrastructure services. Therefore, it is all the more vital to engage citizens in the decision-making process through feedback mechanisms such as citizens report carts (CRCs) seeking feedback on public service quality, policy formulation, specific projects and alternatives. Innovative infrastructure projects would aim to build-in such demand-side feedback mechanisms and provide technical assistance. A recent example of such collaboration is the preparation of the Urban Infrastructure Project in cooperation with the People’s Voice Project (PVP), and piloting the integration of GAC communication actions along the entire project cycle of the Dniester Pump Storage project. On the supply side, encouraging the project implementing agency and the government agency responsible for project oversight to conduct regular public consultations on key features of the project (including use of funds) would go a long way in improving transparency and encouraging openness in the dialog between project entities and civil society. Apply integrated analytical (e.g., governance assessments and governance outcome assessments) and advisory approach advocating sector-wide reforms and assist the government with replacing corruption-prone and “rent-seeking” business models by providing empirical evidence; complement the work to be done through the DPL series, on establishing checks-and-balances for institutional separation of the government’s policy- making, regulatory, and ownership functions; strengthening the financial and administrative independence of the regulators (e.g., NERC); establishing arms-length relationships between the government and infrastructure service providers; strengthening competition among suppliers and thus reducing the bribe tax; advocating rule-based, transparent regulation limiting the discretionary power of regulators and regulatory “capture.” A broad dissemination of the analysis and advice in these areas is an important element of rising awareness and broadening and consolidating support for the governance and anti-corruption agenda.
71 (c) Country Level: Bridging the Expectations Gap through Advocacy Work 3 1. Addressing the expectations gap in the relationship between citizens and the state underpins the country-level strategy for Ukraine. To bridge this expectation gap, the Bank at the country level will emphasize activities that generate demand for reform. 32. A shift to supporting demand for good governance will imply adjustment of the portfolio in the short- to medium-term towards greater emphasis on activities supporting such demand, with relatively less emphasis on investment loans to support supply side improvements in public sector institutions. A significant amount ofresources will be allocated to advocacy activities, such as disseminating and tailoring Ukraine’s environment the recent “Many Faces of Corruption” report and continuing work with NGOs and civil society. Advocacy will be a prominent dimension ofthe CPS. 33. Given that most government-provided public goods are delivered at the local level, opportunities will be sought to work directly with reform-minded local authorities. Such an approach is expected to deliver results, including through demonstration effects. The Bank will use non-lending services, such as the Zaporizhzhia environmental technical assistance or the People’s Voice project, to help build capacity at the local government level and strengthen accountability mechanisms by working with civil society. Where possible, this will be combined with investment lending for the upgrading of municipal infrastructure to achieve a maximum degree of synergy. IFC would play a particular role as a provider of non-guaranteed funding to local governments and private investors, and as an advocate for enhancing private investment opportunities by improving local governance. 34. The private sector is both a victim and an instigator of bad governance. It plays an essential role in the development of self-regulatory and self-policing mechanisms to eliminate malpractice and corruption. Recognizing this role, the CPS proposes to intensie the dialogue with the private sector on GAC issues, seeking to build coalitions for reform with those representatives for whom improvements in governance make good business sense. Indeed, the further integration of Ukraine into the global economy and international institutions demands compliance with high standards of transparency and competitive rules and regulations. The business community can be an important advocate of harmonizing domestic regulations with international standards, particularly those businesses for whom these regulations are already known from their international activities. 35. The Bank will seek to highlight governance shortcomings through its diagnostic tools and regular business surveys. The BEEPS (scheduled to go into its fourth round in 2008) and the annual IFC SME surveys, are potentially useful tools to reach out to business representatives and to the public at large and demonstrate the costs ofcorruption and governance weaknesses. 36. Issues for Bank’s advocacy in support of private sector GAC are: (a) further strengthening of different international and national initiatives promoting private sector integrity anti-bribery preventive mechanisms; (b) work with the State Committee on Financial Monitoring (SCFM) on upgrading the technical capacity of the AMWCFT
72 Center and its role in the Eurasian anti-corruption network; (c) assist the private sector with initiatives to improve the business environment - e.g. ensuring competitive conditions for infrastructure investments, regulatory reforms, urban local governance reforms; (d) assist the private sector with self-evaluation and reporting in the absence of overarching control standards -- from voluntary company code of ethics towards setting up integrity systems and compliance programs in accordance with international standards and approaches2*; (e) strengthen the corporate governance in SOEs, and the implementation of transparent accounting standards (such as IFRSs, IPSAS). The Accounting and Auditing ROSC29has made targeted recommendations for reform, which will be taken forward by a National Steering Committee, led by the MoF and supported by the Bank. 37. The Bank will continue implementation of the existing portfolio and support policy changes through the DPL program. The Bank will support efforts to reinforce public sector efficiency, strengthen public finance management oversight and monitoring, improve taxation and public administration, and reduce arbitrariness of public policy decision-making. Sustained reform in these areas is central for making headway in linked areas such as competitiveness, infrastructure policy, and public service delivery. This engagement will need to be balanced with the need to recalibrate the DPL program to take account of the more gradual pace of policy change (the DPL design had anticipated decided acceleration in governance reforms in 2005). 38. As outlined above, the Bank will continue to provide support to strengthen the country’s own fiduciary systems through technical assistance and regular dialogue and support key reforms, including public internal controls, oversight, improving SA1 roles and capacity. This engagement, begun under the 2003-2007 CAS, will continue to align implementation arrangements for Bank supported activities with Ukrainian systems and processes. Close coordination with other donors, including importantly the European Commission, will be a feature ofthis work. 5. Donors, Partnerships and Communication 39. Donors’ assistance in relative terms is small3’, donor leverage over the Ukrainian institutional environment is quite limited and donor coordination requires improvement. Donors face a major challenge in lending support to the Government, before the emergence of political consensus and stable institutions. The current fragmentation of government agencies engaged in development activities, and uneven
28 E.g. Social Accountability International (SAI) Principles for Countering Bribery; OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions; the ICC Rules of Conduct to Combat Extortion and Bribery and the anti-bribery provisions of the OECD Guidelines for Multinationals; initiatives, such as “Extractive Industries Transparency Initiative” (EITI); the “Equator Principles”, as a baseline on environmental and social procedures; the “Wolfsberg Anti-Money Laundering Principles” as international standards to fighting money laundering in the financial services sector. 29 The Bank has recently updated the Accounting and Auditing Report on the Observance of Standards and Codes (A&A ROSC), which assesses the statutory framework and drivers ofquality for financial reporting in the corporate sector. 30 Currently the size ofthe ODA is less than 3% of total government expenditures.
73 coordination among the donor community limit the absorption capacity of the country and create costly duplication and overlaps. 40. Many donors have adjusted their assistance to the modest pace of change and are emphasizing advocacy, capacity building of civil society, training of public officials and the provision for national debate3'. The Bank's GAC agenda is aligned with the strategic priorities of major donors, including the European Institutions (EC, CoE, EIB, EBRD) and the United States Agency for International Development (USAID). Table A2.3 summarizes current donor assistance in the GAC area. Table A2.3: Donor Assistance to Ukraine for Governance and Institutional Reforms m .;3 E
Public Sector reforms, Governance and Decentralization PA and Governance Reforms BD BBB BBBD Local Government BD. BD Tax Administration BB BB Civil Society BBBB Economic Management and Planning Economic Macro-stability Statistics Technical Support and Advice DBDB mm Rule of Law Judiciary BB BD Property Rights a. BB Security and Police BB Private Sector Development Corporate Governance DB Investment Climate BBB SMEs DBD B BB
Regulatory Reforms BD B
Infrastructure Energy BBB Transport BBB wss BD Municipal Management BB BBD Social Sectors Health BBD Education BD Social Service Social Protection BDB
41. Communication. Over the implementation period of the next CPS, the Bank will aim to widen its reach to a broader audience of public and private sector entities, sub-
31 The technical recommendations in the OECD SIGMA Report (2007) provide the menu for such support.
74 national government, judiciary, and civil society assisting these actors with anti- corruption campaigns or supporting initiatives by civic groups which favor increased transparency that reduces opportunities for corrupt practices and fraud. At the same time, the Bank will increase the transparency of its own activities by strengthening its website and general EXT program. 6. GAC Results Monitoring and Reporting 42. The GAC results are included in the CPS matrix and will be monitored together with the achievement of other CPS results. Thereby, as the matrix of development outcomes in Annex 7 makes clear, GAC goals to be contributed by the CPS have been specified modestly with an aim to measurability and realism. Ukraine’s long-tern development objectives include the harmonization ofits institutional framework with best international practices and the country’s closer integration with the EU. The achievement ofthe modest CPS goals will be one milestone on the path towards this endeavor.
75 ANNEX 3: CAS COMPLETION REPORT (FWO4-07)
I. INTRODUCTION
1. This Country Assistance Strategy Completion Report (CAS CR) takes stock of the effectiveness of the FY04-FY07 Bank assistance to Ukraine and draws lessons for the preparation of the forthcoming CPS. The review takes a medium term look at the program, given the high degree of continuity between the FY00-FY03 and FY04-FY07 CASs. For the preparation ofthis CR, the team has: Examined the alignment between the CAS design and‘the stated objectives ofthe government program; Reviewed progress towards long-term development objectives ofthe country; Reviewed progress made with Bank support in the implementation of the program; Reviewed documentation; 0 Interviewed staff; and 0 Drawn lessons. 2. This report benefited from discussions with the IEG team that worked on the Country Assistance Evaluation (2007) and several reviews undertaken during CAS implementation, such as the CAS Progress Report (2005), and internal staff reviews of investment lending performance (2005), corruption vulnerabilities (2006) and political economy and governance (2007). IFC coverage in this report draws upon the findings of the IEG-IFC Country Impact Review (CIR, 2007).
11. LONGTERMDEVELOPMENT OUTCOMES
3. Ukraine’s long-term development outcomes during this CAS period compare favorably with the expectations set by the government program--“European Choice (2003). ” The CAS put forth a summary set of indicators to assess progress in reaching the long-term development outcomes under the “European Choice” agenda. Table 1 of this document compares them with the results achieved.32 The comparison shows that, despite an ambitious program, the majority of the long-term development targets have been met. 4. Economic growth exceeded expectations. Economic growth, at 7.8 percent per annum from 2003-2006, exceeded the expectation of 5 to 6 percent set under the CAS. Deterioration in the terms of trade and curbed investors’ confidence, brought about by a series of political realignments and changes of government, slowed down economic growth in 2005 to 2.7 percent. Since then, economic growth resumed-it was 7.1 percent in 2006 and is forecast by Bank staff to reach 6.5 percent in 2007. Growth is likely to be above 5 percent for the medium term. With hindsight, observers would seem to have consistently underestimated the potential for economic recovery and growth in Ukraine.
32 Table A3.1 corresponds to Table 3, page 18 of the CAS. This table itself is a summary of a broader set of results expected under the government program and presented in Appendix B-9 of the CAS.
76 Often institutional reform has been linked too tightly with short-term economic performance. In fact, the economy had sufficient room to grow despite the slow pace of institutional reforms overall, while key institutional bottlenecks, such as soft budget constraints, the barter economy, and lack offiscal policy credibility, were removed by the authorities in a timely fashion.33 5. The market has rewarded the strong fiscal position of the government. The objective to reduce external public debt was met handsomely: at 15 percent of GDP, public external debt is now below the ceiling set by the government program (40 percent of GDP).34 A relatively tight fiscal policy, on average, and rapid economic growth, helped lower the external debt burden. The grading of sovereign paper in international financial markets has improved. Standard and Poor’s and Fitch both rate long-term sovereign debt of the government at BB-. Political stability is the main concern of investors today. Moody’s recently increased its rating to B1 from Ba3, after conducting a thorough review of the banking sector.35 The government has easier access to international financial markets. For instance, it placed in June 2007 US$500 million dollars in five year bonds at 6.385 percent. The tight fiscal position and the stable exchange rate have contributed to a reduction of inflation. Recently, however, the sharp increases in energy prices have pushed inflation back into double digits. The level of international reserves stood at around US$26 billion at the end of June 2007, which was equivalent to around four months ofimports. 6.Thefinancial sector is stronger and deeper, although there are still risks. The growth and deepening of the financial sector also proceeded at a pace faster than had been foreseen. Credit to GDP went from 26.6 percent in 2003 to 48.4 percent in 2006. The ratio of deposits to GDP went from 17.1 percent to 33 percent. Competition, both domestic and foreign, has made the sector stronger. A process of bank consolidation is underway. The result ofthis competition has been a decrease in the in the intermediation margins for loans in local currency (from 9.9 percent in 2003 to 7.2 percent in 2006.) This said, however, there are concerns that the rapid growth of credit in the economy may be weakening bank portfolios and that the exposure of the banking system in foreign currency may be too high. However, the high level of international reserves provides a cushion to manage swings in financial investment preferences. 7. Poverty dropped rapidly over the CASperiod. There has been a significant reduction in the poverty rate; poverty levels now stand at 8 percent of the population, low by any standards.36 In addition, in line with the government program, poverty decreased among critical groups like the elderly and the rural population. Salaries increased by 77 percent
33 The Country Partnership Strategy (CPS) for FY08 through FY 11 presents this point in greater detail. 34 It should be noted, however, that implicit public liabilities in the pension system as well as in the so- called lost savings of the former Soviet Sberbank are considerable, if contingent - see Public Finance Review (2006). 35 At the beginning of the CAS period, the Fitch rating was B+, S&P B, and Moody’s B2. 36 Ukraine: Poverty Update, World Bank Report No. 39887-UA, June 2007. This Report measures poverty against an absolute poverty line, calculated to provide the minimum ofcalories plus an allowance for non- food goods and services.
77 during the CAS period, above expectation^.^^ The real increase in pensions was 34.8 percent in 2004 and 28.9 percent in 2005. The rapid increase in salaries combined with increases in social transfers (pensions and assistance) largely explains the decrease in poverty rates. 8. There have been improvements in the education system although quality remains a concern. The coverage of pre-school education is much broader now, although it still lags in rural areas. In addition, enrollment and completion rates in secondary and tertiary education are higher. Around two thirds of the 18-21 year cohort is enrolled in higher education. However, the educational system does not seem to be providing either the skills or the quality needed by the labor market. That said, there is keen awareness that the country needs to improve education outcomes to sustain a pattern ofhigh productivity growth. 9. Progress on health has not met national expectations. The country met the targets the CAS set on maternal and child mortality. However, life expectancy has not recuperated from the substantial drop early during the transition process and the wedge between male and female life expectancy is well above EU or middle income country averages. A key concern in health and education is the emerging gap in the quality of service delivery between rural and urban areas. Regretfully, the fight against TB and AIDS incidence has stalled; and indicators have actually worsened. 10. Ukraine is more integrated into the rest of the world. The growth of trade (both exports and imports) exceeded GDP growth over the CAS period. The EU and the US have declared Ukraine a market economy, Ukraine is close to joining the WTO, for which goal successive governments across the political spectrum have pushed through a sometimes controversial legislative agenda. The objective ofjoining the WTO has been a key driver in achieving institutional change. However, Ukraine has made little progress over the CAS period in the geographic diversification ofexports. The share oftotal trade with the EU has remained roughly constant at around 30 percent between 2002 and 2005, while Russia’s share has recently been growing thanks to buoyant demand in Russia and rising import costs ofRussian energy supplies. 11. There have been gains in governance in selected areas, in particular, voice and accountability and transparency. Various international rankings (WBI, TI) register these gains, although Ukraine stills ranks low on governance for its level of income. The quality of public financial management has improved. Progress towards the intended objective of moving Ukrainian public institutions to European standards, however, has been slow. Even though Ukraine ranks above the mean within the CIS community, it falls behind countries with similar incomes elsewhere in the world.
31 The rapid increase in salaries was supported by a high rate of increase in labor productivity. Still, competitiveness as measured by unit labor costs in foreign currency has decreased.
78 Supporting Macroeconomic and Finan cia1 Sustainability. Annual growth rate at 5-6 percent; Annual growth rate 7.8 percent between 2003- Public debt within safe limits (below 40 2006 percent) Public debt to GDP 15 percent Increased financial depth of the economy. Deposits to GDP increased from 17.1 percent to 33 percent Poverty Reduction, mitigation of Social Risks, and strengthening of the middle class. Poverty head count reduced from 27.8 to Poverty headcount at around 8 percent 23.8 percent. Real salaries increased by 77 percent in real terms. Living standards of working population improved. Comprehensive and Harmonized Human Development Child mortality under 5 reduced from 13.5 Child mortality under five 12.9 per thousands in to 12.8 per thousands. 2005 Enrollment and completion rates in Enrollment rates in secondary education 99.2 secondary education increased; percent Share ofpopulation using drinking water No data on water quality available that satisfies national standards to exceed 88 percent in urban and 54 percent in rural. Protection of the Natural Environment C02 emissions per capita reduced C02 emissions per capita increased from 5.8tlpc in 2000 to 6.42 in 2004, but decline per $ of GDP in PPP from 1.41 t/ 2000 $ to 1.09 t/ 2000 $ First Emissions Reduction Purchases Agreement (ERPA) under Kyoto Protocol signed Gradual Integration into the into the World Economic and Financial Systems Progress with adoption of EU Economy given market status by EU and US requirements; Country close to joining the WTO Share of EU trade in total trade increased. Share of trade with EU constant at 30 percent between2002and2005. Dynamic Regional Development and Reduction of Regional Differences Per capita income variations across regions Systems ofbudgetary transfers improved, but reduced varying rates ofeconomic performance may have increased regional disparities Integrity of Public Governance Public Policy Developments and Significant improvement in voice rankings in the coordination process approaches EU WBI and TI indicators standards Elections seen as free and fair, significant freedom Enhanced role ofcivil society in for media operations and public expression monitoring and assuring public sector Targeted reforms of MoF and Customs accountability Significant improvements in management of public finances, as measured by PEFA Satisfactory implementation ofPeople’s Voice project Note: The left-hand side column presents the expected long-term development outcomes (Table 3, page 18 CAS); the right hand side of the current situation.
79 111. GOVERNMENT’S STRATEGIC GOALSAND CAS DESIGN
12. The 2003-2007 CAS supported the government program titled “European Choice”--a commitment to European-like institutions in Ukraine. The Bank discussed the content of the CAS with the government, the Parliament and with civil society. In addition, the CAS design took account of the lessons derived from the previous CAS.38 The 2003-2007 CAS organized expected results around the seven pillars of the government program in order to acknowledge ownership and facilitate the policy dialogue, 13. There was continuity between the FY00-FY03 CAS and the FY04-FY07 CAS. Most importantly, the emphasis on the demand and supply aspects of institution-building continued to be at the core of the program. On the supply side, the CAS maintained the focus on completing the institutional set-up needed to move Ukraine towards a market economy and to ensure the basic welfare ofthe population. The CAS added emphasis on the move towards European levels of institutional performance and the accession to the WTO as important drivers for the demand for institutional change, as indeed has been the case. It retained the commitment to work with civil society. 14. The government that came in following the events known as the “Orange Revolution ” put forth its own development agenda under the title of “Meeting the People. ” This strategy re-emphasized the country’s commitment to European institutions. The move to European institutions gained credibility as the program of the government focused on improving public sector governance and transparency. The Bank prepared the CAS PR after the inauguration ofa new President and appointment ofa new government in 2005. It introduced adjustments to the lending and AAA programs, but broadly maintained the results structure of the original CAS program. The WBG supported implementation of the government program with adjustment lending (DPL), extensive analytical work, and dialogue. 15. Since the CPR, the Bank has gradually realigned its mode of assistance by increasing focus on sector agendas in areas such as infrastructure (to reflect the Bank Infrastructure Action Plan approved after finalization of the CAS, with a particular emphasis on energy and energy efficiency), public expenditure management, social protection, and reducing industrial pollution. Support for improvements in the business environment and the climate for attracting private investment focused on key policy constraints whilst increasing efforts to support capacity building in the private sector as well as in regulatory bodies (including through IFC’s technical assistance). In addition, the Bank team has been implementing the recommendations of an internal review of investment lending undertaken in 2005 and various portfolio reviews. A significant development during the period of the CAS is the increased engagement of the IFC in
38 Being one ofthe first results based CASs, the country team prepared a formal CAS Completion Report. The CCR recommends (a) continuing with a thematic approach, (b) strengthening sector agendas, (c) targeting ESW to help with the thematic and sector agendas; (d) helping build the capacity of government; (e) improving loan approval and implementation; (0 broadening the audience of the Bank and (8) scaling up civic engagement.
80 Ukraine, through a large technical assistance program and increased investment. The CAS remained in the base case and did not move to the high case.
IV. CAS RESULTSASSESSMENT 17. This section takes stock ofthe contribution ofthe Bank Group to the achievement of expected results under each ofthe seven pillars ofthe CAS. The Results Matrix at the end of this document summarizes the results obtained with the support of the CAS interventions, including dialogue. The presentation here follows the seven pillars of the government program around which the CAS was designed. Pillar I:Supporting macroeconomic and financial sustainability 18. WBG support under this pillar sought to help provide solid foundations for economic growth, combining attention to improved macroeconomic and financial sector outcomes with priority institutional reforms. The major contribution and results came from an improved fiscal position of the government, greater payment discipline in the economy and a stronger financial sector. In addition, the financial position of the energy sector has improved and efforts are underway to refurbish installed capacity and increase energy efficiency. On the other hand, progress in deregulating the economy and lessening the regulatory burden in business although positive has remained behind expectations and Ukraine's position lags in international rankings. Similarly, there remain widespread concerns about governance and transparency in both public and private enterprises. 19. Overall the positive advances made in macro-economic and financial stabilization have created conditions for sustained economic growth and some diversification in the structure of production. Under these improved conditions, the country has been able to make better use of existing resources and has begun a process of capital modernization, in areas like agro-industry, steel, airspace and others.39 Investment as a percentage of GDP stood at 24 percent in 2006-above the target set by the CAS (22.7 percent). FDI increased from slightly over US$1 billion in 2003 to over US$5 billion in 2006. In addition, the country has been able to absorb major increases in energy prices and to meet the challenges posed by preparing for accession to WTO. 20. Two adjustment operations4' provided the framework for the policy dialogue and supported most of the key achievements. Major AAA work supported and complemented the policy dialogue and the design of the adjustment operations. Technical assistance operations, like a Treasury project (completed) and a State Tax Administration Reform project (underway), have assisted the country in building institutions that underpin macroeconomic performance.
39 A forthcoming ECA Productivity Study finds that the productivity of the Ukrainian manufacturing sector increased by 40 percent between 2000 and 2005-half of this increase is accounted for by reallocation of labor from lower to higher productivity fmsas well as the entry of new firms and exit of old ones. The rapid growth in productivity helped support the increases in real wages. 40 The two adjustment operations were the second operation of the PAL series and the first of the DPL series.
81 2 1. Strong private sector demand for financing under improved macroeconomic conditions have led IFC to expand its operations, in particular since 2005. During the CAS period it invested over US$680 million in 20 companies across seven different industries, representing a substantial increase from just US$40 million in investments in the entire decade leading up to the CAS (FY93-03). In line with priorities laid out in CAS Progress Report, IFC’s efforts were predominantly geared towards helping promising local companies increase their competitiveness through a mix of technological, managerial and governance improvements. In particular, many of the companies in the agribusiness and manufacturing sectors, which jointly received 55 percent of IFC investments, benefited from this type of assistance. A number ofprojects also supported the entry of foreign companies into the Ukrainian market, helping to stimulate investor interest through a positive demonstration effect. As was planned in the CAS under Pillar I,IFC’s programmatic advisory services have expanded as well, focusing on a broad range of corporate governance, business climate, and agribusiness development issues. Fiscal and Financial Discipline and Financial Sector Development 22. The Bank adjustment agenda contributed significantly to improved fiscal and financial discipline in the accounts of the central government. The CAS set as an objective to help the government improve the payment discipline of government by eliminating the generation of new budget and tax arrears and reducing the existing stock. That objective has been achieved; new arrears are under control and the stock of arrears has been reduced gradually although not eliminated. A second objective was to help strengthen the fiscal position of government by keeping public debt as a percentage of GDP to below 40 percent, A prudent fiscal stance and rapid economic growth have reduced the ratio ofpublic debt to GDP to 15 percent. 23. Since the CPR, the fiscal position of the government has strengthened further. Privatization revenues and reduced tax expenditures (in 2005) and buoyant tax revenues in line with higher than expected GDP growth (in 2006 and 2007) have contributed to limit public borrowing requirements. The concern now is the increasing absorption ofresources by the public sector-with total spending at 44 percent ofGDP in 2006, the increasing share of public consumption in total spending and the correspondingly limited resources allocated to public investment (around 2 percent of GDP). Nonetheless there is now strong political consensus around the importance of price stability, payment discipline, a tight fiscal position and reduced levels of public sector debt. Politicians and bureaucrats have come to see the public debt ratio as a strategic variable in signaling the strength of the country to the international financial community. 24. The contribution of the Bank came through the two adjustment operations and analytical work. The focus on taxation informed the dialogue on reducing tax expenditures and set the basis for an agenda on tax reform now under implementation. The Public Finance Review (FY06) explored further tax issues, fiscal risks and highlighted the need to increase fiscal space for public investment, In addition, the Bank maintained an on-going dialogue on debt management.
82 25. Bank assistance helped reduce systemic risks and contributed to improve the quality of financial regulatory practices. At the beginning ofthe CAS, the situation of the Savings Bank posed a systemic risk for the financial sector. The implementation of a Memorandum ofUnderstanding (MoU) between the Bank, the Central Bank and the MoF under the PAL and the DPL successfully neutralized this risk.41 Second, the Bank, with involvement from IFC in selected areas, assisted the Central Bank and the government in the drafting of key legislation for the financial sector.42 Third, the adjustment dialogue emphasized improvements in the regulatory framework and capacity to regulate in the banking and non-banking financial sectors. The capacity ofthe Central Bank to supervise the banking sector has improved.43 Accounting practices improved as banks follow IAS and conduct international audits with the aid of top audit companies. However, rules on disclosure of ownership remain to be improved further and compliance with Basle I1 principles is not yet complete. In an effort to enhance the capacity ofthe Central Bank to perform its regulatory mandate, the government has proposed amendments to the Banking Law, which are now before parliament. Fourth, progress on the non-banking financial sector has been slower, although a regulator is in place and the required legal framework is being improved.44 The private sector has gained access to international capital markets, and increasingly is issuing bonds on the domestic market, although the limited presence of the government on the domestic market has slowed its development, due to the absence of a yield curve. A grading system is in place to assess debt issued by domestic enterprises. Further improvements in the grading of the sovereign debt will improve the rating of the enterprise sector as well. This creates an incentive for major economic players to advocate prudent macro-economic policy. The Bank prepared a report on “The Development of Non-bank Financial Institutions in Ukraine” (2006) that outlines options for deepening the financial markets. 26. Two self-standing operations are seeking to improve access to financial services. Two Bank operations, approved in 2006, will support further the institutional strengthening of the financial sector, The Export Development Project 2 (FY07) builds on a similar and successful previous operation and provides funds and technical assistance to the UkrEximBank to help develop a more effective system of export insurance and finance for small and medium companies. The Access to Financial Services Project (FY06) supports efforts to improve access to financial services by smaller companies in rural areas as well as building the institutional capacity of
41 Although the objectives of the original MoU were fully achieved, some observers point out that the freeze of operations during restructuring reduced its franchise value. Arguably, faster implementation of the MOU could have been accomplished with a clearer statement of restructuring objectives. However, a credible solution for the frozen saving deposits and commitment to privatize did not enjoy sufficient olitical consensus to be supported by the government and the Central Bank. A sample of this legislation includes: Credit Unions, Banking, Secured Transactions, National Bank, ’’Deposit Insurance, Mortgage, Leasing, Warehouse Receipts, and Securities. The counterpart on the side of the executive has been the Ministry of Finance. Also, the Financial Sector Policy Review Board, created in 2000, has played a role, much less so since 2003. But, it is still consulted on major legislative initiatives. 43 The ICR on the Programmatic Adjustment Loan I1 reports that by 2006 the National Bank of Ukraine was compliant with 20 of the 30 core Basle principles of Bank supervision. A recent draft Financial Sector Assessment Program (FSAP) update demonstrates further improvements in banking supervision. 44 A draft Insurance law has been prepared and awaits approval.
83 municipalities to finance local high-impact communal projects. Implementation ofthese two operations isjust commencing. 45 27. IFC’s support for the development of financial markets took the form of direct lending in the amount of almost US230 million to strengthen the banks’ balance sheets and provide credit lines for SMEs, leasing, mortgage, and retail lending. This included work with such prominent regional players as Raiffeisenbank and SociCtC Generale in the Ukrainian market. In addition, IFC sought to strengthen financial institutions and diversify their product offerings though a number of advisory programs. The Banking Sector Corporate Governance project provided training on corporate governance for banks throughout Ukraine, worked with NBU to develop national-level recommendations for improving corporate governance in banks, and with banking unions and associations to promote self-regulation of corporate governance in the industry. The Leasing Development project supported the nascent leasing industry, and the Mortgage Note Development project aimed to increase the liquidity ofthe primary mortgage market by introducing a standard mortgage note. 28. With the entry of strategic foreign investors, banking sector consolidation is likely to accelerate. The financial sector has grown fast and inefficient loss making operators are being driven out. Recent entry of foreign banks has increased competition and bettered the quality of financial services. As of now, the share of foreign capital in the statutory capital of banks is close to 30 percent, up from around 10 percent in 2002. Future development of the banking sector is likely to see a strong consolidation and a substantial reduction in the more than 160 commercial banks presently registered in Ukraine. 29. Despite the progress that has been made, the financial sector will require continued vigilance and attention. Fast credit growth may hide underlying quality issues and foreign currency exposure has been increasing. Regulatory capacity needs to hrther improve to better assess underlying risks, while the regulator will need to act quickly and decisively to liquidate insolvent institutions if the going gets tough. Equally importantly, Ukraine needs a much more diversified system of financial intermediation (including equity, debt, as well as derivative instruments to hedge and diversify risks) to help enterprises mobilize resources for investment through innovative mechanisms. Corporate Governance and Business Environment 30. Although the CAS objective to reform the legal basis of corporate governance did not materialize as expected, some progress was achieved on improving corporate governance practices by the private sector. An objective of the CAS was to help the country set the institutional basis for better corporate governance. The last CEM (2004) illustrated how more transparent governance practices, in the public and private sector, would help Ukraine develop into a modem and sophisticated economy. The idea was to help Ukraine’s legislation and practices move to EU standards. Progress has been mixed.
45 Approval of the UkrEximBank operation took place much faster than usual. UkrEximBank had experience dealing with the Bank and appreciated previous technical assistance. See ICR on the Export Development Project 1 on the role and appreciation of technical assistance.
84 First, as expected, some ofthe large financial and industrial groups (FIGS) have initiated governance reform on their own, pressured by the need to operate in the global economy. Some smaller companies have begun to recognize the need for proper corporate governance as well and IFC has assisted a number ofthem, including second tier banks, in improving their practices, helping to access more than US$950 million in external financing as a result. Second, several pieces of legislation, such as a Stock and Stock Market Law, are in place and accounting practices are under modernization. 46 Third, the WBG, jointly with other donors especially USAID, focused on the approval of the of a new Joint-stock Company Law. This has not yet been enacted and remains in the adjustment agenda. With hindsight, experience with legislative changes in this area suggests that a gradual approach, building on the existing legal framework and improving it, may be politically more feasible than a wholesale renewal ofthe legal base. 3 1. Towards the end of the CAS period, emphasis on improving the governance of public enterprises began to have traction. Progress made on the oversight on public enterprises was limited; only recently did the parliament approve legislation on State Holding Companies as well as a framework law on SOEs signaling a renewed interest in the governance of public enterprises. The Bank has highlighted the importance of improving corporate governance in public enterprises through dialogue on adjustment and analytical work-including the Public Finance Review (2006.) The restructuring of major enterprises, such as Naftogaz, did not materialize to the extent expected under the CAS. Such restructuring was one of the conditions for moving to the high case. Both public and private corporate governance remain important items of the broader competitiveness agenda, where better governance and deepening of the financial sector need to develop in parallel. 32. Various WBG initiatives sought to help improve the regulatory environment for business. The Government program placed importance on the growth of SMEs. The focus of Bank assistance centered on improving the regulatory environment for business, and building on the achievements under the previous CAS. The CAS CR for the 2000 CAS noted that substantial progress had been made since the end ofthe 1990s. The 2005 CAS PR likewise noted progress, as did the ICR for PAL-11. The government that took office in 2005 committed to de-regulation and introduced reforms in taxation, customs, licenses, permits, etc. DPL-I supported these actions and the DPL series continues to engage in a dialogue on regulatory practices. In addition, tax compliance surveys carried out as part of the State Tax Administration Modernization Project (STAMP) report less burdensome tax enf~rcement.~~There was significant reduction in tax expenditures, which the Bank supported jointly with the IMF. The IFC, through the Business Enabling Environment Project, has been providing assistance on critical issues such as streamlining and simplification of inspections and permits for SMEs, simplification of technical
46 The country has made progress in areas like accounting, securities, etc. Here other donors have taken the lead. Some progress has been made with legislation in areas related to corporate governance---for instance, the approval ofthe Securities and Stock Market Law. The government has adopted 11 pieces of legislation relating to corporate governance that were drafted or amended with the assistance of IFC’s Corporate Development Project. 47 A redesign of the STAMP survey is underway to better capture costs ofcompliance.
85 regulations, monitoring the business environment through representative surveys, and conducting outreach, information and advocacy work to ensure adoption and implementation ofreforms. With the support of these efforts, laws on permits, licensing and inspections have recently been approved. However, the Bank’s Private Sector Development project, which included support to improve regulatory practices at the regional level, could not be implemented and was ~ancelled.~’ 33. However, international rankings do not reflect these reported gains. In the 2007 Doing Business Survey, Ukraine ranks 139 - behind both Belarus (1 10) and Moldova (92). Individual dimensions of the Doing Business rankings show significant variation, with the costs of contract enforcement assessed as relatively low (rank 46), together with access to credit (rank 68), while notable improvements were made with respect to starting a business (improvement from rank 122 to 109 between 2005 and 2007). Recent IFC reviews of the quality of the business environment concur that Ukraine ranks low with respect to its neighbors and identified taxation, licenses and inspections as the key challenges. The Corruption Perceptions Index for 2006 (TI) ranks Ukraine 99 (out of 163) countries, placing it among the most corrupt in Europe and below its immediate neighbors. The dissonance between the internal reporting ofprogress and the external ranking calls for further analysis to identify whether it is due to reporting lags in international rankings or whether - while Ukraine has been making progress - it has lagged behind the pace in the rest of the world. This said, it should be noted that the rate of business entry was around 8 percent, a rate higher than the target set under the DPL-I. Towards the end of the CAS, the Bank prepared a Private Sector Development Note (2007), which provides a comprehensive review of recent progress and diagnostic ofthe main policy challenges facing Ukraine in this area. Property Rights 34. Concerns with transparency came to dominate the privatization agenda. Transparent privatization, a CAS objective, proved controversial at the early stage of the CAS as efforts at introducing transparency were grounded on domestic procedures that could not easily be evaluated a posteriori. Therefore efforts to evaluate transparency, as those of the Bank in the context of PAL-I1 conditionality, were severely handi~apped.~~ The government that came to power in 2005 questioned previous privatizations and successfully reversed some, including that of the large steel enterprise, Krivorizhstal. The initiative that came to be known as “re-privatization” caused concern on the sanctity ofproperty rights and unsettled investors, as fears emerged that Ukraine may not have the institutional infrastructure to determine which privatizations had been done fairly. Nonetheless, there is now greater public attention to issues of transparency and competitiveness in privatization, which may have a lasting impact. In practice, the process of privatization will continue to be politically controversial and thus remain a difficult area for Bank engagement. In the future, the Bank can still add value in the privatization area by taking a sector rather than a general approach-for instance, it can
48 PSD project ICR. 49 For a more detailed evaluation of the privatization experience, see the ICR to the PAL-I1operation.
86 help in critical sectors like energy, transportation, etc. IFC, on its part, is considering providing post-privatization support to selected companies in these sectors. 35. The FY04-FY07 CAS proposed to help the government modernize agriculture by helping develop the institutions for an active land market and providing access to financial resources. The role of the Bank in agriculture has not been as significant and effective as the CAS expected. However, some partial achievements can be noted. Bank assistance to agriculture centered on helping to consolidate the process of land privatization as envisaged by the Land Code of 2001. Land titling has begun but has not yet been completed. So far, the government has issued around 6 million land certificates. The Bank contribution through the Rural Land Titling and Cadastre System Development Project will be around 1.5 million titles as opposed to the intended four milli~n.~' However, a five-year moratorium on the sale of agricultural land introduced in 2001 has been extended twice to January 2008 and may be extended again given slow progress in the establishment of a registry for property rights in land. The Bank supported, through adjustment lending and the Rural Land Titling and Cadastre System Development Project, the passage of legislation on the creation of a single system of land cadastre and registry of rights in real estate, bringing together separate land and urban real estate systems. However, the law has not been implemented yet, against the background of disagreements as to where the single registry should be located. Lastly, the passage of the Secured Transactions Law and the approval of the Access to Financial Services Project (FY06) should facilitate the financing of agriculture. A project on rural development, foreseen by the CAS, did not materialize. Energy 36. The CAS helped strengthen the energy sector. The CAS focused on improving the financial status of the energy sector and on investments to upgrade reliability. The energy agenda evolved during CAS implementation, especially after the CPR, with greater emphasis on institution building, moving to European standards, a broader investment agenda and leveraging impact on the environment. 37. Bank assistance contributed to improve the financial health and transparency of the energy sector. First, the emphasis adjustment operations placed on financial discipline in the energy sector produced positive result^:^' collection arrears on electricity and gas tariffs declined, and cash collection ratios were above 90 percent until the rise in utility prices in late 2006. Higher payment discipline in the energy complex contributed to higher payment discipline in the economy overall. Second, the government improved transparency and reduced the opportunities for corruption by requiring direct cash payments from Russia for gas transit fees through Ukraine (amounting to around US$2 billion annually). Third, electricity and gas tariffs are closer to operational recovery levels. As a result, the quasi-fiscal deficit in the energy sector has fallen from over 6 percent of GDP in 2003 to 2.6 percent in 2006. In addition, the Bank has assisted in the
The titling ofthe 1.5 million ha has not been completed yet, partly because the Bank project procedures are more thorough than the procedures utilized to grant the other titles. '' This is not the case always for municipal services, especially heat and water.
87 preparation of an action plan on the financial recovery of the energy sector under the DPL agenda. 38. Despite the improvements, major challenges remain. The backlog of inter- enterprise debts in the energy sector remains high, limiting the scope of private sector involvement. While an energy debt restructuring law was enacted with the support ofthe PAL and DPL programs it remains to be fully implemented. The rising prices of energy are testing payment discipline-arrears are beginning to reappear-and the pass-through of energy prices creates social policy challenges. So far, however, the country is adjusting rapidly to the increases and a process of increasing energy efficiency is underway. Improvements in the targeting of social assistance to cushion the impact of rising energy and utility bills are emerging as a policy priority. 39. Bank Pnancial assistance has focused increasingly on refurbishing existing infrastructure. Investment projects in the electricity sector have been good performers in Ukraine. The Kiev District Heating Project was completed satisfactorily, following successful completion earlier of the Kiev Public Buildings energy project. A renewed energy investment agenda is linked to the refurbishment of infrastructure and energy efficiency. To further support the rehabilitation and expansion of the sector, the Bank dropped the APL format foreseen in the CAS to allow preparation of parallel investment operations. The Hydropower Rehabilitation Project, approved after the CPR, is the first operation in this series, followed by the Energy Transmission project, approved by the Board in August 2007. 40. Besides the emphasis on investment afler the CPR, the Bank is supporting greater integration of the energy sector with Europe. As a first step to assist in the integration of Ukraine’s electricity complex to the EU grid, the Bank is supporting changes in domestic legislation required to the make the systems compatible. Additionally, the support the Bank has been providing to Ukraine to qualify for the benefits of the Kyoto Protocol bears significance for the agenda of increasing energy efficiency and moving to “green investments.” 41, Bank work on energy has combined well adjustment, investment and analytical work The combination of analytical work, technical assistance and dialogue helped develop a credible roadmap for strengthening the energy sector. At the same time, the approach was realistic, mindful that the energy agenda is broad and that it takes time to achieve all of the desired results. The agenda ahead remains vast and stability of the sector is at risk from the rapid increases in gas import prices. Work on an investment pipeline ofenergy projects has also helped to improve the capacity of the energy complex to evaluate projects. The Knowledge Economy 42. The Bank did not make the expected contribution to advancing the Knowledge and Information agenda. The CAS foresaw a contribution to increase the sophistication of the economy and develop a knowledge-based economy. The Bank hoped to contribute with a Knowledge Economy Assessment, which did not take place. In addition, poor implementation performance of the E-development Project led to its suspension, the status in which it remained at the closing date. Ukraine has a sizeable potential in
88 knowledge intensive activities given the existing research institutions, the highly qualified personnel and the number ofpatents. These resources remain under-utilized. Pillar 2: Poverty reduction, mitigation of social risks and strengthening of middle class 43. The CAS supported an ambitious government strategy to increase the size of the middle class, reduce poverty in urban and rural areas and improve the social security system. Rapid increases in wages supported by rising labor productivity exceeded CAS expectations. The rapid growth in wages combined with mounting social assistance accelerated poverty reduction throughout the economy (including in rural areas and among the elderly) to one ofthe lowest levels in the region.52 However, the intended improvement in the targeting of social assistance to the poor and the structural reform of the pension system did not materialize, although in both cases there were clear blueprints at the beginning of the CAS period. Political pressure led to substantial increases in social assistance and social security, but there has been little demand for structural changes in the system to increase its financial efficiency and sustainability. So far, this has been possible due to the rapid recovery of labor productivity and the growth in real wages from very low levels. Over the long-term, this strategy is not compatible with maintaining the competitiveness ofthe economy. 44. The Bank helped develop capacity for poverty and social analysis: since the CPR, three studies (PULSE I and I1 and a 2007 Poverty Assessment Update) have evaluated the evolution and status of poverty. The Labor Study (2006) and the Public Finance Review (2006) both examined the taxation of labor, including social security contributions, and concluded that reducing social security contributions (now at 4 1 percent of gross salaries) should be a priority. However, while the Labor Study argues that lower payroll taxes are key to improve the functioning of the labor market, the Public Finance Review cautions that a lowering of tax rates should go hand in hand with measures to improve compliance and close loopholes, including importantly in the Simplified Tax System. The Non-Banking Financial Institutions Review (2006) examined the synergies between the development ofthe non-banking financial sector and pension reform. 45. The dialogue on pensions focused on the financial sustainability of the Pension Fund; however progress on structural reform of the pension system has been limited. The dialogue on pensions, especially after the CPR (2005), centered on protecting the financial balance ofthe Pension Fund, the deficit ofwhich reached 3.3 percent of GDP in 2005, following rapid pension increases that year. DPL-I helped bring this deficit down to around 1 percent of GDP. While the balance of the Fund has improved, the fundamental reforms to assure its long-term sustainability have been postponed.53 The delays in increasing the pension eligibility age, reducing the social security contributions
52 The CAS target “ratio between average pensions to the subsistence level to reach 37 percent” has been met. 53 The Bank carried out periodical analysis of the financial sustainability of the pension system. The recent PFR examines both pensions and social assistance, pointing to the unfinished agenda and its fiscal consequences.
89 and introducing a second pillar are keeping Ukraine behind other countries in the region.54 Political factors rather than the lack ofreform roadmaps explain the slow pace of reform. 46. The WBG commenced providing assistance to simplijlj, and improve the administrative capacity of the social assistance institutions. The Bank, as foreseen in the CAS, supported improvements of the administrative capacity of the social security institutions. Since the CPR, a database of social assistance beneficiaries is in place under the Social Assistance System Modernization Project (2006). The project targets a significant reduction in administrative costs for the government and beneficiaries. The Social Insurance Administration Modernization Project (under preparation) plans to unify social security contributions and improve their administration. The implementation of the Ukrainian Social Investment Fund (USIF) has picked up pace recently led by an active Supervisory Board. It has completed 222 micro-projects (June 2006) of good engineering quality and with active community participation. Donors have also been quite active (KfW, DFID, SIDA, EU, and CIDA). The project remains to have a demonstration impact at the national level, however. 47. Future attempts at reform should make better use of linkages across reform initiatives in social security and assistance to facilitate implementation. For instance, there are linkages between social assistance and pensions-well-targeted social assistance to the elderly poor can help lower the pressure for increases in minimum pensions. In addition, there is a clear linkage between the reform of social assistance and pensions and opening fiscal space for investment. Also, the increase in energy prices and the need to soften the blow on the poor open a window of opportunity for reform, which hopefully will lead to a more efficient targeting and open fiscal space for other critical priorities. Lastly, it is important to keep in mind that given the political sensitivity of these issues, the sector authorities may not be fully empowered to commit to reform and often the dialogue has to go the highest level ofgovernment. Pillar 3: Comprehensive and harmonized human development 48. Progress in increasing basic social indicators has been mixed despite major increases in budgetary allocations. The CAS proposed to help improve access to quality services-education, healthcare and water-and battle the TB and AIDS epidemics. The quality of some basic services has been improving. For instance, maternal and child mortality levels reached the CAS goals. However, the decline in life expectancy continues and life expectancy for women is 12-13 years higher than for men, compared to an EU average difference of 6 years. The biggest shortcoming, however, has been a TB and AIDS challenge that remains unmet. Mortality from AIDS stands at 5.1 per 100,000, while the CAS had targeted .7 per 100,000. HIV cases stand at 15.2 out of 100,000, while the CAS expected 14.1. TB incidence stands at 84.1 per 100,000 above the CAS target of 56.4
54 The recent PFR provides an in-depth analysis ofthe status ofthe pension system, the options for reform and the linkage with labor market issues.
90 49. In education, a major gain has been increasing access of children under 5 to pre-school education, now up to 78.7 percent in urban areas and 36.2 percent in rural areas. At the outset of the CAS, pre-school education was receding. Enrollment in secondary education is now 99.2 percent in line with CAS expectations. The absolute number in post-secondary education has increased steadily. In addition, the government is implementing pilots to improve the quality of education through the adoption of international standards. The government in early 2007 rolled out the Trends in International Mathematics and Science Study (TIMMS), which it piloted in 2005. Resources allocated to education have increased to reach 6.4 percent of GDP in 2006. This said, however, upgrading the quality of education remains a priority to equip the country in advancing a strong competitiveness agenda. 50. The Bank agenda supporting human development was cautious. Human development issues did not figure highly in the adjustment operations as efforts to engage in policy dialogue during the previous CAS found little traction. In addition, the adjustment agenda was already quite overburdened. Analytical work has been sparse. The Bank provided assistance for the development of sector strategies and the analytical work on poverty examined access issues in health and education. In addition an analysis of the Socio-Economic Impact of HIV/AIDS was carried out (2006) which had some impact in re-energizing the public debate on the need to contain both epidemics and may lay the foundation to more effective engagement with the government in the future. An analysis of public expenditure in social sectors, currently underway, should add helpful insights. Investment projects supported the fight against TB and AIDS, education reform and improvements in water supply. 51. The contribution of the Bank to arrest the TB and AIDS epidemic has been modest. The CAS priority set on supporting the government’s efforts to contain and treat TB and HIV/AIDS was correct, but implementation of the supporting Bank’s TB and AIDS project has been unsatisfactory. Arguably, the availability of significant grant funding, including through the Global Fund reduced the attractiveness ofBank resources. Moreover there has been significant opposition to new alternative methods in dealing with TB. Capacity in the Ministry of Health to handle procurement and prioritize spending strategically is weak. The Bank and the donor community have rallied around to press on the government to act in the face of these epidemics. The Bank project was partially suspended for more than a year, and while the suspension was lifted in FY07 and the closing date extended by 18 months to December 2008, prospects for successful implementation remain uncertain. Recently, as a result of a broad stakeholder dialogue (informed in part by the Socio-Economic Impact of HIV/AIDS study), new agreements have been reached on the implementation ofthe project, although the details remain to be worked out. As a result of the delays in implementation, the project has not made a significant contribution on the ground. While a Health Sector Strategy was prepared, in the light of implementation difficulties in the existing portfolio, planned additional investment operations to support the strategy’s implementation have not proceeded. Recently, the Bank has begun to support a pilot to explore ways by which to reduce the
91 impact of environmental hazards on the health ofthe population and plans to expand this approach under the new CPS.55 52. The Bank's support in education is beginning to show some results. The Access to Quality Secondary Education Project supports institutional strengthening, curricula reform, education standards and rationalization of the school network. Early results include the establishment of the Policy Planning Department in the Ministry of Education and attention to improving management and information practices. Pilots are underway to improve quality and the country is beginning to set the basis for testing educational outcomes and rank Ukraine among its peers. Despite some initial implementation difficulties, project implementation is on-track. The dialogue on education is extending to cover issues of skills and in general the requirements of competitiveness. 53. Emphasis on improving delivery of local services was appropriate but coordinating assistance proved difficult. The CAS was right in supporting the renovation of municipal water and sanitation infrastructure; there are deficiencies in the quality of water and sanitation services and finances oflocal utilities are weak. Providing this support has proven challenging. Despite satisfactory completion, the Lviv Water project implementation was often delayed as a result of local political disagreements affecting timely tariff increases and investments. Concerns of central authorities with borrowing by local governments led to a system of required counter-guarantees, which often are not easy to secure from local authorities with short-term interests. Similar factors delayed preparation of a multi-city project (Urban Infrastructure Project, UIP) supporting improving water delivery in several cities. The project was, however, approved in early FY08. 54. Assisting Ukraine in human development, parh'cularly in health, requires a revised approach. A revised approach should begin with greater emphasis on analytical work and dialogue to develop a shared vision on how the Bank can help. The challenge in Ukraine is not resources, but increasing efficiency and focusing on results. One entry point is the link with public expenditure and decentralization. The country needs both to reduce the absorption of resources by the public sector and improve service delivery. In addition, the Bank could try reaching out beyond the government to generate a broader dialogue on the health and education challenges and the options for change. Pillar 4: Protection of the natural environment 55. The ambitious environment agenda of the CAS was scaled down during implementation. Ukraine inherited substantial environment challenges, with energy intensity among the highest in the world. Oddly, the economic contraction improved some of the key environment indicators, but as the economy recovers quickly, Ukraine needs to increase energy efficiency and reduce pollution to maintain its competitiveness and prevent further environmental degradation. The CAS set an ambitious environment agenda building on the National Environment Strategy prepared during the previous
55 The Bank initiated a technical assistance activity in the city ofZaporizhzhia to work on a local environment risk plan together with civil society and government.
92 CAS. Implementation ofthe strategy fell short ofexpectations, due in part to institutional weaknesses in the sector. Nonetheless, the Bank made some positive contributions. 56. The goal to build effective environment institutions was not realized. The CAS proposed an Environment Institutional Investment Loan to help strengthen the institutional capacity ofthe sector. The lack of commitment on the side ofthe authorities cut short the effort. Similarly, lack ofownership by the central level ofgovernment and a very open-ended design led to the cancellation of the Azov Black Sea Corridor Biodiversity Conservation Project. More narrowly defined technical operations (such as Ozone Depletion) fared better. In addition, PAL helped improve the finances of the environment sector through a revision of the fee structure. The concern, however, is that these funds are becoming part of general resources and are not allocated to environment uses as intended. 57. Bank support Jtelped Ukraine to begin profiting from the provisions of the Kyoto protocol. Given that it was not possible to carry out the Environment Institutional Investment Loan, the focus shifted to the implementation of the Kyoto Protocol. The Bank signed, as Trustee for the Netherlands European Carbon Facility, an Emissions Reduction Purchase Agreement (ERPA) with UkrHydroEnergo. This is the first ERPA in Ukraine. The cooperation ofthe authorities in the energy sector was critical to achieve this result. Still, Ukraine has yet to make full use of the international opportunities for cooperation on environment issues. Pillar 5: Integration into the world economic and financial system 58. Over the CAS period, Ukraine significantly advanced its integration into the global economy, as articulated in the Government program. The EU and the US declared Ukraine a market economy and the country is now close to WTO membership with the recent approval of a large body of required legislation and the completion of most bilateral agreement^.^^ The desire to join the WTO proved to be an effective driver for reform. Progress in reform in the context WTO accession covers issues such as: (a) the reform of the tariff system; (b) reform of customs procedures; (c) reduction or phasing out of export duties on scrap metals and selected agricultural products; (d) reform of the standardization, licensing and labeling regimes to remove bias against importers; (e) adopting a stronger system of property rights; and (0 allowing foreign banks to open branches in Ukraine. The Bank, with the help of a Dutch grant as well as under the DPL-I program, provided effective and timely technical assistance to the government in preparing for WTO accession. The EU is ready to consider a Free Trade Agreement with Ukraine, once it joins the WTO. 59. Ukraine has substantially liberalized its trade regime, especially since 2005. The government reformed the customs authority (2005) and reduced the level of import tariffs, slashing the average tariff to 5.1 percent, significantly exceeding WTO requirements. In 2005, a government program to reduce smuggling (“Contraband Stop”)
56 During 2005 and 2007 more than 70 laws and legal amendments were adopted to make Ukrainian legislation compliant with the WTO. Most bilateral deals have been signed (except with the Kyrgyz Republic).
93 initiated significant improvements in the function of the State Customs Service. Support for these initiatives was provided under the DPL I. However, successive governments have on occasion intervened in export markets through quantitative restrictions (on grain in 2006-2007), and significant work remains to be done to complete customs reform. The Bank contributed a Trade Study (2004), which emphasized economic diversification to improve the resilience ofthe economy. The message of diversification remains valid and should be part ofany competitiveness agenda moving forward. 60. Ukraine also made considerable progress reforming the telecommunications sector. The government established a communications regulator supported by a new legal framework. The Bank provided support through the DPL I. Since then, the government has rebalanced telecom tariffs and liberalized the allocation of mobile licenses, frequencies and inter-connections. Mobile telephony has experienced high investment, rapid growth, and competition, with national penetration levels now approaching 100 percent. Thanks to greater competition and improved regulation, tariffs for international calls have fallen from around 2-3 times European levels at the beginning of the CAS to within 30 percent of the EU average. The DPL series will continue to provide support in this area as part of a broader effort to reduce logistics costs and improve trade and transport facilitation in the country. Pillar 6: Dynamic regional development and reduction of regional imbalances 61. Although regional development was and remains a key government prior& this is not matched by the development of a clear roadmap or even agreement on the objectives underlying this agenda. Regional development issues have been controversial and political consensus has been difficult to come by, especially regarding the balance of power between the center and regions. Lacking clear direction at the national level, the Bank undertook isolated interventions. 62. Still, the Bank helped advance various initiatives that promoted stronger local institutions. First, continuing the agenda of the previous CAS, the Bank, through the PAL and DPL programs, continued to engage the authorities on improving the system of inter-governmental budget transfers, an agenda that remains incomplete. The Public Finance Review (2006) provided an analysis of the capital budgeting system, which is being extended to the local government level in a second volume to be completed in FY08. 63. Second, the CAS continued to support greater local government accountability and the capacity of civil society to organize locally through the People’s Voice project, which helps organize citizens’ oversight over the delivery of public services at the level of municipalities. This program has been extended from 4 to 6 cities, and was favorably reviewed by the Canadian government which finances it. However, the original intention of articulating a national strategy out of the lessons from the pilot experiences remains unfulfilled. Attention, therefore, is needed to assure the sustainability ofthe efforts. 64. Lastly, the Bank sought to set the basis to support regions and municipalities through selected investment projects. The proposed Municipal Development Finance project is now part ofthe Access to Financial Services (FY06) project, which will finance local capital investments. Project implementation has just commenced. The CAS
94 proposed to support regions in improving their business environment, but the cancellation of the Private Sector Development project cut short the initiative, and WBG support is now largely provided by IFC, which has developed a strong regional presence. Local deregulation continues to be critical to improve the quality of the business environment. Data shows great regional variation in the quality of the business environment, with the western regions generally showing worse performance than the east. 65. The CAS originally foresaw a project to support European integration with focus on regional development. The project, however, was not developed. Pillar 7: Integrity of public governance 66. Public Jinancial management made signiJicant progress during the CAS, as part of a general effort to improve governan~e.~~The management of public finance is now com rehensive and transparent building on a modem Budget Code approved before the CAS.ps An internal corruption vulnerability review, whilst highlighting that Ukraine must be considered high governance risk, nonetheless concluded that risks to Bank projects were acceptable and to some extent mitigated by the Bank’s fiduciary controls. Analytical work in the PFR has provided a basis on which to articulate future public expenditure reform. 67. Developments of public administration and civil sewice, however, did not meet the expectations set in the CAS of moving quickly to European standards. While key government institutions are now stronger and more capable (Central Bank, Ministry of Finance, and the Energy Complex), this progress has failed to extend to most line ministries. Nonetheless, the authorities have shown skill in facing multiple challenges in the management of economic affairs in spite of imperfect domestic institutions. More realistic expectations can help guide the future of Bank assistance in public expenditure and civil service reform. 68. Progress in improving public expenditure management was gradual but positive. A first step was the completion of the Treasury project, which helped put in place a unified trea~ury.’~The Public Finance Management Reform (PFMR) project, under preparation, seeks to complete the Treasury-I agenda and broaden the scope to a more comprehensive reform of government finances, including consolidation of information systems, budget planning, debt management, and audit. The implementation ofthe Budget Code, approved under the previous CAS, improved the comprehensiveness of the budget and transparency of budgetary practices. A major recent improvement, as already noted, was the collection in cash ofthe transit fees for gas. 69. In addition, the Bank assisted with the design of an internal audit system. The Control and Revision Unit (KRU) of the MoF is responsible for internal audit, while the Chamber of Accounts provides external audit functions for the government. The
57 As noted previously, the CAS retained emphasis on the supply and demand for institutions. Hence, the governance agenda (institution building) cut across the board. 58 See PEFA Report (2006). The PEFA reports strengths in the credibility and the predictability of the budget process and its comprehensiveness. As noted capital budgeting, control over public enterprises, and procurement are weaknesses. 59 The systems developed under the project were deemed provisional. See Treasury ICR.
95 assistance provided by the Bank is helping redesign the role of the JSRU in line with EU principles on internal control. The Cabinet of Ministers approved a white paper launching this initiative under the DPL I,although progress in implementation is slow. 70. The CAS foresaw improvements in capital budgeting, but initial efforts proved timid and ineffective.6o A more forceful effort took place recently with the 2006 Public Finance Review (PFR), which identified major constraints to proper capital budgeting. First, large increases in current expenditure have reduced the fiscal space for public investment. In addition, capital allocations go mostly for transfers to public enterprises and to repairs. Second, government lacks the capacity to identify and evaluate investments reducing ownership for donor finance initiatives. In efforts to build domestic ownership of investment projects and reduce transaction costs, the Bank has increasingly emphasized the increased use ofcountry systems for project implementation. 71. The greater focus and coherence of Bank assistance on public finance management issues provides a possible entry point to the reform of public services more generally.61 A more coherent framework to the reform of public expenditure can help streamline expenditures and advance sector reform, especially on social issues, and help curb the rising levels of public expenditure. The Bank work benefited from stable counterparts at the MoF during most ofthe CAS period. 72. Progress on public procurement reversed. The CAS-supported implementation ofthe 2001 Procurement Law aiming to bring practices in Ukraine in line with WTO and EU requirements. Despite initial progress, vested interests in and outside the Government and Parliament not only blocked fill implementation but sought and obtained a significant reversal. Moreover, capacity constraints at all levels of government remain serious obstacles to the development of a modern procurement system. New legislation out-sources key oversight responsibilities to an NGO, with no effective public control, while fragmenting the implementation of public procurement across government agencies. The parliament overrode a Presidential veto on this legislation by mustering more than the required two thirds of votes (December 2005). The Bank and other donors have actively sought amendments to the current law. The Bank analyzed the current situation and the options in the Country Procurement Assessment Report (CPAR, 2006) and revisited the issues also in the PFR (2006). 73. Progress in public administration and civil service reform has been slow. The CAS supported the government in the intended effort to bring public administration and civil service practices in line with EU standards. But, the expected major overhaul of public administration and the civil service did not take place. A technical assistance operation to support this reform consequently did not materialize. A note on public administration included in the PREM Governance Review (dated February 2005) proposed an Action Plan, which still awaits implementation. While a modern civil
6o On Capital Budgeting, the CAS program only focused on the capital transfers to municipalities. With hindsight, the early emphasis on perfecting transfers to the local level distracted attention from broader public expenditure issues where attention was required.
96 service law aligned with EU principles has been prepared it has so not been presented to parliament and may be further delayed. 74. Efforts took place, however, to reform important individual public institutions, such as the tax sewice and the MoF. The government brought the State Tax Administration (STA) and the Treasury under the Ministry of Finance in 2005 and a functional review of the MoF was prepared. The Bank is supporting the STA, through a direct technical assistance operation, to undertake a comprehensive modernization with emphasis on improving tax payer compliance, reducing costs and introducing mechanisms of accountability. A panel ofexternal reviewers was appointed to take stock periodically of progress in the reform of the tax service. In addition, local boards (Collegiums) with the participation of civil society organizations provide oversight at the local level. However, implementation delays and the nature ofthe project as a long-term institutional transformation, mean that its impact has so far been relatively limited. The government that took office in 2005 also undertook efforts to reform the State Customs Service with the aim to reduce contraband and in line with WTO requirements. These efforts were supported under the DPL I. 75. Despite the imperfect institutional environment, Ukraine has faced with success the major challenges of transition to generate growth and reduce poverty. Arguably, this success has limited the appetite for more thorough reforms of public institutions. It remains a fact though that Ukraine would benefit from a more disciplined and coordinated public administration and a modern civil service. The lack of progress lowers the capacity to carry out reform initiatives across the board. For instance, the concentration ofpolicy decision power at the top ofthe government limits the capacity of ministries to develop policy initiatives and to commit to their implementation. 76. Some progress was made in improving the regulation of natural monopolies. As part of WTO accession efforts, the country put in place a modern regulatory framework for telecommunications. Also, the DPL agenda includes the strengthening of the energy regulator-NERC-and the continued liberalization of the telecommunications sector (tariff rebalancing, frequency allocations, mobile licenses and interconnections).
v. WORLD BANKGROUP PERFORMANCE IBRD Lending 77. Bank performance in lending over the CAS period was satisfactory as a whole, although tainted by persistent problems in implementing the investment lending portfolio. During CAS period the Bank approved 8 operations, of which two were adjustment loans and 6 investment projects. Adjustment constituted around half of total commitments and two thirds of disbursements. Major results from lending interventions during the CAS therefore were achieved through adjustment lending. In investment lending, the Bank overestimated both the ability of the country to absorb and ability of the Bank to deliver a large lending program. In comparison with base-case lending programmed in CAS and re-confirmed by the CAS progress report in the amount ofUS$
97 2.4 billion, actual commitments for the period of FY04-07 were only US$ 1.1 billion (Table A3.2). Table A3.2. Ukraine: IBRD Expected Base-Case Lending, Actual Commitments and Disbursements, FY04-07 (US$ m if not othehise indicated) 2003 CAS 2005 CAS PR
I Investment I 19.5 I 63.5 I 60.7 I 97.2 I 240.9 I Actual Inv Commit to Total Actual Commit 11.3% 100.0% 49.8% 100.0% 55.6% Inv. Disb to Total Disb 20.1% 26.9% 19.5% 100.0% 32.5% Inv Disb to Total Actual Comm 6.9% 33.0% 12.1% 62.8% 21.3%
78. Policy-based (adjustment) lending has played the leading role in producing results62. As the review of effectiveness of Bank assistance under each of the individual pillars shows, the policy reform agenda, supported by the adjustment operations, delivered the main results expected and achieved under the CAS.63 Key achievements that adjustment supported included: (a) financial discipline in the public and private sectors; (b) removing systemic threats to the financial sector; (c) setting the basis for financial regulation and improving regulatory practices; (c) opening up the economy to trade and finance; (d) keeping a prudent fiscal position; (e) improvements in property rights; (f) partial de-regulation ofthe economy to encourage entry and moving out ofthe shadow economy; and (g) improving the financial and technical performance of the energy complex. These reforms were enough to allow the Ukrainian economy to respond to the demand stimulus from abroad and - as productivity and wages recovered - to the domestic demand pull. 79. Variousfactors explain the relative effectiveness of adjustment lending:
0 First, adjustment operations have helped Ukraine signal to international markets its commitment to and progress in moving to a market economy. This signaled strong ownership not just ofthe government but of key business interests.
During CAS implementation, the Bank produced a paper on lessons from experience with Bank conditionality as a result of which the Bank issued new guidelines for conditionality reflected in a change in the name of the main Bank instrument from Adjustment to Development Policy lending. 63 IEG rated PAL-2 and DPL-1 as satisfactory.
98 0 Second, the adjustment program helped the authorities coordinate implementation of the policy agenda among different agencies. In this area, analytical work was an important support and complement to the adjustment dialogue. The policy dialogue helped maintain continuity across different administrations. Third, although budgetary support is not as important in financing terms as it was early on, the government continues to appreciate that the Bank provides long-term funds at competitive prices and these helped improve Ukraine’s debt profile. Thus, even Ukraine’s most recent international bond issue at the peak offavorable emerging market sentiment achieved only a five-year maturity. 80. Nonetheless, the broad agenda supported by adjustment moved at a pace slower than expected. Adjustment was conceived as an instrument to tackle broad systemic or thematic constraints. To a large extent it met this challenge with success by breaking key constraints and helping move the economy ahead. The downside ofthe approach was the tendency to cover too many areas as adjustment became the predominant instrument of policy dialogue in areas where the Bank was engaged. Arguably, the broad canvas of topics covered under adjustment reduced the focus and may have reduced the Bank’s effecti~eness.~~In addition, the institution-building agenda moved at a slow pace, especially when it required legislative approval. Delays in the legislative agenda largely account for the fact that instead ofthe planned annual series, the gap between adjustment operations was around two years on average. 81. Rapid economic growth and increasing creditworthiness reduced the urgency of and commitment to broad-based reforms.65 The slower than anticipated progress did not prevent Ukraine from achieving most of the targeted CAS outcomes, suggesting that these reforms, while critical to sustain growth in the longer term, were not immediate roadblocks for economic growth and poverty reduction. Transition successes despite partial reform efforts include:
0 The government was able to manage increases in pensions within a solid fiscal framework-the lack ofpension reform was not a stumbling block. The government was able to reduce the quasi-fiscal deficit in the energy sector, with a relatively weak regulator and without continuing the privatization process.
0 The partial development of the non-banking financial sector did not limit access to financing by major groups as they had access to local banks or
64 The IEG Report (2007) also points to the wide range of issues covered under the adjustment agenda. 65 Many important reforms or results were not accomplished as the CAS had foreseen: (a) pension reform; (b) full compliance with Basle norms and an effective non-banking regulatory framework under implementation; (c) legislation on private corporate governance; (d) more aggressive de-regulation of the economy; (c) public administration reform in line with European norms; (d) increased effectiveness in social sector expenditure, etc. Lastly, as noted, the program in Ukraine did not move to the high case. The triggers for a high case considered restructuring of the main public gas company NAFTAGAZ, accelerated reforms of the Savings Bank, accelerated implementation ofmeasures to join the WTO and accelerated implementation of measures to improve public sector accountability. Only regarding the WTO did the country move in an accelerated fashion.
99 2004 2005 2006 2007 Total # Proj 12 11 12 11 46 I NetCommAmt I 921.3 I 789.2 I 1,008.6 I 924.1 I 3,643.1 I # Prob Proj 3 4 3 4 14 # Pot Proj 0 0 0 0 0 % At Risk 25 36 25 36 30 % Realism 100.0 100.0 100.0 100.0 100.0 % Proactivity 100 100 67 90 % Commit at Risk 10.3 37.7 25.8 46.6 29.7 Disbursement ratio 3.3% 8.5% 8.3% 1 1.3% 8.2%
Inv Total Undisb at start of FY 590.7 603.4 699.6 863.0 nla
Investment Disbursed in FY 19.3 51.0 58.1 97.2 225.6
84. The delivery of investment operations was re-adjusted significantly during implementation. Table 1 in the Appendix compares programs and deliveries. As already noted, only two of the four intended adjustment operations were delivered. Of the new projects foreseen by the original CAS, the Development ofthe Statistics System is under
100 Total Outcome Outcome Inst Dev Inst Dev Sustainabi Sustainabi Evaluated % Sat ($) % Sat Impact Impact lity lity ($MI (No) % Subst % Subst %Likely %Likely ($1 (No) ($1 (No) Ukraine Overall 351.1 99.4 71.4 99 57.1 99.3 66.7 I Adjustment I 250.0 I 100.0 I 100.0 I 100 I 100.0 I 100.0 I 100.0 I PAL 2 250.0 100.0 100.0 100 100.0 100.0 100.0 Investment 101.1 98.0 66.7 98 50.0 93.9 60.0 I ODS PHASE-OUT (GEF) I 0.0 I I 100.0 I I 0.0 I I 100.0 I 1 EXPORTDEVT I 67.4 I 100.0 I 100.0 I 100 I 100.0 I I I AZOV-BLK SEA GEF 0.0 0.0 0.0 0.0 TREASURY SYSTEMS 16.4 100.0 100.0 100 100.0 100.0 100.0 PRIV SEC DEV (APL #1) 2.1 0.0 0.0 0 0.0 0.0 0.0 KIEV PB ENERGY EFFIC 15.2 100.0 100.0 100 100.0 100.0 100.0 I E-DEVTTA I 0.1 I I I I I I 86. As a result of the above mentioned difJiculties, the resultsproduced with the help of investment projects were modest There are several reasons for this:
0 First, projected results of investment lending in the CAS relied heavily on the implementation of seven key investment projects that were ready at the beginning of the CAS: the Social Investment Fund, the TB/AIDS Control Project, the Private Sector Development project (PSD), the State Tax Administration Modernization
101 project, the Rural Land Titling and Cadastre project and the E-development project. Of these seven projects, the PSD project was cancelled, while E-development, TB/AIDS, and the Rural Land Titling and Cadastre project were all partially or completely suspended for extended periods of time. The projected CAS results did not foresee the weight of implementation problems in these key operations.
0 Second, most ofthese projects sought a high degree ofinstitutional change, which meant that, by design, the projects were not expected to produce results right away. For instance, the State Tax Administration Modernization project was designed as an APL-with an initial focus on the design of new processes and pilots and full implementation in later APL operations.
0 Third, the rest of the portfolio (five investment operations already under implementation as the CAS was approved) also suffered from implementation difficulties and several projects were restructured. This means that they may not meet all ofthe intended development objectives.
0 Fourth, the intended simplification of country internal procedures for approval and implementation of projects did not take place. New projects-as opposed to repeater operations-continue to take long to develop, approve and reach effectiveness.
0 Fifth, in a highly fractured public administration, the lack of proper capital budgeting has meant that investment projects are often seen as “owned” by the Bank and not the government. Lastly, projects implemented by central government agencies ran into severe implementation difficulties due to the complicated procedures of the central government. Projects experienced lesser implementation problems in autonomous spending units such as state-owned enterprises, especially in the energy sector.66 87. The Bank was proactive in analyzing the causes of poor investment lending performance and developing recommendations for improvement. An internal review of investment lending (2005) proposed to: (a) to restructure or cancel non-performing projects; (b) to reduce the institution building components of investment projects; (c) to move to a greater use country systems; (d) to encourage the government to simplify its procedures for the approval and implementation ofoperations, and (f) to improve internal coordination between Bank teams. These recommendations are under implementation. The Bank and the government have advanced in cleaning up the portfolio through cancellation or re-pr~gramrning.~~In addition, new operations have sharper objectives
66 As result ofthe difficulties experienced in the implementation of investment operations (especially those in place at the beginning of the CAS), investment and adjustment operations were not as complementary as expected. The investment operations were supposed to help build the institutions in areas critical for the reform agenda-taxation, land titling, private sector development, pensions and social security, technology, environment, etc. Cancellations, delays and restructuring meant delays in achieving results that would have made the reform agenda more effective. 67 The following projects were cancelled: PSD, Azov-Black Sea (GEF), while E-development closed at the end ofan extended period of suspension. Loan amounts were reduced significantly in the Kyiv District Heating and Land Titling and Cadastre projects, while two further projects were under partial suspension for extended periods (TB and HIV-AIDS and Land Titling and Cadastre).
102 and are less institutionally loaded, which should make it easier to implement them and to evaluate results. Greater use is being made of country systems, with the Social Administration Modernization Project, approved in FY06, leading the way. Reducing the complexity of the design and focusing on the rules under which executing agencies operate can help improve the performance ofinvestment operations. 88. These efforts have yielded some improvements in performance, but Ukraine still lags the region in disbursement performance. The ratio of disbursements to net commitments has been increasing, albeit slowly, from 8.4 percent in FY06 to 11 percent in FY07, with initial indications in FY08 that it may increase further. It remains, however, quite low by the standards of the ECA Region and the Bank. The main impact of these delays is less financial than on effectiveness of the program. The new CPS establishes clear portfolio performance targets as one of the benchmarks modulating the level of lending support and proposes to accelerate portfolio restructuring, simplify project design, emphasize greater client ownership, and deepen the move towards country systems in reflection ofthe lessons learned during the FY03-07 CAS. IFC Lending 89. IFC lending provided an important source of financing for the private sector, and early evaluations suggest positive development implications. During the CAS period, IFC invested $681 million of its own funds in private sector companies in Ukraine and mobilized $263 million in additional private sector financing toward a total of 28 investment projects. This lending supported the implementation of a broad range of greenfield, modernization, and expansion projects by IFC’s private sector clients in agribusiness, power distribution, construction materials, retail, logistics, hotel, and steel sectors worth $2.4 billion. The portfolio is very strong with no non-performing loans. Although the majority ofthe projects under this CAS have not reached operating maturity for proper evaluation, the risk profile analysis carried out by CIR indicates that IFC took justified risks in terms of sector distribution but mitigated the sponsor, project type and financial structure risks by prudent selection and sound structuring of the deals. The few projects that are mature enough to be evaluated show consistently high development outcomes. IFC’s value added was particularly pronounced when it supported emerging strong local players in sectors where Ukraine has prospects for establishing a strong competitive position. Analytical and Advisory Activities 90. The Bank delivered good, and sometimes outstanding, AAA products. The CAS program for AAA was implemented satisfactorily, including amendments made during the CPR.68 The themes covered by AAA work, such as competitiveness, fiscal space, energy, poverty, and pensions, were highly relevant. The quality of AAA was good or outstanding, as the IEG Country Assistance Evaluation acknowledges. AAA products facilitated the dialogue with government mainly around the adjustment agenda and helped develop credible roadmaps in critical sectors like energy. The main areas that received attention from AAA activities were:
See Table A3.5.
103 public sector management (PER, PEFA, CPAR; advice on debt management; advice on intergovernmental relations); social sectors (pensions, poverty assessments, labor markets study, informal reports on education policy, review ofhealth sector and socio-economic consequences ofHIV/AIDS), and infrastructure and energy (transport study; coal sector note, reports on gas and electricity sectors; note on impact ofincreased energy prices; advice on implementation ofKyoto Protocol). Analytical and advisory work was mainly utilized to (i)develop the dialogue with the government around certain policy areas and thus encourage its support in policy reforms (pensions study, CEM, trade study, CPAR; GIS options study), (ii)inform the government’s decisions (policy notes; note on impact of energy prices) and (iii)underpin lending (both adjustment and investment - e.g., in energy sector). 91. A distinct feature of AAA program implementation during the previous CAS was the shijit from core diagnostic AAA to more country-tailored and responsive products. This included fast-response notes at the request from the government on selected policy issues, as well as informal reports (e.g., in the area of intergovernmental finance, education policy, and joint health sector review). In addition, the Bank increasingly moved towards a programmatic mode of AAA work, such as in the public finance management area, or in the energy sector, in order to map out a sequence of reform measures with Bank support extended over the full period ofimplementation. 92. Table A3.5 shows the Bank mostly delivered its AAA program as was planned in the CAS, although with some changes in terms oftopics covered (e.g., dropped TA on forestry and telecom; a planned development marketplace didn’t materialize). Moreover, the AAA program experienced some slippages. Some activities completed over the CAS period (poverty assessment, CPAR) were delivered much later than planned or have been disseminated much later than completed (HIV/AIDS study; GIS options study).
Comuleted in FY04
104 Global Development Learning Network Affiliate in
Transport Study 2006 I Delivered in FY07 Public Administration Incentives TA 2 2005 I Delivered in FY06 Carbon Financing (GIs Options Study) 2006 Delivered in FY07 Forestry Policy Note 2006 Delivered in FY06 Integrated Social Analysis 2006 Dropped Health and Education PSIA (associated with PULSE) 2005 Delivered in FY06 Governance and Use of Country Services (Corruption Vulnerability Scan) 2006 Delivered in FY07 PULSE 2006 Delivered in FY07 I Public Expenditure Review 2006 I Delivered in FY06 I Ukraine 11: Corporate Governance ROSC Assessment 2006 I Delivered in FY06 FY2007 Poverty Update 2007 Delivered in FY07 ROSC Accounting and Audit 2006 Delivered in FY07 Private Sector Development Strategy Note (Investment climate, competitiveness and growth) 2007 Delivered in FY07 Civil Service Governance TA 2007 Delivered in FY07
93. Despite its overall high quality, AAA work could have had a greater impact. The Bank used its AAA work mostly to enrich its dialogue with the authorities and to improve the design ofits lending interventions. There is a need to make AAA work more responsive to client demand, improve timeliness of delivery and make the analytical work more focused on policy advice that can inform concrete decision making. In addition, the Bank could use the results of its analytical work to advocate for policy changes in areas where there is not yet a national consensus. With hindsight, more needs to be done to reach out to a broader audience than the government.
105 94. The Bank could also enhance its own learning from engagement with Ukraine. As a large Middle Income Country (MIC) that still demands the full range of Bank services, Ukraine offers potentially important lessons for the Bank’s engagement in MIC countries. The Bank should use opportunities for learning together with the client and adjusting its service mix accordingly more. Greater attention to client needs and demands would over time create opportunities to involve clients in disseminating lessons from their experience of working with the Bank to other MIC clients in the region and outside. 95. IFC’s advisory services performed well in addressing broad private sector development challenges and specific client needs. IFC’s advisory operations under this CAS that have been evaluated were found to be strong on all performance indicators, including development effectiveness and overall work quality. Success drivers included project strategic relevance, timeliness, and structure. The majority of these projects are now leading to a series of follow-up operations that have built on their success and expertise. Advisory services linked to particular IFC investments show high success rates as well, addressing specific needs of committed clients and logically lending themselves to consultant engagements. Results Framework 96. Thefocus on results benefited both the design and implementation of the CAS. The FY03-FY07 CAS helped pilot the results-based approach to CASs in the Bank. With hindsight, the road map presented in the results matrix was a useful guide for the policy dialogue and adjustment. The linkage with investment operations was weaker. Future designs may benefit from a stronger linkage between policy-based lending and investment operations. 97. The design of the indicators was satisfactory. The drafting of the expected development outcomes under the CAS was precise and most indicators were benchmarked. The CPR took stock of the path to results by mid-term. The advent of a new government raised expectations that the pace of implementation would pick up and therefore the CPR did not adjust the results matrix. With hindsight, perhaps this should have been done. In some cases, the proposed indicators were not developed (governance, technology, legal alignment with Europe, etc.) making it difficult to track impact. The next strategy should pay greater attention to the measurement and tracking ofresults. A more direct dialogue on the tracking ofresults with government is also advisable. Field Presence 98. The increased presence of the Bank in Ukraine has made it possible to provide timely assistance to the government. This presence also permits to maintain a continuous policy dialogue and make progress in the development and implementation of sector agendas, as has been the case in the energy sector. However, country presence is a necessary but not a sufficient condition for effectiveness, as experience in other sectors shows.
106 Working with Successive Governments 99. Political developments affected implementation of the reform agenda the CAS supported. The CAS was implemented during the tenure of four different governments, and included periods of substantial political change, including the events that became known as the “Orange Revolution”. Arguably, political uncertainty diverted attention from reform. Moreover, the move to European institutions is not as powerful an incentive in Ukraine as in Central Europe where there was a concrete accession perspective. Deepening integration with the European Union continues to attract broad national support, including across the political spectrum, albeit more recently with a greater sense of realism and a sense that societal and institutional change in Ukraine will take time. 100. Progress was made in areas where political consensus existed or was forged. Across the political spectrum, there is consensus on issues such as fiscal discipline, emphasis on social expenditures, accession to WTO, and energy security and efficiency. Shared priorities helped achieve results. The opposite has been the case in areas of discrepancy-for instance, in privatization, pension and social assistance reform, corporate governance, etc. In areas of high consensus, the Bank can play a productive role in providing knowledge and technical assistance as well as resources. In areas of limited consensus, the WBG can play an advocacy role supported by good analytical work. 101. Overall the quality of governance has improved in the country, but still remains a major development challenge. Indicators such as the World Bank Development Institute Governance Indicators track major progress in government effectiveness, the quality of regulation and the control of corruption. The intended Bank support to scale up engagement with civil society did not develo as expected. On the other hand, the situation in 2006 is strikingly different from 1998.89 The political events of2004 brought about improvements in voice and accountability-with greater transparency (freedom of the media, economic policy, and government information). Thus, it is in the area of civil engagement where the greater progress in the country was made, even if the agenda the Bank intended to implement did not hlly take off. 102. Still, there is the perception that governance issues represent a major constraint in critical sectors-effectiveness in the use of public resources, the environment for business, corporate governance, and corruption. In summary, while Ukraine ranks relatively well in the context of CIS countries, it lags peer countries in Central Europe and at similar levels ofincome.
69 Ukraine improved its ranking in all of the six WBI governance indicators from 1998 to 2006. Still, it ranks below 50 percent (amongst the sample countries) in all of the six indicators. Of the six indicators, voice and accountability provides the best performance, reflecting more freedom of the press and a more active civil society. By contrast, Ukraine ranks lowest-despite improvements-in control of corruption and the rule of law. In these two rankings, Ukraine in 2006 scarcely ranks above 25 percent of countries in the sample.
107 VI. LESSONS 103. Institutionally capable and committed national agencies increase the likelihood of implementation effectiveness. The Central Bank, the MoF and the energy complex are capable, committed agencies that get things done. In such cases, although it may take time to reach agreement, prospects for successful implementation are high. Weak institutions are less likely to implement agreements even if there is a high level of formal “ownership.” This partly explains the difficulties with advancing progress on social issues and in the environment. Understanding the capacity of country authorities helps to realistically assess the likelihood of implementation. However, the capacity to implement is not fixed and can increase through strong political mandates, good leadership and institutional reform. It can also deteriorate. 104. Linkages across themes reinforce the effectiveness of interventions. This review has shown how a keen understanding of the linkages across themes can help advance reform and produce results. Improving payments and fiscal discipline has helped make further progress in the financial and the energy sectors. In addition, the focus on linkages between energy and the environment (Kyoto and “green energy”) has already produced positive results. By contrast, the linkage between fiscal programming and expenditure (“social sectors”) remains highly undeveloped. Likewise, the linkages between delivery of social services and fiscal approaches to decentralization, despite some attempts, remain insufficiently articulated. 105. Effectiveness requires not only a clear vision, including expected results, but an understanding of the remedies to remove the barriers to achieve them. This review has shown that clear objectives are not enough to achieve results. The complicated and often non-transparent political economy of Ukraine stalled progress in several areas. These include lending to municipalities, pension reform, governance of public and private enterprises, privatization, creation of a unified property registry, social assistance reform, service delivery, etc. In most of these areas, those who hold formal mandates often do not have the political mandate. This is not surprising in countries of the former Soviet Union where by design there was a divorce between policy decision making and execution. The tendency to concentrate policy decision-making at the top will continue in the absence of a deeper reform ofthe state. 106. A broad agenda risks wide variability of results. The 2003 CAS agenda was broad because it endeavored to cover most aspects ofthe government program. The price has been a wide variability of results. It was simply not possible to deal with all of the issues thoroughly, with limited country and Bank resources. With hindsight, greater selectivity would have helped improve the quality of the overall delivery. Selectivity requires putting in place rules of engagement and disengagement and enforcing them. Flexibility helps move in areas ofopportunity and drop slow-moving agendas. 107. Achieving results demands sustained efforts that combine the use of various instruments. Although there may be cases of quick wins, in most circumstances, progress came about through a combination ofintensive dialogue supported by analytical work and adjustment, and, in a few cases, investment. Marginal or exploratory efforts without explicit disengagement after a trial period or persistent follow-through can lead
108 to inflated expectations of Bank assistance and divert resources from areas with higher potential impact.
VII. MOVINGFORWARD 108. The Bank should adopt greater selectivity in its strategy approach, targeting a limited set of thematic areas that exploit synergies and at the same time provide for greaterfocus. The strategy for FY08 to FY 1 1 should focus on key themes that cut across the board and avoid narrow sector approaches. It should also be selective in the themes for full engagement. Taking a long-term perspective helps achieve selectivity by postponing interventions that are not ready. A selective and prioritized agenda helps focus Bank and country resources on achieving substantive results rather dispersed incremental gains. Selectivity, however, is a challenge because the pace of progress has differed substantially across sectors. Interventions are likely to be more effective in areas with clearly defined agendas and with more solid institutions; however, lack of progress in lagging reform areas can drag down other agendas.70 A partnership with Ukraine would best combine interventions in areas with strong delivery potential with a presence in key strategic arenas where progress has lagged. An open dialogue based on quality analytical work and a good understanding of the linkages/synergies across initiatives should help partners to evaluate trade-offs. 109. Allow for flexibility in program design. The Bank should follow a flexible approach mixing adjustment and investment lending. Demand for adjustment is likely to continue into the medium term as an instrument to signal the country’s commitment to modern market institutions to the international community. In this regard, adjustment can be a powerful instrument to drive institutional change. Still, the demand may shift overtime, depending on the need for resources and shifts in priorities. Within the adjustment framework, partners should keep an open mind as to whether to continue with the broad umbrella operations as in the past or to target sector issues more narrowly to provide the leverage needed to unblock persistent constrains. While policy-based lending remains the best option to achieve institutional reform, care must be taken not to overload adjustment operations. The potential contribution of AAA work to drive reforms forward could be better exploited, including through advocacy work. Lastly, the next strategy should avoid rigid programming over time and follow instead a rolling business plan approach. A two year program could be designed and then updated at mid-term review.
70 Lagging areas that need attention are: (a) private and public corporate governance; (b) regulatory compliance costs for business; (c) public expenditure management-ntry point to: fiscal space for investment, social sector reform; and decentralization; (d) social sector reform, and (e) reform of the state. Poor corporate governance will slow down financial sector deepening, economic diversification, and the competitiveness of the economy. A lagging small and medium enterprise sector reduces the dynamism of the economy. Lack of attention to budgetary issues and the need for increased effectiveness ofpublic expenditures is likely to delay service delivery improvements. Improved service delivery has to take stock ofthe role and performance of the local governments. Shortcomings in capital budgeting will cut short efforts to open fiscal space. Hence, attention to the laggard sectors cannot be avoided.
109 110. Evaluate the likelihood of implementation before undertaking significant commitments. Clarity of objectives, direct evaluation of ownership and technical capacity of implementing authorities, and a sense of the political economy behind a particular reform roadmap are essential if the Bank is to be effective in contributing to the country’s development objectives. In some cases, the emphasis should be on capacity building; in other cases, the Bank can play a positive role by tilting the balance of political interests towards reform. 11 1. Make investment interventions work Without functioning investment projects, the scope for delivering results narrows. The recommendations of the 2005 review of investment lending remain valid. Attention to improving internal procedures in Ukraine-- the emphasis of the last CAS--should be complemented by extending recent increased discipline on the Bank’s side concerning preparation time, effectiveness delays, project extensions, etc. A shift towards implementation agencies outside the central government (e.g., energy companies) may favor implementation success, but such an approach leaves open the question of how to assist with building institutions at the central levels. In addition, a tighter alignment of investment operations with government priorities and institutional and budgetary processes, and with the adjustment agenda helps bolster ownership, as do improvements in capital budgeting and greater use ofcountry systems. 112. The WBG should strengthen cooperation amongst its agencies and with the donor community. The expanding role of the IFC calls for greater harmonization with the Bank in achieving common results. Coordination between the WBG and other donors is also critical to various strategic agendas. A competitiveness agenda requires not only harmonization and cooperation within the WBG but working with others, like the European institutions, which will also likely help advance the governance agenda. The Millennium Challenge Corporation is likely to become a more prominent participant as well. 113. Broaden the dialogue on transition. The emphasis on demand for institutions and better governance continues to be valid. For the donor community to be effective the dialogue must extend outside the government to include parliament, local authorities, civil society, interest groups and the poor. In this regard, the dissemination of the results of economic and sector work should a priority. Ukraine has an open political system and a free press, which can contribute to debates on strategic choices. 114. Enhance efforts for two-way learning. While the Bank aims to bring a combination of knowledge and lending services to Ukraine and Ukraine’s current rapid economic development is likely to make knowledge services more important during the coming CPS, there are also opportunities for the Bank to learn from its engagement in Ukraine, which need to be used more effectively. Greater attention to client demand and ownership would further enhance operational returns to such two-way learning.
110 IBRD LENDING OPERATIONS (This table compares what the CAS foresaw with actual events. 2004 data are from CAS report;
FY FORESEEN $ mill. ACTUAL $ mill. 2004 PAL2 250.0 PAL-2 250.0 Devstat 30.0 Devstat 32.0 Rural Finance (APL-1) (later merged 250.0
I (Agricultural Competitiveness) I Pollution Reduction & Improved I 50.0 I I I Compliance in Industry (Greening I I I Industnal Modernization) Social Insurance/ Employment 75.0 Infrastructure (more than one project) 425.0
Total 1,000.0 Total 154.5 GRAND TOTAL 2,400*** I GRANDTOTAL 1,139.8
* - approved in early FY08; ** - scheduled for FY08; *** Grand total exp. lending does not equal sum of annual expected lending but reflects overall base case envelope. Backloading was programmed into FY06 and FY07 expected lending.
111 IFC LENDING OPERATIONS FY04-07
CMT PROJECT YEAR DEPARTMENT PROJECT TOTAL YR STATUS NET CMT (US$ mil) 2004 21071-Mironovsky Agribusiness ACTIVE 30.0 I 2004 I 23257-Sandora I Agribusiness I ACTIVE I 10.0 I 2004 11316-First Lease Financial Markets CLOSED 2.0 2004 2 1077-MBU RI Financial Markets CLOSED 1.o I 2004 I 22197-HVB Ukraine RI I Financial Markets I ACTIVE I 0.5 I 2004 22571-Procredit Ukrain Financial Markets ACTIVE 8.5 2004 10682-Okean Shipyard Manufacturing CANCELLED (10.0) 2004 22295-Nova Liniya Manufacturing ACTIVE 5.0 I 2005 I 24011-Mironovsky II 1 Agribusiness 1 CLOSED I 60.0 I 2005 22762-Aval Financial Markets ACTIVE 35.0 2005 23845-RZB Ukraine Financial Markets ACTIVE 30.0 2005 24157-SocGen CELT Financial Markets ACTIVE 95.0 I 2005 I 11134-AESKvivObleneero I Infrastructure I ACTIVE I 30.0 I 2005 24305-AES RivneEnergo Infrastructure ACTIVE 15.0 -----2006 23257-Sandora Agribusiness ACTIVE 10.0 2006 23794-Rise Anribusiness ACTIVE 10.0 I 2006 I 24264-AvalII I Financial Markets I ACTIVE I 50.0 I 2006 22500-EVU I1 Funds ACTIVE 7.5 2006 23961-Biocon Health & Education ACTIVE 3.5 2006 24084-Sofia Kyiv Hyatt Manufacturing ACTIVE 16.5 I 2006 I 24395-NovaLinivaII I Manufacturing I ACTIVE I 10.0 I 2006 24437-Asnova Manufacturing ACTIVE 8.0 2006 24656-Zeus Ceramica Manufacturing ACTIVE 9.0 I 2006 I 24685-ISD I Manufacturing I ACTIVE I 100.0 I 2006 24764-Velyka Kyshenya Manufacturing ACTIVE 45.0 2006 24264-Galnaftogaz Oil, Gas, Mining & Chemicals ACTIVE 25.0 2007 24644-Delta Wilmar CIS Agribusiness ACTIVE 17.5 I 2007 I 25232-SandoraII I Agribusiness I ACTIVE I 20.0 I 2007 25668-Khlibprom Agribusiness ACTIVE 30.0 2007 24 157-SocGen CELT Financial Markets (17.0) 2007 24765-First Lease CELT Financial Markets ACTIVE 17.0 2007 I 21813-IMB I Financial Markets I ACTIVE 7.0 I Total 681.0
112 IBRD ANALYTICAL AND ADVISORY OPERATIONS
YEAR FORESEEN ACTUAL* 2004 Country Economic Memorandum Country Economic Memorandum (CEM) (CEMj (FYO4) Civil Society TA Risk and Vulnerability Assessment (FYO 1) Poverty Assessment Agriculture Policy Note (FY03) Telecom ICT Energy Sector Work (FY03) Trade Policy/WTO Telecom ICT (FY04) Business Environment TA Business Environment TA
2005 Labor Study Trade Policy/ WTO Access (FY03) Regional Development Strategy Poverty Assessment (FY04) People’s Voice TA Pensions (FY05) Public Administration Incentive TA Coal Policy Note Update (FY05) Forestry TA Pensions
2006 Carbon Financing PFR (FY06) Policy Notes Forestry Policy Note (FY05) CPAR Health and Education Notes (FY05) Governance TA Labor Study (FY05) PULSE Policy Notes (FY05)
Transport Study Public Administration Incentives TA 2 (FY05) Telecom Study Savings Bank Restructuring TA (FY03) Public Finance Review Business Environment TA (FYO1) TA for Privatization (FYOO)
2007 Transport Study Transport Study (FY06) GIS Options Study GIS Options Study Governance, Use of Country Systems Governance, Use of Country Systems (FY06) Poverty Update PULSE (FY06) CPAR (FY07) Civil Service Governance TA Civil Service Governance TA HD Policy Notes Poverty Update ROSC Accounting and Audit Environmental Protection PFR 2 Financial Sector Dialogue TA Jobs Agenda TA PSD/ FSD Advisory Services TA PVP 2 TA * Origin2 projection of the milestone step that marks le project delivery is shown in parenthesis (from SAP
113 IFC ANALYTICAL AND ADVISORY OPERATIONS (Programmatic projects active during the CAS period, investment-linked projects are excluded)
I Project Name I ApprovalFY I Status I Area I Agribusiness Development 2):; 1 :;;: I AgribusinessILinkages 1 Corporate Development Corporate Governance
I Banking Sector Corporate Governance Study 1 2004 1 Closed 1 Corporate Governance Banking Sector Corporate Governance Project 2005 1 Active I Corporate Governance Commerical Mediation I Dispute Resolution Business Enabling 2005 Active 1 I Environment 1 Leasing Development Financial Markets ------Preparation ofa Development Program for the Pulp and Paper Industry 1~~ Southern Ukraine Vegetable Supply Chain 2005 Active AgribusinessiLinkages
Vinnitsa Dairy Supply Chain Development 2005 Active AgribusinessiLinkages
I Vinnitsa Fruit Supply Chain Development 2005 1 Active I AgribusinessiLinkages I I SME Survey (Phase I- V) 2006 1 Closed 1 SME 1 I Agribusiness Insurance I Risk Management 2007 I Active I Financial Markets I Business Enabling Business Enabling Environment 2007 Active 1 I Environment 1 Mortgage Note Development 2007 I Active 1 Financial Markets
114 RESULTS MATRIX
BANK GROUP OBJECTWES PERFORMANCE ASSESSMENT & KEY LESSONSLEARNED PER STRATEGIC AREA 1. Supporting macroec zomic andfinancial sustain 11.11ility Maintain public debt Rapid economic growth Bank support came Emphasis on payments as a share of GDP at (7.8 percent on average through analytical work, discipline and fiscal less than 40 percent 2003-2006) and prudent technical assistance on prudence was strategic, fiscal management reduced debt management, and contributed to Public Debt to GDP to 15 adjustment. economic growth and percent. helped improve the standing ofthe country Budget arrears dropped to in international .17 percent of GDP in markets. Fiscal 2006. prudence also created conditions for the financial sector to grow. High government ownership. Stronger financial The CAS targets were Extensive Bank dialogue Permanent dialogue sector measured as a exceeded. The financial and technical assistance with the Central Bank share ofcommercial sector is stronger and has on financial regulation and the Ministry of banks’ equity to GDP grown very rapidly; and its enforcement as Finance proved (7.3 percent) and concerns that the expansion well as on containing effective in developing share ofdomestic is too fast. Deposits to risks emanating from the a credible reform deposits to GDP (33.8 GDP at 33 percent ofGDP Savings Bank. Technical agenda in the financial percent) and bank capital at 7.6 assistance and sector and bolstering percent ofGDP in 2006. adjustment were the the regulatory capacity. Credit growth over 40 main vehicles to assist There is awareness and percent annually since on policy dialogue and commitment to 2001, one ofthe fastest in the Savings Bank. continued vigilance and transition economies. Bank improving oversight vulnerability up with The Bank Board and enforcement increasing foreign currency approved two investment capacity. However, exposure. However, operations that will Bank has not had growing presence of improve the capacity of access to complete strategic foreign investors a the financial sector to sector information, mitigating factor, channel funds to SMEs reducing effectiveness and help improve of assistance as sector Significant improvements capacity of EXIMBANK becomes more in regulatory framework to facilitate exports sophisticated. Also, and enforcement practices through a guarantee capital market in the banking and non- scheme. regulation remains banking; fine-tuning of weak. Banking Law to facilitate IFC advisory services on Central Bank enforcement bank corporate under way. Corporate governance helped governance in the financial second-tier banks attract sector improved. Not full a total ofUS$950mln in compliance with Bade 11. external finance.
115 STRATEGIC COUNTRYPROGRESS BANK GROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT & KEY LESSONSLEARNED PERSTRATEGIC AREA Systemic risks from the Savings Bank contained.
New legislation adopted regarding secured transactions and the securities market. Stronger SME sector Market economy status Bank and the IFC Progress mixed due in measured as share of achieved (EU/US) followed improvements the area ofprivate employment in labor in the quality ofthe sector development force. Gross investment at 24 business environment (business environment, percent ofGDP (2006) through technical privatization and Share of investment to assistance and corporate governance) GDP to increase to High Foreign Direct adjustment. Private due possibly to a lack 22.7 percent of GDP investment-US$5 billion Sector Development of adequate in 2006, after US7.3 (PSD) project cancelled counterparts. billion. in 2005. limiting capacity ofthe Improved system of Bank to help with More forceful actions corporate governance Efforts to simplify business improving the business advisable, but true legislation intensified. environment at the commitment from the Reported progress on regional level. authorities needed, facilitating tax compliance. otherwise the Tax expenditures reduced. Bank supported reputation risk for the Still Ukraine ranks low on government Bank is high, especially business environment and transparency in on privatization. the quality of tax practices. privatization agenda through adjustment. IFC will increasingly Transparency of be a driving force to privatization increased in State Tax Administration support the 2005, although Modernization project development ofthe sustainability remains under implementation private sector. unclear. has focused on improving voluntary tax Financial Industrial Groups compliance and greater (FIGS)consolidating and accountability of the tax improving governance. agency. Project has However, long-awaited already contributed to Joint Stock Company Law the redesign oftax not passed. processes. Project re- programmed to deliver Legislation setting basis for outcomes earlier. improved public corporate management approved. Bank provided assistance on drafting legislation on security markets, but was unable to push through comprehensive reform, including Joint Stock Company Law and legal
116 STRATEGIC COUNTRY PROGRESS BANK GROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PER STRATEGIC AREA amendments strengthening capital market regulators.
Bank analytical work has consistently emphasized need to enhance corporate governance transparency to bring Ukraine up to par with international standards. The IFC has been providing direct assistance to enterprises and banks to improve corporate governance.
IFC has increased channeling ofresources into Ukraine-flow per year now stands at around US$300 million (FY06). With a US$658 million committed portfolio, 8" largest IFC exposure. Role ofmarket Implementation of a Bank support has A more candid analysis institutions in decision to establish a focused on the of the potential for agriculture enhanced unified land cadastre and development ofa conflict amongst the registry for immovable modern real estate various stakeholders in Long-term lending in property remains pending, registration system real estate registration agriculture increased given lack ofconsensus through the Rural Land was warranted. where the registry should Titling and Cadastre be located. project. Progress has The agriculture sector been slow. The continues to lag below Availability of finance to establishment ofa potential and the the rural sector increased, unified registry for land continuation of except for small and and real estate has been moratorium on land medium producers. delayed due to lack of sales could delay consensus where it needed sector Progress on titling land should be located. The restructuring. (around 6 million land titles project itself is under issued up to now), but partial suspension for moratorium on land sales poor implementation twice extended (to now Jan performance. Project 2008). implementation did not prevent meeting the land titling objective with the help ofother donors, however.
117 STRATEGIC COUNTRYPROGRESS BANKGROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT & KEY LESSONS LEARNED PER STRATEGIC AREA
The Bank supported improving availability of finance to rural areas through legislation (secured transactions) and the Access to Financial Services project. Quality ofenergy The quality and reliability Kiev District Heating Helping build services improved of energy supply has (energy efficiency) institutional capacity in increased. project successfully the energy sector has implemented. yielded a positive dialogue and enhanced Bank has approved an the ability of the Bank investment operation to to help strengthen the help strengthen the sector. Similar reliability the electricity approach can be sector, supplying the followed in domestic market and infrastructure. supplying energy for export. Bank projects implemented outside Bank has assisted the the central government sector authorities in appear to be developing energy implemented more strategy, evaluating smoothly. energy projects and undertaking needed investments.
Strong on-going AAA program in energy.
Bank is assisting Ukraine electricity sector adopt European Standards to permit linking to the EU grid. Fiscal risk from Collections for electricity Bank provided Emphasis on financial energy sector reduced and gas above 90 percent. assistance in the drafting health of the energy Quasi-fiscal deficit in ofenergy debt sector was strategically energy sector reduced from restructuring legislation well founded, with over 6 percent ofGDP in as well as in the positive results for the 2002 to 2.6 percent in evaluation ofthe economy and the 2006. financial sustainability sector. of the electricity sector. Law providing the basis to The financial clear inter-enterprise The Bank also has sustainability ofthe arrears is in place and stock prepared extensive sector requires
118 STRATEGIC OVERALL OBJECTIVES ASSESSMENT & KEY LESSONSLEARNED PER STRATEGIC AREA ofdebt from electricity economic and sector continued attention. An distributors to Energorynok work taking stock of improved financial reduced by UAH 3 billion. status of the various situation favors the I energy sectors. participation of the Sector finances are still private sector. weak; strategies to further improve finances under preparation. Ukraine continues to rank Engagement developed Providing assistance on based economy high in the capacity to more slowly than developing a develop advanced anticipated. The knowledge based technologies; the challenge Knowledge Economy economy did not is their use for commercial Note is under materialize and purposes. preparation and the provides an example of dialogue is expected to areas that while continue in the new included in the CAS CPS. The E- did not take off or were Development project not successfully closed, however, implemented. following an extended period of suspension. How to profit from the high tech capacities in the country continues to be relevant.
The governments’ standards of working 77 percent cumulatively has emphasized reducing strategy to increase population measured during 2003-2006. labor taxes. However, incomes and the living as an increase in real concerns about the standards was correct. salaries by 75 percent. Social insurance sustainability of the However, the increases contribution rate remains pension system have are eroding among highest in the region delayed actions. competitiveness and at 41 percent. may not be sustainable. Labor market study I (2005) shows labor market flexibility is not a major constraint. Poverty headcount Poverty headcount reduced Bank has assisted with Responding to the reduced from 27.7 throughout 2003-2005 to the financial heightened political percent to 23.7 reach 8 percent in 2005. sustainability analysis of demand to provide percent. Substantial increases in the pension system. social security, the minimum pension DPL-1 focused on authorities responded Reduced rural poverty introduced in late 2004 measures to improve the by increasing pensions have been an important sustainability ofthe and social assistance Reduced poverty driver in poverty reduction. pension system. benefits. These among the elderly measures have measured by poverty Consequently, pensioner Bank support targeted to contributed headcount to less than headed households do no improve the significantly to the 25 percent longer face administrative capacity reported drop in disproportionate poverty ofadministering social poverty, but with a
119 STRATEGIC COUNTRY PROGRE~~ BANKGROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PERSTRATEGIC AREA risk (poverty rate equal to assistance through the high fiscal cost. national average of 8 Social Assistance percent). Systems Modernization Fundamental reform of Project (2006). the pension system and social assistance has Satisfactory proven difficult, even if implementation ofthe issues have been clear Social Investment Fund since the beginning of Project has contributed the CAS. with over 222 micro- projects in depressed Linkage between social communities largely in security expenditures rural areas. and the fiscal stance could be used to achieve greater leverage for reform.
There is a need to improve and modernize de-centralize administration ofsocial protection programs, to reduce administrative cost and review social contribution to reduce taxing of labor.
I 3. Comnrehensive and harmonized Human Develovment Improve access to Lack of traction with quality services, authorities in including education developing and and health care implementing social sector policy has limited the capacity of the Bank to contribute in health, education and AIDS.
120 STRATEGIC COUNTRY PROGRESS BANK GROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PER STRATEGIC AREA Maternal mortality Maternal mortality 17.6 per The Bank has provided Bank should consider below 21 per 100,000 100,000 live birth in 2005 technical assistance for alternative approaches born alive the development of a to engagement; for Infant mortality 10 per Health Sector Strategy. instance, focusing on Child mortality below 1,000 live birth in 2005 the linkages between 5 reduced to less than PULSE has identified service delivery, 13 percent Under 5-mortality 12.9 per emerging challenges to budgeting and 1,000 live birth in 2005. accessing health services decentralization. and pharmaceuticals by Male and female life low-income population Joint work, events and expectancy have been groups. information exchange decreasing from 1998, life with other agencies expectancy for women (WHO, EC delegation, continues to be 12-13 years USAID) has been key higher than for men (EU in maintaining policy average 6 years) dialogue with Government. Significant barriers remain in accessing health services Cooperation with other - in 2004, 7.6 percent of donors has been critical people from lowest income in areas like TB and quintile reported having AIDS, where the used outpatient health attention ofthe services against 12.8 authorities slips or percent in richest quintile. where the power of vested interests is strong. For 2006 AIDS: 71958 The Bank has been (152.8 per 100,000) - actively involved in the registered HIV cases, development ofthe including 7,175 (15.2 per national policy and 100,000) AIDS programs for HIVIAIDS control and worked AIDS deaths: 24 16 in closely with other absolute numbers (5.1 per partners to support 100,000). national coordination.
TB 2005: Active TB However, the direct prevalence 219.1 per contribution to service 100,000 provision has been Active TB incidence 84.1 limited due to delays in per 100,000 implementing the Mortality rate 25.3 per 100 TBIAIDS project. 000 (Data MOH, 2006) Bank authored a major The national program on Socio Economic Impact HIViAIDS implemented Study ofHIV-AIDS in jointly by the State and Ukraine. NGOs. National coordination is functioning, The major progress has
121 STRATEGIC COUNTRYPROGRESS BANKGROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT & KEY LESSONSLEARNED PER STRATEGIC AREA but weak. Stronger been made in adopting leadership is needed to the TB DOTS strategy The Bank should focus scale up the national and its implementation. on assisting Ukraine in response more efficient use of Improved access to Enrollments in general The Bank has resources, as well as quality education by secondary education contributed analytical ensuring adequate increased enrollment reached 99.7 percent in work and techmcal quality and relevance and completion rates 2006 as compared to 99.2 assistance in preparing a of the education system in secondary percent in 2004. Number of sector strategy. PULSE 1 by providing education (99.5 students decreasing in and 2 has identified programmatic policy percent and 95 absolute terms due to emerging challenges in support to the percent respectively) decreasing population. the delivery of education Government in Access to pre-school services. Ukraine School development of sound Number of higher education (enrollment of 5 Facility Survey provided strategies for Education education graduates year old) remains an issue recommendations on the sector. (I11 and IV levels of especially in rural areas: in improvement ofmaterial accreditation) urban areas 2005 - 77.7 and technical base of increasing to 49 percent, 2006 - 78.7 percent education system. Broad sectoral percent. and in rural areas - 32.9 coordination with other percent and 36.2 percent The implementation of partners needs to be respectively. the Bank’s Education ensured in supporting project is proceeding at a policy development Number of students in HE pace slower than and monitoring in the institutions of111-IV levels expected. It supports areas of GS schools’ ofaccreditation has been introduction of new financing and increasing every year (2004 curricula and management, quality - 1,843.8, 2005 - 2,026.7, improvement of monitoring and 2006 - 2,203.8), while the education standards. It evaluation in GS and number ofinstitutions provides assistance to HE, as well as better remained about the same the gradual skills supply for growth (2004 - 339,2005 - 347, implementation of and competitiveness. 2006 - 345). National Assessments in Ukraine and building the Allocation ofresources to capacity of the Policy education has increased to Planning Department in 6.4 percent ofGDP, but the Ministry. Project efficiency in expenditures supports improvement of has not increased. Average school system Ukrainian school has 15 management by classed386 students; introducing the new average class size is 16-17 forms and methods in students; 2.9 percent of training school schools have less than 5 principles and students per class (in rural administrators of the areas). system at all levels. Progress has been achieved in quality assurance by Promotion of European introduction ofthe National co-operation in quality External Assessments in assurance still remains a 2006 (Ukrainian language, challenge, as the national
122 STRATEGIC COUNTRYPROGRESS BANKGROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PERSTRATEGIC AREA Maths, History) and system of accreditation implementing TIMMS (test and licensing is still in international bureaucratic, lacks mathematics and science) transparency and Efforts to improve quality remains slow. through pilot implementation ofBologna principles are being completed. At the national level, a Homogenization of degrees under way. Improved access to No information on water Lviv Water project, Support to improve quality water quality at national level close to completion, has capacity of measured by share of available. contributed to the up- municipalities to the population using grading local service deliver services well drinking water that New national water delivery. placed; however, it is satisfies national standards introduced in necessary to put in standards to exceed April 2007. New Financial Services place a transparent 88 percent in urban operation includes framework within and 54 percent in component to channel which the central rural areas. resources to government extends municipalities for guarantees to investment in municipalities. Also infrastructure. local politics has to be factored in the design New Urban of investment projects. Infrastructure Project approved in August 2007. 4. Protection of natur6 mvironment Improve The resources available to The intended Bank Despite good preceding environmental the environment sector Environmental analytical work, the policies and increased as a result of Institutional weak public institutions regulations and make updating fee structure. Strengthening Project to in the environment them an engine of build the institutional sector handicapped technological change capacity of the sector did Bank effectiveness. not take place. Still, Bank continued to Progress on Kyoto with provide advice on the signing ofthe fist environment policy-fee ERPA driven by more structure and allocation effective energy sector of resources. institutions. Effectiveness ofwork Energy intensity Energy intensity 0.5 Institutional weaknesses on environment issues reduced to less than 8 toe/lOOO USD GDP in PPP and design problems led will continue to depend toe/l,OOO USD of (2004) to the cancellation of the on improving GDP in PPP terms Azov-Black Sea institutions. CO emissions 1.09 kg/l Ecological Corridor CO emissions reduced USD of GDP in PPP (2004) Project (GEF grant). to less than 1.72kdl
123 STRATEGIC COUNTRYPROGRESS BANK GROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PERSTRATEGIC AREA USD of GDP in PPP terms (ERPA) under Kyoto due to strong GDP Number ofnational signed. growth, but still lagging environmental behind CEE countries. standards compliant with international The Bank signed the norms increased to 10 ERPA as Trustee of the Netherlands Carbon Facility with UkrHydroEnergo.
5. Good integration ini the world economic andfin cia1 system Increased trade with Ukraine close to WTO Bank encouraged Bank, in cooperation new partners: accession. through adjustment and with other donors technical assistance tariff (Dutch), provided low- Progress with Progress made on reduction, reform of key but effective advice adoptions of EU harmonizing product customs and by following rather requirements; standards and certification harmonization oflocal than pushing with EU practices. product standards with government initiatives. WTO membership the EU. Shows Bank assistance Trade reform lower import is effective when Share of EU exports tariffs (average 5.1 percent) Bank provided targeted authorities take the increased to more below WTO commitments. assistance to the lead. than 20 percent authorities in their Size oftrade with EU stays efforts to join the WTO. roughly constant at 30 percent of total
Government initiated reform ofthe customs administration.
6. Dynamic regional ll velopment and reduction of gional imbalances Increasingly The formula to transfer The Bank continued to Regional issues are harmonized regional budgetary resources to the provide assistance on highly political and development and regions and municipalities improving the allocation controversial in reduced number of have been fine tuned. De ofresources to the Ukraine but continue to depressed territories facto not much progress regions as a function of be highly relevant as Regional disparities have needs and revenue effort. disparities may be on increased. the increase. The attempt to help improve business Transformation ofthe environment at the People’s voice project regional level could not from a pilot stage to be implemented through national initiative the PSD project, which remains to be was cancelled. implemented.
People’s Voice project
124 STRATEGIC I COUNTRYPROGRESS I BANK GROUP OVERALL 0m E c T IVE s PERFORMANCE ASSESSMENT& KEY LESSONSLEARNED PERSTRATEGIC AREA to foster accountability of local authorities performed satisfactorily and has been expanded (from 4 to 6 cities). vernance Increased Adopted cash payment for Transparency, gas transfers through accountability and Ukraine, rather than integrity of payment in kind as in the government past. Civil service Limited progress in Civil The Bank has Low traction in civil approaching EU Service Reform-improved undertaken analytical service and public standards measured regulation to streamline the work and has prepared administration reform through annual pay system. options to move in the despite availability of baseline assessment direction of European supporting analytical of civil service Standards. work and manifest Institutional structure Limited progress in overall The Bank has government ofpublic Public Administration undertaken analytical commitment to move administration reform-targeted work and has prepared to European standards. supports effective interventions in the options to move public These two areas remain policy implementation Ministry of Finance and administration in the critical and a credible and enhances customs. direction of European roadmap is needed as accountability for Standards. efforts have to be policy outcomes sustained over the long haul. Attempts to concentrate all reforms at once risk failure. System offinancial PEFA reports Ukraine has The Bank has Political forces, in the accountability/control relatively well developed raditionally provided RADA, overrode the and public procuremen public financial controls. idvise on procurement Government program compliant with fiducial ind analytical work, the damaging the requirements and EU Progress and then reversal ast being the CPAR and institutional standards on public procurement-- he Public Finance environment for new legislation driven by ieview both of 2006. procurement. The interests outside 3ood cooperation with country would benefit government. 3U and OECD on much from reversing irocurement reform, but this situation soon. Limited progress in moving IO far too little effect. Internal Financial Control Reform ofthe overall to EU standards-KRU The Bank has public expenditure reform still on hold. strengthened the system has been procurement capacity of piecemeal. The country the local office. is ready for a more systematic treatment The Bank has that envisages a maintained a permanent credible time path. dialogue on internal control, procurement Additionally, it is around the adjustment important to leverage
125 STRATEGIC COUNTRYPROGRESS BANK GROUP OVERALL OBJECTIVES PERFORMANCE ASSESSMENT& KEY LESSONS LEARNED PERSTRATEGIC AREA agenda. reform in public expenditure with the Bank Treasury Systems reform of the social Project contributed to sectors and the the creation ofa unified transfers to local treasury. governments.
Effective natural Telecommunications The Bank support for monopolies regulatory regulations adopted in line improving the quality of bodies in place with WTO. the regulatory institutions in the area of NREC law ready for natural monopolies has enactment. come through adjustment and energy sector dialogue. Assure public money Increases in budgetary Public Finance Review are used effectively spending driven by current (2006) took stock of and according to expenditures (wages and fiscal issues in taxation National Priorities pensions) lowering space and expenditure. for investment. Independence of Greater priority to judicial The Bank is preparing a judicial system sector reform after the project to support the measured as share of orange revolution. upgrading ofthe judicial court decisions Government developed infrastructure. cancelled by higher reform strategy with donor courts decrease to less assistance-EU. than 1.3 percent Higher courts cancel 2.26 percent of civil cases and 1.43 of criminal cases. (2006)
126
ANNEX 4: IEG RECOMMENDATIONS FROM THE COUNTRY ASSISTANCE 2003-2007 EVALUATION AND MANAGEMENT’S RESPONSE
IEG Recommendation Management Response
Strategy. The Bank strategy should strive for greater 1 The new CPS will propose greater selectivity for selectivity, focusing on public financial Bank interventions, as part of a Bank Group (not management, PSD, energy, and social protection, Bank-only) engagement strategy. and within these areas, on improving governance and b Consistent with Ukraine’s MIC status, the focus institutional development. areas of engagement will be determined following discussion with the government, and not by Bank management alone. 1 The CPS will propose a more programmatic engagement, with programs representing a flexible mix ofpolicy-based and investment lending, AAA, and partnerships. b The CPS will build on the extensive work already underway in GAC, and will articulate specific additional cross-cutting initiatives.
ESW. The Bank should be placing greater emphasis 1 AAA work will be determined by agreement with than in the past onprivate sector development and the government, consistent with the overall CPS infrastructure. approach noted above. It will include provision to respond to borrower demand, and will be programmatic rather than sectoral in definition.
1 Consistent with the increased emphasis on infrastructure noted in the 2005 CAS Progress Report, additional investment will be made in infiastructure AAA.
Investment lending. A tighter alignment is needed 1 Broader programs aligned with government between investment projects and the government priorities will drive the selection ofinvestment priorities. In addition, the Bank should simplify projects. Investment project delivery will be investment projects and reduce their scale to match increasingly aligned with Ukrainian institutional implementation capacity, and ensure line ministries’ processes, while carefully managing associated engagement in project preparation, and also their fiduciary risks, Use ofPIUs is declining, and this more direct involvement in project implementation, will continue. avoiding off-line PIUs.
Adjustment lending. A shift from broad, multi- 1 The shift to more focused, single tranche sectoral loans to loans that are more narrowly operations is already underway. The CPS will focused and disbursed in single tranche is elaborate how this shift will continue within the appropriate for Ukraine, which would also provide context ofmore programmatic engagement that the opportunity for follow up and deeper policy and seeks to balance the need for focus with the cross- institutional reforms. sectoral nature of many ofthe reforms that remain.
127
ANNEX 5: CPS PRINCIPLES AND OPERATIONAL FRAMEWORK FOR SELECTION OF PROGRAMS
1. Three principles underlie the development of the CPS: (i) selectivity, (ii) flexibility, and (iii)partnerships. Selectivity 2. In moving towards greater selectivity in Bank activities in the next strategy period, a framework for the selection of programs was developed as part of the CPS preparation. Three criteria were established to inform the selection:
0 Client ownership: the Bank’s activities should respond to the demands of the client in order to be effective.
0 Development urgency: to the extent that particular development challenges stand out, the Bank should be willing to support measures to address these challenges. This may or may not coincide with the priorities ofthe client.
0 World Bank’s comparative advantage: this criteria encompasses the Bank’s current capacity to address a specific issue, and the related potential needs for investment in diagnostic work or in staff skills, as well as the role other donors are playing in a particular area. 3. In the implementation of this framework, the diversity of comparative advantages among various World Bank Group institutions needs to be taken into consideration. Because IFC responds to the needs of private sector clients in addition to the government and its comparative advantage may differ from that of IBRD in meeting their needs, the classification ofprograms according to the criteria above may be different for the two institutions. Specifically, due to a different set of instruments at its disposal (ability to provide direct financing to the private sector) and a vast experience focusing specifically on private sector development, IFC may be better positioned to take the lead on addressing the challenges faced by the private sector clients, while IBRD would predominantly apply its competencies in the public domain. 4. Based on the rules for selectivity presented above, a typology of programmatic interventions was developed depending upon which criteria they fulfill (Figure A.4.1). At the intersection of the three perspectives of client demand, urgency of need and Bank capacity to lead are the “core programs”. At the intersection of client demand and urgency ofneed, but where a reform path (or the Bank’s capacity to lead) remains to be fully developed, are the “development programs”. At the intersection ofurgency of need and Bank capacity, where client demand is limited are the “advocacy programs3771.
71 The notion of client demand is naturally quite subjective. Client demand may not be uniform depending on who in the Government one talks to. What matters for selectivity is that there is clear and expressed demand for engagement from the central authorities, in particular the MoF, the Ministry of Economy, the Cabinet ofMinisters and the Deputy Prime Minister responsible for the Economic Block.
128 Figure A.4.1: Selectivity in the CPS
Urgency of Need Development Core Program
Comparative Advantage
Advocacy Program
5. Core programs combine a range of instruments, including investment and adjustment lending, and AAA targeted towards specific needs that have already been identified as part of an overall reform patldagenda. Core programs are programs, where basic strategic AAA has already been carried out and a reform path has thus been developed. The Bank is therefore in a position to bring its full support to bear on this area and to do this based on a reform strategy owned and supported by the client. Core programs are also expected to benefit from synergies across different thematic engagements and instruments. 6. Development programs would typically not include investment lending (although they might include one first “door-opening” operation). Development programs would be expected to be AAA heavy, with significant spending on the development of a reform roadmap and investment into a sequenced policy agenda that might be supported by adjustment. AAA may include basic ESW, but would be expected to also include targeted policy notes, selected pieces of advocacy work and the mobilization oftechnical assistance. 7. Advocacy programs would not include investment or adjustment lending and would be driven entirely by MA. Since the purpose is to advocate for reform where client ownership is limited but the Bank judges development urgency to be high, these programs would include substantial outreach efforts to society at large. 8. The framework for selectivity among thematic areas will be complemented in the new Strategy with a move towards fewer, larger and more efficient investment lending operations. The CPS foresees no more than four lending operations each year, ofwhich one is planned to be a DPL. The remaining three investment lending operations are expected to be concentrated in the core programs ofthe strategy. In addition, the CPS aims to bring preparation and implementation times down from current high levels. Success in doing so will be one of the benchmarks modulating the level of assistance in the CPS (see below). 9. IFC investments and advisory services will complement IBRD lending and non-lending activities across all three types of programs. In response to strong demand from the private sector and the government, IFC is planning to scale up its
129 operations by i)extending direct loans to private companies, ii)exploring opportunities to mobilize direct private investment as co-financing for public projects, and iii)providing advisory services for broad-based improvements in the business environment, corporate company practices, and supply chains. Through its operations, IFC would support the demand for policy change and create positive demonstration effects in the private sector. IFC would also aim to reach the relatively poorer regions in the west and south of Ukraine as well as underserved segments of the private sector, where the availability of financing and expertise has been limited to date. Due attention will be dedicated to ensuring to development effectiveness and long-term sustainability of IFC interventions. 10. The concentration on fewer lending operations and the reduction of preparation and implementation timetables will set free administrative resources for advisory services but also for advocacy and communication work. A key principle of the CPS is that the Bank’s engagement in Ukraine should become more programmatic and less oriented towards the preparation of investment projects. The greater focus on AAA activities will see investment in greater dissemination and communication efforts. In this regard, a renewed engagement with civil society will be a key plank of the Bank’s governance strategy in Ukraine and reflects the views of non- government stakeholders, which have encouraged the Bank to provide a forum for debate on key development and social issues. 11. An additional benefit of the increased focus on non-lending activities is that it generates positive knowledge spillovers for other Bank clients. Ukraine’s experience as a fast-growing middle income country and its need to innovate institutionally to adapt existing world practice to its specific circumstances could benefit other countries likely to follow a similar path. The Bank’s global knowledge can help Ukraine, but Ukraine’s specific experience will also enrich the Bank’s global knowledge. In reflection of this two-way learning, non-lending activities where possible will be carried out jointly with local partners, and opportunities sought to share Ukraine’s expertise with other countries in the region. 12. The cross-sectoral DPL will continue, but here too conditionality will become more selective. Policy conditionality will aim for a realistic assessment of reform progress and focus attention on those areas where reforms are most urgent but also success is most likely. The DPL-11, prepared in parallel with this new CPS, continues a cross-sectoral focus in order to maintain a broad anchor for the policy dialogue during a time of increased uncertainty. The program contains reform benchmarks for one additional policy operation in the series, which would bring to a close several important reform agendas initiated under the PAL program in the 2000-2003 and 2003-2007 CASs. Beyond the DPL 111, the CPS leaves open the possibility of a move towards more thematically focused DPLs if the government sees benefits in deepening the policy engagement and support in a particular area (see Section VI on CPS pillars). Flexibility 13. As a MIC, Ukraine requires a flexible menu of support. The current CPS does not develop a full lending pipeline or a complete business plan for the entire four-year period. Instead, consistent with Ukraine’s status as a lower middle income country with
130 significant implementation and fiduciary risks, and inherent country uncertainties, a two- year lending and AAA program is specified, while activities in the outer years ofthe CPS would be discussed and finally agreed during the mid-term review of the strategy after two years. 14. Flexibility in the CPS applies to both themes and instruments. The choice of programs can be reviewed at mid-term and some development or advocacy programs may have matured enough to qualify for focused investment lending support in the subsequent period. Other core programs may have failed to live up to expectations and the scope of the Bank’s support may be reduced. The decision whether to move from cross-sectoral to thematic DPLs would also be part ofthe review process at mid-term. 15. The greater focus on AAA activities raises significant challenges to be addressed in the course of implementation of this CPS, including: (i)Increased responsiveness to client demand in the selection oftopics for AAA; (ii)Developing a results framework for AAA to strengthen accountability; (iii)Cooperation and co-funding of key analytical work with other donors; (iv) Exploring fee-for-service arrangements with the Government at various levels to allow AAA to be scaled up. 16. One specific proposal still in the process of discussion with the authorities is the creation of an “Innovation Fund” that would bundle AAA resources and make them available for demand-driven analytical and advisory services. The authorities have so far not indicated interest in fee-for-service arrangements as in Russia or Kazakhstan. However, the creation of such an Innovation Fund that would contain perhaps initially up to US$400-500,000 in administrative budget could lay the basis for subsequent co-financing. Co-financing from other donors, including Ukrainian charitable foundations, will also be explored. Partnerships and Harmonization 17. Since 2006, the WBG has been overtaken by the combined European institutions (EBRD, the EC, and the EIB) as the largest provider of official development assistance to Ukraine. The Action Plan agreed with the EU sets a framework for reform in many areas of interest for the Bank. Other large donors are USAID (with a very significant program in the development of capital markets and financial services, for instance), the Millennium Challenge Corporation, CIDA (the leading provider of finance for the People’s Voice project), the Swedish International Development Association (SIDA) (with a keen interest in environment), as well as Dutch, German and Japanese bilateral assistance (all currently involved as co-financiers or as donors to Bank-managed trust funds in Ukraine). Close coordination is therefore imperative. Annex 6 provides an overview ofdonor activities by thematic area. 18. Coordination with partners has implications for selectivity. On the one hand, it is possible that the Bank may be asked by the donor community to take the lead in a particular area because it has the greatest expertise or because other donors are not currently present in it. On the other hand, the Bank may decide not to be active in a particular sector because it is crowded by other donors and the Bank’s value added is not
131 immediately obvious. But there are also many areas in which donors complement each other and the presence ofpartners may increase the returns to the Bank’s investments. In deciding which areas to focus on, the Bank needs to take these considerations into account. 19. The importance of the donor community in influencing policy choices in Ukraine should not be over-estimated. Combined donor assistance (including EBRD lending to the public sector) may currently be in the order ofUS$1- 1.5 billion per annum, which is around 1 percent of GDP, or 2.5 percent of total government revenues. However, donor assistance is a much larger proportion ofUkraine’s capital budget. 20. Compared to the size of financial transfers, the transaction costs for Ukraine of dealing with the donor community are high. Despite a commitment to harmonize aid procedures, coordinate on policies, and avoid duplication, the donor community remains relatively fragmented in Ukraine. Many donor assistance projects bypass the budget, are implemented under special procedures from procurement to financial management, and require the Ukrainian side to set up costly project management functions which are not well integrated into existing government ministries and agencies. A perceived high level of fiduciary risks limits the extent to which donors are willing to move fully towards the adoption of country systems. However, the current parallel processes are not only costly and fail to build adequate government capacity, but also contribute to the fragmentation of the capital budget system itself. Individual government agencies are given a license to chase after their own assistance projects without these having been reviewed against a set ofstrategic priorities. 21. Improved coordination will require government leadership. But the Bank will continue to explore avenues for greater harmonization of its procedures with those of Ukraine and encourage other partners to follow the same route as one of the main tools to force greater coordination from the government’s side. Key milestones ofthe CPS in this regard include routing all project disbursements through the State Treasury, including World Bank projects in the state budget, and improvements in the state procurement system. Over the medium-term, the Bank will work on a framework for assistance to specific sector programs through the budget and tied to meeting specific performance benchmarks. The EU is also working on a framework for sector budget support, providing a good opportunity for donor collaboration. This could evolve into a series ofSWAPS in the outer years ofthe CPS.
132
ANNEX 6: DONOR ENGAGEMENT BY AREAS
H HIGH L Low M MODERATE
133
\c) m 3 t- m 3 m M 3 t
I
ANNEX 8: COUNTRY PARTNERSHIP STRATEGY - PUBLIC CONSULTATIONS
1. The goal of public consultations in Kyiv and regions was to discuss the general directions of the proposed Bank strategy for Ukraine, as well as specific programs and instruments. Bank staff met with about 300 representatives of NGOs, academia, professional associations, think-tanks, business circles, parliamentarians, members of local governments and mass media. Background materials (briefing notes, presentations) were prepared and distributed in advance of the discussions. The draft CPS was published on the web to solicit public feedback and comments. 2. The summary ofdiscussions and comments is presented below. Progress of Reforms in Ukraine 3. The implementation of reforms in Ukraine was a thorough issue of all the discussions. Following are the main comments and messages received: The participants felt that reforms are not yet noticeable, in particular in improvement ofpeople’s lives. There is public disillusionment in the reforms process and decrease in public trust in the authorities. It was noted that public involvement is not customary in Ukraine and civil society should be stimulated and encouraged to participate, especially at the local level. There were also specific grievances expressed on particular government policies, including (i)the quasi exchange rate peg, which had led to the rising cost of imports (due to depreciation of the UAH against the Euro), (ii)the increase in energy tariffs combined with a lack of transparency over use of the resulting additional revenues and (iii)the administration and lack of transparency of the VAT. Good Governance and Anti Corruption 4. Good governance and anti-corruption is a topic which cuts across themes and was mentioned during all discussions, as it is perceived as the major obstacle to the country’s development. Following are the main comments and suggestions received: The causes for corruption are deeply rooted and further aggravated by low civil servant salaries, the fall in living standards of the population, and the general disregard of the law. The laws are in place but their implementation is lax and there are many loopholes that encourage violations. Another reason for rampant corruption is said to be the apathy of the population and its somewhat indifferent attitude toward unlawful practices. Most people would rather pay a bribe than report violations or file complaints. Corruption is permeating through the whole bureaucratic state machinery. The only way to reduce it is to reform the state bureaucracy according to the modern standards. Corruption is spreading out in Ukraine because there are a number of laws and legal provision that are designed in such a way that behaving in accordance with
147 the law is simply not possible and since a legal violation is inevitable the threshold for bribery is correspondingly reduced.
0 The following issues need to be addressed in the fight against corruption: regulatory reform; strict observance of the existing laws; need to understand the issue ofconflict ofinterests, especially in business and politics; need for advocacy and civil education to make citizens aware of their rights and voice in order to prevent abuse by corrupt officials. The World Bank’s role is mostly seen as providing advice, public education and advocacy, and assistance in the structural reforms, especially in the administrative and civil service reform. Human Development 5. Participants ofthe consultations pointed out that the CPS should put an emphasis on the improvement of social services delivery. Reforms in education are also seen as a priority area that could lead to the increasing competitiveness of Ukraine. Following are the specific comments received: Improvement of Ukraine’s education system is the most critical issue for the country and the WE3 should provide strong support in this area. Right now the private sector development in Ukraine is hampered by the lack of well educated and skilled professionals.
0 Youth unemployment is increasing; university graduates do not have enough necessary skills and knowledge to enter the job market. The WB should help Ukraine in improving standards in higher education.
0 In spite of the proclaimed GDP growth, the life of Ukrainians is not improving. Public services do not reach those who need them. Civil servants have no idea how to serve people.
0 The WB should support development of the non-state pension funds. For this purpose, the mechanisms for the Ukrainian citizens should be developed in order to accumulate funds for their pensions, and the relevant information campaign should be launched. Maybe creation of the regional funds is worth considering, because they are more trusted by the local population. 0 The NGOs stressed that demand for reforms and for high quality services should stem from the people and NGOs should help mobilize society to that end.
0 Civil society/government cooperation is seen as imperative in the provision of social services and implementing the social reforms.
0 Improvement of demographic situation is another area for possible World Bank support through improvement ofquality ofhealth and heath services delivery.
0 Transition to healthy lifestyle should be one of the national priorities. The World Bank could contribute to this agenda by pushing the government to take serious measures to address this issue especially among the youth. Environment 6. Environment was discussed at the regional meetings in Lviv, Kharkiv and Kyiv. Some written comments were also received from the environmental NGOs. The NGOs
148 believe that Ukraine should bring its environmental protection policy and practice in correspondence with EU standards. Following are the NGOs' recommendations: As far as the new CPS is concerned, the NGOs would like to see a greater emphasis on the environmental protection, linking it to the improvement in the quality ofpeoples' lives. Ukraine faces the problem of informing the public about the ecological situation. The WB should initiate the full and free access to environmental information in Ukraine. The WB should support introduction of the most ecologically safe technologies, especially in small towns and push the government to allocate more funds for nature conservation. The WB could help by providing small grants for village and small town communities to solve the waste management problems, also for construction of small electric power stations. Quite a few problems can be solved if communities are energy independent.
0 The WB may help establish the institutions for environmental examination without government's support since the government gains nothing from such activity. 0 NGOs would like to promote environmental education at schools and look to support from the WB. Agriculture 7. Agriculture is still suffering from the "Soviet Style" management. The financial support form the Bank should go to these areas only after key political decisions are being made by the new parliament and new government. The WB's involvement in the agriculture sector would be very difficult as less economy but more politics are present. Infrastructure 8. The Bank's involvement in infrastructure has been discussed during practically all meetings. Some participants see this issue as a top priority for Ukraine; others don't believe that Bank support is necessary as the sector already enjoys investments from the private entities: The WB should invest in development of infi-astructure, including water supply and sewerage systems, and construction of solid waste storages, especially in small towns.
0 Bearing in mind the specific geographical location of Ukraine (between the East and the West), it is theoretically possible to earn millions of dollars by means of transit. The WB should consider supporting this area.
0 One of the priorities of infrastructure development in the Volyn region is construction of the checkpoint on the Polish border, including motels, relevant services, etc. The building is planned for the next 2-3 years, and it is possible, with the help of the WB, to make a model of this border corridor and to make forecasts of the future cargo and human flows, amount of investment required, and the possible period ofinvestments return.
149 The proposed CPS envisages support to already “financially rich” areas - infrastructure, energy, transport. They do not need such support and the assistance should be targeted toward ‘socially oriented’ programs. The water supply infrastructure in Ukraine is in poor condition and suffers from non-transparent and poor management. One of the ways to improve it would be the replacement of the existing system with the private mini-water supply facilities. Business Environment 9. This is the area where the Bank, through the IFC, has been conducting extensive consultations with the business community for several years. Regular meetings with businesses and business associations, round tables and conferences, have helped to develop the deregulation program supported by the Bank as well as to give a greater voice to the business community in their demand for a better business environment. During the CPS discussions, entrepreneurs mentioned that: Removing obstacles for private business development is essential to increase Ukraine’s competitiveness and sustained economic growth. Improvement of the environment for doing business is the only way to create a real middle class in Ukraine. The Bank should continue facilitating the dialogue between the government and the business community in order to achieve stable business laws and good legal protection ofbusinesses. The legislative framework for business requires an in-depth analysis and adequate systematic changes that will meet present-day challenges. The Bank should pay more attention to training of entrepreneurs and enterprise managers; introduction of innovations; elaboration of the development strategy and bringing the Ukrainian information standards in line with the European norms. The WBG may promote building partnership between authorities and business by organizing forums and providing a platform for such a dialogue. The World Bank and IFC should put some efforts in promoting positive image of entrepreneurship in the Ukrainian society. Regional Development and Local Self-Governance 10. During public consultations, irrespectively ofthe topic and audience, many ofthe participants expressed a strong view that support to the regional development and local self-governance reform should be in the center ofthe WBG agenda in Ukraine. The key views are presented below: In addition to working with the central government, the Bank should support programs at the local level. Such programs could produce tangible results as people at the local level are much more responsible and have a very concrete interest in achieving project success. Village, settlement or district councils can not maintain themselves as they do not have the budgets that would enable them to satisfy their needs by 100 percent.
150 With the tax legislation currently in force, it is almost impossible to change the situation. The WB has to persuade the government that it is needed to extend the powers of local governments while trying to strengthen local budgets. The WB should support public finance reform to allow local governments borrowing money under regional guarantees. The local government should not receive the reallocated funds from the state budget. Instead, it would be better to establish a more efficient system of local budget receipts. The state should finance only the national programs essential for national defense, security and transport. As far as the local programs are concerned, they must be supported by properly defined financing sources. The Bank should promote an introduction of real estate tax that will be for the benefit of local government as this tax could provide additional local budget financing. The Role of the NGOs 11. All NGOs expressed a desire to become partners of the Bank. They specifically mentioned that: The WB should resume dialogue with the civil society that was so active and successful a few years ago, and should pay more attention to the opinion and views ofthe civil society. The Bank should also provide a platform for civil society organization for open public debates on the government policy.
0 The NGO could play a special role in “increasing public knowledge” about the Government initiatives; in increasing public participation through public hearings, information dissemination, and preparation and distribution ofprinted material; as well as in monitoring the implementation of government policy decisions that impact the society. The civil society organizations should become major partners of the World Bank in implementing Governance and Anti-corruption agenda. 0 To influence the authorities and the decision-making in Ukraine the civil society organizations should have the respective rights. The World Bank role is seen to lobby for empowerment ofthe civil society in Ukraine.
0 The new CPS would benefit from introducing mechanisms of public and civil society control over the implementation ofthe Bank projects in Ukraine as well as over the government policy decisions. The CPS should envisage assistance from the WBG for the development of the capacity of NGOs, through supporting the development of their infrastructure as well as supporting their program activities (especially their research programs and programs directed at work with the public).
151 Advocacy and Public Informatiom 12. The issue of public understanding of critical issues of Ukraine’s development, as well as public support to reforms, was highlighted during the consultations. The main messages are summarized below: 0 The public has to understand reforms to make them successful. The WB should initiate public information programs on various reform issues to build public support to reforms. The Bank should educate the media how to cover different aspects of reforms (e.g., in energy and infrastructure). Within the new CPS cycle the WB should envisage broader dissemination of more comprehensible information about its projects, programs and development issues as a whole. Advocacy programs under the new CPS would be a critical tool to mobilize support of non-governmental stakeholders and stimulate public debates around issues urgent for the development of Ukraine; as well create public pressure on the government for delivering on reforms.
152
Page 1 of 3
Ukraine at a glance 9/28/07
Europe & Lower Key Development Indicators Central middle Age distribution, 2006 Ukraine Asia income (2006) Female
Population, mid-year (millions) 46.6 460 2,276 Surface area (thousand sq. km) 604 24,114 28,549 Population growth (%) -1.1 0.0 0.9 50-54 Urban population (% of total population) 68 64 47 40-04 30-34 GNI (Atlas method, US$ billions) 90.7 2,206 4,635 GNI per capita (Atlas method, US$) 1,950 4,796 2,037 20-24 GNI per capita (PPP, international $) 7,520 9,662 7,020 10-14
GDP growth (%) 7.1 6.8 8.8 10 5 0 5 10 GDP per capita growth (%) 8.3 6.8 7.9 percent
(most recent estimate, 2000-2006)
Poverty headcount ratio at $1 a day (PPP, %) 22 1 Under-5 mortality rate (per 1,000) Poverty headcount ratio at $2 a day(PPP, %) 5 10 Life expectancy at birth (years) 68 69 71 Infant mortality (per 1,000 live births) 13 28 31 601 Child malnutrition (% of children under 5) 1 5 13 I
Adult literacy. male (% of ages 15 and older) 100 99 93 Adult literacy, female (% of ages 15 and older) 99 96 85 Gross primary enrollment, male (% of age group) 107 103 117 Gross primary enrollment, female (% of age group) 107 100 114
Access to an improved water source (% of population) 96 92 81 lSS0 1985 2000 2005 Access to improved sanitation facilities (% of population) 96 85 55 I Ukraine U Europe & Central Asia
Net Aid Flows 1980 1990 2000 2006 a
(US$ mi//ions) Net ODA and official aid 289 541 41 0 Growth of GDP and GDP per capita (%) Top 3 donors (in 2005): United States 113 2o T Germany 53 10 Canada 19 0
Aid (% of GNI) 0.3 1.8 0.5 -10 Aid per capita (US$) 6 11 9 -20
Long-Term Economic Trends -30 80 95 00 05 Consumer prices (annuai % change) 5371.0 28.2 9.1 GDP implicit deflator (annual % change) 16.3 23.1 13.7 +GDP -GDP per capita
Exchange rate (annual average, local per US$) 0.0 5.4 5.1 Terms of trade index (2000 = 100) 100 115 1980-90 1990-2000 2000-06 (average annual growth %) Population, mid-year (millions) 50.0 51.9 49.2 46.6 0.4 -0.5 -0.9 GDP (US$ millions) 81,456 31,262 106,469 -9.3 7.8 (% of GDP) Agriculture 25.6 17.1 8.7 -5.6 3.2 Industry 44.6 36.3 34.6 -12.6 6.3 Manufacturing 39.3 19.2 20.7 11.4 Services 29.9 46.6 56.7 5.3
Household final consumption expenditure 57.1 54.4 59.7 -1.7 13.1 General gov't final consumption expenditure 16.5 20.9 18.9 -4.4 2.7 Gross capital formation 27.5 19.6 24.3 5.6
Exports of goods and services 27.6 62.4 47.2 2.7 Imports of goods and services 28.7 57.4 50.1 7.1 Gross savings 35.8 24.9 22.8
Note: Figures in italics are for years other than those specified. 2006 data are preliminary. .. indicates data are not available. a. Aid data are for 2005.
Development Economics, Development Data Group (DECDG) Page 2 of 3
Ukraine
Balance of Payments and Trade 2000 2006 Governance indicators, 2000 and 2006 (US$ millions) Total merchandise exports (fob) 15,722 38,949 Total merchandise imports (cif) 14,943 44,143 Voice and accountability Net trade in goods and services 1,406 -3,067 Political stabilitv Workers' remittances and compensation of employees (receipts) 33 595 Regulatory quality
Current account balance 1,481 -1,617 Rule of law as a % of GDP 4.7 -1.5 Control of corruption
Reserves, including gold 1,476 23,502 0 25 50 75 100
a2006 Central Government Finance Country's percentile rank (0-100) u 2000 higher velues impiy better ratings (% of GDP) Current revenue (including grants) 33.3 40.9 Source: Kaufmann-Kraay-Mastruni, World Bank Tax revenue 35.3 35.8 Current expenditure 33.3 38.2 Technology and Infrastructure 2000 2005 Overall surplusldeficit -1.1 -1.3 Paved roads (% of total) 96.7 97.2 Highest marginal tax rate (%) Fixed line and mobile phone Individual 40 13 subscribers (per 1,000 people) 228 545 Corporate 30 25 High technology exports (% of manufactured exports) 5.1 3.7 External Debt and Resource Flows Environment (US$ millions) Total debt outstanding and disbursed 12,190 33,297 Agricultural land (% of land area) 71 71 Total debt service 3,661 5,890 Forest area (% of land area) 16.4 16.5 Debt relief (HIPC, MDRI) Nationally protected areas (% of land area) 3.3
Total debt (% of GDP) 39.0 38.7 Freshwater resources per capita (cu. meters) 1,128 Total debt service (% of exports) 18.1 13.0 Freshwater withdrawal (% of internal resources) 70.7
Foreign direct investment (net inflows) 595 7,808 C02 emissions per capita (mt) 6.2 6.6 Portfolio equity (net inflows) -193 82 GDP per unit of energy use (2000 PPP $ per kg of oil equivalent) 1.5 2.0 Composition of total external debt, 2005 Energy use per capita (kg of oil equivalent) 2,644 2,958
Private, 14824.015 US$ millions
Private Sector Development 2000 2006
Time required to start a business (days) 33 Cost to start a business (% of GNI per capita) 9.2 Time required to register property (days) 93
Ranked as a major constraint to business (% of managers surveyed who agreed) Tax rates 45.6 Access tohost of financing 40.5
Stock market capitalization (% of GDP) 6.0 40.3 Bank capital to asset ratio (%) 16.2 11.5
Note: Figures in italics are for years other than those specified. 2006 data are preliminary. 9/28/07 .. indicates data are not available. - indicates observation is not applicable.
Development Economics, Development Data Group (DECDG). Page 3 of 3
MiI len n i u m Developmen t Goa Is Ukraine
With selected targets to achieve between 1990 and 2015 (estimate closest io date shown, +/- 2 years)
Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education (YO) Women employed in the nonagricultural sector (% of nonagricultural employment) Proportion of seats held by women in national parliament (%)
Goal 4: reduce under-5 mortality by two-thirds Under-5 mortality rate (per 1,000) Infant mortality rate (per 1,000 live births) Measles immunization (proportion of one-year olds immunized, %)
Prevalence of HIV (% of population ages 15-49) Contraceptive prevalence (% of women ages 15-49) Incidence of tuberculosis (per 100,000 people) Tuberculosis cases detected under DOTS (%)
Forest area (% of total land area) Nationally protected areas (% of total land area) CO2 emissions (metric tons per capita) GDP per unit of energy use (constant 2000 PPP $ per kg of oii equivalent)
labor force ages 15-24)
Education indicators (%) Measles immunization (% of I-year olds) ICT indicators (per 1,000 people) 125 1 1 600 7
2: i2000 2002 2005
1990 1995 2000 2005 +Primary net enrollment ratio UFixed +mobile subscribers +Ratio of girls to boys in primary 8 Ukraine 0 Europe & Central Asia secondary education 0 Internet users
Note Figures in italics are for years other than those specified indicates data are not available 9/28/07
cs, Development Data Group (DECDG)
CAS Annex B2 - Ukraine Selected Indicators* of Bank Portfolio Performance and Management As Of September 3,2007
Indicator 2005 2006 2007 2008 Pottfolio Assessment Number of Projects Under Implementation a 12 12 11 12 Average Implementation Period (years) 2.6 3.0 3.2 3.1 Percent of Problem Projects by Number 41.7 25.0 36.4 25.0 Percent of Problem Projects by Amount 38.2 25.8 46.6 29.5 Percent of Projects at Risk by Number 41.7 25.0 36.4 25.0 Percent of Projects at Risk by Amount 38.2 25.8 46.6 29.5 Disbursement Ratio (%) e 8.5 8.2 11.3 1.9 Portfolio Managem en t CPPR during the year (yeslno) Yes no Yes Yes Supervision Resources (total US$’OOO)’ 1,292 1295 1400 nla Average Supervision ( US$’0001project)2 81 86 108 nla ’ including BB, TF BB only
Memorandum Item Since FY 80 Last Five FYs Proj Eva1 by OED by Number 25 8 Proj Eva1 by OED by Amt (US$ millions) 2,785.2 351 .I % of IEG Projects Rated U or HU by Number 18.2 28.6 % of IEG Projects Rated U or HU by Amt 3.3 0.6 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 Bank’s 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. CAS Annex B3 - IBRDllDA Program Summary Ukraine As Of Date 08/20/2007
Proposed IBRDADA Base-Case Lending Program a
Strategic Rewards b lmplemenfafion b Fiscal year Proj ID US$(M) (H/M/L) Risks {H/M/L)
2008 Power Transmission Project 200.0 H M DPL II 300.0 H na Judicial System Support Project 40.0 M H Public Finance Modernization Project 50.0 H H Roads and Safety Improvement Project 400.0 M M Urban Infrastructure 140.0 H H Result 1,130.0
2009 Municipal Infrastructure Development (Euro 2012) 300.0 M M
DPL 111 400.0 H M Power Transmission II 250.0 H H Social Insurance Administration Project 113.0 H H Result 1,063.0 Overall Result 2,193.0
a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L).
Template created on 11/19/2007. Annex B3 - Ukraine: IFC Investment Operations Program
2005 2006 2007 2008* Commitments (US$m) Gross 160.00 307.50 324.50 Net** 160.00 294.50 74.50
Net Commitments bv Sector (%) Accommodation & Tourism Svcs 5.60 Agriculture & Forestry 50.00 3.40 Chemicals 9.68 Collective Investment Vehicles 2.55 Finance & Insurance 21.88 16.98 9.40 Food & Beverages 3.40 90.60 Nonmetallic Mineral Product Mfg 3.06 Primary Metals 33.96 Utilities 28.1 3 Wholesale & Retail Trade 21.39 Total 100.00 100.00 100.00
Net Commitments by Investment Instrument (%I Equity 12.50 2.55 Loan 75.00 75.72 86.58 Quasi equity*** Quasi loan 12.50 21.73 13.42 Total 100.00 100.00 100.00
* As of September 30,2007 ** IFC's Own Account only *** Quasi Equity includes both loan and equity types
MlGA Outstanding Exposure (Gross Exposure, $ milllion) FY2003 FY2004 FY2005 FY2006 FY2007 As of end of fiscal year
Sectoral Distribution Finance 19.0 114.0 132.1 132.1 0.0 Agri businesslManufacturinglService 0.0 48.8 48.8 44.2 34.2 19.0 162.8 180.8 176.2 34.2 MIGA's Risk Profile Transfer Restriction 19.0 162.8 180.8 176.2 34.2 Expropriation 19.0 162.8 180.8 176.2 34.2 War & Civil Disturbance 0.0 48.8 48.8 44.2 34.2 Breach of Contract 0.0 0.0 0.0 0.0 0.0
MIGA's Gross Exposure in Ukrain 19.0 162.8 180.8 176.2 34.2 % Share of MIGAs Gross Exposu 0.4% 3.1 % 3.5% 3.3% 0.6% MlGA Net Exposure in Ukraine 17.1 101.4 115.8 108.3 28.2 % Share of MIGAs Net Exposure 0.5% 3.1 % 3.7% 3.2% 0.9% Annex 84
CAS Annex B4 - Summary of Nonlending Services - Ukraine As Of Date 08/20/2007
Product Completion FY Cost (US$OOO) Audience a Objective
Recent completions Labor Study 2006 56.1 PUB KG, PD Health & Education 2006 60.3 OTH KG, PS Forestry Policy Note 2006 96.7 OTH KG, PS Policy Notes 2006 214.4 GOV KG, PS, PD Savings Bank Restructuring/ Non-Banking Financial institutions Regulation TA 2006 468.4 GOV KG, PS TA for Privatization 2006 146.6 GOV KG, PS Business Environment TA 2006 170.5 GOV KG, PS Public Administration incentives TA 2006 67.4 GOV KG, PS Public Expenditure Review 2006 269.6 GOV KG, PS ROSC Accounting & Audit 2007 207.9 GOV KG, PS Transport Study 2007 113.4 OTH KG, PS GiS Options Study 2007 236.8 GOV KG, PS PULSE 2007 116.4 GOV KG, PS Poverty Update 2007 115.7 PUB KG, PS CPAR 2007 160.6 GOV KG, PS Private Sector and Finance Work 2007 207.5 GOV KG, PS Civil Service Governance TA 2007 61.2 GOV KG, PS Underway Public Finance Review 2 2008 227.4 GOV KG, PS People’s Voice TA 2008 201.2 PUB KG, PS FSAP Update 2008 25.0 GOV KG, PS Financial Sector Dialogue 2008 115 GOV KG, PS ESMAP: Thermal Power Piant Rehabilitation 2008 7.5 GOV KG, PS Environmental Protection TA (Zaporizhia) 2008 242.9 GOV KG, PS international Emissions Trading Institutions and Pilot Green Investment Schemes TA 2008 98 GOV KG, PS Kyoto TA 2008 40 GOV KG, PS Agricultural Policy Notes 2008 100 GOV KG, PS Labor Demand and Skills Relevance 2008 102.9 GOV KG, PS Strengthening demand for good governance 2008 141.6 GOV KG, PS Governance and Anti-Corruption 2008 150 GOV KG, PS Capital Market TA Partnership Program 201 0 41.2 GOV KG, PS Financial Sector TNDialogue 2008 84.6 GOV KG, PS Private Sector TNDialogue (linked to KE & Comp TA) 2008 46.3 GOV KG, PS Accounting and Auditing ROSC Follow-up TA 2008 30 Knowledge Economy - Competitiveness Dialogue 2008 36 GOV KG, PS Planned Housing & Municipal Utilities 2008 180 GOV KG, PS Social Sector Financing AAA; Poverty Update and Health and Demography advocacy work 2009 688.5 PUB KG, PS Gas Market Note and Coal Policy Note update 2009 Country Economic Memorandum - Growth & Competitiveness 2009 331.5 GOV KG, PS PFM TA (linked to Dutch TF on cap bud and PFM) 201 0 201.16 GOV KG, PS
a. Government, donor, Bank, public dissemination. b. Knowledge generation, public debate, problem-solving. Annex B5
Ukraine Social Indicators
Latest single year Same regionlincome group
Europe & Lower- Central middle- 1980-85 1990-95 19994005 Asia income POPU LATlON Total population, mid-year (millions) 50.9 51.5 47.1 471 .a 2,474.6 Growth rate (YOannual average for period) 0.3 -0.1 -0.9 -0.1 1 .o Urban population (YOof population) 64.7 67.0 67.8 63.7 49.5 Total fertility rate (births per woman) 2.1 1.4 1.2 1.6 2.1 POVERTY (% of population) National headcount index 19.5 Urban headcount index Rural headcount index 28.4 INCOME GNI per capita (US$) 920 1,520 4,143 1,923 Consumer price index (2000=100) 28 147 127 131 Food price index (2000=100) 0 29 121 INCOMElCONSUMPTlON DISTRIBUTION Gini index 25.7 28.1 Lowest quintile (% of income or consumption) 9.4 9.2 Highest quintile (% of income or consumption) 34.8 37.5 SOCIAL INDICATORS Public expenditure Health (% of GDP) 3.7 4.5 2.6 Education (Yo of GDP) 6.2 6.4 4.4 4.3 Net primary school enrollment rate (% of age group) Total ao a3 91 93 Male ao 83 92 94 Female ao a3 90 93 Access to an improved water source (% ofpopulation) Total 96 96 92 82 Urban 99 99 99 94 Rural 90 91 80 71 Immunization rate (% of children ages 12-23 months) Measles 97 96 96 86 DPT 98 96 95 86 Child malnutrition (% under 5 years) 1 5 12 Life expectancy at birth (Years) Total 70 67 68 69 71 Male 66 62 62 65 68 Female 74 73 74 74 73 Mortality Infant (per 1,000 live births) 20 22 13 27 31 Under 5 (per 1,000) 26 30 17 32 39 Adult (15-59) Male (per 1,000 population) 283 395 404 320 176 Female (per 1,000 population) 116 I48 150 136 111 Maternal (modeled, per 100,000 live births) 35 58 163 Births attended by skilled health staff (YO) 100 94 86
Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year of age or at any time before the survey. World Development Indicators database, World Bank - 27 April 2007. Annex B6 Ukraine - Key Economic Indicators
Actual EbtktC Projected fndicator 2002 2003 3004 2005 2006 2007 2008 2009 2010 National accounts (as % of GDP) Gross domestic producta 100 100 100 100 100 100 100 100 100 Agriculture 15 12 12 10 10 10 10 IO 10 Industry 35 35 36 32 32 32 33 34 34 Services 51 53 52 57 58 58 57 57 56 Total Consumption 75 75 71 77 80 81 82 82 82 Gross domestic fixed investment 19 21 23 22 23 23 24 24 24 Government investment 2 3 2 2 2 2 3 3 3 Private investment 17 18 20 20 21 21 21 21 21
~xports(GNFS)~ 55 58 61 51 47 43 41 40 40 Imports (GNFS) 51 55 54 51 50 48 46 46 45 Gross domestic savings 25 25 29 23 20 19 18 18 18 Gross national savings' 28 28 31 26 22 19 19 18 18
Memorandum item Gross domestic product 42393 50133 64883 86142 106449 127392 139774 150397 160925 (US$ million at current prices) GNI per capita (US$, Atlas method) 780 970 1260 1520 1940 2390 2800 3170 3440 Real annual growth rates (%, calculated from 1990 prices) Gross domestic product at market prices 5.2 9.6 12.1 2.7 7.1 6.0 5.5 5.0 5.0 Gross Domestic Income 4.7 14.7 3.7 7.4 6.0 4.9 4.5 5.0 Real annual per capita growth rates (%, calculated from 1990 prices) Gross domestic product at market prices 6.0 10.4 12.9 3.3 8.2 7.1 6.6 6.1 5.8 Total consumption 5.8 11.8 10.5 16.5 12.5 8.1 6.6 5.8 4.9 Private consumption 10.3 12.3 13.9 21.5 15.1 7.4 6.6 5.3 5.0 Balance of Payments (US% millions) EXPO~~S(GNFS)~ 23351 28953 39719 44378 50239 54870 56963 60140 64286 Merchandise FOB 18669 23739 33432 35024 38949 42316 43398 45525 4861 1 ~mports(GNFS)~ 21494 27665 34846 43707 53307 60578 64811 69064 72964 Merchandise FOB 17959 24008 29691 36159 44143 50780 54521 58272 61702 Resource balance 1857 1288 4873 67 1 -3068 -5708 -7848 -8924 -8678 Net current transfers 1922 2184 2576 2845 3173 3700 4100 4200 4300 Current account balance 3173 2891 6804 253 1 -1617 -5024 -7323 -8624 -8902 Net private foreign direct investment 698 1411 1711 7533 5336 5500 5700 6000 6500 Long-term loans (net) 124 560 2575 3470 12030 16071 10788 7183 882 Official -260 -183 -385 -3 -406 44 218 155 105 Private 384 743 2960 3473 12436 16027 10570 7028 777 Other capital (net, incl. errors & omissions) -2950 -2817 -8864 -3109 -13750 -13000 -7600 -3400 2500 Change in reservesd -1045 -2045 -2226 -10425 -1999 -3547 -1565 -1160 -98 1
Memorandum item Resource balance (% of GDP) 4.4 2.6 7.5 0.8 -2.9 -4.5 -5.6 -5.9 -5.4 Real annual growth rates ( YR90 prices) Merchandise exports (FOB) -0.9 18.2 24.9 -13.5 -3.8 5.6 5.7 5.4 5.9 Primary Manufactures Merchandise imports (CIF) -1.4 30.6 13.7 3.1 6.9 9.1 7.9 5.5 4.5
(Continued)
Template created on 11/19/2007 Ukraine - Key Economic Indicators Annex B6 (Continued)
Acd Estimate Projected Indicator 2002 2003 2004 2005 2006 2007 2008 2009 2010
Public finance (as % of GDP at market prices)e Current revenues 35.5 35.5 34.6 39.1 41.7 41.4 40.7 39.5 39.2 Current expenditures 32.9 32.4 32.9 37.8 38.6 39.1 38.3 37.8 36.9 Current account surplus (+) or deficit (-) 2.6 3.1 1.7 1.2 3.1 2.2 2.4 1.8 2.3 Capital expenditure 3 .O 4.4 6.3 4.2 4.4 5.0 5.0 4.7 4.9 Foreign financing -0.7 1.o 1.5 0.6 0.8 0.9 0.8 0.3 0.7
Monetary indicators M2/GDP 28.5 35.3 36.4 43.8 50.4 53.4 55.4 57.2 59.7 Growth ofM2 (%) 42.3 46.9 32.8 53.9 34.7 26.8 19.5 16.7 17.2 Private sector credit growth / 99.2 103.1 107.1 146.3 70.4 82.9 82.7 82.7 83.6 total credit growth (%)
Price indices( YR90 =loo) Merchandise export price index 114.9 123.7 139.5 169.0 192.3 201.0 195.1 194.1 195.7 Merchandise import price index 116.2 119.0 129.4 152.9 176.6 184.0 183.0 185.5 187.9 Merchandise terms oftrade index 98.9 103.9 107.8 110.5 108.9 109.2 106.6 104.6 104.1 Real exchange rate (US$/LCU)' 95.2 86.7 81.7 90.0 99.9 104.5 113.3 125.9 142.4
Real interest rates Consumer price index (% change) 0.8 5.2 9.0 13.6 9.1 10.7 10.2 8.3 7.3 GDP deflator (% change) 5.1 8.0 15.2 24.7 13.7 12.9 9.2 7.6 7.0
a. GDP at factor cost b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use ofIMF resources. e. Consolidated central government. f. "LCU" denotes "local currency units," An increase in US$/LCU denotes appreciation.
Template created on 11/19/2007 Annex B7
Ukraine - Key Exposure Indicators
Actual Estimate ProJeczcct indicator 2002 203 2003 2005 2006 2007 2008 2009 2010
Total debt outstanding and 13478 25997 32329 39107 54256 70929 82408 90010 89892 disbursed (TDO) (US$m)"
Net disbursements (US$m)a 81 11885 4809 5752 15131 16672 11480 7601 -118
Total debt service (TDS) 3243 3686 4614 7159 6993 7859 10355 13053 17474 (US$m)a
Debt and debt service indicators
TDO/XGS~ 57.0 88.6 80.3 86.2 107.5 127.2 142.2 147.1 137.5 TDO/GDP 31.8 51.9 49.8 45.4 51.0 55.7 59.0 59.8 55.9 TDS/XGS 13.7 12.6 11.5 15.8 13.9 14.1 17.9 21.3 26.7 Concessional/TDO 6.7 5.0 3.3 2.3 1.8 1.5 1.3
IBRD exposure indicators (%) IBRD DS/public DS 14.3 12.1 11.6 11.5 13.4 15.3 18.3 16.4 22.2 Preferred creditor DSipublic 41.9 33.6 36.8 34.2 37.1 38.0 37.2 22.2 24.9 DS (%)' IBRD DSiXGS 0.8 0.7 0.6 0.5 0.6 0.6 0.6 0.7 0.7 IBRD TDO (us$m)d 2233 2271 2168 2429 2324 2558 2930 3258 3525 Of which present value of guarantees (US$m) Share of IBRD portfolio (%) 2 2 2 2 2 3 3 3 4 IDA TDO (US$~I)~ 0 0 0 0 0 0 0 0 0
IFC (US$m) Loans 0 3.50 26.29 84.31 185.20 264.85 0 0 0 Equity and quasi-equity /c 11.92 11.92 22.22 68.12 110.87 83.67 0 0 0
MIGA
MIGA guarantees (US$m) 19.0 162.80~ 180.80 176.20~ 34.20 a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. d. Includes present value of guarantees. e. Includes equity and quasi-equity types of both loan and equity instruments.
Template created on 11/19/2007 Annex 08 (IFC) for Ukraine - Statement of Commltted and Outstandlng Portfolio In Ukralne As of September 30,2007 In US$ Mllllons
20061 Industrial Un ... 100.00 0.00 0.00 0.00 0.00 100.00 250.00 100.00 OW 0.00 0.00 0.00 100.00 250.00 mn7 _""* I I 2006 IKvIza I 45.001 0.001 0.001 0.001 0.001 45.001 0.001 0001 0.001 0 001 0.001 0.001 0.001 0.00 20W/ lNova Llnlya 10.001 0.001 3.951 0.001 0.001 13.951 0.001 8.001 0.001 3.951 0.001 0.001 11.951 0.00
LWI I 20% Zeus 900 000 000 000 000 900 0001 900 000 000 000 000 900 000 Total 455.89 750 95.95 0.00 ow 55927 wxw 266.82 2.11 e3.oe 0.00 ow 362.0~ m.0~ Pwtfouc:
* Denotes Guarantee '* Denotes Risk Management Pmduwt '** Quasi Equity includes both loan and equity types
MAP SECTION
OCTOBER 2004 OCTOBER
REPUBLIC REPUBLIC
the Map Design Unit of The World Bank. The boundaries, This map was produced by colors, denominations and legal any other information shown or any endorsement Group, on this map do not imply, acceptance of such the part of The World Bank HUNGAR boundaries. HUNGARY
SLOV SLOVAK
50 °
POLAND
status of any territory, N any judgment on the
AK
Tarnow T
ar
To To T
now o UKRAINE
Y
ZAKARP
ZAKARPAT Uzhhorod Uzhhorod
Satu Mare Satu Mare
Warsaw W
INTERNATIONAL BOUNDARIES OBLAST BOUNDARIES RAILROADS MAIN ROADS RIVERS NATIONAL CAPITAL OBLAST CAPITALS SELECTED CITIES AND TOWNS
To To T
arsaw
T To To o
o C C C
a a a
W Warsaw r r r
p p
p arsaw
Hora Hoverla
To T To
o
a a a A
LVIV L
(2061 m) (2061 m)
t t
t L'viv L'viv
T VIV
h h
ROMANIA h
i i i
a a a
N N N o o o
r r r
t t t h h h
FRANKIVSK FRANKIVSK
n n n
Buh Buh Buh
IV IVANO-
ANO- M M
25 M
t t
t VOL VOLYN
° VOL
n n n Frankivs'k Ivano- Frankivs'k Ivano- E
s s
s TERNOPIL TERNOPIL . . . Luts'k Luts'k
Kovel CHERNIVTSI CHERNIVTSI
25
D D D
YN
n n n
i i i
e e
e °
s s
s E30
Ternopil' Ternopil'
t t Tirgu Mures t T
e e e
irgu Mures
r r
Chernivtsi r Chernivtsi
To To T o
BULGARIA 45
RIVNE RIVNE
° N
Rivne Rivne
Buzau Buzau
KHMELNYTSKYI Sarny Sarny
To To T o BELARUS BELARUS
Khmel'nyts'kyi Khmel'nyts'kyi
Birlad Birlad
To To Tecuci T T
ecuci o
To To T
o
M M
VINNYTSY VINNYTSYA ZHYTOMYR ZHYTOMYR
O
O Zhytomyr Zhytomyr
Medgidia Medgidia
L L
D
To To D T
O o O
V V A A
Izmail Izmail Vinnytsya Vinnytsya
D D D Korosten Korosten
S S S
n n n
o o o
u u u
t t t
h h
h Zhlobin Zhlobin
i i i
e e e B B B
A
T To
u u u
o
p p p
h h h
e e Vilkova e
ODESSA ODESSA
r r r
Mouths of the Danube
Reservoir 30
U U
° U
E
p p p Kyiv
° KYIV KYIV
E35
l l
l Minsk Minsk
a a a
CHERKASY
Uman' CHERKASY Uman'
T To
Black Sea o
n n n
(KIEV) KYIV d d d
Odessa
KIROVOHRAD KIROVOHRAD
CHERNIHIV CHERNIHIV Cherkasy Cherkasy Mykolayiv Mykolayiv
Chernihiv MYKOLA MYKOLA MYKOLAÏV
D D D n n n i i i
e e e
p p p
e e e
D D D r r r
n n n
i i i
e e e
p p p
Kirovohrad Kirovohrad
DDesn e e
e e
r r r Ï Ï s
Yevpatoriia n
V
V a Kherson Kherson
L L
Sevastopol L
POL POLTAVA
KHERSON KHERSON
Kremenchug Kremenchug
o o o
Kryvyi Rih Kryvyi Rih Reservoir Reservoir
w w w
SUMY Inhulets SUMY Simferopol’
l l l
a a a
CRIMEAN CRIMEAN T
Kremenchuk Kremenchuk
n n n A
d d
Nykopol d Nykopol V DNIPROPETROVSK DNIPROPETROVSK
A Poltava Poltava Sumy Sumy
FEDERATION FEDERA
Br Bryansk
yansk
RUSSIAN RUSSIAN
T To o Yalta
° Reservoir
E
Kakhov
ZAPORIZHZHIA ZAPORIZHZHIA Teodosiia Dnipropetrovs'k Dnipropetrovs'k 35 Zaporizhzhia Zaporizhzhia ° 0 0 E
Melitopol Melitopol TION
KHARKIV Teodosiia KHARKIV
50 Orel Orel
T To
Kharkiv Kharkiv o 50
Kerch
Azov D D
100 D
Sea
of o o
Berdiansk o
DONETSK DONETSK n n n
e e e
150 Kilometers
t t t
s s 100 s
Mariupol B B B
a a
Donets'k a Donets'k
V Voronezh
LUHANSK LUHANSK s s s oronezh
i i
i Sieverodonetsk Sieverodonetsk
T To
n n n o
D D
150 Miles D
o o o
Armavir Ar
FEDERA FEDERATION
n n n
mavir
To To T e e e
o
t t t
s s s RUSSIAN
UKRAINE
Sochi Sochi
To To T o
Luhans'k Luhans'k
V Voronezh
oronezh
To T o TION
45 50
° °
N N IBRD 33505 IBRD