Public Disclosure Authorized FEDERAL REPUBLIC OF YUGOSLAVIA
BREAKING WITH THE PAST: THE PATH TO STABILITY AND GROWTH
Volume II: Assistance Priorities and
Public Disclosure Authorized Sectoral Analyses Public Disclosure Authorized Public Disclosure Authorized ii TABLE OF CONTENTS
ABBREVIATIONS AND ACRONYMS………………………………………………………...viii ACKNOWLEDGEMENT……………………………………………………………………….. ix
CHAPTER 1. AN OVERVIEW OF THE ECONOMIC RECOVERY AND TRANSITION PROGRAM…………………………………………………………………………………….... 1 A. Introduction……………………………………………………………………………..... 1 B. The Government’s medium-term Challenges…………………………………………..... 3 C. Medium-term External Financing Requirements………………………………….……... 4 D. The 2001 Program………………………………………………………………………... 8 E. Implementing the Program………………………………………………………….…....13 CHAPTER 2. FISCAL POLICY AND MANAGEMENT………………….…………………..15 A. Reducing Quasi Fiscal Deficits and Hidden Risks…………………………………….. ..16 B. Transparency and Accountability of Public Spending………………….………………..27 C. Public Debt Management………………………………………………………………...34 D. Tax Policy and Administration…………………………………………….…………... ..39 CHAPTER 3. TRADE………………………………………...…………………….…………..48 A. Patterns of Trade in Goods and Services ……………………………..………..……… ..48 B. Trade Policies: Reforms to date and plans for the future………………………………...51 C. Capacity to Trade: Institutional and other constraints to implementation…………….....55 D. Market Access: The global, European and regional dimension……………………….. ..57 E. Policy recommendations………………………………………………………………....60 F. Donor Program……………………………………………………………….…………..62 CHAPTER 4. GOVERNANCE……………………………………………………….………. ..68 A. Introduction……………………………..…………………………..………….…….…..68 B. Creating an effective Public Sector……………………………………………………....70 C. Enhancing the Efficiency of the Public Sector………………………………………… ..73 D. Increasing the accountability of the Public Sector…………………………………….....76 CHAPTER 5. PRIVATE SECTOR DEVELOPMENT………………………………………. ..81 A. Introduction………………………………………………………………..……………..81 B. Socially owned enterprises: Privatization and Restructuring………………….………. ..82 C. Private small and medium new enterprises……………………………….……………...97 D. Other reforms for private sector development…………………………………….……105 CHAPTER 6. FINANCIAL SECTOR………………………………………………………... 111 A. Introduction……………………………………………………………………………..111 B. Macroeconomic environment and the Financial Sector……………………..…….……112 C. The Yugoslav Financial Sector…………………………………………………………117 D. Banking Regulation and Supervision………………………...……………….…….…..120 E. Problem banks resolution……………………………………………………………….128 F. Asset resolution strategy………………………………………………………………..136 G. Donor program………………………………………………………………………….140
iii CHAPTER 7. ENERGY……………………………………………………………………….143 A. Summary..………………………………………………………………………………143 B. Electricity……………………………………………………………………………….148 C. Coal……………………………………………………………………………………..158 D. Oil and Gas…………………………………………………………………………….. 163 E. District Heating and Energy Efficiency…………………………………….…………..170 CHAPTER 8. TRANSPORT………………………………………………...…...…….. …….181 A. Road and road transport……………………………………………………….………..182 B. Railways………………………………………………………………………………...188 C. Maritime transport……………………………………………………………………... 194 D. River transport………………………………………………………………….……… 198 E. Trade and Road transport Facilitation…………………………………………………. 201 CHAPTER 9. WATER, WASTEWATER AND SOLID WASTE………………………….. 209 A. Background on Organization and the Quality Situation……………….……………….209 B. Policy reforms needed for the success of the Donor Program…………….……………218 C. Donor Program for Water Supply and Sanitation………………………………………220 CHAPTER 10. COMMUNICATIONS…………………………..……………………..…….. 229 A. Telecommunications……………………………………………………………………229 B. Broadcasting………………………………………………………………….………... 233 C. Postal Services…………………………………………………………………………. 233 D. ICT/Information Society…………………………………………………….………….234 E. Sector Priorities for Transition and Recovery…………………………………………. 235 CHAPTER 11. AGRICULTURE…………………….………………………………………. 237 A. Introduction……………………………………………………………………………..237 B. Background……………………………………………………………………………..238 C. Sector Constraints and Challenges…………………………………………………….. 248 D. Priorities and Investments for Recovery and Transition………………………….…… 250 CHAPTER 12. ENVIRONMENT……………………………………………………………..260 A. Introduction……………………………………………………………………………..260 B. Environmental Situation…………………………………………………………….…. 261 C. Environmental Institutional Framework and the Role of Civil Society……………… 272 D. The Regional Dimension…………………………………………………………….… 274 E. Towards and Environmental Agenda………………………………………………….. 275 CHAPTER 13. SOCIAL PROTECTION………………………………………………..…… 280 A. Pensions………………………………………………………………………………... 280 B. Unemployment Benefits and Other Labor Market Programs…………………………. 292 C. Social Welfare…………………………………………………………………………. 296 CHAPTER 14. HEALTH………………………………………………………...…………... 307 A. Background……………………………………………………………………………..307 B. Key Challenges……………………………………………………………………….... 314 C. Priorities for Transition and Recovery………………………………………………….316 D. Proposed Donor Program ……………...……………………………………………….320
iv CHAPTER 15. EDUCATION…………………………………………………………………322 A. Background……………………………………………………………………………..322 B. Priorities for Transition and Recovery………………………………………………….333 CHAPTER 16. POVERTY…………………………………………………………….……... 339 A. Introduction……………………………………………………………………………..339 B. Poverty and Inequality: Snapshot and Changes………………………………………...340 C. Explaining Poverty……………………………………………………………………...345 D. Conclusions and Recommendations for Policies and the Donor Community.…………347
LIST OF TABLES Table 1.1: External Financing Requirements, FRY medium term ERTP, by Sector……….….. 5 Table 1.2: External Financing Requirements, FRY medium term ERTP, by Category……….. 6 Table 1.3: External Financing Requirements for 2001, FRY medium term ERTP……………. 9 Table 2.1: Fiscal Risks – Liabilities and Expenditures………………………………………. 17 Table 2.2: Fiscal Risks – Assets and Revenues…………………………………………….… 18 Table 2.3: Donor Program: Fiscal Policy and Management………………………………… 43 Table 3.1 Trade and Services Balances…………………………………………………….. 49 Table 3.2 Main Export Markets…………………………………………………………….. 50 Table 3.3 Main Import Markets……………………………………………………………... 50 Table 3.4 Exports and Imports by Commodity……………………………………………… 51 Table 3.5 Donor Program: Trade…………………………………………………………… 64 Table 4.1 Donor Program: Governance…………………………………………………….. 80 Table 5.1 Enterprises and Workforce by type of Ownership……………………………….. 83 Table 5.2 Losses/Profits by ownership in 1999 and Jan-June 2000………………………... 85 Table 5.3 Employment and value added in small enterprises, 1998……………………….. 98 Table 5.4 Donor Program: Private Sector Development…………………………………… 110 Table 6.1 Monetary Aggregates, share of GDP……………………………………………. 114 Table 6.2 Monetary Aggregates……………………………………………………………. 116 Table 6.3 Structure of Domestic Credit……………………………………………………. 117 Table 6.4 Estimated direct costs of resolution alternatives………………………………… 133 Table 6.5 Donor Program: Financial Sector………………………………………………... 142 Table 7.1 Overall Donor Program: Energy Sector………………………………………… 147 Table 7.2 Priorities for Electricity sub-sector recovery and reform………………………... 152 Table 7.3 Donor Program: Electricity sub-sector………………………………………….. 157 Table 7.4 Coal production………………………………………………………………….. 158 Table 7.5 Donor Program: Coal sub-sector………………………………………………... 162 Table 7.6 Priorities for Oil and Gas sub-sector recovery and reform……………………….168 Table 7.7 Donor Program: Oil and Gas sub-sector…………………………………………170 Table 7.8 Donor Program: District Heating/Energy Efficiency…………………………… 180 Table 8.1 Road Expenditures (1990-2000) in US$ millions……………………………….. 183 Table 8.2 Donor Program: Transport……………………………………………………… 208 Table 9.1 Sample Cleansing Service Fees…………………………………………………. 215 Table 9.2 Solid Waste Characteristics……………………………………………………… 216 Table 9.3 Investments planned for Landfills……………………………………………….. 217 Table 9.4 Donor Program for Water, Wastewater and Sanitation………………………….. 222 Table 9.5 Rivers of FRY…………………………………………………………………….223
v Table 9.6 Water Supply Coverage in FRY…………………………………………………. 224 Table 9.7 Water Supply service levels………………………………………………………224 Table 9.8 Interruptions to water supply…………………………………………………….. 224 Table 9.9 Sewage disposal methods………………………………………………………... 225 Table 9.10 Solid Waste disposal methods…………………………………………………… 225 Table 9.11 Main data from selected utilities………………………………………………… 225 Table 9.12 Investment and employees in public water supply (1988-1997)………………… 226 Table 9.13 Quantities of wastewater generated and treated in settlements………………….. 226 Table 9.14 Water company estimates and identified pledges………………………………...227 Table 9.15 Novi Sad Water Supply and Sewerage Company data…………………………...228 Table 10.1 Structure of Telecommunications in FRY……………………………………….. 230 Table 10.2 Fixed usage tariffs – Serbia and Montenegro……………………………………. 231 Table 10.3 Donor Program: Communications Sector………………………………………...236 Table 11.1 Budget Support for Agriculture (2000)………………………………………….. 243 Table 11.2 Donor Program: Agriculture……………………………………………………..259 Table 12.1 Pressures on the Environment and Natural Resources during the 1990s…………263 Table 12.2 Air quality trends for selected cities……………………………………………... 265 Table 12.3 Donor Program: The Environment……………………………………………… 279 Table 13.1 Pensions as a proportion of GDP in FRY 1998-2000…………………………… 280 Table 13.2 Pension Fund Beneficiaries and Average Pensions………………………………282 Table 13.3 Share of old-age, disability and survivor pensions………………………………. 282 Table 13.4 Ratio of average pension to average wage………………………………………..284 Table 13.5 Contribution Rates in 2000………………………………………………………. 286 Table 13.6 Pension reforms and their likely fiscal impacts………………………………….. 288 Table 13.7 Spending on Labor Market Programs in FRY in 2000…………………………...293 Table 13.8 Social Welfare spending in FRY as a share of GDP, 1998-2000………………... 299 Table 13.9 Comparative Social Welfare spending……………………………………………299 Table 13.10 Republican Social Welfare Programs, end 2000………………………………… 300 Table 13.11 Donor Program: Social Protection……………………………………………….306 Table 14.1 Basic Health Indicators for FRY………………………………………………….308 Table 14.2 Revenue to the Health Insurance Fund, 2000, by source…………………………310 Table 14.3 Structure of Health Expenditures in the Health Insurance Funds, 1999………….312 Table 14.4 Comparison of Health Service Delivery Indicators, 1999………………………..313 Table 14.5 Donor Program: Health…………………………………………………………...321 Table 15.1 Total Enrollments by Level, 1990/1991 and 1999/2000………………………… 324 Table 15.2 Percentage of 1990 population with at least a secondary education…………….. 326 Table 15.3 Student/teacher ratios in Serbia, Montenegro and selected Comparators……….. 328 Table 15.4 Serbia average net salaries, by sector ,1999 and 2000……………………………330 Table 15.5 Republican expenditures on education by level…………………………………..331 Table 15.6 Shares of Financing sources for Education in Serbia……………………………. 332 Table 15.7 Local government expenditures in Serbia by sector, 2000………………………. 332 Table 15.8 Education expenditures of the Belgrade City Assembly, 2000………………….. 333 Table 15.9 Donor Program: Education………………………………………………………. 338 Table 16.1 Poverty Lines in FRY in April, 2000……………………………………………..340 Table 16.2 Poverty in FRY in the first half of 2000…………………………………………. 341 Table 16.3 Donor Program: Poverty………………………………………………………….348
vi LIST OF BOXES Box 1.1 The Urgent Needs Program………………………………………………………….2 Box 1.2 The Case for Support for Recurrent Expenditures…………………………………..7 Box 1.3 Key Implementation Challenges: Lessons Learned………………………………..13 Box 5.1 The Bureau of accounts and payments (ZOP)…………………………………….. 84 Box 6.1 Frozen Foreign Currency deposits………………………………………………...115 Box 8.1 Examples of Excess Costs (Transport)…………………………………………... 202 Box 10.1 Elements of a Regulatory Toolkit and required Capacities……………………… 232 Box 12.1 Mainstreaming Environmental Concerns in the Sectoral Reform Programs……..277 Box 13.1 FRY Labor Relations Framework………………………………………………...295
LIST OF FIGURES Figure 6.1 Implementation of Serbian Banking Sector restructuring strategy………………..135 Figure 6.2 Possible BRA organizational structure……………………………………………136 Figure 7.1 Monthly heating expenses by energy source…………………………………….. 171 Figure 8.1 Port of Bar – Turnover of Goods (1985-2000)…………………………………... 194 Figure 8.2 National and International Goods Transport on Inland Waterways……………... 198 Figure 12.1 Trends in Air Pollution…………………………………………………………... 265 Figure 12.2 Trends in Infant Mortality……………………………………………………….. 266 Figure 12.3 Trends in Artificial Afforestation………………………………………………... 269 Figure 13.1 System Dependency in Serbian Pension Funds…………………………………..285 Figure 16.1 Poverty Headcount 1990-1999…………………………………………………... 342 Figure 16.2 Inequality in Selected Transition Countries………………………………………344
vii ABBREVIATIONS AND ACRONYMS
BiH Bosnia and Herzegovina IMF International Monetary Fund BRA Bank Rehabilitation Agency IOSCO International Organization of Securities BSE Belgrade Stock Exchange Commissions CAD Current Account Deficit IRU International Road Transport Union CBM Central Bank of Montenegro IT Information Technology CEE Central and Eastern Europe KfW Kreditanstalt fuer Wiederaufbau CEFTA Central European Free Trade Agreement LMB Labor Market Bureau CIS Commonwealth of Independent States MOF Ministry of Finance CSW Centers for Social Work MSEC Montenegrin Securities and Exchange DCR Directorate for Commodity Reserves Commission (Serbia) NATO North Atlantic Treaty Organization DEM German Mark NBY National Bank of Yugoslavia DFID UK Department for International NGO Non Governmental Organization Development OECD Organization for Economic Cooperation DOS Democratic Opposition of Serbia and Development EBRD European Bank for Reconstruction and OCSE Organization for Security and Cooperation Development in Europe EC European Commission PAYG Pay as you go ECA Europe and Central Asia PF Pension Fund EIB European Investment Bank PRA Public Revenue Agency EPS Electric Power Company of Serbia SAA Stabilization and Association Agreement ERTP Economic Recovery and Transition SEE Southeast Europe Program SFRY Socialist Federal Republic of Yugoslavia EU European Union SICR State Institution for Commodity Reserves FDI Foreign Direct Investment (Montenegro) FSO Federal Statistical Office SME Small and Medium Enterprise FIAS Foreign Investment Advisory Service SOE State Owned Enterprise FMM Frequency Management Monitoring TIR Transports Internationaux Routiers FRY Federal Republic of Yugoslavia TM Telecom Montenegro FTA Free Trade Agreement TS Telecom Serbia FYROM Former Yugoslav Republic of Macedonia UB Unemployment Benefits GDP Gross Domestic Product UN United Nations GNP Gross National Product UNDP United Nations Development Program HBC Hard Budget Constraint UNHCR United Nations High Commissioner for IAS International Accounting Standards Refugees ICSID International Center for the Settlement of UNOCHA United Nations Office of Coordination of Investment Disputes Humanitarian Affairs ICT Information and Communications UNMIK United Nations Mission in Kosovo Technologies WB World Bank IDP Internally Displaced People WFP World Food Program IFC International Finance Corporation WTO World Trade Organization IFI International Financial Institution YUD Yugoslav dinar ILO International Labor Organization ZOP Agency for Accounts and Payments
viii ACKNOWLEDGEMENT
This report was prepared by the World Bank and the European Commission, working closely with counterparts in the International Monetary Fund (IMF), the European Bank for Reconstruction and Development (EBRD), the United Nations system, other international organizations and bilateral donors. It was prepared in close collaboration with government counterparts in the Federal Republic of Yugoslavia (FRY), and also draws upon information provided by academics, private sector analysts, and civil society organizations in FRY.
ix CHAPTER 1. AN OVERVIEW OF THE ECONOMIC RECOVERY AND TRANSITION PROGRAM A. INTRODUCTION
1.1 Elections in the Federal Republic of Yugoslavia (FRY) late last year marked a watershed in Southeast Europe. Through these elections the Yugoslav people demonstrated their strong desire to make a break with the civil strife, international isolation and poor economic management of the past decade. The new government took office with a mandate to pursue modernization, market-economy reforms, and international re-integration. As described in greater detail in the companion first volume of this report, the government is committed to a program of macroeconomic, structural and institutional reforms that will provide the foundation for economic recovery. However, progress on the reform agenda is a necessary but not sufficient condition for recovery and growth. Given FRY’s extremely weak fiscal and external starting point, concessional assistance from donors – in sufficient amounts and in the appropriate forms – will also be essential to set FRY on a path toward stability and prosperity. This second volume of the Economic Transition and Recovery Program (ERTP) report aims to present a coherent framework for such donor assistance.
1.2 Ten lost years have left a daunting economic and human legacy in FRY: a collapsed economy, fragile institutions and increased vulnerability. GDP today is less than half its level at the start of the decade. The number of poor has doubled. With decapitalized, state- and socially- owned enterprises, loss-making and deeply mistrusted banks, and over-committed, poorly functioning social safety nets, FRY must now catch up with reforms begun a decade ago by its neighbors in Central and Eastern Europe (CEE). The process will be made more difficult by large and mounting fiscal pressures, a crippling external debt, weakened governance, and damaged infrastructure. Ten years of conflict and isolation have also cause severe rents in the social fabric of life. Standards of living have plummeted for most Yugoslavs, especially for refugees and internally displaced people. The physical, institutional and psychological scars of the decade will not heal quickly.
1.3 Much has been accomplished in the last several months to begin to address this legacy. Shortly after taking office, the new governments of FRY and Serbia put in place a stabilization and liberalization program that included controlling inflation through cash-balanced budgets and tight monetary policy, unification of the exchange rate and a start to trade liberalization. (Montenegro had begun stabilization and transition reforms earlier, with donor assistance.) The program was supported in December 2000 by an IMF Emergency Post-Conflict Facility. More recently, FRY has committed to an ambitious reform program for 2001 to be backed by an IMF Stand-By Arrangement. A Donor Coordination Meeting was organized in December 2000, and mobilized substantial urgently-needed aid to see FRY through the 2000-2001 winter (Box 1.1). Good progress has also been made in re-integrating with the international economy. In November 2000, FRY was recognized as a member of the UN and joined the OCSE, and also joined the IMF in December. FRY became a member of the EBRD and was admitted as a guest of the parliamentary assembly of the Council of Europe in January. In May, FRY met the conditions for membership in the World Bank (one of which was agreement on a plan to resolve arrears), and was granted temporary exceptional eligibility for concessional IDA resources. Access to EIB funds is also expected soon. In addition, FRY has initiated discussions with the Chapter 1. The Economic Recovery and Transition Program: Overview
Paris Club, requesting debt relief on concessional terms. In the context of the envisaged IMF Stand-by Arrangement, Paris Club creditors have agreed to provide financing assurances for the program through rescheduling FRY's debt service payments to Paris Club creditors during the period of the Stand-by Agreement, which will help minimize the strain on the balance of payments in the near term. Taking into account FRY's situation, Paris Club creditors also indicated that, if needed, they would be ready to consider providing FRY with a successor Paris Club agreement in the future. These developments, achieved in a relatively short period of time, signal the authorities’ strong commitment to reform and recovery and the international community’s willingness to respond quickly.
Box 1.1 The Urgent Needs Program
Upon taking office in the run-up to winter, the authorities faced a desperate situation in the energy, agricultural and health sectors. Severe shortages of heat and electricity reflected the legacy of past mismanagement, excessively low tariffs, under-investment and lack of maintenance, and the impact of a severe drought on hydro power generation. Agriculture had suffered from policies which distorted incentives and from a lack of critical inputs. The problems in the health sector, including a shortage of pharmaceuticals, reflected the impact of the collapse of economic activity on available financial resources.
Based on an urgent needs assessment prepared by the UN,1 the authorities focused on protecting the most vulnerable by mobilizing sufficient assistance to assure the availability of critical goods, particularly energy (electricity and gas for heating), basic foods and medicines, and to improve the delivery of social assistance. A first Donor Coordination Meeting in December 2000, co-hosted by the World Bank and the European Commission, raised some US$500 million toward meeting these needs, set against requirements of about US$700 million.
While comprehensive data on commitments and disbursements of these resources is not yet available,2 partial information indicates that support was rapidly mobilized and has been largely effective in keeping basic services functioning, alleviating more pressing vulnerability and keeping economic disruption to manageable levels. A fortuitously mild winter also reduced demand in the energy sector. Most support has been in the form of “in kind” assistance such as energy imports and food aid. Some support has been also been earmarked for specific social payments. These urgent-needs contributions have taken pressure off government budgets indirectly, by covering expenditures that would otherwise need to have been met by fiscal resources.
Even with the winter behind, however, urgent needs will remain in the near term, particularly in relation to refugees and the internally displaced. Early indications from a recent UNHCR census suggest a refugee population of around 400,000. In addition, around 229,000 internally displaced from Kosovo continue to be vulnerable. In April, 2001 the World Food Programme provided emergency food aid to a total of 643,000 vulnerable people – nearly half of whom were refugees – reflecting the continuing requirement for this support. Even with best case growth projections and recovery outlined in the ERTP, humanitarian assistance will continue to be a critical element of the social safety net in the near term.
1.4 As it tackles its economic agenda, however, FRY also faces a number of political challenges. The FRY government has re-established relations with its neighbors, ruptured over years of conflict. It also now faces the challenge of clarifying relations within the county, in particular in Montenegro and Kosovo. These relationship are in a process of re-alignment that may be ongoing for some time. This is bound to create challenges and stresses in the process of
1 “Urgent Needs in the Federal Republic of Yugoslavia,” December 2000, UN OCHA. 2 Responses to a European Commission-World Bank Joint Office request for written information from donors have been partial to date. However, the Ministry of International Economic Relations of the Government of Serbia has been active in tracking pledges and the status of projects through its Development and Aid Coordination Unit, which maintains a website (http://www.mier.sr.gov.yu/).
2 Chapter 1. The Economic Recovery and Transition Program: Overview implementing the reform agenda. An additional challenge is the conflict in southern Serbia’s Presevo valley, near the administrative border with Kosovo. The spillover into neighboring former Yugoslav Republic of Macedonia demonstrates the region’s still-fragile inter- relationships. Finally, perhaps the most critical challenge for the government will be meeting the expectations of the Yugoslav population who desire rapid progress toward social and institutional change and increased economic well-being. While these challenges represent potential risks to implementation of the reform and recovery agenda, they are outweighed by the benefits to be derived by assisting FRY achieve its long-awaited economic recovery. These benefits will be felt not only by the Yugoslav people but also by the populations of Southeast Europe, and Europe more broadly, since FRY’s economic recovery will enable it to become a factor of stability in the region.
1.5 This second volume of the ERTP sets out the policy challenges, public investment priorities and external financing requirements needed in fifteen sectoral and thematic areas of the economy to set FRY on a path to sustainable growth. The broad scope of the program is the medium-term, with particular focus on external financing requirements for activities and expenditures to be undertaken in the remainder of 2001 – as well as to make a start on needs in the early part of 2002. The present overview chapter presents the program framework, defines the external financing requirements – both in terms of level and modality of support – and explains how such support will further the government’s economic recovery and transition objectives. Finally it raises some considerations related to donor coordination that will be critical to ensuring the sustainability and efficiency of the program. The remainder of this second volume is comprised of detailed sectoral chapters that present background information, an agenda of near- and medium-term policy reforms, and a program of public investments in the areas of trade, fiscal reform, governance, private sector development, financial sector development, telecommunications, energy, transport, water and wastes, agriculture, environment, social protection, health, education and poverty. In each chapter, external financing requirements on a commitment basis in that sector over a three to four year period are set out; a table detailing these requirements is provided at the end of each chapter.
B. THE GOVERNMENT’S MEDIUM-TERM CHALLENGES
1.6 In order to pursue its vision of a modern market economy – and break with the legacy of the recent past – the FRY authorities have identified three goals: (a) full reintegration into the international community in the near term; (b) self-sustaining growth without aid dependence in the medium term; and (c) accession to the European Union in the longer term. To achieve these goals, FRY must address three highly interdependent challenges, which the ERTP takes as its primary themes:
• Restoring macroeconomic stability and external balance. As described in the first volume of this report, the legacy of fiscal imbalance, and risks associated with fiscal pressures, are large. These risks will increase as FRY begins servicing its external debt and as macroeconomic tightening continues to put pressure on enterprises and banks. Efforts to ensure fiscal sustainability, further liberalize trade and build the institutions of macroeconomic management will all be needed.
3 Chapter 1. The Economic Recovery and Transition Program: Overview
• Stimulating growth and creating the basis for a sustainable supply response. Restarting growth in the near term will be essential to creating jobs and to meeting the expectations of the population; while sustainable longer term growth will provide the basis for successful recovery. This will require ambitious reforms to spur private sector- led growth and restructure the financial sector. It will also require sectoral reforms and investments in key infrastructure sectors, particularly energy and transport, as well as in agriculture and environmental management. • Improving the social wellbeing of the most vulnerable and building human capacity. Measures are needed to move away from humanitarian interventions of last winter to more carefully designed and sustainable social protection policies and programs – particularly to prepare for the social costs of the transition and adjustment ahead. Healthcare and education systems also must be strengthened to build a more productive, healthy and flexible labor force that better meets the needs of a modern market economy. 1.7 A prerequisite for success in all of these areas will be investing in effective institutions. FRY’s institutional capacity has been weakened by lack of investment, “brain drain” and years of isolation. It will be particularly critical to build capacity at all levels of government (increasingly in line with European standards and norms), build the public’s confidence in transparency and accountable government, and develop rule-based governance. If not forcefully addressed, the perception and reality of past corruption could deter both external aid as well s investment.
1.8 Success in meeting these challenges would set FRY on a path toward greater stability, income growth, better governance, and integration into Southeastern Europe (SEE) and Europe as a whole. Under this scenario, described more fully in the first volume of this report, FRY would begin to catch up to, and increasingly resemble, the most successful reformers of the CEE region. The recent steps described above have successfully launched FRY on this path. Turning this strong start into something more sustained will require significant efforts from both FRY and donors, immediately as well as over the medium-term. The delayed transition and decrepit state of physical assets requires going much beyond quick first-generation reforms and the management of short-term pressures. New sources of fiscal pressures (e.g., restoring debt service and improving social protection) will emerge as old ones are resolved. Therefore, successful transition in will require a sustained multi-year partnership between the international community and FRY. Its ultimate success will come from a combination government commitment to and delivery on a coherent, prioritized, well-sequenced and sustained program of reform and institutional strengthening, along with generous, promptly delivered, and well- targeted donor support (including the financial and technical assistance set out in the ERTP as well as debt restructuring).
C. MEDIUM-TERM EXTERNAL FINANCING REQUIREMENTS
1.9 As a key part of the ERTP, a public investment program has been designed, in collaboration with the authorities, to cover recurrent, investment and technical assistance needs over the medium term. Some limited need for donor funding of equity, guarantee and line of credit financing is also included, as a means of jump-starting more medium-term private sector investment. Based on an assessment of sectoral needs, the minimum external financing requirement over the next three to four years to fund the ERTP is about US$3.9 billion, on a
4 Chapter 1. The Economic Recovery and Transition Program: Overview commitment basis. This estimate assumes that the government’s reform program remains substantial and credible. It also assumes that the bulk of commitments will disburse during the ERTP timeframe3. Importantly, the estimate also assumes that FRY receives debt restructuring from official and commercial creditors on appropriate terms. If such debt restructuring is not forthcoming expenditures, and therefore external financing requirements, may be larger. On the other hand, any extension of the moratorium period beyond the assumed end date of March 31, 2001 would reduce near-term debt service payments, but would not address FRY's longer-term creditworthiness. In terms of the ERTP’s three core program objectives, the program breaks down as follows (Table 1.1): • restoring macroeconomic management, including expenditures in the areas of trade, governance, poverty and fiscal management (including budget support) the three to four year ERTP period would require about US$567 million (or 14 percent of total program needs); • promoting sustainable growth, including expenditures needed to continue transition in the private and financial sectors, to address physical rehabilitation of infrastructure and agriculture and ensure appropriate environmental mitigation, would require a further US$2.5 billion (the bulk of the planned program, or 65 percent of total); and • improving social sustainability, including social protection, health and education needs, would require US$819 million (21 percent of total) over the period. Table 1.1: External Financing Requirements FRY Medium Term Economic Recovery and Transition Program By Sector (in US$ millions on a commitment basis) CY2001 CY2002-2004 Total Percent
Macroeconomic Management 156.6 409.9 566.5 14.5
Promotion of Growth 773.3 1,745.9 2,519.2 64.5 Private Sector Development 112.4 215.5 327.8 8.4 Financial Sector Development 18.3 27.0 45.3 1.2 Communications 18.0 46.0 64.0 1.6 Energy 258.5 686.9 945.4 24.2 Transport 218.7 449.7 668.4 17.1 Agriculture 71.0 147.0 218.0 5.6 Environment 38.5 56.5 95.0 2.4 Water/Wastes 38.0 117.3 155.3 4.0
Social Development 319.3 499.2 818.5 21.0 Social Protection 170.5 194.9 365.4 9.4 Health 65.3 140.3 205.6 5.3 Education 83.5 164.0 247.5 6.3 - Total 1,249.2 2,654.9 3,904.1 100.0
3 If committed funds are not largely disbursed during this period the objectives of the ERTP will not be realized, and progress towards sustainable growth could be significantly hindered.
5 Chapter 1. The Economic Recovery and Transition Program: Overview
1.10 The commitment levels outlined in table 1.1 are presented as absolute minimums to achieve the objectives of the ERTP. However success will require not only adequate overall levels of assistance, but also appropriate composition of support. FRY’s financial needs fall into four categories: (a) recurrent expenditures; (b) investment; (c) technical assistance; and (d) credit lines, equity and guarantees. As further explained below, a comparatively large proportion of the external funding required, particularly in 2001, is in the form of support for FRY’s government budgets (including budget support and more indirect forms of support to recurrent expenditures) and maintenance investments. Such assistance – expected to be disbursed very quickly after being committed (and typically within the same calendar year) – will be needed to ensure financing of FRY’s budget and balance of payments deficits, which are described in detail in the first volume of this report. This point is further illustrated by breaking down the program financing requirements into the four identified categories of expenditure (Table 1.2).
Table 1.2: External Financing Requirements FRY Medium Term Economic Recovery and Transition Program By Category of Financial Assistance (in US$ millions on a commitment basis)
Recurrent Costs Investments Credit/Equity Tech. Ass't. Total Program
Amount 1,132.5 1,926.4 426.0 419.2 3,904.1 Percent 29.0 49.3 10.9 10.7 100.0
Recurrent expenditures
1.11 FRY’s need for support for recurrent expenditures is a defining feature of the ERTP, and reflects the economic legacy of accumulated fiscal and external pressures (Box 1.2). Over the ERTP period, the external financing requirement to fund recurrent expenditures is estimated to be of the order of US$1.1 billion, or around 29 percent of total program requirements. The need for support to recurrent expenditures will take two forms: (a) support to government budgets to meet the gap in the annual budget; and (b) more indirect assistance to the budget by funding expenditures that would normally be covered by fiscal resources (e.g., pharmaceuticals and school books, providing support for social programs). These recurrent expenditures would constitute needs which have not been met in the federal, and “core” Serbian and Montenegrin budgets, defined in conjunction with the government on the basis of its efforts to maximize domestic resource mobilization through the tax system while cutting budget expenditure to the minimum required for sustainability. In addition, the ERTP program includes limited support for recurrent expenditures of corporatized entities (e.g., energy imports for the power companies).
1.12 As a general principle, support for recurrent costs without policy changes, however, would provide only short term sustenance to a system that needs reform. To avoid compromising incentives for reform, such assistance should be strictly conditional on reforms to enhance the financial sustainability of these programs. For example, support for severance payments should be conditioned on making severance pay requirements substantially less generous than under the present system. Given the high cost of the pension system, any targeted
6 Chapter 1. The Economic Recovery and Transition Program: Overview support for pension payments should be linked to well-designed conditionality to limit the growth of entitlements and to credibly eliminate structural deficits in the pension system.
1.13 The need for support to recurrent expenditures is front-loaded and will decline over time. This reflects not only the larger one-off expenditures to be made at the beginning of transition (e.g. for social payments), but also the expectation that structural reforms would gradually bring lower expenditures in other areas while tax reform and improved tax administration enhance revenue collection capacity. As budget execution and fiscal transparency are strengthened, such support could increasingly shift from earmarked to more direct forms linked to closely monitored reform programs.
Box 1.2 The Case for Support for Recurrent Expenditures
The comparatively large need for funding of recurrent expenditures reflects the severe accumulated pressures on FRY fiscal and external accounts. For several years, four unsustainable measures have been used to bring cash expenditures in line with available fiscal resources: (a) halting debt service payments; (b) allowing budgetary arrears to accumulate; (c) maintaining low public utility tariffs (and thus shifting part of the fiscal burden to the enterprise sector (e.g., in late-2000 the quasi-fiscal deficit of the energy sector alone was 10 percent of GDP); and (d) deferring needed public investments and maintenance.
With fiscal reforms, these sources of financing will disappear. First, even after extensive debt restructuring and debt relief, projections indicate that public debt service payments will rise from almost zero to an average of over 5 percent of GDP in 2001-03. Second, more realistic budgeting of expenditures will add an amount roughly equivalent with the previous level of accumulated budgetary arrears (over 2 percent of GDP). Third, the partial conversion of hidden public utility deficits into more transparent direct budgetary costs (e.g., through explicit subsidies to public utilities) will lead to higher cash outlays. Fourth, a reversal of the past under-investment and lack of maintenance in public infrastructure (a gradual increase of such expenditures to about 4 percent of GDP) will be needed to drive a strongly-growth oriented program. Finally, in addition, the immediate impact of enterprise and bank restructuring will place new pressures on social programs while eroding some sources of budgetary income in the near term.
The government has taken measure to ensure that the federal, “core” Serbian and Montenegrin budgets have been trimmed to the minimum essential expenditures, and to maximize domestic revenue mobilization in the near term. Budgets include, or are backed by, measures to: (a) control entitlements to pensions, health care services and social assistance; (b) sharply cut expenditures on defense and internal security; and (c) increase prices for energy and pharmaceuticals (bringing these expenditures on budget). Any deeper near-term cuts in expenditures would be inconsistent with restoring growth or ensuring social sustainability. On the revenue side, reform measures (in particular, a revenue-positive tax reform in Serbia), along with increased privatization revenues, will also contribute to cutting the fiscal financing gap. However, the increase in the four noted categories of expenditures will be so large that a substantial fiscal financing gap is projected to remain over the medium term. Given the extremely low monetary base in Serbia, and the use of a foreign currency as legal tender in Montenegro, any attempt at significant monetary financing would risk renewed high inflation and/or crowd out private investment.
For these reasons, appropriately delivered and conditioned support for recurrent expenditure is a crucial element of the donor program for FRY. A donor program which provided inadequate amounts of such support, even while providing large total volumes of support, would leave FRY exposed to serious macroeconomic risks.
Investment
1.14 Investment needs under the ERTP will focus nearly exclusively on projects to repair the effects of conflict-related damage and delayed maintenance. These investments would be for both: (a) those facilities which are funded through government budgets (e.g. roads, health and
7 Chapter 1. The Economic Recovery and Transition Program: Overview education); and (b) those facilities provided by corporatized entities which are not included in government budgets (e.g., power and railways companies, municipal enterprises).4 Over the ERTP period, external financing requirements for such investments amount to about US$1.9 billion on a commitment basis, representing about 49 percent of the total program (Table 1.2). Such support would repair conflict-damaged infrastructure, compensate for long-delayed maintenance and remove key bottlenecks to growth, thus helping to promote a more rapid supply response. The need for support for investment as a share of the total program is expected to increase somewhat over time, as the need for new investment is more carefully assessed and as the most pressing maintenance needs are met.
Technical assistance
1.15 FRY’s need for technical assistance, training and other similar support is substantial, given the erosion of capacity experienced at most levels and in most areas of the economy over the past ten years. Training and technical advice will be crucial for initiating reforms and placing these on a more sustainable basis, including beginning the enterprise privatization and bank restructuring process, strengthening governance, and building the capacity of key government institutions. Over the ERTP period, external financing requirements for such technical assistance are estimated to total US$419 million on a commitment basis, or about 11 percent of program total, and are distributed across all sectors. The annual requirement would remain fairly constant over the period.
Credit lines, equity investments and guarantees
1.16 As noted earlier, external financing from donors to jump-start private-sector led growth – through support to credit lines for SMEs and agriculture, direct equity investments (both in banks and in the enterprise sector) and guarantees for trade facilitation – has been included in the ERTP. Such support to the enterprise sector is estimated to require about US$426 million on a commitment basis, or about 11 percent of the program needs. The need for credit lines, equity investments and guarantees would decline sharply over time, and composition is expected to shift from an early emphasis on credit lines and guarantees towards direct equity investments.
D. THE 2001 PROGRAM 1.17 Turning to the program for 2001, total external financing requirements are estimated to be US$1.25 billion, on a commitment basis (Table 1.3). About 37 percent would be required for recurrent expenditures, 42 percent for investments (mainly for maintenance), 11 percent for technical assistance, and 11 percent for lines of credit, guarantees and equity. Viewing the program from the perspective of its three core objectives – restoring macroeconomic stability, promoting growth, and improving social sustainability – provides means of assessing more particularly the financing needs and the expected results of donor support in each of these three areas.
4 Such enterprises could be state-owned, socially-owned or privately-owned. In select cases, support to such enterprises could cover some recurrent costs, such as electricity imports by power utilities and key agricultural inputs as noted in para. 1.11.
8 Chapter 1. The Economic Recovery and Transition Program: Overview
Restoring Macroeconomic Stability and External Balance
1.18 With FRY’s fiscal and external legacy, macroeconomic stability is inconceivable without adequate and appropriately structured donor support. About US$157 million (12 percent of total) is estimated to be required in 2001 to help finance government budgets and provide technical assistance for reforms and institution strengthening (Table 1.3). Further details are set out in Chapters 2 through 4 of this volume. Support is required in two forms:
• Recurrent expenditures. It is estimated that about US$140 million will be needed as budget support in 2001. As noted in Box 1.2, the need for such assistance grows out of the sharp increase in expenditures as debt service payments are resumed, as more realistic budgets are prepared, and as restructuring places added pressure on social programs. This support would allow FRY to make such payments without unsustainable increases in taxes (which would cut growth prospects and further push economic activity into the unofficial sphere) and/or unsustainable cuts in public expenditures, including on social payments. This support should be granted with strict monitoring of the use of funds, and with adequate assurances that the reforms which are being supported are being effectively implemented. (Some already-identified sources for such finding include ongoing support to the Republic of Montenegro, as well as new adjustment/macro-financial support from international financial institutions and official sources to the federal and republican budgets, however further commitments are required.) Details are provided in the first volume of this report.
Table 1.3: External Financing Requirements for 2001 FRY Medium Term Economic Recovery and Transition Program (in US$ millions on a commitment basis) Recurrent Credit/ Costs Investments Equity Tech. Ass't. Total Percent
Macroeconomic Management 140.0 - - 16.6 156.6 12.5
Promotion of Growth 95.0 457.3 132.0 89.0 773.3 61.9 Private Sector Development - - 90.0 22.4 112.4 9.0 Financial Sector Development - - - 18.3 18.3 1.5 Telecommunications - - 15.0 3.0 18.0 1.4 Energy 80.0 168.8 - 9.7 258.5 20.7 Transport - 213.0 - 5.7 218.7 17.5 Agriculture 15.0 12.0 27.0 17.0 71.0 5.7 Environment - 27.5 - 11.0 38.5 3.1 Water/Wastes - 36.0 - 2.0 38.0 3.0
Social Development 230.0 63.6 - 25.7 319.3 25.6 Social Protection 160.0 4.6 - 5.9 170.5 13.6 Health 30.0 25.0 - 10.3 65.3 5.2 Education 40.0 34.0 - 9.5 83.5 6.7
Total 465.0 520.9 132.0 131.3 1,249.2 100.0 Percent of Total 37.2 41.7 10.6 10.5 100.0
9 Chapter 1. The Economic Recovery and Transition Program: Overview
• Technical assistance. Support for strengthening macroeconomic management capacity and institutions is needed, in particular to place FRY’s fiscal accounts on a more secure and sustainable foundation. Estimated needs reach about US$17 million in 2001, and include the strengthening of budget management procedures, enhancing the transparency of fiscal accounts, improving the management of public debt, implementing tax and trade policy reforms (including preparation for WTO accession, stabilization and association agreement with the EU, and enhancing regional trade), the strengthening of tax and customs administration, and the improvement of economic statistics.
Stimulating Near-Term Growth and Creating the Basis for a Sustainable Supply Response.
1.19 Over the coming years, FRY will have inadequate domestic resources to finance rehabilitation and repair of infrastructure. A low savings rate, combined with a dysfunctional financial sector, will limit the access of FRY enterprises to credit resources. Moreover, in the initial period when private investors may perceive risks to be excessively high, donor supported equity investments and guarantee facilities can provide crucial financial resources to stimulate recovery. Finally, successful reform and institutional strengthening to achieve “early wins” and to create the foundations for sustainable growth will require FRY’s existing know-how be supplemented by donor-supported technical assistance. About US$773 million (62 percent of total) will be needed, on a commitment basis, in 2001 to address these needs in the areas of private and financial sector development, infrastructure, agriculture and environment (Table 1.3). Further details are provided in Chapters 5 through 12 of this volume. Support would be required in four forms:
• Recurrent costs. Needs of US$95 million have been identified, in two sectors. First, in the energy sector, while reduced electricity demand due to increased power prices and improved maintenance should make a substantial improvement, electricity imports will continue to be required (though on a much smaller scale) in the winter of 2001-2002. Financing for these needs is estimated at US$80 million in 2001. Second, in the agricultural sector, there remains a need for some key inputs, such as fertilizer, with a total need estimated at US$15 million in 2000.5
• Investments. Financing needs for rehabilitation of infrastructure in 2001 have been identified at about US$457 million, and would focus on repair and maintenance of critical transport, energy, water and waste management, and communications infrastructure. The design of such assistance should be in the context of regional and European integration, including the existing and proposed regional programs and initiatives This support represents the largest single element of the 2001 program, and consists of:
5 In addition, limited financial support for bank restructuring could be considered, provided it is in support of a fiscally-viable bank resolution strategy. The ERTP program does not currently include any support of a recurrent nature for the costs associated with bank restructuring (although technical assistance costs are included), pending further development of this strategy. Room for such support within the program would need to be made through concurrent reductions in funding from other areas of the currently-defined ERTP.
10 Chapter 1. The Economic Recovery and Transition Program: Overview
• US$169 million for energy sector (electric power, coal, district heat, oil and gas) rehabilitation, all of which would be provided through public companies outside the state budget (Chapter 7); • US$213 million for transport rehabilitation, most of which would be in the form of public investments financed through government budgets, with a focus on rehabilitation of roads, river transport and trade facilitation (Chapter 8); • US$36 million for investments in water, wastewater and solid waste infrastructure repair and US$12 million in investments in upgrading agricultural water resource management facilities, to be provided through local government budgets (Chapters 9 and 11); and • US$28 million in environment-related investments, also to be provided mainly through government budgets (Chapter 12).
• Technical assistance. Total technical assistance needs in the growth-promotion area for 2001 are estimated at US$89 million across a range of sectors, to implement reforms needed to generate a quick supply response, employment creation, a shift from the gray to the official economy, and reduced corruption. Such reforms would focus on removal of distortions and institutional bottlenecks which limit foreign trade and output expansion and greater competition. Among the key technical assistance needs are assisting FRY in enterprise privatization and removing entry barriers to new enterprises and banks; developing and launching a fiscally-responsible bank resolution strategy; improving incentives for output and trade expansion in the agricultural sector; and enhancing the flexibility of labor markets.
• Credit lines, equity investments and guarantees. Properly delivered (i.e. without creating new distortions in the economy), such support will be crucial for jump-starting economic recovery. Needs for 2001 are estimated to total US$132 million, of which US$102 million would be through credit lines to enterprises, US$10 million through equity investments and US$20 through guarantees. Most of this support would be disbursed in 2002, but given the required lead time for project preparation, would need to be committed in 2001. A number of multilateral and bilateral agencies have already announced plans for such support, including for credit lines directed primarily at SMEs and at the agricultural sector, equity investments in the enterprise and banking sectors, and possibly in telecommunications, and guarantees largely for trade facilitation.
Improving Social Well-Being and Building Human Capacity
1.20 The start of deep enterprise restructuring will place pressure on FRY’s already fragile social safety net, and will create a particular need for one-off payments to smooth this restructuring. FRY’s budgetary resources will be inadequate to fund the needed expenditures on rebuilding health and education facilities and in providing equipment, materials and supplies. The extensive agenda of reforms and institutional strengthening in these sectors will need to be supported by technical assistance. Total needs are estimated at US$319 million (26 percent of program total) in 2001 on a commitment basis (Table 1.3). Details on these sectors are provided in Chapters 13-17. This support would take three forms:
11 Chapter 1. The Economic Recovery and Transition Program: Overview
• Recurrent costs. The vast bulk of the recurrent cost financing needs comes from the social sectors. Such support would help FRY mitigate the impact of economic restructuring in the early years, to prepare these sectors for the gradual integration of refugees, and to reverse the legacy of inadequate equipping of the health and education sectors. By covering these “one-time” expenditures which would otherwise have had to be financed from domestic budgetary resources, such assistance will also help cover the overall fiscal financing gap, and would thus contribute to supporting macroeconomic sustainability. The total needs in this area for 2001 are estimated at US$230 million, in three specific areas:
• US$90 million is required in 2001 in the area of social welfare and labor markets. Specific areas to be supported include existing social welfare programs, and the financing of severance payments and “one-off” social support payments, through government budgets (and special budgetary funds). Such support should be backed by reforms to the existing social protection system. • US$70 million is required for well-targeted support to pension systems. This is justified only if targeted to the most needy, i.e. at the lowest minimum pensions, and if backed by reforms which bring a gradual reduction of other entitlements in the pension system. • US$70 million is required to cover recurrent costs in health and education. The main recurrent costs needs in health are basic medical supplies (particularly pharmaceuticals), the provision or repair of equipment, and support for public health programs, including for non-communicable diseases and HIV/AIDS. In education, needs include re- equipping schools with essential and updated educational materials and equipment.
• Investment. Ten years of under-investment and a lack of maintenance has left hospitals, clinics and schools in extreme disrepair. Estimated needs for 2001 on a commitment basis reach US$64 million to repair, rebuild and refurbish health facilities, schools and social protection infrastructure. These investments are proposed only in the context of commitment to system rationalization and tighter deployment of existing resources.
• Technical Assistance. Technical assistance and training needs would include support for the planning and implementation of reforms to the pension systems, labor legislation and labor programs; for development of a social welfare strategy; reform of health financing, health policy, restructuring of the health sector, and reform of pharmaceuticals policy; and to develop a strategy for more efficient development and use of educational resources, upgrading educational content, and bringing excluded groups (including the Roma) into the mainstream education sector. Total 2001 requirements reach US$26 million on a commitment basis. In all of these areas, there is also a need to support dissemination of information on reforms to the public, build capacity, develop information systems, and provide extensive training to prepare reforms and meet the needs of a market economy. Finally, there are needs to develop comprehensive poverty analyses as well as the capacity to undertake and maintain such analysis as a basis for designing policy reforms in these and other sectors.
12 Chapter 1. The Economic Recovery and Transition Program: Overview
E. IMPLEMENTING THE PROGRAM
1.21 The ERTP presents an ambitious agenda for FRY’s recovery and transition to sustainable economic growth and stability. The program is not dominated by large-scale reconstruction or large new investment projects that provide immediate stimulus to economic activity. The main feature of the FRY program is a far-reaching reform agenda, and the need for substantial support – particularly in the near term – to recurrent expenditures and long-delayed maintenance. The reform agenda is likely to increase hardship in the short-term, with consequent risks for successful economic stabilization and a return to sustainable growth and improved poverty outcomes. Strong donor coordination and careful project design will be essential. Implementation of reform and investment projects alike will require careful planning, with particular attention to appropriate phasing, to the implications for institutional development, and to lessons learned in other experiences in the region (Box 1.3).
Box 1.3 Key Implementation Challenges: Lessons Learned
For the International Community • Coordination of Conditionality: As substantial amounts of international assistance, particularly direct budgetary support or earmarked assistance, will require policy conditionality such conditionality needs to be coordinated. The government will not be able to meet multiple, perhaps conflicting, conditions in order to meet disbursement criteria. IFI conditionality on policy reform may be serve as a useful source of benchmarking for other interested donors. • Coordination of Programming: Donors are encouraged to program their assistance according to the priorities outlined by the government as detailed in this ERTP. Poor coordinating will result in sub-optimal resource allocation and possible gaps and overlaps in programs. Both the Federal and Republican governments have taken a pro-active approach to coordination and prioritization of international assistance. It will be important for donors to continue to work closely with the relevant coordination ministries, as well as with the sectoral line ministries when developing and implementing projects. • Information dissemination: The complex environment in FRY will place large demands on the ability of the government to collect, collate and disseminate information about needs, commitments, disbursements and status monitoring. Fully exploiting synergies through coordination can only be achieved through comprehensive and accurate information flows which will require timely and accurate information from international donors to the government. The Joint Office of the European Commission and the World Bank will work with the government to collate and disseminate up-to-date information on commitments and disbursements and project implementation.
For the Government • Clarity of Coordination Mechanisms: Although the structural relationships between the Federal and Republican level of government are unlikely to be finalized for some time, coordination mechanisms appropriate for the first phase of the transition program need to be agreed, articulated and communicated to the international community. It will be important for the governments to clarify to donors its processes for coordination and prioritization of assistance, which will continue to be further developed and strengthened. • Establishment of Appropriate Fiduciary/ Procurement capability:. Donor funding, and particularly budgetary support, is certain to require improvements in fiduciary control and procurement capability. While it is likely that there will be substantial technical assistance available to the government in this regard, a sustained and determined effort will be required to facilitate necessary long-term support.
13 Chapter 1. The Economic Recovery and Transition Program: Overview
1.22 It will be critical to ensure not only that donors coordinate with each other, but that they closely coordinate with the government. The government (at both federal and republican levels) is expected to play a primary role in such coordination efforts. Donors also will need to be willing to provide information on their programs, as successful monitoring will require accurate reporting. Finally, sector-specific working groups or task forces of donors and government representatives are also an important potential tool for coordination. Sectoral working groups can serve as forums for: (a) providing an effective interface between donor sector experts and the government as implementing agency; (b) coordination of sectoral policies; (c) identification of funding gaps; (d) coordination of project design and implementation; and (e) monitoring of sectoral program information.
14 CHAPTER 2. FISCAL POLICY AND MANAGEMENT
INTRODUCTION
2.1 Fiscal control is the most important prerequisite for macroeconomic stability. Without strong domestic adjustment and foreign support, FRY’s fiscal deficits are unsustainable. The objective of fiscal sustainability will be supported by sectoral reforms to control the structural sources of fiscal pressures, and by reforms to strengthen fiscal policy and management. Among these reforms, four inter-related priority areas stand out:
i. Reducing quasi-fiscal deficits and hidden risks. As described in Volume 1 of this report, and as outlined in greater detail below, quasi-fiscal deficits represent one of the major sources of fiscal unsustainability. Measures are needed to both manage the legacy of such deficits in the past and to prevent their future creation.
ii. Enhancing the transparency and accountability of public spending. High standards of financial management and transparency in the use of budgetary resources will be essential for achieving an adequate level of donor support. Such institutional reforms are also important to lay the foundations for robust and socially acceptable structural adjustment.
iii. Strengthening public debt management. FRY’s very large debt burden represents one of the largest risks to fiscal stability. Both external and explicit public debt are over 100% of GDP, excluding hidden implicit/contingent liabilities. Monitoring and managing these liabilities (including strengthening institutional aspects and developing debt restructuring policies) will be crucial for ensuring macroeconomic sustainability.
iv. Reforming tax policy and strengthening tax administration. A highly complex and distortive tax system has limited the efficiency and volume of production and trade. Significant discretion in tax administration has created uncertainty and opportunities for corruption, while capacity limitations have hampered revenue collection.
2.2 This chapter is divided into four sections which discuss the priority areas listed above. Each section contains a discussion of the priority reforms required and suggests a donor program of technical assistance. The donor program is summarized in table 2.3 at the end of the chapter. Total technical assistance needs of $34.5 million were identified over three to four years in the area of fiscal policy and management. The identified technical assistance requirements for 2001, on a commitments basis, amount to $11.0 million. These needs are included under Economic Management in the summary Tables 1.1 and 1.3. Chapter 2. Fiscal Policy and Management
A. REDUCING QUASI FISCAL DEFICITS AND HIDDEN RISKS
Background and key challenges 2.3 The public finance system of FRY was undermined in the past decade by extensive quasi-fiscal activities on both sides of the central government’s balance sheet.1 The cash budgets were either balanced or had low deficits, although it is hard to be precise due to incomplete consolidation. Non-cash (hidden) deficits were much larger, reflecting financing through arrears’ accumulation, both in the main budget and in the extra-budgetary sphere. In 1998-1999 hidden annual deficits of the republican budget were conservatively estimated at 3 percent of GDP (Popovic, 1999). These hidden deficits persisted and are now coming into the open. These practices have given rise to a vast pool of open and hidden liabilities. A conservative estimate puts the total stock of quantifiable hidden liabilities at 110 percent of GDP.2
2.4 In analyzing quasi-fiscal activities, we follow Polackova (1998), classifying fiscal risks from government obligations into four types: direct explicit, direct implicit, contingent explicit and contingent implicit. Government direct explicit liabilities are specific obligations that fall due with certainty and are defined by law or contract. For FRY, they include its large external sovereign debt and the government’s share of obligations under the 1999 Law on frozen foreign currency deposits. In the longer-term, direct explicit liabilities include legally mandated pension and health expenditures. Government direct implicit liabilities represent a moral obligation - a political, rather than legal, government commitment that will occur with certainty. They arise as a presumed consequence of public expenditure policies. In FRY, the largest of these implicit obligations are the projected reconstruction needs. Explicit contingent liabilities represent the government’s legal obligations to make a payment if a particular event occurs, such as state guarantees for non-sovereign borrowing. Finally, implicit contingent liabilities are those that are not officially recognized until a failure occurs. The triggering event, the value at risk, and the required size of the government outlay are uncertain. The most prominent class of these liabilities in FRY come from enterprise and bank restructuring. Table 2.1 presents the full matrix of risks stemming from government obligations. Due to the close interrelationship between the risk exposure of the Federal and Republican governments, this table consolidates risks for these two central components of Yugoslavia’s public sector. Lower levels of government (provinces, cities and opstinas) are included inasmuch as they present fiscal risks to the central government. Table 2.2 completes the picture of the government’s balance sheet by classifying risks on the asset/revenue side. Some indication of the central government liabilities are provided in Annex A at the end of the chapter.
1 The central government is defined here as the Federal government of FRY and the governments of the Republic of Serbia and of the Republic of Montenegro. Fiscal practices of Montenegro and Serbia have been largely similar throughout the nineties, with Montenegro making earlier attempts to contain fiscal risks. 2 Unless otherwise stated, all shares of GDP are expressed relative to year 2000 GDP, while all stocks are end-2000. This excludes the direct debt of the central government and called guarantees on external debt of banks and enterprises which are treated as direct liabilities of the central government , as well as those of the non-contractual (implicit) liabilities which are less likely to burden the government balance sheet and/or whose estimation is more difficult.
16 Chapter 2. Fiscal Policy and Management
Table 2.1: Fiscal Risks – Liabilities and Expenditures Liabilities a Direct (obligation in any event) Contingent (obligation if a particular event occurs) Explicit • External direct debt of the Federal and • Federal and republican guarantees on Government republican governments external and domestic debt of enterprises, liability is • Federal/Republican parts of local governments, and commercial banks recognized by obligations under the Law on the • Debt guarantees issued by other govt. law or Frozen Foreign Exchange deposits agencies (some evidence, e.g. by Defense contract • Domestic debt (incl. to the NBY) of Ministry) the Federal and Republican • Guarantees of the Republican Export governments and their agencies, such Promotion Agency (planned by the as the Comissariat for refugees and Republican MFER) displaced persons • Enterprise Restructuring Agency under the • Debt and arrears of the Federal Army Republican Ministry of Privatization • Expenditures under the Law on the (closed in 2000) Budget year, incl. civil service wages • Federal Bank for Investment Promotion and pensions (inactive) • Republican and federal civil service • Guarantees and insurance policies of the wage arrears Republican Investor protection agency • Debt and arrears of the federal and (planned by the Republican MFER) republican Pension Funds, Health • Deposit insurance scheme managed by the Fund, Social Security fund, Labor Bank Restructuring Agency (BRA) Market Fund, and Child Welfare Fund • Agricultural insurance and other sectoral • Debt and arrears of the Directorate for insurance schemes Reconstruction and other such agencies • Debt and arrears of the Directorate for Strategic Reserves and of the commodity reserve agencies Implicit • Future reconstruction needs and • NBY guarantees on external and domestic A “moral” investment budgets debt of enterprises and commercial banks obligation of • Recurrent costs of ongoing public • Debts and arrears of regional governments the investment projects and municipalities government • Future severance payments of civil • Regions’ and municipalities’ guarantees on (reflects servants and employees of publicly- foreign and domestic borrowing public and socially-owned banks and • Non-guaranteed debts and arrears of public expectations enterprises if not specified by Law and socially owned enterprises and pressures • Future public pensions, social security • Non-guaranteed debts of commercial by interest schemes, and health care financing if banks (to be restructured by BRA) groups) not specified by Law • Government support to the NBY in case of weakened capacity to provide foreign exchange guarantees, defend the national currency, provide balance of payments stability and liquidity to the banking system • Exceptional military financing • Cleanup of environmental damage of the past decade’s conflicts • Natural disaster relief a. Liabilities of the Federal and two Republican governments; excludes the NBY.
17 Chapter 2. Fiscal Policy and Management
Table 2.2: Fiscal Risks – Assets and Revenues
Sources of Existing Assets Future Revenues risk (possible drop in the asset value) (contingent revenue short-falls)
• Deterioration of government asset • Tax expenditures Explicit portfolio from purchases of bad assets • Tax exclusions, exemptions and at high price during bank and deductions, which reduce taxable income enterprise restructuring Risk emerges • Preferential tax rates, which apply lower • from Reduction in the asset value from cuts rate to part or all of a taxpayer’s income government in complementary inputs (drugs, • Credits which are subtracted from taxes as revenue and textbooks) into the service provided ordinarily computed budget laws by the asset (hospitals, schools) • • Assets dilution (e.g. from privatization Deferrals of tax which result from delayed of the best assets) recognition of income or from allowing in the current year deductions that are properly attributable to future year • Refundable tax (tax with a promise of future refunding) • Asset exposure to weak foreign • Failure to collect revenues from politically Implicit investors confidence influential agents • Asset exposure to volatility in • Failure to collect revenues due to weak tax Risk emerges exchange and interest rates and gold and custom administration, evasion, and from factors price (for FX reserves) corruption other than • Asset exposure to mismanagement • Revenue exposure to macroeconomic government and corruption (incl. asset stripping) volatility revenue and • Asset exposure to force majeure • Revenue exposure to volatility in budget laws commodity prices and in output (commodity tax, tax on agricultural production, revenue from export- dependent industries and goods with high demand elasticity) • Revenue exposure to a narrow tax base • Commercial bank and SOE debts to the National Bank of Yugoslavia • Government failure to collect debt (default on past government lending, such as onlending to enterprises)
2.5 All governments are tempted to use quasi-fiscal tools, since under traditional cash budgeting practices, their cost appears to be zero. For this reason, quasi-fiscal instruments may appear politically more attractive than cash expenditure items. Transition economies are particularly vulnerable to losses from quasi-fiscal practices, due to non-transparent and shifting ownership structures and weak contract enforcement.
2.6 During the past decade, while income per capita was falling rapidly, quasi-fiscal activities were used to support either the vulnerable or politically influential social groups and organizations. Most of these activities were arbitrary and not fully transparent, undermined market discipline and creditor rights, and led to the accumulation of hidden
18 Chapter 2. Fiscal Policy and Management debt. The fiscal sphere spun increasingly out of control. While insiders could thrive on arbitrage, the less connected and disadvantaged social groups eventually lost out, since they lacked the leverage to distort resource flows to their advantage.
2.7 Among the more pervasive quasi-fiscal problems in FRY are:
• The economy-wide chain of non-payments, including budgetary arrears;
• Price controls for key goods and services (e.g. in energy and transportation sectors), through which extensive subsidies were and still are provided to households and to “socially relevant” enterprises;
• Financial system distortions, such as directed credit, pressure on banks to lend at below-market rates to ”strategic” enterprises; liquidity support to these banks; and
• Rigid barriers to shedding excess labor.
2.8 Bringing quasi-fiscal risks under control is an enormous challenge. The accumulation of hidden liabilities needs to be stopped, as it severely jeopardizes growth and poverty reduction goals. The containment of fiscal risks is impossible without deep structural and institutional reform. A particular short-term trade-off lies between the visible fiscal imbalances and the quasi-fiscal ones, as any reform measures will require increasing the transparency of the fiscal system, and will inevitably bring hidden deficits into the open.
2.9 FRY faces particular constraints in containing such hidden fiscal risks. It does not have the luxury of a stable macroeconomic environment to gradually develop a range of risk mitigation schemes. The country’s very large external debt, estimated at US$12.2 billion, or 136 percent of GDP, prescribes very narrow limits to the liabilities that could be prudently recognized. Since most external debt is long in arrears, most guarantees can be treated as called, and most of these debts are now viewed as direct central government obligations.
2.10 On the liability side, the future burden will depend on the concessionality of any future debt rescheduling. On the asset side, the fiscal inflows from historical claims on the enterprises and banks are particularly uncertain. Principal debtors are large socially- owned enterprises, many of which generate losses and have negative net worth. While guarantee contracts and legal provisions prescribe ultimate collection from the guaranteed beneficiaries, recoveries could be limited. Since the guarantees have already been executed, such collections are the responsibility of the governments. Collection prospects on enterprise debts guaranteed by the banks look slightly better from the fiscal burden perspective, as these banks still exist, and promise some chance of restitution. However, since most banks are losing money, attempts to collect these debts would put further strain on the banking sector.
2.11 Weaknesses in the design of central government guarantees will remain a problem in the future. If guarantee issuance continues on the same principles as in the past, the guarantee portfolio will present an increasing risk to the budget. Guarantees are almost exclusively of a general (umbrella) type, which makes cost containment
19 Chapter 2. Fiscal Policy and Management particularly difficult. Typically, such costs balloon up to the face value of the covered liability. No guarantee pricing is in evidence, and budget provisioning practices are inadequate. Institutional and design weaknesses in the guarantee portfolio need to be addressed urgently, as the government will be pressed to support worthy projects with guarantees.3 The two republican governments already have a portfolio of guarantees, both domestic and external, estimated at end-2000 at over 1 percent of GDP, and set to grow. Large economic reconstruction needs, particularly in infrastructure, can only be met via concessional external financing and private sector participation. Some private investors and international financial institutions will request government guarantees. However, imprudent guarantee policy would generate moral hazard and exacerbate fiscal threats to the government. The current modest level of guarantees provides the authorities with some breathing space to design, legislate and begin implementing cautious guarantee management practices.
2.12 The 30 percent share of the NBY and the commercial banks in the proposed compensation of frozen foreign currency deposits represents an indirect fiscal risk. These liabilities are analogous to implicit guarantees of the state. Servicing of the NBY portion is more likely to have direct fiscal implications, as it represents a claim on NBY reserves and/or could fuel the growth of money supply. The portion owed by commercial banks is not a direct government obligation. However, since most of the obligor banks are in a difficult financial position, this portion could also land on the government’s books. So far, the government has limited the outflow through making partial payments. Since the Law has no penalty provisions for such deferrals, this ad hoc approach has allowed management of payments in line with available resources.
2.13 Several other forms of expenditures mandated by the Budget Law, particularly the high civil service wage bill, represent sources of fiscal risks. The government payroll represents 40 percent of consolidated expenditures in Serbia and 51 percent in Montenegro. While these wage bills translate into modest absolute wage levels, they may not be affordable for the republican governments in the current economic environment. So far, expenditures have been kept in line with revenues through budgetary arrears, which at end-2000 had exceeded 3 percent of GDP (excluding arrears of local governments and interest payments on foreign debt). Financing through arrears has to be stopped, since it undermines the contract discipline in the economy, and leaves wage earners vulnerable to delays in payments.
2.14 The reconstruction and investment budget4 looms as a larger issue in the future than it is now. Reconstruction and modernization needs are vast; the challenge is to achieve the maximum efficiency of investments, to ensure the future flow of assistance funds, and to build debt servicing capacity. The experience of other transition economies shows that the investment budget is fraught with specific risks –lack of continuity, fragmentation of priorities, poor sectoral choices. Typical institutional problems include
3 At this time, no information is available on guarantees issued by other public sector entities, such as local governments and SOEs. 4 Investment budget exists only on republican level, as part of the overall budget, which is a good fiscal practice.
20 Chapter 2. Fiscal Policy and Management weak monitoring, budgeting and provisioning, and inadequate regulation and enforcement. The efficiency of the public investment program is often undermined by imbalances between new investment and maintenance; and between investment in fixed assets and complementary inputs. Often, guarantees are sought for reconstruction projects which raises specific challenges, such as design, structure of collateral, performance and market risks, and sustainable risk coverage.
2.15 Extensive quasi-fiscal activities have been being carried out through extra- budgetary funds. The combined extra-budgetary sphere (equivalent to over one-quarter of GDP) is much larger than either the federal or republican budgets. Key funds (Pension, Health, Employment) are weakened by contribution arrears. The problems are concentrated in the pension funds, where the inflow of regular contributions covers less than 50 percent of payouts. As a result, regular Fund income has had to be supplemented through ad hoc surtaxes. These non-transparent funding arrangements were established outside the regular revenue system and in 2000 provided about 40 percent of the combined revenues of the funds. Extra-budgetary funds have also received substantial republican budget transfers (2-3 percent of Serbia’s GDP annually). Nevertheless, claims on the funds significantly exceed their resources, and most are behind schedule in their payouts (an estimated total stock of 9 percent of GDP at end-2000). The republican Pension Funds have been chronically behind schedule for around 1-2 months and the Farmers’ Pension fund in Serbia for a significantly longer time (see Chapter 13).
2.16 Existing legislation allows the funds to conduct risky financial operations. They can borrow from the state, from each other, and from banks. They can also place securities, and some have borrowed abroad. Another source of borrowing was the Republican Development Funds in both Serbia and Montenegro, which are authorized to extend loans and grants to enterprises. In 1999-2000, financing of these funds (both lending and grants) averaged 0.4 percent of GDP. The development funds were funded from the regular republican budgets, privatization proceeds and a now abolished surtax on wages. These funds were essentially operated outside the regular fiscal system, redistributing budgetary resources in a non-transparent way. Their evident purpose was to support “strategic” enterprises: this worked to soften the budget constraint on these enterprises, which included some of the largest loss-makers: in Serbia - Yugoslav Railways; EPS, Zastava, and NIS; in Montenegro – the railway company and KAP, the aluminum concern.5
2.17 The new government of the Republic of Serbia had taken encouraging first steps to stabilize the finances of extra-budgetary funds, consolidating all their exceptional revenue sources in 2001 into the core republican budget. It has also pledged to prohibit borrowing operations of the four extra-budgetary funds, and stop the accumulation of their arrears. Still, the challenges to the social funds system are enormous, as layoffs will lead to an increase in claims.
2.18 Beyond the system of extra-budgetary funds, several special government- supported vehicles (Funds or Agencies) also carried out important safety net functions.
5 Both Health and Pension funds borrowed from the Development fund in DEM in 1999, incurring a foreign exchange loss after the devaluation of Dinar in 2000.
21 Chapter 2. Fiscal Policy and Management
These include the Directorate for Commodity Reserves (DCR) in the Republic of Serbia and the State Institute for Commodity Reserves (SICR) in the Republic of Montenegro. These agencies are responsible for holding strategic reserves of food and fuel and for stabilizing consumer prices. To this end, they sell food products (e.g. wheat, milk) at the official floor price and carry any losses associated with buying from producers at much higher prices. They also sell on the domestic market food received through humanitarian assistance channels, also at official floor prices. These agencies have run up significant debts. In early 2001 in Serbia, debts of the Directorate for Commodity Reserves have been rescheduled over three years, thus adding to the debt burden of the Republic. For proper fiscal control, operations of these agencies have to be brought into the budget immediately and price subsidies phased out.
2.19 Fiscal risks from intergovernmental relations appear to be moderate. Local governments have limited fiscal power in Serbia. In 2000, their expenditures stood at slightly over 3 percent of its GDP. Local governments have their own revenue base, mostly non-tax revenues and property taxes, and until 2000 received only modest transfers from the republican level (1-2 percent of the local government revenue base). In 2000, however, reconstruction needs have caused a massive jump in transfers, which reached 23 percent of total local government revenues. Much of this was financed outside of the regular revenue system from surtaxes. This is not a sustainable situation.
2.20 A characteristic feature of FRY’s economic policies in the 1990s was the limited independence of the NBY and its utilization to provide quasi-fiscal support to particular banks and enterprises. Directed credits were actively used and moral suasion applied to require banks to lend at artificially low interest rates. Contingent liabilities increase the financial vulnerability of NBY. There exists sufficient rationale to treat its explicit contingent liabilities (and its claims on the banking and enterprise sector) as quasi-fiscal in nature, therefore requiring their incorporation into fiscal accounts on the same basis as the government guarantees. Examples are: directed credit, export, investment and deposit guarantees, and liquidity support to banks. On the other side, implicit liabilities of the central bank, such as financial obligations to assure systemic solvency of the financial sector, currency defense, and price and balance of payments stability should concern the fiscal powers only if they give rise to quantifiable commitments (Blejer 1999). Estimating the latter is difficult, since they are triggered by discrete future events.
2.21 Implicit liabilities aside, NBY may be a source of fiscal risks if contingent liabilities are accepted. Of particular relevance is the stock of directed credits from NBY, amounting to 2 percent of GDP (end-2000). The quality of this portfolio of assets is low. Among the recipients are the largest loss-makers in the industrial and banking sectors. Stock numbers are a poor guide to the extent of the NBY’s quasi-fiscal activities, since it is bound by law to write-off arrears after a 60-day period, just like any commercial bank. Only a fraction of past directed credit (about 1.5 percent of GDP) has been converted into long-term government debt under the Law of 24 December 1999. This write off rule appears to be particularly damaging to the contract discipline of large loss-making enterprises, which got used to these directed credits, and rarely if ever had to pay them back.
22 Chapter 2. Fiscal Policy and Management
2.22 The financial system, particularly large commercial banks, was long used as a quasi-fiscal vehicle (see Chapter 6 for more on the structure of the banking sector). Cross-ownership ties between the leading banks and large SOEs distorted credit allocation, and weakened lending standards and creditor rights. Large banks were primarily intermediating government and NBY funds, and had little interest in developing risk evaluation and portfolio management capacities. Large commercial banks are a source of fiscal risk to the government from both sides of their balance sheets. On the asset side, and apart from the pass-through external debt and frozen foreign currency deposits, the banks’ lending activities that are not affected by past government interventions are modest, although even on this portion of their assets the banks encounter problems due to distress in the real sector. On the liability side, all banks face a lack of trust as evidenced by a very low level of deposits, the bulk of which are provided by enterprises which own these banks. Due to the accumulated problems, none of the bank restructuring options will be cost-free to the government. Even closing the large loss-making banks would entail fiscal costs (see Chapter 6 for details) .
2.23 At the same time, fiscal risk from the well-designed deposit insurance scheme appears to be modest. It now guarantees up to YUD 5000, and even if this amount is doubled under the current plans, the end-2000 stock of eligible bank deposits was estimated at less than 0.5 percent of GDP. Also on the positive side, NBY has issued very few explicit guarantees on external borrowing of banks and enterprises.
2.24 In both Serbia and Montenegro, quasi-fiscal activities undertaken through non- financial public enterprises have de facto functioned as a second social safety net. This is demonstrated by excess employment (Alliance, 2000), controlled prices of key products and services, and extensive losses and persistent arrears, both between enterprises and between enterprises and the budget. Direct subsidies from the government have been relatively small, and provided mostly as grants from the republican Development Funds. The practice of directed NBY credit was discontinued at end-2000.
2.25 More risky are: (a) large hidden subsidies still being provided through administered prices for utilities and infrastructure enterprises: and (b) artificial labor market rigidities. For example, until the spring of 2001, both electricity and railroad tariffs remained well below cost recovery levels (see Chapters 7 and 8). The Serbian power utility EPS amassed a third of all losses of the public enterprise sector, and power and energy combined account for 75 percent of losses. Loss-making enterprises have been kept afloat through direct subsidies, non-collectible loans, and the tolerance of wage, tax and social payments arrears.6 For the three largest loss-makers – NIS, EPS and Matroz, the stocks of arrears to social funds stood at 5 percent of GDP at the end of the third quarter of 2000. Large inter-enterprise arrears clog the economic system, and hamper the normal conduct of business. These arrears are very costly in terms of foregone supply response. Government agencies themselves were is massive arrears to their suppliers for various goods and services, although these were periodically reduced by tax offsets.
6 The relative efficiency of the Agency for Accounts and Payments (ZOP) in tax collections had kept the tax arrears at a relatively modest 2.3% of GDP.
23 Chapter 2. Fiscal Policy and Management
2.26 Among labor market rigidities, it is worth singling out the process of negotiating the minimum wage. In both Serbia and Montenegro, this process has at times not taken sufficient account of the fiscal capacity of the Government. For example, in Montenegro, minimum wages were raised in 2000 by around 60 percent. These increases, while appealing in the short-term, appear to exceed the fiscal capacity of the two republican budgets. Furthermore, since many wages in the economy are linked to the minimum wage, SOEs have been pressured to increase wages in parallel, exacerbating the problem of wage and social funds arrears, and/or creating further losses which erode the government’s tax revenues.
2.27 The use of the non-financial enterprise sector for social safety net purposes has stifled productivity and growth, as enterprises adjust by cutting into their working capital. In 1999 alone working capital nominal value decreased by 24 percent. Furthermore, the resulting negligible replacement of physical assets leads to their rapid depletion. As quasi-fiscal financing through arrears and subsidized credit is available only to the large socially owned enterprises, the cost of financing presents new private businesses with very high barriers to entry. Similarly, barriers to exit are also very high: employers have to make large redundancy payments, creditors cannot easily collect from delinquent debtors, while liquidation procedures are weakly enforced. Finally, pervasive arrears are linked to budgetary (tax) offsets, which are difficult to contain, and perpetuate the arrears they seek to eliminate. They also distort expenditure composition and tax equity. For many years, both republican governments have been unable or unwilling to enforce their bankruptcy laws, and did not force the restructuring of large loss-makers, which has created moral hazard and fed the arrears cycle.
2.28 Starting in 2000 in Montenegro and in early 2001 in Serbia, the republican governments have strengthened their resolve to take decisive measures to restructure the enterprise sector. These measures include: a decision of the Serbian republican government to discontinue tax offsets, and the suspension of the previous Serbian privatization law which opened possibilities for insider buying and/or asset stripping of public enterprises. As a result, the fiscal risks from the enterprise sector may gradually subside. However, the near-term fiscal costs of enterprise restructuring will increase due to the costs of attrition.
2.29 The existing institutional framework and budget execution processes also generate fiscal risks. First, the role of the executive is excessive, with the government able to change both the level and composition of tax revenues as well as redirect expenditures within the budget period by decree, without consulting the legislature. No less serious is the dispersion of expenditure authority across ministries (direct spending units), with the MOF wielding insufficient control over specific expenditures in the course of the year. In the past a substantial part of expenditures has been financed from extra-budgetary taxes, and this portion of expenditure activities has traditionally been less transparent, even for the central government itself. Verifying how efficiently public funds were spent in this environment was difficult.
2.30 Concluding this overview of fiscal risks, it is important to stress that both in Serbia and Montenegro, the governments’ space to accommodate fiscal risks is very limited, not only due to large direct debt, but also due to a peculiar revenue paradox.
24 Chapter 2. Fiscal Policy and Management
While fiscal revenue is among the highest in Central and Eastern European region as a share of GDP, the government’s revenue base remains fragmented, with almost half of the revenues generated outside regular budget. The revenue system has been characterized by discretion and arbitrariness. As a result, fiscal risks of the assets side (listed, but not quantified in table 2.2) may also be large. Tax policy reform priorities are discussed in detail in section D.
Priority reform program
2.31 The new governments in FRY have demonstrated a clear understanding of the risks of contingent liabilities, and intend to arrest their future growth. However, the governments’ scope for recognizing hidden liabilities will remain limited. Without comprehensive reform of budgeting and public expenditure management.
2.32 In the near-term, the government needs to (a) achieve credible macroeconomic adjustment and initiate crucial structural reforms; and (b) amend the fiscal management process to contain the fallout of past quasi-fiscal activities.
2.33 By implementing a strong agenda of adjustment and structural reform, the federal and republican governments would take the lead in re-establishing the contract discipline undermined by past non-payments and soft budget constraints. These measures would amount to the radical hardening of the budget constraint for the government itself, enterprises and the financial system. Key steps here are:
• Adopting a time-bound plan to break the vicious circle of arrears and offsets. Some measures, like the discontinuation of directed credit are or can be implemented immediately. Others - breaking the non-payments cycle - will take more time, as the newly-acquired market discipline gradually takes root. These measures will eliminate fictitious non-cash revenues and hence increase the realism and efficiency of revenue policy. Simultaneously, the measures will make expenditure policy less volatile and more consistent with the government’s revenue-generation capacity.
• Adopting a time-bound plan to phase out administered prices, particularly in the energy and infrastructure sectors. Without this action, power and utilities will continue to be the largest pool of arrears and non-payments in the economy. The experience of other transition countries shows that this is also a dangerous vehicle for the accumulation of new external debt. More flexible phase-out schedules could be applied to a small group of socially-sensitive prices.
• Adopting the private sector development reforms described in Chapter 5. These include; (a) accelerating privatization; (b) defining property rights and preventing asset stripping; (c) simplifying enterprise exit; and (d) adopting legislation to uphold creditor rights. Transparent privatization that creates real ownership is essential to consolidate the budget constraint and market discipline.
• Closing insolvent banks, strengthening legal mechanisms to prevent connected lending, and facilitating foreign entry into the banking sector. Large insolvent
25 Chapter 2. Fiscal Policy and Management
banks are a major drain on the fiscal sphere, and any attempt at their extensive re- capitalization could cause sustained fiscal imbalances. Some of their liabilities are hard to ignore (e.g. direct external debt) but even here, workout schemes should take into account the very limited debt-carrying capacity of the government.
2.34 On the fiscal management side, near-term government priorities should include:
• Improving the overall efficiency and transparency of fiscal management (see respective section below for more);
• Laying the foundation of an institutional and policy framework for fiscal risk management. This should include; (a) identifying all hidden liabilities and conducting an evaluation of their legal status to determine which do not need to be accepted, or to what degree the government should accept liability; (b) disclosing these liabilities if and where feasible; (c) bringing hidden risks in line with the government’s limited debt-carrying capacity; (d) stronger provisioning procedures for contractual contingent liabilities, e.g. establishing a guarantee risk fund or strengthening counter-guarantee and collateral arrangements; (e) amending the legislation on extra-budgetary funds to prohibit borrowing operations; and (f) closing the Serbian Republican Development Fund.
2.35 In the medium-term (2003-04), priority areas of reform include:
• Reforming the budget process to move to output-oriented budgeting.
• Consolidating legislation and further developing the institutional framework for the integrated management of public liabilities. This includes strengthening guarantee design and risk provisioning procedures, introducing efficient collection and asset recovery arrangements, and introducing pricing and cost-based budgeting for contingent liabilities.
• Pursuing intergovernmental fiscal reform. This includes introducing legislation to increase the transparency of intergovernmental fiscal relations, reviewing and reforming revenue and expenditure assignments to increase the efficiency of service delivery, controlling the borrowing operations of local governments and connected entities, and strengthening the accountability of the local government fiscal management (via the national Treasury mechanisms).
Donor program (Table 2.3)
2.36 The measures listed above will require the support of the international community. This will include facilitating the adoption of the best international fiscal management practices via technical assistance and support to the key areas of reform as listed above. Major gains for improving the management of contingent liabilities will result from reforming the budgeting process and fiscal reporting, as well as from strengthening integrated debt management procedures, which are reviewed in the next two sections. On top of these key reforms limiting off-balance sheet activities of the
26 Chapter 2. Fiscal Policy and Management government, a targeted program is warranted, specifically for containing/phasing out quasi-fiscal activities.
2.37 In the near-term, assistance should include the following:
• Strengthening of fiscal risk monitoring in the Federal and republican governments including the regular preparation and public disclosure of fiscal risk statements.
• Review of legal acts pertaining to different classes of contingent liabilities, and the introduction of necessary revisions.
• Local capacity-building and advisory services on asset recovery mechanisms.
• Technical assistance for the closing of special funds and disposing of their bad debts and other obligations.
2.38 In the medium-term, assistance should include:
• Assistance to the federal and republican governments with the implementation of integrated project design and credit risk management procedures, including risk- sharing arrangements with the private sector.
• Local capacity-building and advisory services on guarantee valuation and design.
• Local capacity-building and advisory services on limiting the risks of investment and exports promotion schemes, and other such insurance schemes.
B. TRANSPARENCY AND ACCOUNTABILITY OF PUBLIC SPENDING
Background and key challenges
2.39 The federal and republican governments need to strengthen their fiscal accountability and control procedures. These governments are charged with the spending of scarce public resources in accordance with legislated priorities. Spending systems that are non-transparent and/or have weak enforcement mechanisms can lead to the misuse of public funds. Efficiency of spending is another key concern. The existing system of fiscal reports does not allow the government to evaluate the real outcomes of public spending, while government banking arrangements are not conducive to the efficient utilization of funds. Idle cash balances are large, and ZOP transaction costs are high. A budget execution system with thousands of accounts for government spending units creates opportunities for the misuse of public funds.
2.40 At present, transparency is limited by excessive fragmentation, with a large share of expenditures in (often hidden) extra-budgetary funds. Accountability in the State budget and the operation of public agencies is inhibited inter alia by the lack of a state audit function, limited parliamentary control, and inadequate public procurement procedures.
27 Chapter 2. Fiscal Policy and Management
2.41 Institutional reforms (particularly aimed at controlling misappropriation of public funds) should lay the foundations for robust, socially acceptable medium-term reforms. The reform program will demand a tight fiscal stance, however fiscal austerity will only be supported by society if the government can transparently demonstrate that public funds are being spent efficiently and that scarce resources are not being captured by privileged/connected social groups. Likewise, high standards of financial management and transparency in the use of budgetary resources are essential for achieving an adequate level of donor support, which will materialize only of the government has adequately addressed the fiduciary concerns of donors.
2.42 In both republics, and particularly in the Republic of Serbia, fiscal reporting is constrained by the system of budget management based on the distribution of funds from the main Ministry of Finance (MOF) account to the primary budget managers (direct spending units, e.g. ministries) and only subsequently to their subordinate budget users. All republican ministries (with the exception of Interior, the Public Revenue Administration, and a few specialized agencies) have their payments orders prepared and processed through the Joint Services Administration (JSA) which keeps the books and prepares the aggregate payment orders and monthly expenditure reports. There are two main weaknesses in the current system. First, coverage is incomplete, as the definition of, and reporting on, general government is ambiguous, especially in Serbia. Second, reporting is limited, since the republican MOFs have information on their transfers to the spending units, but much less data on final spending patterns. Through the daily reports supplied by ZOP, the Budget Department is able to monitor the line ministries’ use of funds, but only on a very aggregate basis. The Consolidation Department monitors the operations of extra budgetary funds and the local governments. The latter provide monthly aggregate reports, but reports of the local governments are of inferior quality and are submitted with a significant lag. No reports are submitted by the end-users of the budget funds. Fiscal reporting is especially weak on the expenditure side, with no reliable in-year breakdown of general government spending.
2.43 Budgeting methodology in the FRY has evolved little in the past ten years. The budget consists of a limited number of aggregate positions which provide only very broad information to the Parliament. Excessive aggregation does not allow discussion of input costs (and therefore an open examination of their efficiency and the possibility of alternative use) or of the policy objectives and programs for each ministry (and therefore the basis to assess performance). Another weakness is the absence of consistent classification of revenues and expenditures. While the Law on Revenues and Expenditures defines a large number of revenue items, the extent to which these are appropriately classified and presented in the annual budget remains in question. For the accounting phase, a standard chart of accounts is prescribed, though many items are aggregated. For payments, however, there is an almost complete absence of economic classification, except for a few broad items such as wages and material costs.
2.44 Major reforms are required in the structure of the budget and the methodology used in its preparation. The first step is to ensure that there is a sound basis for determining the input costs for the budget and the means of financing it. The second is to develop a functional/operational classification of the Government's activities, which will provide a framework for the introduction of meaningful programs, from which
28 Chapter 2. Fiscal Policy and Management pre-defined and measurable results and outcomes can be evaluated. While the first step is relatively straightforward, the second step will take several years. In Serbia, it is essential that the new GFS-based classification be adopted for both budgeting and accounting, in order to facilitate and simplify reporting of actual revenues and expenditures.
2.45 Effective budgeting based on sound policy will require the upgrading of FRY’s official statistics, as the statistical system and capacity has suffered severely over the past ten years. The statistical system needs not only to be strengthened, but in some areas completely rebuilt. Statistical standards used previously differed considerably from those used in the rest of the world, data collection modes and methods do not adequately capture economic and social developments. In comparison with other transition economies, FRY lacks considerably in the area of introduction of international standards and methodologies especially in the area of macroeconomic and trade statistics. More specifically, the statistical system will need to complete the switch from a Material Product System (MPS) to the System of National Accounts (SNA). In the area of micro, household and firm-level data collection, questionnaires for enterprise surveys and household data will have to be revised in conformity with internationally recognized standards.
2.46 In addition, a system of sample surveys has to be introduced to replace the system of universal and compulsory reporting. Data collection by means of sampling will require changes in the procedures of processing and aggregation. This in turn may require changes in the organizational structure of the Federal Statistical Office (FSO). More generally, the relationship between the Federal and the Republican statistical offices needs to be clarified, streamlined, and brought in line with the new reformed data collection protocols and dissemination needs. It will be important to ensure the continuity of data collection while reforming existing survey instruments and structures.
2.47 The present system of expenditure control is limited by the narrow view of budget execution based on distribution of funds from the main account, rather than releasing funds when required for actual spending. The supporting reporting system focuses on tracking these transfers of funds rather than the expenditure undertaken with these funds.
2.48 The tracking of commitments is probably the most important missing element in the present FRY financial management system, both at the Federal and the Republic level. By focusing on cash controls, the present system has an inherent weakness in not being able to control for commitments coming due. Without such controls, any unexpected commitment falling due, or any shortfall in expected revenues, is translated into arrears and/or to undue disruption and deterioration in government services.
2.49 A more efficient commitment system would ensure that the Federal and the republican MOFs are informed of potential obligations (including guarantees) of the Government prior to the signing of any agreement that will establish a future liability. The responsibility for negotiating and managing agreements, as well as verifying delivery of goods and initiating payment requests from ensuing invoices, would remain with the spending units. The MOF would ensure that contracted obligations are within the budget, that the resulting cash flow is sustainable, and that documentation is complete. The MOF
29 Chapter 2. Fiscal Policy and Management should also have the power to cut planned commitments. A general lowering of commitments could be requested in conditions where revenues are clearly below target. In this case, spending units would review all their commitments to establish which can be reduced to meet the requested expenditure cuts. Finally, all subsequent payments must be related to the registered commitment.
2.50 Specialized procedures are needed for donor funds, in order to satisfy donor expectations of transparent and efficient use of their aid, and in order to ensure a distinct procedure from the routine budget. Donor funding will be (a) for the funding of specific projects; (b) for funding earmarked areas of routine expenditure; or (c) direct budgetary support. In the first two cases, the funds will most likely be deposited in foreign currency accounts at the central bank, and detailed bank statements of each account, showing each individual replenishment and disbursement, will be required. Within the MOF, the Treasury should be nominated as authorized representative for these accounts. A special Donor Funds Management Unit (DFMU) within the CAD of the Treasury Department should be responsible for keeping track of all these agreements. This unit would work closely with the beneficiaries and donors to ensure that the donors’ accounting procedures are followed, and would establish the necessary procedures that each beneficiary must follow for committing and disbursing funds.
2.51 Financial audit is another essential function in government that needs to be strengthened considerably. Audit provides budget management with appropriate independent controls and improving accountability and transparency. In Serbia, internal audit has been carried out by the Budget Inspection Department and has primarily prosecuted reported financial irregularities post factum. The external audit side is particularly weak. A Supreme Audit Institution reporting to the legislature does not exist. Recently, a task force has been assembled to formulate recommendations for the development of the audit in budget management. The audit function needs to move away from the concept of it being an investigative arm of the MOF. Furthermore, internal audit functions need to be strengthened both in the MOF and the line ministries. This requires standardization of the accounting procedures for spending agencies, local authorities, and special funds, and assignment of accounting and internal inspection responsibilities within the Ministry of Finance and the spending agencies.
2.52 In the Serbian government, a limited form of cash management is undertaken in the form of cash rationing to direct spending units. The Budget Department receives the daily report of revenues from the ZOP, and rations out the available funds according to a list of priorities agreed by the Government. Similar arrangements are in operation at the Federal level. The weaknesses of this system are evident in the face of adverse macroeconomic developments, financing falling below projected levels, unrealistic budgeted levels of spending, and pressure from contingent liabilities falling due. Such a system is prone to generate arrears, the outstanding stocks of which have been rolled over into the next fiscal year without separate budget provisions. The result was to make the next year's budget estimates even more unrealistic.
2.53 Furthermore, the accounts of the MOF are held mostly with the NBY. Subordinate spending units have their accounts in commercial banks, normally as sight deposits underpinning the ZOP giro accounts. Over the years, some 40,000 revenue giro
30 Chapter 2. Fiscal Policy and Management accounts were established, leading to a substantial accumulation of idle cash balances, estimated at over YUD 9.2 billion at the end of January 2001. Beyond the payments issues, problems exist with regards to the cost of the payment services provided by the ZOP, which charges a fee of 0.15 percent of the value of each payment order. This is in striking contrast with modern trends in payment systems, where fees are flat charges per transaction, notably for large payments.
Priority reform program
2.54 Measures aimed at improved transparency and accountability of public spending should be sequenced. In the near-term, they should aim to accommodate the immediate needs of a very difficult interim period of adjustment supported by external financial flows. The near term priorities are as follows:
• Reform and strengthen the audit function. The independent assurance of the integrity of government accounts requires establishment of a supreme external audit institution accountable to the legislature. There is also a need to review the existing internal audit processes and staffing, and to redesign their organizational structure and responsibilities.
• Strengthen fiscal reporting. Given the uncertain budget parameters during early years of recovery, MOF should strengthen its reporting capability to adjust to within-year changes in budget fundamentals. More information is needed on the actual spending of budget institutions. Fiscal reporting should be increasingly based on GFS economic classification, covering all operations of government, including those arising from foreign aid inflows. Special attention will need be paid to developing a reporting system for aid flows as well as arrears. A related need is to centralize accounting functions in the MOF.
• Ensure adequate expenditure controls. The stock of budgetary arrears should be carefully audited, and improved control and monitoring procedures should be introduced to curtail future arrears. Controls should be placed on the commitments of budget institutions, and enhanced financial planning should be introduced in the MOF. Given the uncertainties over the extent and timing of foreign external assistance, mechanisms should exist to “ringfence” the development and reconstruction budget.
• Improve government cash management. Bank accounts of budget institutions should be consolidated, all foreign exchange accounts closed, and a treasury single account for the main budget users introduced. The government's banking arrangements, particularly with the NBY, should be reviewed, and a rolling short- term cash flow plan should be adopted in the MOF. These measures are needed before the resumption of large debt servicing payments.
2.55 Over the medium-term, a comprehensive reform of the public expenditure system should be implemented to bring it closer to the patterns found in mature market-based economies. This reform should target the following priorities:
31 Chapter 2. Fiscal Policy and Management
• Continuing to strengthen the audit institutions. There will be a need to restructure audit practices, in particular to move pre-payment audit to a sampling basis, freeing resources for systems and other types of audit. Audit manuals will need to be prepared based on the new vision of the internal audit service and a training program designed for internal auditors to fulfill their new role. There will also be a need to develop a program of recruitment and staff development for the internal audit service, and to encourage internal audit involvement in the development of new financial and accounting management systems to ensure that adequate controls are built into these systems.
• Further enhance the transparency of government operations. Building upon improved fiscal reporting, the authorities should commit to further increase the openness of the fiscal accounts, so as to assure lenders and investors that the government is observing internationally recognized principles of fiscal transparency. These issues principally revolve around improving the definition of general government, and the adoption of more open budget preparation and approval procedures
• The treasury system. Plans should be prepared for the future transfer of treasury functions from ZOP to a Treasury Department in the Ministry of Finance. The design of the treasury system, its scope, and the required technical capacities should be carefully considered at an early stage. The creation of a treasury system should not be viewed as replacing ZOP, but as a means of introducing broader reforms in government financial management.
• Financial planning. It is necessary to re-orient the system of funding budget institutions away from cash rationing to a financial planning system with forward looking rolling projections of both revenues and expenditures. The aim is to anticipate rather than react to shocks, and to accommodate the latter with less disruption to the provision of government services, and less accumulation of arrears. Financial planning should be closely integrated with government debt management, and be a central concern of the Treasury (to be created).
• Reforming government accounting and developing treasury ledger accounting. The accounts of all budget institutions at every level should be treated uniformly so as to register every stage of the spending process and become the basis of comprehensive fiscal reporting. This will cover operations from the initial recording of the line item in the budget, through the intermediate stages of budget execution, and the recording of final cash settlement. This will require a careful delineation of which institutions are to be covered by the uniform government accounting system, as well as prescribing a unified accounting standard. Such a ledger system should rely upon the integrated computerized financial management information system (FMIS).
Donor program (Table 2.3)
2.56 The comprehensiveness of the reforms envisaged, as well as the need to begin these reforms as soon as possible, requires setting priorities and planning the phasing of
32 Chapter 2. Fiscal Policy and Management the reforms. Substantial external technical assistance will be required to support these reforms and to introduce in FRY the best public expenditure management practices pioneered in other mature market and emerging economies.
2.57 In the near-term, major activities that need to be supported are:
• the establishment of a supreme audit institution, the establishment of the Central Accounting Department (CAD) in the Republican MoF, and the initial strengthening of the Treasury Department. Staffs should be hired to these departments and on-the-job training provided.
• technical assistance in fiscal reporting and the introduction of new economic classification will bring tangible improvements in budget transparency, while support for improving cash management practices could allow the government to save considerably on the transaction costs of the budget execution.
• technical assistance to upgrade the statistics collection capabilities of the governments, including (a) training of staff in SNA methodology and its implementation; (b) the implementation of international classifications; (c) training in modern computer skills for statisticians; (d) building the capacity to derive and disseminate macro information in a timely fashion through the installation of modern computer technology; and (e) consultancy in the design of a long-term strategy for the development of the FRY statistical system.
2.58 In the longer term, technical assistance should prioritize the deployment of integrated IT systems and accounting practices consistent with international standards.
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7 C. PUBLIC DEBT MANAGEMENT
Background and key challenges
2.59 Overview of the government’s direct debt portfolio. FRY’s external debt is very large at over US$12 billion, or 136 percent of 2000 GDP. Originally, only a very small fraction of external debt was owed by the Federal government, and none by the Republican governments. Most foreign debt was contracted prior to 1992 by enterprises, or by commercial banks on their behalf, and guaranteed by the Federal government. Federal guarantees covered over one-half of the total external debt of the FRY. Another one-fifth of external debt directly owed by enterprises was guaranteed by commercial banks (Annex A). As most of these external obligations have long been in arrears, they are now on the government’s books as direct liabilities. The hyperinflation of the early 1990s largely erased direct domestic debt, which remains under one percent of GDP.
2.60 Another category of direct debt is a stock of frozen foreign exchange deposits in the amount of DEM 7.482 billion, equivalent to around 40 percent of 2000 GDP.8 The federal and republican governments shoulder 70 percent of the total stock of obligations related to this program (about DEM 5.6 billion). The remaining 30 percent is to be paid by the NBY and commercial banks, and may be treated as the government’s implicit liability (see above on quasi-fiscal deficits). Traditionally, loan guarantees are evaluated as part of the direct debt portfolio of the government, although they represent contingent (indirect) liabilities.
2.61 Institutional and legal setup. Existing public debt management arrangements are complex, and are inherited from a decentralized federation (SFRY) where the fiscal power of the federal government was limited. Some elements of the existing debt management system are sophisticated and/or almost adequate to the current needs (e.g., the transaction management and monitoring capacity). At the same time, other essential elements of the debt management framework (e.g. strategy formulation and investor relations) are largely absent, reflecting the legacy of the past and the long period of isolation and default. The most vulnerable feature of the existing debt setup is its fragmentation across the federal and republican levels of government.
2.62 Wide-ranging institutional reform is required, driven by:
• The need to adjust to a changed (and still uncertain) constitutional context.
• The need to resume servicing a large external debt portfolio (although after rescheduling, its complexity is likely to decline considerably).
7 The discussion in this section focuses on debt management institutions at the central government level (federal and republican governments) and comprises the management of both direct and contingent liabilities. Debt management is also an important dimension of public finance management in other units of the public sector, e.g. local governments and SOEs. The latter are analyzed here only from the perspective of the federal and republican governments, for which debts of the rest of the public sector represent indirect (hidden) risks. 8 By Law, this DEM-denominated stock pays 2 percent interest and is serviced on an annuity basis.
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• The need to efficiently manage new external assistance flows, in the form of both debt and grants, which can be substantial and volatile.
• In the longer term, the need to develop the domestic government debt market and reenter international markets, as under the strong recovery scenario, aid flows will decline considerably after the first few years.
2.63 A peculiar feature of the historical debt management system was that the sovereign borrower was embodied in the international arena by the Federal government, whose fiscal power was (and remains) narrower than what is needed to service its total obligations under direct and contingent debt contracts. The federal government actually carried very small direct debt, and mostly issued guarantees for enterprises borrowing abroad. As a result of economic decline, the debt servicing capacity of most enterprises is likely to be very low. Since almost all of this guaranteed debt is legally in arrears, the guarantees have been already executed and these obligations have transformed into direct government debt. The fiscal power of the federal government alone will be inadequate to service these debts, even after any concessional rescheduling. This means that the preparation for re-entering the capital markets will require enhancement of legal provisions that guarantee investor and creditor rights. This could take the legal form of joint liability of the federal and republican governments for external sovereign obligations, or the republican governments counter-guaranteeing these obligations.
2.64 Arrangements for new borrowing have to be equally carefully considered. Guarantee design will assume key importance. Creditors may require a republican government counter-guarantee. At the same time, the government will have to lay stringent conditions for the beneficiaries of guarantees, and establish prudent guarantee risk management procedures. A similar, but distinct set of issues arises with regard to the local governments’ authority to borrow. The government should monitor and establish prudent norms for all forms of local government borrowing.
2.65 Caution will need to be exercised with regards to the issuance of domestic debt. Various contingent liabilities are likely to be converted into domestic debt obligations similar to those that are proposed to be issued to finance compensation for frozen foreign currency deposits from 2004. Once enterprise and bank restructuring gets under way, more government bonds may be issued to support the cleanup of bad debt. There should exist clearly defined ceilings for such debt issuance. The terms of these obligations, if inevitable, should be determined to minimize the future fiscal burden.
2.66 The above discussion points to the need to carefully revise the legislation for public borrowing arrangements, consolidating provisions for the management of all types of public liabilities. This new legal act should cover both direct and contingent obligations of the public sector, particularly of the federal government, to lay the foundations for the rebuilding of sovereign creditworthiness.
2.67 Transaction management. It is difficult to fully evaluate the adequacy of this function in the central government, since almost all external debt has been in arrears. Debt recording and monitoring generally appear to be of high quality. However, inter- agency cooperation could be strengthened. The Federal government does not always
35 Chapter 2. Fiscal Policy and Management receive full and detailed information from the NBY. In terms of debt monitoring capacity, a weaker link appears to be the Republican level, whose role in sovereign debt management has historically been very modest. Debt management capacity at this level will need to be strengthened, regardless of future constitutional arrangements.
2.68 The settlement of debt falling due has been carried out by agent banks. NBY serves as the fiscal agent for the federal and republican governments for the purposes of debt servicing, while local government and SOEs have used the services of commercial banks provided under special agent agreements. These agent agreements will need to be evaluated for adequacy in terms of risk management and on the portfolio of public sector obligations and accountability of the agents.
2.69 Decision support (portfolio analysis and risk management). The realism and efficiency of the sovereign debt strategy depend upon the quality of information at the disposal of decision makers. While basic portfolio reports seem to be easily available and quite reliable, scenario debt sustainability analysis does not appear to be a regular feature of the MOF’s macroeconomic work. Debt scenarios and stress testing are not prepared on a regular basis. The analytical capacity of the government’s debt management departments will need to be strengthened (on both the federal and the republican levels). Such analysis should cover all forms of government debt, both direct and indirect. It would be advisable to begin with a simple debt sustainability framework, assessing the fiscal and external sustainability of the public debt position, and gradually enhancing the model with stress-testing and risk measuring features. Preparing regular (at least monthly) debt portfolio overviews for the senior government officials should be prioritized. In the longer term, once marketable instruments become dominant in the sovereign debt portfolio, a debt portfolio benchmark should be constructed to address the main sources of portfolio risk.
2.70 Strategy formulation. The twin challenge of resuming the servicing of past debt and efficient utilization of new financial assistance will require that the FRY government follows a very cautious debt strategy. Strategy will need to be strengthened urgently.
2.71 Reporting and investor relations. Information about FRY’s debt portfolio is relevant not only to government officials, but also to creditors and investors, to the legislature that approves the borrowing program and to the taxpayers who ultimately foot the bill. At this time, disclosure and investor relations policy is not elaborated and the amount of publicly available information is inadequate. There is no single source of data on the government debt (e.g. Internet site of the Republican or Federal MOF). Credible public disclosure is an extremely important aspect of good debt management policy. It is particularly important in Yugoslavia’s situation, when large debt service obligations will soon begin to compete for scarce public funds. If the society and the legislature in particular are to support the normalization of international financial relations, they should be able to verify the extent of government debt operations, and that borrowed resources are applied in the most efficient way. Creditors and investors look for much the same type of information. Continued debt financing, and the eventual return to the capital markets will only become possible if creditors have a comprehensive and trustworthy set of figures on the government debt portfolio. Under these conditions, the country’s
36 Chapter 2. Fiscal Policy and Management progress up the creditworthiness ladder would be stable and smooth, and the responsible debtor will be rewarded with better financing terms.
2.72 Debt information systems. NBY uses a more complex information system (loan- by-loan debt database) to monitor all government and government-guaranteed debt. It appears to be adequate in generating precise debt projections and for the purposes of transaction management. Both the federal and republican MOF keep debt records in simple Excel spreadsheets, that require extensive manual manipulation every time a data request is received. While for the immediate future the NBY’s agent functions might be an adequate (and efficient) solution, in the longer term weak debt information systems in the republican and federal governments will present a serious constraint for moving to active debt management. These information systems need to be upgraded.
2.73 A two-stage approach is recommended here. In the near-term, a simple but integrated system solution should be implemented, to cover all forms of government debt (both external and domestic). This would facilitate expedient debt portfolio analysis and risk assessment. Once a broader strategy for government financial management is defined, modern debt information systems can be implemented, either as free-standing solutions, or as parts of the overall Treasury financial management information system (FMIS). Such solutions would feature single-entry and straight through processing, facilitating the management of complex government debt portfolio and supporting increasingly active and market-oriented debt strategy.
Priority reform program
2.74 Near-term priorities:
• Normalize relations with the creditors: renegotiate external debt and resume servicing direct liabilities as soon as is feasible, address remaining debt allocation/division issues.
• Build up the debt portfolio analysis/risk management function, on the basis of which enhance the decision-support capacity and begin formulating long-term borrowing strategy targeted at gaining an improved sovereign rating and integration of the domestic markets for government securities with the European and international capital markets.
• Review the legal framework for sovereign debt management, eliminate inconsistencies and gaps between different levels of legislation, begin drafting laws on public liability management.
• Strengthen/regularize institutional cooperation between the government agencies involved in sovereign debt management; outline a medium-term plan for institutional development (options are as a unit in the Treasury or as an independent debt agency).
37 Chapter 2. Fiscal Policy and Management
• Integrate/centralize information flows on all types of public sector borrowing, and formulate a time-bound action plan for strengthening the monitoring of the borrowing operations of public sector entities other than the central government.
2.75 Medium-term priorities:
• Consolidate the legal framework for sovereign debt, develop and adopt an integrated Law on public liability management.
• Centralize the institutional mandate for sovereign debt management.
• Upgrade to an integrated public debt monitoring system, to cover all parts of the public sector and all types of contractual liabilities.
• Formulate and implement an active disclosure and investor relations strategy, begin working with the rating agencies to gradually improve the sovereign rating.
• Begin elaborating a plan for the development of domestic government debt markets.
Donor program (Table 2.3)
2.76 Near-term technical assistance in public debt management should prioritize the following:
• Advice on debt analysis, borrowing strategy formulation, and debt renegotiation;
• Review of the legal acts and institutional arrangements for public sector borrowing;
• Integration/enhancement of existing information systems; and
• Staff development
2.77 Medium-term technical assistance priorities should include:
• Preparation of the Law on public liability management and supporting/implementing legislation.
• Creation of a centralized sovereign debt management institution and staff development.
• Implementation of an integrated public debt monitoring system.
• Investor relations/return reintegration to the international/European capital markets.
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• Development of domestic government debt markets.
• Risk management function for the portfolio of government liabilities (active portfolio management).
D. TAX POLICY AND ADMINISTRATION
Background and key challenges
2.78 The public sector in FRY is large compared to that of most other transition countries, raising over 35 per cent of GDP in taxes in 2000. The principal tax instruments in FRY are social insurance contributions and payroll taxes, sales tax, income tax, excises, customs duties, property tax, and profits tax.
2.79 From the point of view of constitutional law, the republics are in charge of the tax system. At the federal level only the basic principles, the so-called Foundations of the Tax System Act (FTSA), are set. However, since 1996 the republican governments of Montenegro and Serbia have suspended the provisions of the FTSA, and the system of public revenues has been almost completely regulated at the republican level. The differences between Serbia and Montenegro have been widening.
2.80 The federal government is entitled to collect only customs tariffs and other import duties.9 The republican governments collect sales and excise taxes and share these with the federal government, keeping 60 per cent. The republican governments also collect the profit, income and property taxes, as well as a large number of surcharge taxes. The proceeds of a number of other taxes are shared between the republican and the local governments.
2.81 Montenegro has stopped contributing to the federal budget, and the federal budget has stopped contributing to the Montenegrin pension funds. Hence, the public finances of Montenegro are effectively separated from those of Serbia. Since 1998-99, federal tax legislation has only been applied in the Republic of Serbia.
2.82 The tax administration faces the dual challenge of protecting revenue collection in the short term, while modernizing its operations to meet the needs for the future.
Tax Policy Issues 2.83 The Serbian tax system has been supported by high and distortionary taxes, which are neither conducive to long-run growth nor sustainable. The system has also been characterized by an excessive number of levies, particularly on sales, excisable goods and employment compensation. There are various forms of discretionary tax exemption. More generally, the system has lacked transparency, and uniformity with many exemptions favoring particular industries or even particular tax payers. The system has also been very unstable, with a large number of changes in tax legislation and regulations. The tax system is also highly centralized. All major revenue sources belong to the
9 Since the Kosovo crisis in 1999, a federal sales tax on goods and services earmarked for financing of the Army has been introduced.
39 Chapter 2. Fiscal Policy and Management republican level: there are few levies that are introduced by local authorities and belong to the local budget.
2.84 The remainder of this section outlines some key issues in tax policy - by instrument, as of March 2001. In early April 2001 the Serbian Government adopted an important package of tax reforms, which are outlined in paragraph 2.89.
2.85 Social insurance, income and profit taxes. Direct taxes account for 54 percent of general government tax revenue. The five social insurance levies are the most important direct taxes, accounting for 40 percent of tax revenue. The social insurance levies – which finance the pension and disability, health insurance, and unemployment insurance funds – apply to all earned income. The social insurance contribution rate for both the employer and the employee is 26.6 percent. Employers also pay a local facilities charge and a housing solidarity contribution. The very low exemption for the income tax on employment income and the flat and high combined rates for the various levies lead to a high average tax burden on labor income with very little progressivity.
2.86 The revenues of the profits tax are very low, in large part because of the depressed economy but also because of generous tax incentives. The profits tax rate is 20 per cent, which is competitive in the region. FRY provides generous tax incentives in the form of tax holidays, reduced tax rates, special allowances and tax credits. It is estimated that in 2000, potential profits tax receipts were reduced by YUD 794 million or 47 per cent by such initiatives. Yugoslavia treats foreign investors more generously than domestic companies.
2.87 Sales tax. On a consolidated basis, the various sales taxes account for almost 10 per cent of GDP in FRY.10 This is above the average for central and eastern Europe, but relatively lower than the sales tax revenue raised by Croatia and Slovenia. The various sales taxes effectively create a regime with six major rates for goods and two for services, where the top combined rate for goods is 28 per cent. The combined revenue costs of the various reduced rates and exemptions is significant, and is estimated to have lowered revenue by the equivalent of 6 per cent of GDP in 2000 alone. Harmonizing rates and reducing exemptions will raise revenue and will also allow a substantial reduction in the standard rate.
2.88 In late 1999 FRY adopted a federal VAT law, which is generally consistent with international standards. The government has delayed the effective date, and it is now anticipated to come into effect in 2003.
2.89 Excises. On a consolidated basis, the FRY government raises 3.5 per cent of GDP from both ad valorem and specific excises. These rates have been lowered repeatedly over the past two years to combat smuggling. Serbia’s system, which on most goods imposes multiple specific excises (often earmarked) and multiple ad valorem taxes is further complicated by differential sales taxation. Multiple excises are also complicating tax administration and are raising collection costs.
10 This includes the Serbian sales tax, the Federal sales tax earmarked for the army, the sales tax earmarked for financing railways, and the Belgrade sales tax.
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2.90 Recent reforms. In early April 2001, the Serbian Parliament adopted a number of important tax and fiscal reforms. These include:
• The various sales taxes have been unified at a rate of 17 per cent. An additional 3 per cent is added for the Federal sales tax (for financing the army). • The number of exemptions has been reduced, and is now restricted to bread milk, certain agricultural products, and utilities. • One uniform excise tax rate has been established. • To increase transparency, income taxes will be calculated on gross wages. In the past, taxes were levied on three different tax bases, two of which were based on net salary. Tax Administration Issues
2.91 Tax administration in Serbia is executed by the Public Revenue Agency (PRA). The PRA possesses a number of assets, including a well-educated staff, effective – if somewhat outdated – computer systems, and good infrastructure. Despite these important strengths, the PRA faces a number of challenges. The level of voluntary compliance among tax payers in Yugoslavia is very low. Tax arrears are huge, and it is estimated that tax evasion may be as high as 50 per cent of potential for certain sources. There is a general lack of a “tax culture”. The tax administration has been unable to target the proliferating gray economy effectively.
2.92 Weaknesses in tax administration and enforcement are contributing to the low level of compliance among tax payers. This includes outdated organizational arrangements, the absence of systematic management and planning methods, and the lack of modern audit methods. One of the main weaknesses of the tax administration is its high degree of fragmentation and the lack of coordination among the several agencies with revenue responsibilities, as well as fragmentation within the PRA itself.
2.93 The administrative provisions of the current tax legislation also has various features that tend to undermine the effectiveness of tax administration. Multiple bases and rates complicate tax administration and raise both collection and compliance costs. Taxpayer services, which in all modern tax administrations are a major contributor to tax compliance, are virtually non-existent in FRY. For example, tax returns must be purchased instead of being free of charge. Pamphlets explaining the different tax obligations are not available.
Priority reforms – Tax Policy 2.94 The tax reform should create a simpler, more transparent tax system, with wider bases and relatively low rates. Near-term policy priorities include:
• The consolidation of the sales tax has been a positive step. Federal sales taxes earmarked for the army and the republican sales taxes and levies should be integrated into a single tax with a single rate, or at most one standard and one reduced rate. New federal-republican sharing rates may have to be established, consistent with federal and republican budgetary needs.
41 Chapter 2. Fiscal Policy and Management
• The consolidation of the different excise taxes has been a positive step. The excises on soft drinks, coffee, table salt, and luxuries should be eliminated. Excisable products should be limited to alcohol, tobacco and petroleum products. Rates for gasoline, beer, wine, and domestic cigarettes should be raised in line with regional levels of excise taxation. • The existing tax incentives for investors should be repealed. Given the need for enterprises to modernize, the current incentives could be replaced with a tax credit scheme for investment in fixed assets. In the case of income tax, the local facilities and housing charges should be consolidated into the income tax in 2002. 2.95 Medium-term policy priorities:
• Plans for the implementation of the VAT should be pushed forward. The VAT law should be reviewed in 2001, and a new VAT law enacted, so that the tax administration and tax payers have one year to prepare for its introduction in 2003. • In the near to medium term, the excessive burden on labor income needs to be addressed. However, this will first require decisions to be made with regard to benefits, as the various funds financed by social insurance are currently under funded. In the medium term, reform of the social insurance system will enable a cap to be placed on the amount of monthly earnings subject to social security contributions. The relief provision for reduced social insurance contributions for certain companies should be repealed. • Fiscal decentralization. To ensure fiscal discipline, the authorities at all levels of government must face the financial consequences of their decisions. Traditional local taxes can be revitalized, including a tax on immovable property, taxes on capital transactions, payroll taxes etc. thus creating a framework for stable municipal tax revenues. This would decrease the levels of transfers required from the republican budget. Priority reforms – Tax Administration 2.96 There is a clear and urgent need to set a new tone for tax administration. Integrity needs to be restored. To this end, the government needs to communicate clearly to the public that it intends to reduce the burden of the tax system, provide better services and further protection to tax payers, and has zero tolerance for corruption within its ranks. In return, tax payers and tax officials will be expected to comply fully with their obligations under the law, and if they fail to do so, they will be subject to the full range of penalties provided by the law. The authorities need to reduce the size of the shadow economy and corruption through a favorable environment and targeted anti-corruption measures, including tighter tax administration, improved coordination between various government bodies, and increased transparency of tax administration.
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2.97 Near-term priorities:
• The government should enact a consolidated Law on Tax Administration, which will regulate tax procedures. • A Code of Conduct for tax officials and a charter of tax payer rights should also be enacted. • PRA headquarters should be reorganized and strengthened and special units within PRA established to monitor compliance of the largest tax payers. 2.98 Medium-term priorities:
• The PRA should be reorganized along functional lines (collections, audit, tax payer services etc.). • The financial police should be consolidated within the PRA. • The fragmentation of tax administration responsibilities should be reduced. • The Par’s computer system needs to be updated. • Auditing standards need to be improved to help control tax evasion.
Table 2.3: Technical Assistance requirements for Fiscal Policy and Management (US$ millions) Priority Estimated Total Financing Program Requirement US$ m CY01 CY02-04 Reducing quasi-fiscal deficits and hidden 2.5 5.0 liabilities Transparency and Accountability of public 2.0 7.5 spending Public Debt Management 2.5 5.0 Tax Policy and Administration 4.0 6.0 Totals 11.0 23.5 34.5
43 Chapter 2. Fiscal Policy and Management
Annex A: Stock of Selected Liabilities of FRY’s Federal and Republican Governments End-2000 Estimates YUD billion DEM USD Percent of percent of million million GDP 2000 revenues 2000 1. DIRECT EXPLICIT External debt of the federal Government 525.2 17507.1 7839 87.0% 222.4% of which direct 3.8 127.3 57 0.6% 1.6% executed Fed. guarantees on external debt 521.4 17379.8 7782 86.3% 220.8% o/w on debt owed by local governments debt owed by NBY 107.4 3580.0 1603 17.8% 45.5% debt owed by commercial banks 335.4 11180.1 5006 55.5% 142.0% debt owed by SOEs 78.6 2619.7 1173 13.0% 33.3% Direct external debt of the Republican Governments of Serbia and of Montenegro Direct domestic debt 1.7 58.0 26.0 1.3% 3.2% Fed. govt. to NBY Fed. govt. to comm. Banks Serb rep. Govt. to NBY 1.5 50.1 22.4 0.2% 0.6% Serb rep. Govt. to Commercial Banks 0.2 7.9 3.5 0.0% 0.1% Montenegrin Rep. Govt. to NBY Montenegrin Rep. Govt. to comm. banks Comissariat for refugees and displaced persons 1.0% 2.5% Frozen FX deposits (70% share of Fed./Rep. governments) 168.8 5628.0 2520 28.0% 71.5% Social funds Arrears receivable 16.7 555.3 249 2.8% 7.1% Child welfare 5.8 192.1 86 1.0% 2.4% Social security 1.9 64.8 29 0.3% 0.8% Employment fund 0.9 30.0 13.4 0.1% 0.4% Health Fund 3.1 103.3 46.3 0.5% 1.3% Rep Pension Funds 4.1 135.1 60.5 0.7% 1.7% Fed Pension Fund 0.9 30.0 13.4 0.1% 0.4% Arrears payable 53 1767.2 791 8.8% 22.4% Child welfare Social security Employment fund 0.868 28.9 13.0 0.1% 0.4% Health 6.36 212.0 94.9 1.1% 2.7% Rep Pension Funds (only recent pensions) 45.8 1526.3 683.4 7.6% 19.4% Fed Pension Fund Debts Child welfare Social security Employment fund Health Fund Debt to Development Fund 4.7 155.9 69.8 0.8% 2.0% Rep Pension Funds (1994-95 pension debt) 10.0 334.4 149.7 1.7% 4.2% Debt to Development Fund 16.4 546.3 244.6 2.7% 6.9% Fed Pension Fund Debt and arrears of central government agencies The Federal Army Directorate for Reconstruction Directorate for Commodity Reserve Agency for Commodity Goods
44 Chapter 2. Fiscal Policy and Management
Stock of Selected Liabilities of FRY’s Federal and Republican Governments (continued) 2. CONTINGENT EXPLICIT Outstanding Fed. guarantees on external debt Outstanding Republican guarantees on external debt Serbia Montenegro 3.5 116.0 51.9 0.6% 1.5% Outstanding Republican guarantees on domestic debt... of the local governments of NBY of commercial banks 2.6 88.1 39.4 0.4% 1.1% of SOEs 0.0 0.0 0.0% 0.0% Deposit Insurance claims (BRA) 0.9 28.5 12.8 0.1% 0.4%
3. DIRECT IMPLICIT Expected subsidies to the SOEs (from Repub. Development fund) Recurrent costs of ongoing public investment projects Future Investment projects Future severance payments of civil servants; Future public pensions, social security schemes, and health care financing
4. CONTINGENT IMPLICIT Local governments Budgetary arrears Social payments' arrears Borrowing (not guaranteed by higher levels of government) Loan Guarantees National Bank of Yugoslavia Domestic borrowing Frozen FX deposits (NBY share) 36.2 1206.0 540 6.0% 15.3% Foreign borrowing (w/o Govt. guarantee) 23.6 786.1 352 3.9% 10.0% Guarantees on foreign borrowing 2.1 71.5 32.0 0.4% 0.9% to Banks 0.6 20.1 9 0.1% 0.3% to SOEs 1.5 51.4 23 0.3% 0.7% Credit to Government 11.6 386.6 173.1 1.9% 4.9% Directed credits To banks 4.6 151.7 67.9 0.8% 1.9% To SOEs 3.7 124.5 55.8 0.6% 1.6% Commercial banks Cost of stabilization (FSD estimate, only 2001-02) 44.3 1476.0 660.9 7.3% 18.7% Redundancies @ 12,000 @DEM 2400 (FSD) 0.9 28.8 12.9 0.1% 0.4% Frozen FX deposits (the banks' share) 36.2 1206.0 540 6.0% 15.3% Foreign borrowing (w/o Govt. guarantee) 55.3 1842.5 825 9.2% 23.4% Called Guarantees on foreign borrowing for SOEs (old 143.4 4779.3 2140 23.7% 60.7% SFRY debt) Lending, total 63.7 2124.5 951.3 10.6% 27.0% Credit to Government 3.8 127.8 57.2 0.6% 1.6% non-profit/others? 25.5 850.0 380.6 4.2% 10.8% To SOEs 31.8 1060.0 474.6 5.3% 13.5% to households 2.6 86.7 38.8 0.4% 1.1% BRA operations 0.6 20.0 9.0 0.1% 0.3% Public enterprises Regular obligations, total Annual cost of excess labor @ 25% of the total (@ total labor cost) Serbia 36.7 1224.0 548.1 6.1% 15.5% Montenegro 4.8 161.4 72.3 0.8% 2.1% Debts, total External (not guaranteed) 21.6 721.4 323 3.6% 9.2% Domestic (not guaranteed) to the Republican budgets Serbia 64.5 2150.0 962.7 10.7% 27.3% Montenegro 6.5 215.0 96.3 1.1% 2.7%
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Stock of Selected Liabilities of FRY’s Federal and Republican Governments (continued) To the Republican Development Funds Serbia 2.3 78.2 35.0 0.4% 1.0% Montenegro (arrears outstanding) 0.2 7.8 3.5 0.0% 0.1% To commercial banks (=directed credit) Serbia Montenegro (arrears outstanding) Arrears receivable owed by Govt. agencies owed by other customers incl. SOEs Arrears payable Wages (4 months @ 100 DEM) for 1.8 million 23.8 792.0 354.6 3.9% 10.1% Suppliers Tax 14.07 469.0 210.0 2.3% 6.0% Social payments 50.3 1675.0 750 8.3% 21.3% Future severance payments @200,000 @ DEM2000 12.0 400.0 179.1 2.0% 5.1% Non-profit sector Debts 2.479 82.6 37 0.4% 1.0% Future severance payments @... @ DEM2000
46 CHAPTER 3. TRADE
INTRODUCTION
3.1 The trade policy of the government of Federal Republic of Yugoslavia (FRY) and the effectiveness of FRY institutions that support the conduct of international trade are critical for the long term sustainable growth of the economy and the reduction of poverty. For a small economy like FRY bordering on many countries, an open trade regime is essential for the development of an efficient private sector and for the integration of the economy in global trade. It is simply not possible for FRY to establish a competitive market economy, promote growth and increase employment and incomes of the poor behind protective barriers which limit imports of goods or services.
3.2 Trade is also important for the restoration of growth in the short term. The lifting of sanctions and the increase inflow of imports is essential for the short term recovery of exports and output and the reduction of unemployment.
3.3 Until very recently, FRY had been isolated from the international economy. In the last few months, the FRY government has taken steps to end this isolation and to seek closer relations with regional trading partners and the EU. Changes in many trade related institutions are needed for the efficient operation of the economy, but will also help with the integration of FRY into the EU structures, as well as WTO accession. Nonetheless, the pursuit of these integration efforts simultaneously will tax the ability of the FRY authorities to negotiate and implement the many changes needed. The international community will need to support these integration efforts with appropriate financial and technical assistance.
3.4 This chapter reviews the current situation and constraints affecting FRY trade; outlines the changes needed in FRY trade related policies and institutions in order to promote integration in the world economy and effective participation in regional and global institutions, and presents a preliminary listing of areas in which assistance by the international community could be helpful in the pursuit of these objectives. The external financing requirements for the trade sector are estimated to be US$7 million for technical assistance over three to four years and are presented in Table 3.5 at the end of the chapter. The estimated financing requirement for 2001 on a commitment basis is US$2.7 million. These requirements are included under Economic Management in the summary Tables 1.1 and 1.3.
A. PATTERNS OF TRADE IN GOODS AND SERVICES
3.5 In the old SFRY, trade between FRY and other SFRY republics accounted for a significant share of total trade. In 1989, trade turnover (exports plus imports) accounted for 90 percent of GDP. However, 60 percent of this was destined for other SFRY republics. During the early sanction years (May 1992 to December 1995), trade declined dramatically – in large part because of the break-up of the SFRY and the regime of sanctions. Some recovery took place in 1996, when merchandise trade turnover was roughly USD 6 billion, and amounted to almost 40 percent of GDP. Chapter 3. Trade
3.6 Following increases in the 1996-1998 period, in 1999 and 2000 foreign trade declined drastically. As shown in Table 3.1, exports fell by almost 50 percent between 1998 and 1999, and recovered only marginally in 2000. Thus, exports in 2000 were just over one-third of their 1991 level. Exports as a share of GDP fell from 42 percent in 1989 to 12 percent in 1999.1 The impact of war and sanctions on imports has been similar, but somewhat less pronounced: in 1999 imports were around 60 percent of their 1991 level.
3.7 During the past ten years, FRY has been running a considerable deficit on the merchandise trade balance, a slight surplus on the services balance and a very large current account deficit. All the FRY trade data should be treated with a high degree of caution, however. Official data tend to undervalue both exports and imports of goods and services. Companies under-invoiced exports to reduce the losses arising from the sale of hard currency to the National Bank of Yugoslavia at the official rate. On the services side, unregistered income resulting from the export of construction services to Russia also appeared to be important. The underestimate of official import data results from smuggling and from the operation of the cash system on the import side which promoted under-invoicing.2
Table 3.1: Trade and Services Balances, in millions of US dollars.
1991 1996 1997 1998 1999 2000 2001 (authorities)
Trade Balance -847 -2260 -2431 -1991 -1798 -1988 -2455 Exports f.o.b. 4701 1842 2368 2858 1498 1723 2310 Imports f.o.b. -5548 -4102 -4799 -4849 -3296 -3711 -4765
Services, net na 156 168 157 43 161 330 Receipts na 433 530 578 286 454 800 Expenditures na -277 -362 -421 -243 -293 -470 Source: National Bank of Yugoslavia, Federal Statistical Office, IMF.
3.8 The largest market for FRY exports is the European Union. As shown in Table 3.2, the EU has been receiving around 40 percent of total FRY exports. Traditionally, Germany and Italy have been the most important markets, with each receiving around 10 percent of FRY exports, followed by Greece which takes around 5 percent of exports. In 2000, exports to the EU increased by more than 20 percent, accounting for 38 percent of total FRY exports.
3.9 Bosnia (Republica Srpska) and FYR of Macedonia together account for around one- third of total FRY exports. There is evidence that a significant share of exports to Bosnia- Herzegovina and to FYR Macedonia are re-exported to other countries in Europe and the rest of
1 In 1989, more than half of ‘exports’ from Serbia and Montenegro were destined for other SFRY republics. 2 Importers used to under-invoice. Since letters of credit and bank guarantees have been relatively expensive in FRY, importers often chose to use simple bank transfers. However, since Yugoslav legislation did not allow for advanced payments, such payments were made via illegal channels, and they were not reflected on the invoice – hence the under-invoicing on the import side.
49 Chapter 3. Trade the world. These trading links date from the old SFRY and were strengthened during the periods of sanctions in the 1990s. 3.10 During much of the 1990s barter trade became increasingly important for FRY, as regular means of trade finance declined. In particular, barter trade in cereals has become an important means for securing energy imports. In 2000, 90,000 tons of wheat was bartered for Russian natural gas. Restoration of trade finance should diminish the incentives for barter and result in efficiency gains for the economy.
Table 3.2: Main export markets, as a percentage of total 1989 1992 1996 1998 1999 European Union 46 44 42 38 37 Bosnia (RS) --62220 FYR Macedonia --5912 Switzerland n.a. n.a. n.a 9 7 Russia 15 15 5 5 5 Romania 25312 Hungary 22322 Bulgaria 15511 USA 54310 Source: Federal Statistical Office
3.11 The EU is also the largest source for FRY imports. As shown in Table 3.3, around 40 percent of FRY imports is coming from the EU. As in the case of exports, Germany and Italy are especially important trading partners, accounting for roughly 10 to 12 percent of imports each. This is followed by imports from Russia, which amount to 8 to 10 percent of total imports. In 2000, the most important import markets for FRY were Germany, Italy, Bulgaria and Russia.3
Table 3.3: Main import markets, as a percentage of total 1989 1992 1996 1998 1999 European Union 44 44 32 41 41 Bosnia (RS) --2156 FYR Macedonia --1154 Switzerland Na Na na 2 2 Russia 23218118 Romania 18323 Hungary Na Na na 2 3 Bulgaria 13325 USA Na Na na 3 2 Source: Federal Statistical Office
3.12 The predominance of intermediate and capital goods is evident in the structure of traded goods. As shown in Table 3.4, the main export sectors are foodstuffs, non-ferrous metals,
3 Bulgaria has been an important trading partner during sanction years, when selected Bulgarian companies chose not to comply with the UN oil embargo.
50 Chapter 3. Trade machinery and equipment and chemicals. Over the past decade, exports of machinery, transport equipment and finished goods have fallen significantly, and consequently the relative importance of primary commodities in exports has risen. The main imports are foodstuffs, machinery and transport equipment, chemicals, and petroleum products. Imports of fuels, machinery and transport equipment also fell during this period because of low investment demand and general declines in economic activity.
Table 3.4: Exports and Imports by Commodity 1996 1998 1999 Imports Exports Imports Exports Imports Exports Food 12 22 11 13 10 21 Chemicals 14 9 14 10 16 10 Petroleum products 12 0 9 2 12 0 Machinery and transport 19 12 21 10 22 12 equipment Non-ferrous metals 2141101 12 Miscellaneous manufactured 21 12 8 14 6 15 goods Other 20 31 36 41 34 30 Total 100 100 100 100 100 100 Source: Federal Statistical Office
B. TRADE POLICIES: REFORMS TO DATE AND PLANS FOR THE FUTURE
3.13 Very significant progress has been made with the reform of the trade policy system in the 6 months since the new government has taken office. From the onset, the administration was aware of the need to introduce basic reforms of the trade regime as early as possible in order to promote private sector development and competitive markets, as well as Yugoslavia’s integration into the world economy. The government enacted a number of reforms in December, 2000, and a series of additional measures including a new tariff structure were proposed to Parliament in April, 2001 and enacted in May. These changes go a long way in overcoming the legacy of the highly protectionist, non-transparent trade regime built by the previous administrations. A significant number of the distortions resulting from the use of licenses and quantitative restrictions for both exports and imports have also been removed.
3.14 There are uncertainties in the commercial relations with Montenegro which has enacted its own tariff structure, although foreign trade policy is a ‘Federal’ responsibility. The FRY government is engaging in negotiations with Montenegro in order to reach understandings that would facilitate trade. In this context, an agreement was reached in March 2001 between Montenegro and the FRY government regarding the mechanics of trade with the EU, as required by the EC Customs Code.4
4 Implementation of ATP preferences extended by the EU was delayed somewhat over issues regarding rules of origin for products of Montenegro. This issue was resolved in March 2001.
51 Chapter 3. Trade
The Legacy of the Past 3.15 The ‘old regime’ was characterized by an import-substitution strategy implemented through quantitative controls resulting in massive state patronage and pervasive corruption. Acute shortages of foreign currency both compounded the problem and provided a further justification for a system of licenses and controls of trade and foreign exchange. The imposition of a foreign investment ban and asset freeze by the EU and US following the eruption of the Kosovo crisis in March 1998 led to the imposition of additional measures limiting foreign trade activity. There was a dual rate of exchange, substantial levies on foreign trade transactions, including Central Bank deposits and compulsory sale of a significant percent of hard currency revenues to the Central Bank at official exchange rates.
The Reforms in late 2000 3.16 Soon after the new government took office, it introduced a number of fundamental reforms to the foreign exchange and trade system.
• In late 2000, the exchange rate was unified and current account convertibility was established. In addition, the obligation to sell a share of hard currency revenues to the National Bank of Yugoslavia has also been abolished. • Amendments to the Law on Foreign trade, were enacted on December 27 2000,5 which reduced the very large number of administrative barriers to trade through the repeal of the following controls which had previously been the source of delays and corruption: 1. Abolition of the minimum requirements related to company capital (10,000 DM), assets (size of premises, office and telecom terminal equipment), and employment; 2. Cancellation of the annual registration tax of 1000 DM for trading companies; 3. Abolition of the obligation to report and to pay a tax over imports/exports transactions to the Federal Ministry of Foreign Economic Relations. All these measures have already improved the climate for business and simplified the procedures for carrying out trading activities.
The Trade Regime in February 2001
3.17 Imports: tariffs and quantitative restrictions. The tariff regime had an unweighted simple average tariff rate of 14.4 percent. But, the tariff structure was highly dispersed and biased in favor of protection of domestic producers of agriculture products, food and consumer goods. There were 37 custom tariff rates within a range of 0 to 40 percent. The average tariff applied for consumer goods in 2000 was 22.4 percent, but for many agricultural products and durable consumer goods the maximum rate of 40 percent was applied, resulting in substantial escalation. There was also a special additional tariff on agricultural products of 20 percent, which is added to the regular tariff rate. Finally, a customs inspection levy at 1 percent of CIF import value was charged.
5 Published in the Official Gazette of the FRY (issues 68, 69, 72, 73, 74/2000),
52 Chapter 3. Trade
3.18 Until the unification of the exchange rates in late 2000, all tariff calculations and payments were done at the official exchange rate. This decreased very significantly actual tariff protection during much of 1999 and 2000, which made a range of imported goods – including foreign cars – competitive in the domestic Yugoslav market. Ceteris paribus the unification of the exchange rates in late 2000 has resulted in a large increase in the effective rate of tariff protection.
3.19 In order to offset the disincentive of the existing tariff regime on exporters, two alternative duty drawback mechanisms were in place: (a) direct duty drawback financed through the Federal Ministry of International Economic Relations; (b) other ‘drawbacks’ applied as a variable percentage of the value of export earnings in different industries. None of these mechanisms however, have been operative in recent periods because of lack of funds.
3.20 Imports also were subjected to significant quantitative restrictions. There are two basic types of non-tariff barriers inherited from the old regime: import quotas and licenses (see annex I). For 2000, estimates show that 11.8 percent of imported products (by tariff line) and 6.7 percent by value were subject to quotas. Both quantity and value-based quotas are in place with most of the import quotas in agriculture. In addition, individual quotas require that each importer could import no more than 10 percent of the total quota.
3.21 The administration of the quotas was implemented by the customs office. Once the quota had been met, imports could still take place if the importer paid two-and-a-half times the normal tariff rate. In a range of product categories, the import quota was set to 0, effectively implying that all imports are charged tariffs at the much higher tariff rate.
3.22 Import licenses were another form of non-tariff barrier. Roughly 4.4 percent of imported goods (by tariff line and by volume) required licenses. Licenses were issued by the Federal Minister for Foreign Economic Relations, and are not transferable. Ministry officials had the discretionary right to issue a license or decline a request. The procedure was non-transparent, and there is substantial room for corruption and cronyism. There is evidence that under the old regime import licenses were only issued to a few well-connected companies.
3.23 Restrictions on exports of goods in the form of quotas were also prevalent. They used to apply to about 4 percent of tariff lines and result in considerable distortions (see Annex I). This overall estimate may well understate the restrictiveness of the controls which covered almost all tariff lines in HS6, Chapters 1 through 13 (mainly agricultural products and materials such as live animals; meat; dairy produce; products of the milling industry) as well as tobacco products, ores, slag and ash. The incidence of quantitative restrictions is small in manufactures, where they only affect selected raw materials in leather and wood. This has been done in order to provide domestic processors with a degree of protection by enabling them to obtain these raw materials at lower than world prices.
6 HS: Harmonized System. A classification of goods commonly used in international trade and tariff data.
53 Chapter 3. Trade
Trade Reforms Enacted by Parliament in May 2001
3.24 The government has proposed and the Parliament recently enacted a bill involving major changes in the trade regime.7 The proposed legislation envisaged significant liberalization of the tariff regime and the quantitative restrictions and licensing for both imports and exports. The streamlining and simplification of the tariff structure includes lower rates and a reduced variance of rates.
3.25 In particular the tariff structure is proposed to be revamped in a number of ways: (a) to account for the changes resulting from the unification of the exchange rate in a way that would leave the rate of protection unchanged in sectors with significant domestic production; (b) to reduce the over all rate of protection, but less for sectors in which quantitative restrictions and licenses are eliminated. Furthermore, as a general rule of thumb goods produced domestically will be subject to higher tariffs than goods that are not produced in FRY.
3.26 The new tariff schedule has 6 different rates - of 1, 5, 10, 15, 20 and 30 percent. The overall simple average tariff rate is reduced from around 14 percent to 9.2 percent. Weighted average (weighted by 2000 imports) will decline from about 10 percent to about 8 percent with major reductions in most manufacturing sectors, and smaller reductions in agriculture and textiles.8 Even so, the proposals envisage a significant number of tariff lines, many of them in agriculture, with rates at 30 percent.
3.27 The tariff revenue to import ratio is projected to increase from 4 to 8 percent as the tariffs will be calculated on the basis of the official exchange rate that was introduced in December 2000. Furthermore, we feel rather confident, based on conversations with the Customs Authorities and others, that the main factors that have affected tariff revenues in the past are lack of compliance, corruption and smuggling. If the government is able to increase compliance, through a simplified tariff structure, reduction of corruption, elimination of licensing and reduced smuggling further increases in tariff revenues are likely to result – despite the lowering of the average tariff.
3.28 The trade reforms proposed would also reduce the number of import licenses. Nevertheless, in addition to those required by international agreements, import licenses will continue to apply to about 40 tariff lines covering steel products, because of concerns about the viability of the steel industry, in the absence of such controls.
3.29 Export licenses are to be eliminated, except as required by international agreements. Export quotas however, are intended to continue to apply to about 30 tariff lines of basic agricultural goods, including wheat, corn, live animals, edible oil, and sugar. While the number of tariff lines affected is small, the quotas in some sectors would appear to be quite restrictive. They also cover some of the main agricultural products in the economy.
7 This section provides an outline of the proposed trade reforms. To the best of our understanding, Parliament has enacted the proposed reforms, but we have not yet had a chance to review the law. 8 The use of import weights, especially of 2000, when the regime was very distorted and import levels very low, may result in distortions in the resulting estimates of reductions in the tariff rates.
54 Chapter 3. Trade
Montenegro
3.30 The Republic of Montenegro has taken a series of actions to assume control over functions which Article 77 of the 1992 FRY Constitution set under the jurisdiction of the federal state, including the monetary and banking system, foreign trade, customs, and taxation. Montenegro has established a de facto customs territory, albeit in a rudimentary form. The initial reach of the customs territory was limited to the external boundaries of Montenegro. The Montenegrin government has assumed control over the regulation of customs and the collection of duties and taxes on its international borders with Kosovo, Albania, Croatia and Bosnia. In July 2000, the Republic of Montenegro adopted a Temporary Act on Customs Tariffs. The new act has introduced five different tariff rates (1,3,5,10 and 15 percent). Almost 92 percent of all products are imported at rates of 5 percent or less, and the average tariff rate is just below 3 percent. All tariffs are calculated on the DM value of goods.
3.31 As far as quantitative restrictions are concerned, 3 percent of goods imported are subject to quotas, and 1.4 percent of products imported require licenses. On the export side, 1.2 percent of goods are subject to export quotas and 1.1 percent require export licenses.
3.32 Reforms have also started to make import procedures in Montenegro less time- consuming and less costly. For example, as in FRY, complicated registration requirements with the Ministry of Trade have now been eliminated.
3.33 With two different tariff regimes and customs administrations effectively in place, the incentives for smuggling and trade diversion are significant. The FRY Federal Customs Administration has put up checkpoints as of 12 February, 2001 on the administrative border with Montenegro. Such tax collection points had already been set up on the administrative border with Kosovo at an earlier date. At these checkpoints, customs duty on the goods is levied, or the goods are forwarded to designated customs offices. Goods subject to customs duties entering FRY from Kosovo or Montenegro, and for which there is no proof of FRY customs duties having been levied in accordance with the Federal regulations, will have duties levied upon them - with all the customs, foreign trade, tax and hard currency regulations being applied. For goods being sent to Montenegro and Kosovo, and intended for eventual export outside FRY, i.e. goods that are being shipped from Serbia but leave FRY through the territory of Kosovo or Montenegro, customs duties will be levied for export at these check points. The director of the Montenegrin customs office also recently announced that Montenegro would soon establish its own customs controls on the border crossings with the Republic of Serbia.
C. CAPACITY TO TRADE: INSTITUTIONAL AND OTHER CONSTRAINTS TO IMPLEMENTATION
3.34 The Federal Republic of Yugoslavia’s capacity to engage in international trade is severely limited by a variety of constraints. Some of these constraints are the result of the long isolation of the economy as well as disruptions caused by the regime of sanctions and the Kosovo conflict. Others reflect the remnants of the previous regime of controls and favoritism. Still others involve longer term weaknesses in the institutional infrastructure for trade. All need
55 Chapter 3. Trade to be tackled urgently in order to provide a stimulus to trade, which in turn is essential for the revival of the economy.9
3.35 Customs and Border Crossings. Customs administration has suffered from severe weaknesses. Over the past decade there has been widespread non-compliance, and the customs administration is saddled with a legacy of malpractice, preferential treatment, arbitrary managerial direction, and disregard for the rule of law. Many of these can be traced to favoritism and corruption under the previous regime.
3.36 To become an effective and efficient organization, the Federal Customs Administration will have to embark on an ambitious program of renewal and modernization. The leadership of the Customs Service has been changed. The new management team, which was only recently appointed, seems determined to eliminate the corrupt practices of the previous administration.
3.37 But administrative and other weaknesses remain, and the customs administration faces significant funding and resource pressures. The widespread incidence of smuggling remains a serious problem and limits the government’s capacity to raise revenues. According to some estimates 70 percent of imported cigarettes are illegal, representing a revenue loss of YUD 3 billion a year. Many of the smuggled goods reach FRY via Montenegro and via the Danube.
3.38 The IT infrastructure of the customs administration is strained and is unable to support the modernization of the customs clearance process. More generally, procedures for customs clearance at border crossings continue to be cumbersome, time-consuming and costly; as are requirements for inspection of trucks. All shipments are visually inspected at the point of entry and documents checked. Shipments are then directed to inland border posts for further examination, payment and final clearance. Shipments of excisable goods are escorted to the inland port with costs borne by the importer.10 (See also Chapter 8 - Transport).
3.39 Finally, the present Customs Law is long, complex and very prescriptive. It contains provisions which prevent the introduction of accelerated, modern clearance provisions. For instance, it requires the inspection of all shipments, and the payment of duties and taxes prior to release; and it prescribes hours of operation of border posts.
3.40 Transport Facilitation. Traders face excessive logistical costs for their export, import and transit operations. Road transport services for traders are expensive due to a number of regulations in place and the incomplete reintegration of FRY in the international sphere. These barriers have the same impact as formal protection: they reduce the competitiveness of traders on international markets, through a significant increase in cost and a perception of low quality due to the difficulty to arrange timely delivery. Consultation with private operators to remedy the
9 Evidence regarding these constraints is based on interviews with firms and FRY government officials. Many of the conclusions presented here are based on more detailed analysis presented in other parts of the report, e.g. infrastructure. 10 At the inland office, documents are presented again and verified. A visual or more thorough examination may take place, and other inspection services may be called (agriculture, health etc.). Duties and taxes are then calculated. Payment is effected at the Agency for Accounts and Payments (ZOP). Upon proof of payment, goods are released.
56 Chapter 3. Trade situation was until recently very limited, but the new administration seems committed to consult with private operators in the future. (see Chapter 8 - Transport).
3.41 Finance. Previously, FRY’s banking system had considerable experience in trade finance, both for exports and imports, with established international networks of correspondent banks. The overall deterioration of the banking sector however, has also had adverse repercussions on trade finance, with banks finding it difficult to provide short term finance for customers, except in the context of cash based or matching export/import transactions. There is an urgent need to re-establish foreign credit lines for trade finance. There is also a need to establish longer term export credit finance for capital goods exports, for which there is productive capacity. The agency, JUBMES, founded in 1989 to provide with export insurance for non-commercial risks and the financing of exports of capital and durable consumer goods, no longer does so.
3.42 Physical Infrastructure. Existing weaknesses in many sectors were exacerbated by the damage resulting from the Kosovo conflict: a road transport system which was inadequate, was further weakened by the lack of maintenance resulting from the diversion of government resources to rebuild damaged bridges. Navigation on the Danube has not yet been restored. Also, access to the port of Bar has been complicated by disagreements with the government of Montenegro on jurisdiction over customs.
3.43 Other Services. The competitiveness of the export sector in general, depends heavily on efficiency in the provision of different types of service inputs. In FRY, many of the service sectors appear to be inefficient in part because of the existence of monopolies and the lack of competition. While it has not been possible to make a detailed analysis of the situation, lack of competition and inefficiencies appear to plague the telecommunication sector, insurance and air transport, and energy inputs from oil and gas are available at higher than world prices. Lack of competition and inefficiencies raise costs and undermine the competitiveness of the export sector, but they are also a handicap for the operation of the economy as a whole. The Yugoslav authorities need to address these issues as part of their general effort to establish a competitive market. Until they do, the export sector will operate under a significant handicap.
D. MARKET ACCESS: THE GLOBAL, EUROPEAN AND REGIONAL DIMENSION
3.44 Following the lifting of sanctions, few formal market access impediments are present in the form of protection against FRY products, with the exception, of course, of sectors such as textiles and agriculture where there is worldwide protection from all sources. In this area, the preference regime offered by the EU is likely to be of special importance to FRY, once it starts being implemented.
3.45 The long term isolation of the FRY however, has created different problems for exporters: the sanctions have disrupted business contacts and market presence; and they created an unfavorable image for products originating in FRY. Moreover, the long isolation has made some of the technology used by exporters obsolete and therefore undermined competitiveness.
57 Chapter 3. Trade
3.46 At the same time road transport operators are constrained by the policies of FRY’s trading partners regarding permits, visas and insurance. The number of available road permits to the EU, Croatia, and Hungary represents only a limited fraction of what is required. Visas for the Schengen area are limited to three months for truck drivers creating significant downtime and cost for FRY road operators. Truck insurance policies issued in FRY are not recognized by several countries, creating the need to have double insurance.
3.47 All these problems can be addressed, but it will take time as well as resources which need to be devoted to export promotion and marketing, as well as upgrading of technology and strengthening of domestic institutions, for example in the area of insurance. In some instances, they will also require co-operation from FRY’s trading partners.
WTO Accession
3.48 The government’s application to accede to the WTO is an important step in the integration of the FRY economy in international trade. WTO membership will provide an opportunity for FRY authorities to liberalize the economy further as well as to realign the policies and practices of trade related institutions to make them compatible with WTO requirements. It will also make market access for FRY exporters more secure (through the provision of unconditional MFN treatment on FRY goods) and will give FRY the opportunity to use the WTO Dispute Settlement Mechanism, which will strengthen its capacity to safeguard its trading interests.
3.49 The WTO accession process is lengthy and complex and places heavy burdens on the government of acceding countries, both in the preparation of reports regarding the current situation and in the modification of legislation and practices of institutions affecting the conduct of international trade. It is obviously too early to say which FRY legislation will need to be modified and in what ways; for example legislation affecting intellectual property rights, anti- dumping or safeguards may be affected. But it is almost certain that some legislation will require amendment.
3.50 Although SFRY was a member of GATT, the WTO agreements cover a much wider area of economic activity over which members have made commitments. One such area is that of technical standards which is covered by the agreement on Technical Barriers to Trade (TBT). It appears that FRY has a number of regulations covering technical standards, but that they are either incompatible with international standards and/or they are not effectively enforced11. Similar issues are likely to arise in the implementation of Sanitary and Phyto-sanitary standards (SPS) which have become extremely important for the EU, the major trading partner of FRY, as well as on other policies such as Trade Related Investment Measures (TRIMS).
3.51 How rapidly the accession process is completed depends largely on the actions of the acceding country. The government has taken several positive steps, organizing itself quickly through the appointment of a high level group to coordinate the overall accession process. This
11 It has been reported that the fact that a FRY shipyard did not adhere to the appropriate ISO standards resulted in the loss of an important order recently.
58 Chapter 3. Trade group will be headed by a senior official, with direct access to the highest level of government, and with the participation of appropriate representatives of all the Ministries and other institutions whose responsibilities are related to WTO commitments12. The first tasks of the group will be to identify the areas, e.g. drafting of revised legislation and regulations, institutional changes, in which the FRY authorities need assistance and to seek such assistance from bilateral donors and multilateral institutions. They will also need to prepare a memo outlining the foreign trade regime, which will lay the basis for the negotiations with the WTO. The European Union
3.52 Trade relations with the European Union are extremely important to FRY since these countries account for over 40 percent of its total trade. The EU has already lifted all previously imposed trade sanctions and has declared FRY eligible for autonomous trade preferences (ATP) as a well as for the negotiation of a Stabilization and Association Agreement (SAA) when conditions are fulfilled. The EU’s objective in trade policy for the Balkans is to promote trade liberalization and facilitation among the South Eastern European countries, as well as the integration of these countries into the multilateral trading system (WTO).
3.53 The ATP provides access to EU markets free of tariffs and quantitative restrictions for a very large list of products with very few exceptions, as of January 1, 2001. Implementation of this very generous market access offer was delayed somewhat over issues regarding rules of origin for products of Montenegro. Resolution of this issue in March 2001 has provided FRY with very good opportunities for expanding exports to EU markets.
3.54 Indeed it may be difficult to improve under an SAA the market access provided under the ATP. Nonetheless, the conclusion of an SAA is an important step that the FRY authorities need to pursue actively for two other reasons: (a) the SAA is a contractual arrangement providing more security of market access than the ATP, which involves a unilateral EU action; (b) eligibility for the SAA would require commitments that would start the alignment and implementation of harmonization of FRY legislation and regulation to those of the EU, which would be helpful to the long run integration of FRY into the European structures.
3.55 The conclusion of an SAA with the EU depends on progress on a wide range of political and economic issues. But on the economic front, the commitments for harmonization of legislation and regulations, as well as for liberalization of markets and increased competition will be compatible with and, in many cases, identical to what the government would have to do to secure WTO accession. Thus, while participation in two concurrent but separate negotiations is undoubtedly going to be a challenge for the government, the actual economic reforms it would need to undertake would be converging.
Regional Free Trade Agreements
3.56 The FRY has two active free trade agreements, one with Russia and the other with FYROM. The one with Russia has begun to be put in place, whereas the one with FYROM has been in existence for several years. Both countries are significant trading partners with total trade
12 We understand that preparations for the establishment of such a group are already under way.
59 Chapter 3. Trade
(exports + imports) amounting to 5 to 10 percent each. Both agreements appear to cover a substantial amount of trade (probably over 90 percent by tariff line) with relatively limited exemptions13.
3.57 Under the terms of a future SAA with the EU, FRY would be committed to conclude FTAs with other countries in the region which have also concluded SAAs. This is because the preferential trade agreements signed would tend to have larger benefits for the participants if they are accompanied by FTAs with the other signatories.14 At the same time FRY has committed itself in the context of the Stability Pact to work towards liberalizing its trade with partners in the region15. All this means that FRY needs to examine its trade policy regarding regional partners in the near future. This includes both other countries in the Stability Pact and countries in CEFTA.
3.58 In this examination, it is important to keep in mind that not all FTAs are going to be economically advantageous. Indeed considerable care needs to be taken to ensure that current and future FTAs meet certain standards, or else they may be detrimental to the economic interests of the country. Some of the criteria that would tend to lead to economically beneficial FTAs are the following: (a) the FTA should cover virtually all products and sectors—the EC recommends at least 90 percent of product coverage; (b) countries in the FTA should not have high tariffs towards third countries—thus limiting the potentially harmful trade diversion; (c) customs authorities should be able to handle the complex rules of origin requirements of multiple FTAs. But before a decision is made, a thorough analysis of the economic implications of any proposed agreement is needed.
E. POLICY RECOMMENDATIONS
3.59 A transparent, stable and open trade regime is critical for private sector development, the establishment of competitive markets, and the integration of FRY into the global economy. The Government has already taken some initial steps in liberalizing trade. The recent approval of the trade bill by Parliament has gone a considerable way towards establishing a liberal trade regime. The government, now needs to consider a number of additional measures to address remaining problems in ways consistent with WTO provisions. At the same time it needs to begin addressing, with the help of the international community, the major institutional, regulatory and other constraints that inhibit the private sector’s capacity to engage in international trade.
The main immediate policy priorities are:
3.60 Trade Policy: The government needs to take steps to abolish the remaining few quantitative restrictions and licensing requirements except as required by international agreements, in particular to safeguard national security interests, meet international obligations to protect the environment, contain traffic in illegal substances, maintain appropriate national
13 For details of the FRY-FYROM FTA see J.C. Maur and P. Messerlin “Which Free Trade Agreements for Southeastern Europe”, Stability Pact, Jan.2001. 14 For a discussion of this issues, see World Bank “Strategy for South East Europe” 2000, Chapter 3. 15 Memorandum of Intent signed by representatives of seven Stability Pact countries, Geneva, January 18,2001.
60 Chapter 3. Trade health and safety standards, and protect the environment. In particular, export controls will continue to apply to about 30 tariff lines of basic agricultural goods to ensure domestic food supplies. It will be important to ensure that these quotas would be allocated in a competitive fashion, for instance by auctioning the quotas. Alternatively, the government may want to consider applying export taxes rather than quotas.
3.61 In addition to those required by international agreements, import licenses will continue to apply to about 40 tariff lines covering steel products. It would be preferable to put in place time-limited and transparent safeguard mechanisms, which are consistent with the WTO and can shelter the industry during a period of restructuring.
3.62 Trade facilitation: There is an urgent need for the reform of Customs and related rules and procedures, aimed at facilitating trade and increasing compliance and tariff revenues. An efficient and transparent customs administration is critical to the conduct of international trade. The Federal Customs Administration will have to embark on an ambitious program of renewal and modernization. The leadership of the Customs Service has already been changed, and the new management seems determined to eliminate corrupt practices. Immediate priorities should be to restore integrity and public confidence in the customs administration, and to build the foundations for a future strengthening of the organization. The customs administration should also undertake a detailed review of customs legislation to identify the changes that will be required to support the modernization of the customs administration. The customs administration should also undertake a review of the organizational structure at the customs office and port level.
3.63 A comprehensive strategy and national campaign to combat smuggling should be initiated. Beyond the realm of customs administration, the full restoration of navigation on the Danube is also an urgent priority (see Chapter 8).
The medium and longer-term policy priorities are:
3.64 Trade policy: The government should consider further reductions in the tariff rates, in the context of WTO accession, in about two years. For example, the remaining “nuisance” tariffs of 1 percent should be eliminated at this point. More generally, a long term structure of low tariffs with relatively little variability and few rates in excess of 10 percent should be the target. There is also a need to establish a simple, transparent and uniform system of duty- drawbacks, so as not to penalize exporters using imported inputs on which tariffs are imposed. If and when the existing tariff structure results in potential serious injury to a particular industry, the appropriate response (which is compatible with the WTO) is time limited and transparent safeguard measures. The government should ensure that appropriate safeguard legislation is in place so as to deal with potential problems.
3.65 Market access: Trade liberalization, improvement of market access, and regulatory reform should be pursued through (i) WTO accession, (ii) the conclusion of a Stability and Association Agreement with the EU; and (iii) the conclusion of further free trade agreements with countries in the region.
61 Chapter 3. Trade
3.66 Capacity-building: The operational capabilities of the customs administration should be strengthened, and a modernization of customs clearance procedures should start. FRY should be re-integrated into the TIR convention as soon as possible. New computer systems will need to be implemented in the customs administration to address the strained IT infrastructure.
3.67 There is also an urgent need to re-establish foreign credit lines for trade finance. Longer term export credit finance for capital goods exports needs to be made available. The lack of competition and inefficiencies that appear to plague the telecommunication sector, insurance and air transport should be removed. These inefficiencies raise costs and undermine the competitiveness of the export sector; but they are also a handicap for the operation of the economy as a whole. The Yugoslav authorities need to address these issues as part of their general effort to establish a competitive market.
3.68 Key complementary policy actions in order to make the trade reform sustainable and successful are:
1. An effective macro-economic policy. Stability in the real exchange rate is an important ingredient for long term trading relations.
2. Reform of the service sectors, including finance, insurance, banking, and transport, which are critical for the competitiveness of exports.
3. Private sector reforms, including of the rules and regulations dealing with foreign investment, which is very important in bringing in new technology and providing links to export markets.
4. The development of a functioning judiciary system that can ensure the rule of law in the business sector and reduce the potential for corruption.
3.69 In the very short term, revitalization of the export sector in FRY requires substantial increases in imports, which would probably need to be financed from abroad. However, it would appear inappropriate to provide such additional import financing without sufficient progress in improving the import regime along the lines suggested, since the current structure of incentives heavily penalizes exporters.
F. DONOR PROGRAM
3.70 Assistance to FRY to help in its longer term integration in the world economy should support the following objectives: (i) trade liberalization and capacity and institution building, (ii) trade facilitation, (iii) the re-introduction of FRY into the world trade community.
• Trade liberalization, and institution building: support for the next 18-24 months should be provided to the Ministries to strengthen their long term capacity to implement the reforms recommended above.
• Enhancing the capacity to trade: Most of the requirements for assistance to address the long term constraints that undermine competitiveness, inhibit exports and prevent the full
62 Chapter 3. Trade
integration of Yugoslavia into the global economy do not relate to the trade sector per se, but to strengthening the service sectors that support the production and shipment of exportables. Thus, trade finance needs to be addressed in the context of banking reform; transport requirements for external trade need to be addressed in the context of strengthening transport infrastructure; some of the improvements in the provision of services need to be tackled in the context of privatization and greater competition in the provision of various services and so on. Thus, specific recommendations on assistance requirements in these areas which are very important to international trade can be found in other sections of this assessment.
• Trade facilitation: Measures should be supported in order to ensure that the existing potential for international trade is actually realized. These measures focus mainly on:
(1) Integrated border management, customs and infrastructure work so the goods can physically cross the borders and enter the destination importing country. An efficient and transparent customs administration is critical to the conduct of international trade. Introduction of simplified procedures and streamlining of inspections on the basis of risk analysis, reduction in the time needed for customs clearance and in the waiting time at border crossings and similar improvements, are a high priority for facilitating trade. In this area it is very urgent that FRY is assisted to modernise its custom service and improves transport facilitation, for instance by participating in the regional program of Trade and Transport Facilitation in South East Europe (TTFSE) organized under the auspices of the World Bank, and by taking full advantage of CARDS (the EC’s assistance program, for the region) supported customs and Border Management Programme (see Chapter 8, Transport).
(2) Norms and standards – so the manufactures (and services) for export are acceptable for destination importing countries.
(3) Veterinary and phyto-sanitary control so the agricultural produce for export is acceptable for destination importing countries.
• The introduction of FRY in the world trade community
3.71 WTO accession will impose serious challenges to the government in meeting the requirements of the various WTO agreements. There are technical assistance needs in three specific areas: (a) revising, and as appropriate introducing new legislation and regulations to ensure consistency with WTO agreements; (b) strengthening the capacity of institutions dealing with technical standards, phyto-sanitary controls, intellectual property and other such matters to meet the requirements of the WTO agreements; (c) strengthening of human resources through training in all these issues as well as in the interface between the design and implementation of trade policy and strategy and WTO accession. Technical assistance and training in these areas should be sought from both bilateral donors and multilateral institutions.
3.72 The SAA with the EU. The EU is ready to provide direct technical expertise with trade matters that emerge directly from the SAA process and bilateral negotiations. The EU sets
63 Chapter 3. Trade emphasis on institution building and trade facilitation measures (e.g. standards, customs, infrastructure, etc) so that countries can actually implement their trade agreements on the ground.
3.73 Technical assistance in customs administration is covered in Chapter 8 (Transport), under the section for Trade Facilitation. This section also details investment needs of customs facilities required for trade facilitation.
Table 3.5: Estimated Technical Assistance Needs for Trade
Priority Estimated Total Financing Program Requirement US$ m CY01 CY02-04 Technical Assistance Needs Trade reform implementation support 0.8 0.6 WTO compliant legislation/regulation 1.4 2.1 Technical standards, phyto-sanitary controls, 0.2 1.0 intellectual property. Human resources and Training 0..3 0.6
Totals 2.7 4.3 7.0
64 Chapter 3. Trade
ANNEX I: QUANTITATIVE RESTRICTIONS
The following tables summarize the quantitative restrictions (licenses and quotas) effective in FR Yugoslavia, as of March 2001.
Quantitative Restrictions in Yugoslavia's Trade Regime
Sector Weighted Number of Number of Number of Average Tariff Products on Products on Products subject Rate /1 Export License Import License to Import Quotas Regime Regime /2 1 Animal and animal products 25.84 104 1 37 2 Vegetable products 8.29 26 18 51 3 Animal or vegetable fats 13.67 2 9 3 4 Prepared foodstuffs 20.36 28 19 94 5 Mineral products 6.18 8 9 2 6 Chemical products 7.54 33 41 21 7 Plastics and rubber 9.24 0 3 6 8 Hides, skins and leather 16.17 28 0 7 9 Wood and wood products 11.06 13 0 0 10 Paper and paper products 8.12 4 4 16 11 Textiles and textile articles 12.67 0 1 242 12 Footwear and headgear 22.28 0 0 22 13 Articles of stone, plaster, cement, 18.5 0 0 53 asbestos 14 Pearls, precious stones, metals 18.53 19 15 0 15 Base metals and articles thereof 10.24 21 181 102 16 Machinery and mechanical 10.39 4 49 219 appliances 17 Transport equipment 12.6 3 70 7 18 Instruments 6.28 0 4 25 19 Arms and ammunition 30.66 19 27 0 20 Miscellaneous manufactures 15.35 0 0 18 21 Fine art 10 7 0 0 Total 9.71 319 451 925
Number of products defined at HS 10-digit level. 1. The structure of imports in 2000 was used as a weight. 2. Quotas can be either value-based or quantity-based.
65 Chapter 3. Trade
Sectors with the largest number of products on import license regime (10 or more)
Sector Number of Products on Import License Regime Iron and steel 150 Cars and car parts 59 Iron and steel products 31 Electric machinery 30 Organic chemicals 25 Nuclear reactors & 19 machinery Air and space craft 10
Note: Number of products is defined at HS 10-digit level.
Sectors with the largest number of products subject to import quotas (10 or more)
Sector Number of Products subject to Import Quotas Apparel articles (not knitted) 151 Nuclear reactors & machinery 149 Apparel articles (knitted) 72 Electric machinery 70 Copper and copper articles 44 Base metal tools 38 Edible fruits and nuts 34 Glass and glassware 33 Vegetable, fruit and nut 27 preparations Beverages and spirits 27 Meat and edible meat offal 26 Optical and photographic 25 instruments Footwear 22 Furniture and lamps 18 Ceramic products 17 Iron and steel articles 17 Paper and paper products 14
Note: Number of products is defined at HS 10-digit level.
66 Chapter 3. Trade
Sectors with the largest number of products on export license regime (10 or more)
Sector Number of Products on Export License Regime Meat and edible meat offal 64 Live animals 28 Raw hides, skins and 28 leather Organic chemicals 24 Pearls, precious stones, 19 metals Arms and ammunition 19 Tobacco 13 Wood and wood products 13 Iron and steel 13 Rubber and rubber articles 12 Cereals 11
Note: Number of products is defined at HS 10-digit level.
67 1 CHAPTER 4. GOVERNANCE
A. INTRODUCTION
4.1 The foundation for the planning and sustainable implementation of FRY’s recovery and reform strategy lies in the governance framework of federal, republican, and municipal public institutions. The recent victory of the group of political parties united as the Democratic Opposition of Serbia (DOS) represented a dramatic change in the leadership of FRY. Equally as fundamental is the shift in policy toward transition and a market economy, the elections have brought a dramatic shift in the mode of governing. The centralized authority of the last ten years has given way to a coalition government with a mandate to move to a more decentralized and democratic state. Many of the close personal links between politicians and the business community that characterized governance in the last decade have been broken, creating an opportunity for reduced corruption and greater representation of diverse interests in policy- making.
4.2 While the change in government has brought about a significant shift in leadership at the senior levels of the state, it has not yet brought with it an equally dramatic change in the overall structure and fabric of governance of the country. A decade of politicization and centralization of authority – combined with economic collapse and “brain drain” (some estimates suggest that between 300,000 and 400,000 professionals left during the 1990s) – has left in its wake an inherited national governance apparatus with limited capabilities. Much of FRY’s human capacity has migrated to private informal sector occupations or to NGOs. This leaves the government with a fragile set of institutions. With low public sector salaries (which are unlikely to change significantly in the short term), it will be difficult to reverse the drain away from public service. Thus there is an extensive agenda for public sector reform.
4.3 The challenge of governance in FRY is intensified by the wide variance in needs and in capacity of public institutions in different parts of the country. FRY is a country of economic, cultural, and ethnic diversities, and its regions became industrialized and semi-modernized at different times and under different circumstances. Northern areas, such as the province of Vojvodina, developed more quickly due to proximity to the trade routes from Central Europe to the Adriatic ports. Southern areas, by contrast – including the republic of Montenegro, the province of Kosovo, and the Sandzak region – have remained largely agrarian. While the events of the past decade have affected the whole country, these regional differences have led to differing degrees of public sector capacity.
4.4 Moreover, the limited human capacity of the government is stretched by the multiplicity of the challenges it faces: maintaining macroeconomic stability, initiating first-generation structural reforms toward transition while restarting economic development in the near term, and rebuilding infrastructure and social assets. At the same time, the government must agree on an appropriate resolution to concerns from Montenegro for increased autonomy and manage a
1 Public-sector reform in Serbia is more complex as a consequence of its size, and is at a slightly less advanced stage than in Montenegro. For these reasons, the discussion in this chapter focuses almost exclusively on governance challenges in Serbia. Chapter 4. Governance sustainable, equitable solution to the conflict in Southern Serbia. These difficult problems need to be tackled by a state governed by a fragile coalition of 18 political parties unified largely by their common objective of making a break with the past. Each one of the challenges they face is likely to generate honest controversy and disagreement. The influx of donor assistance in the last several months has added to the burden on a limited number of key government officials, and highlights the importance of donor coordination. Meanwhile, the public statements by leaders of NGOs, strikes by labor unions in Serbia, and other actions in early 2001 already serve to highlight the rising impatience of civil society for real, tangible positive changes. The increasing expectations for quick simultaneous governmental action on a wide range of fronts combined with expectations of transparency and inclusion in public policymaking put a high degree of pressure on the government.
4.5 In the short term, the governance needs of Yugoslavia at all levels of government revolve around the urgent task of setting up the new government and building immediate capacity to set strategic priorities and organize the normal functions of the state. This process requires expedient solutions such as temporary employment of expatriate Yugoslavs and international experts. However, short-term actions should not be taken at the expense of the medium-term objective of the federal, republican, and municipal governments to build efficient, effective and accountable public sectors. No matter how difficult, the two sets of tasks must be undertaken almost simultaneously to ensure a successful transition. Three broad challenges are essential to this goal:
• public administration reform and capacity building to enhance the effectiveness of the public sector;
• reduction of discretion in administrative and judicial decision making to improve the efficiency of the public sector; and
• strengthening of consultation within government and consolidation of the governments’ partnerships with civil society to help build the accountability of the public sector.
4.6 With these challenges also come risks. The political and economic legacy of Yugoslavia has clear implications for the way in which reform is conducted. Specifically, the reform process will need to ensure:
• proper sequencing: In an environment that has experienced as much corruption as Yugoslavia, reforms that reduce discretion and enhance accountability should precede other types of governance reforms. Like many modern societies, Yugoslavia appears interested in adopting a public management system that involves a delegation of power to lower bodies. Without prior strengthening of accountability – for example, which includes developing a system and capacity for financial and performance monitoring – these reforms could lead to increased corruption and reduced quality in service delivery;
• sufficient preparation for decentralization: In an environment with serious constraints on human and financial capacity as exists in Yugoslavia, premature decentralization could introduce lower quality, increased corruption, and geographic inequities. Capacity
69 Chapter 4. Governance
building at the regional and municipal levels is a crucial prerequisite for decentralization, again recognizing the importance of proper sequencing; and
• realism in the reform program: There is always a tension in governance reform, between designing a complete systemic reform (because of the complementarities between institutions) and targeting specific priorities and specific sectors where the demand by officials for governance reform is high (because of limited capacity and political obstacles to governance reform). Experiences elsewhere suggest that systemic reform frequently fails; it also suggests that focused, demand driven reforms can build up experience and an internal constituency for reform.
4.7 This chapter reviews the current governance situation in FRY and highlights key areas to be targeted by the reform effort; the creation of an effective public sector, reducing discretion in administrative and judicial processes, and increasing accountability. Estimated external technical assistance requirements of US$13 million over three to four years are presented in Table 4.1 at the end of the chapter. The estimated financing requirement for 2001 on a commitment basis is US$2.4 million. These requirements are included under Economic Management in the summary Tables 1.1 and 1.3.
B. CREATING AN EFFECTIVE PUBLIC SECTOR: PUBLIC ADMINISTRATION REFORM, CAPACITY BUILDING AND PROFESSIONALIZATION
Public Administration Reform and Capacity Building
4.8 The Government of Serbia has taken a number of important steps to consolidate the structure of governance and lay the groundwork for transition. In March 2001, it announced the creation of a high-level Public Administration Council, which will propose measures to increase the efficiency of government, work with ministries to prepare a medium-term strategy for reforming public administration, and monitor the strategy’s implementation. The Council will conduct diagnostic studies of the structure, functions, and management systems of public-sector bodies; establish a professional and unified public service system; review administrative acts, regulations, and laws for their conformity with the professionalism of the public service; prepare proposals for the delegation of functions to local government taking into account the existence of ethnic minorities; and establish an Institute of Public Administration for the continuing education of public officials.
4.9 The establishment of the Public Administration Council is an important first step toward sustainable public administration reform. The effectiveness of this body depends on the extent of its authority (e.g., whether it reports directly to and its decisions are supported by head of government), the depth of its capacity, and the extent of its consultation with ministries and executive agencies in the preparation and implementation of the action plan for reform.
4.10 A catalytic fund has been established, with the support of UNDP and the Soros Foundation, to fund short term urgent needs for public-sector capacity building and simultaneously finance the groundwork for longer-term reform. Such a fund could provide an important impetus to policy reform. However, one potential risk is that it could create incentives
70 Chapter 4. Governance for managers to work independently of their bureaucracies. Care should also be taken that the fund does not arbitrarily favor specific ministries or public-sector bodies. In addition, a donor coordination council has been formed under the chairmanship of the Minister of International Economic Cooperation, tasked with coordinating overall donor efforts in the area of public administration reform and capacity building.
4.11 Finally, a nascent process of public dialogue has begun, including some televised debates on public issues and key statements by senior officials of the government. Public sector reforms are often very difficult, and it is important to garner supporters both within and outside of government. For this reason, it can be tactically useful to demonstrate the practical benefits of reform. Pilots might be conducted in an effort to create internal constituencies for reform, and could be conducted in service delivery bodies that serve key constituencies, such as the business community and ordinary households
Professionalization of the Public Sector
4.12 FRY’s government, like most countries beginning the transition process, has a bureaucracy that is reported to be bloated, politicized, poorly trained, and poorly remunerated. Precise estimates of the size of government vary widely.2 Jobs in the public sector were often created for social, not productive reasons, so that hidden unemployment exists. Ministers have discretion to recruit and promote staff, with each ministry having its own system of advancement. While recruitment decisions must be confirmed by the Cabinet, this does not appear to have been an adequate check on the expansion of the bureaucracy: it is reported to have grown several-fold during over the last decade. Staff did not receive any specialized training, largely due to resource constraints.
4.13 A new Law on Government has been adopted in Serbia, which reduces the number of ministries to 17, less than half the previous number. As part of this reorganization, departments are being merged and functions and staff streamlined. The new law is an important step in the right direction, and the reorganization process will provide the Serbian government with an opportunity to greatly modernize and rationalize its public sector, in a way that is consistent with EU integration.
4.14 Appropriate remuneration is an important element in a professional civil service. Public sector wages range from the equivalent of US$100 to US$200 per month, and are set according to a public sector pay system. Compressed budgets have eliminated the bonus fund, 13th month salaries, and other ordinary monetary supplements. Public-sector workers do receive hot lunches and, if low income, child benefits. Other benefits have reportedly been discontinued. Wage reform is currently being contemplated. Public-sector workers are permitted to have other jobs, although politicians and senior bureaucrats must declare income and assets. Given the low salaries, a system to grant permission to some officials to work at other jobs might be desirable, as long as these jobs are not in conflict with the person’s official function and are performed
2 Estimates of the size of Serbia’s core public sector range from 35,000-55,000 staff, plus 110,000 teachers and medical workers. The exact definition of the core public sector is not known.
71 Chapter 4. Governance outside the normal working hours of government (for more details on labor markets, see Chapter 13 on Social Protection).
4.15 Policy Recommendations
• To develop and implement a successful reform agenda, the Public Administration Council should have sufficient and qualified staff, and should establish clear consultative mechanisms with line ministries.
• To ensure coordination in the implementation of public sector reform projects, each recipient ministry could consider creating an advisory body (headed by the minister and comprised by his/her key department heads, relevant non-government organizations, and donors) to oversee project implementation.
• The success of reviews of the structure, functions, staffing, and management systems of ministries and executive agencies in increasing the efficiency and effectiveness of government worldwide is mixed. To increase chances of success, the Public Administration Council might consider designing a two-stage review: a review of management and control systems in the short term and a review of structure, functions, and staffing in the medium term. The second review could be usefully linked to the development of strategic priorities within a budgetary process and envelope. Salary reform and opportunities for staff training could also be linked to adoption of the recommendations of this second review. Finally, the review process should explicitly consider requirements for conformity to EU standards in terms of organizational structure and public administration practices. The responsibility for monitoring centrally the recruitment, promotion, and remuneration of public servants, and for ensuring that the public service is managed according to law should be assigned to an existing or new public-sector body, and requisite capacity developed.
• The responsibility for monitoring centrally the responsibility for resolving possible conflicts of interest should be assigned to an existing or new public-sector body, and requisite capacity developed.
4.16 Recommendations to Donors
• In the near term, donors can consider supporting the capacity building fund already established.
• Over the medium term, once the Government of Serbia adopts its public-sector reform strategy, donors could support a medium-term governance strengthening program designed to implement this strategy. Donors could provide oversight that the reform program contains the proper sequencing, does not call for premature decentralization, and is not overly ambitious.
72 Chapter 4. Governance
C. ENHANCING THE EFFICIENCY OF THE PUBLIC SECTOR: REDUCING DISCRETION IN ADMINISTRATIVE AND JUDICIAL PROCESSES
Administrative Decision-Making3
4.17 Administrative decision-making in FRY over the last ten years has been riddled with corruption. In large part, this was a consequence of the high level of regulation of the economy and society, and the excessive level of discretion that was embedded in administrative procedures, particularly in the areas of trade, the business environment, utilities and public services. These levels of regulation and discretion were justified as a necessary means to survive the economic sanctions, but were used by many officials as a way to obtain bribes or other favors.
4.18 Corruption was prevalent in international trade. Smuggling was encouraged as a means to evade the sanctions, in turn creating an environment of permissiveness in the trade bureaucracy. The fact that trade was heavily regulated added to this by creating many opportunities for corruption. Traders had to register their intent to trade, obtain permits to import contingent on permission of domestic producers, submit to import and export quotas; and pay tariffs on imported goods. A highly differentiated tariff regime created opportunities for traders to negotiate rates and misclassify goods to reduce tariffs. Moreover, tariff rate differentials (between different parts of Serbia, between Serbia and Montenegro, and between FRY and Macedonia, which has joined Yugoslavia in a customs union) have created an incentive for traders to import goods into the country or province with the lowest trade barrier or most easily corrupted customs officials, to illegally obtain a false certificate of origin for that good in the country, and to export the good at no charge to the consuming country or province in the union (for more details, see Chapter 3 on Trade).
4.19 The business environment was also affected, with discretion in the systems of licenses, permits, and inspections. Municipal authorities in many towns set informal prices for issuing various types of permits, particularly for the renting or sale of business premises, the sale of land under the jurisdiction of the local authorities, or for the issuing of building permits or permits for performing certain activities. Bribes were also charged to obtain building permits or to buy land for the construction of business premises or commercial facilities in the town center. Bribes were commonly paid to regulatory inspectors, including those regulating construction, sanitation, safety, water, fire, labor, and taxes (for more details on the business investment climate, see Chapter 5 on Private Sector Development).
4.20 Public utilities and social service delivery were also subject to corruption. In order to obtain a new telephone line, an official in the telephone company might charge a special fee. Illegal hookups were common. Bribes were also paid to link newly-built apartments and houses to existing heating systems and to obtain permits for the adaptation of existing facilities. Beginning in 1996, some municipalities out-sourced public transport to private providers, and there have been alleged “kickbacks” for arranging these concessions, in addition to apartments
3 Information based on Suspended Transition, UNDP, ‘0’ Edition (Serbia) of the Early Warning System for FRY, January 2001.
73 Chapter 4. Governance and vehicles. The law governing procurement provides inadequate procedures for public tenders (specifically, insufficient rules for establishing a best offer), so that procurements can be easily manipulated. There are currently no provisions for public monitoring of procurement at any level of government. Corruption was also present in service delivery. In hospitals, informal payments for medical care and pharmaceuticals were common, and was exacerbated by the scarcity of medicines and equipment during the sanctions. At universities, students used connections to become state sponsored (instead of fee paying), and to pay professors for grades. The elected municipal authorities responsible for this system have been voted out of office, but the bureaucracy they created still remains. (More detail is contained in the relevant sectoral chapters.)
The Judicial System
4.21 As in many other countries in the region, the court system in FRY is frequently depicted as overworked, inefficient and an obstacle to economic development. The imposition of sanctions and harsh economic conditions led many individuals to take the law into their own hands. The state was complicit in that it often failed to enforce laws or enforced them arbitrarily or improperly. Prosecution and adjudication decisions were highly politicized. The Prosecutors Office is subordinate to the Prime Minister, and therefore could be mobilized to implement political directives (e.g., judges who would not implement these directives could be fired). Professionalization and de-politicization of the judiciary is urgently needed.
4.22 The criminal procedures code also facilitated this politicization of the justice system, by providing both prosecutors and judges with high levels of discretion. Prosecutors reportedly have discretion in deciding which cases to prosecute; there are low standards of evidence4; and judges have high levels of discretion in ruling on the admissibility of evidence. All of these features worked together to facilitate selective prosecution and conviction of cases. In this environment, the court system became unreliable and several justice officials became highly suspect. The courts are critically important and need to become respected players in the new economic order.
4.23 In contrast to other countries in the region, FRY enjoyed a strong tradition of commercial law litigation. There are 16 commercial courts including one in Kosovo. The system is not appropriate for a market economy integrated into global markets, however. Judges do not enjoy the confidence of the business community, either because they are not conversant with business or commercial issues or because they often bring an excessively legalistic rather than practical solution to disputes. Furthermore, judges are not well remunerated which contributes to corruption. Non-compliance and general cynicism regarding the rule of law is widespread. Laws are many, excessively detailed and – where not recently revised to conform to EU norms – tend not to be well drafted. Uncertain and unpredictable bureaucratic interpretations are the norm, and even where the laws are satisfactory their implementation is often poor.
4.24 There are also serious imperfections in the current operations of the courts. The courts are overloaded with cases and lacking in basic levels of information technology. Many cases
4 Ironically, a reported exception to this is high standards of evidence for cases of corruption.
74 Chapter 4. Governance could more efficiently be handled by non-judicial staff. In particular, the land and business registers are located in the courts and are much in need of restructuring. While it is technically possible to register a new business in one day, in practice, the process tends to take several weeks, as there are invariably mistakes in the application documents. Not infrequently, the registration judges find irregularities in the company’s voting procedures which means that the application has to be remedied and re-filed. This is inefficient and a wasteful use of resources.
4.25 Policy Recommendations
• A public procurement law could be drafted, and an agency designated to ensure proper implementation of public procurement in accord with this law.
• Regulations could be reviewed and streamlined to reduce inefficiency and bring them into conformity with EU standards. In particular, reform of administrative procedures is needed to create standards for issuing licenses and permits, conducting inspections, and addressing and adjudicating consumer complaints. Compliance with these procedures would have to be monitored by a public-sector body.
• Since one of the best opportunities for introducing reforms that limit opportunities for corruption is when the structure and management practices of an organization are redesigned, the Public Administration Council could consider embedding an assessment of the organization’s vulnerability to corruption in the functional review process.
• Given the legacy of excessive discretion in policymaking and administration, systems for managing and monitoring public-sector performance should be introduced and made operational before any attempts are made to delegate functions to independent or semi- independent service delivery bodies. Otherwise, there is a risk of corruption and loss of financial control.
• The capacity of the state to audit budget execution needs to be strengthened (see Chapter 2 on Fiscal Policy and Management).
• In the near term, procedures to recruit, select, train, promote, compensate, and hold judges accountable; file and process cases and monitor their disposition; hold auctions; and ensure enforcement of judicial decisions should be reviewed, with the aim of identifying appropriate reforms. The adequate representation of ethnic minorities within the judiciary should be considered as part of this review.
• Over the medium term, judicial conditions of service will need to be improved, including the quality of court buildings and other physical infrastructure of the judicial system. Donor supported training of judges in all aspects of the laws affecting the development and operation of a market-oriented economy is also important, as is introduction of basic levels of information technology. Amendments to the criminal procedures code to reduce prosecutorial and judicial discretion should be considered.
75 Chapter 4. Governance
4.26 Recommendations to Donors
• Donors could support the various anti-corruption diagnostic exercises that are underway in FRY and should coordinate their efforts explicitly.
• A detailed assessment is needed to identify specific forms of assistance in the judicial sector. USAID has recently conducted an assessment, and OSCE and the World Bank are in the process of conducting assessments. The results of these assessments should be shared.
• Programs to train judges in all aspects of the laws affecting the development and operation of a market-oriented economy could be supported.
• Basic levels of information technology are lacking and donor support for such investments will be critical.
5 D. INCREASING THE ACCOUNTABILITY OF THE PUBLIC SECTOR: BUILDING PARTICIPATION INTO POLICY-MAKING AND CONSOLIDATING THE STATE-SOCIETY PARTNERSHIP Participation in Policy-Making
4.27 As noted, public expectations are high and could give way to a more critical evaluation if the government is not able to begin delivering on its key election promises. The credibility of the government is closely linked to its capacity to develop and implement policies, regulations, and laws in the public interest, which address key concerns of their main constituencies. To do this, government officials will need to engage the public in constructive dialogue about strategic priorities and policy-making, as well as about their willingness to bear costs in the short term in exchange for benefits in the medium term. This type of consultation can take place in public and private forums with leaders and members of key constituencies, as well as with the media. In this effort, there is an understandable tension between the short-term objectives to rapidly demonstrate capacity to govern and the medium-term objective of effecting change. The lessons of experience of other eastern European countries demonstrate that some key policies were adopted too quickly, subsequently resulting in poor implementation and unintended consequences.
4.28 Beyond politics, consultation in the policymaking process is crucial to the efficiency and implementability of policy. Policies, regulations, and laws that are formulated through a consultative, participatory process can more closely take the preferences of intended beneficiaries into account, and limit the costs to regulated parties. For this reason, formal procedures that allow interested parties within and outside the government to observe and comment on draft policies, regulations, and laws are crucial.
5 The accountability of the state is achieved through a multiplicity of mechanisms; participation of and monitoring by state and non-state bodies are only two of these mechanisms. Other crucial mechanisms include human resource management systems, financial control systems, and justice systems.
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4.29 Despite a legacy of consultative policymaking in the 1970s and 1980s, policymaking over the last ten years was highly centralized, and did not provide adequate opportunities for consultation either within or outside of government. Policymaking authority that had been delegated to local authorities during the socialist period was withdrawn, justified by the need to centrally manage the economy and society during the sanctions. Control over the flow of information about government decisions was enforced using heavy sanctions on the dissemination of information through a draconian information law – since repealed – which severely restricted the freedom of the media The law and its implementation effectively hindered the ability of the media to monitor and report on policy and other developments Independent media were denied licenses through rigged lotteries to broadcast on radio or television and were shut down or severely fined for any violation.
4.30 As described, the centralization of policymaking gave a small group of civil servants a great deal of discretion in managing the economy and society, allowing some politicians to manipulate the economy to their own personal benefit. Links between government and business were very close. While there has now been a dramatic break between policymakers and special interests, it is nevertheless crucial to ensure that the policy process be as transparent as possible, allowing a diverse set of interests to openly compete in the policy debate. The present system is more liberal, allowing ministers a great deal of discretion in policy formulation. Ministers are required to submit draft legislation to the Secretariat for Legislation, to check for its legal correctness and consistency with existing law. After this, Ministers reportedly can present laws directly to the Parliament. While there is an informal understanding that cross-sectoral laws should be discussed in the Cabinet or in a full government session, there does not appear to be sufficient procedures safeguarding participation of interested parties either within or outside of government. The government is committed to opening the policy process to greater non- government participation, however, and many of the new laws are being drafted by NGOs, where many of the country’s best experts reside.
The State-Society Partnership
4.31 The past decade has represented a special period in the history of Yugoslav state-society relations. Non-state institutions such as NGOs and trade unions played a pivotal role in bringing the present government to power. In addition, such institutions provided a shelter for many in the latter part of the 1990s. More recently, many ministers, advisors, and high officials have come into government from civil society institutions. The federal and republican governments have also drawn heavily upon the capacity of such institutions in formulating policy and preparing analyses and strategies. The wide-ranging partnership and dialogue between institutions of the state and of civil society represents a unique characteristic of the Yugoslav transition.
4.32 One of the greatest challenges of the leaders of FRY, both inside and outside of government, will be to ensure that this special relationship does not dissolve in the exigencies of the transitional process. Between 1990 and 2000 over 1,800 non-governmental organizations and civil associations were registered in FRY. Combined with the so called “inherited organizations” (i.e., those established and financed by the socialist regime), there were a total of
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25,000 NGOs in Yugoslavia at the beginning of 2001. In addition, 58 international NGOs and foundations are active in the country. The “third-sector” movement in FRY was financially supported and encouraged by the international community during the 1990s. But, due to a combination of regime policies and international sanctions, links with international donors and NGOs were often clandestine. While this has perhaps had the negative impact of weakening a sense of accountability, it has created an NGO movement that did not develop in the shadow of models of international assistance but has grown up relatively indigenously from a base in Yugoslav society.
4.33 NGOs in Yugoslavia face many difficult transitional issues. Some institutions in Yugoslavia during the 1990s proudly referred to themselves as “AGOs” (anti-government organizations), reflecting their strong roots in political action. The NGO movement was united in its common cause of changing the political situation in the country. This change having been largely accomplished, third-sector groups should not give up their commitment to change but rather adapt to the new circumstances. For example, with the gradual transition from humanitarian assistance targeted to displaced populations to a mainstreaming of humanitarian assistance based upon vulnerability, many humanitarian NGOs must rethink their strategies and priorities. NGOs must develop roles which are compatible with government either through providing services and analysis which government cannot efficiently manage or through open, legitimate advocacy for specific concerns based upon sound reasoning and logic. Where they are membership organizations, they may give voice to the concerns of specific interest groups and this is a legitimate and important function for a healthy civil society. They serve public interests through their own expertise and effort in the specific issue areas in which they have a comparative advantage. They need not be co-opted by the government, but they do need to recognize that they do not represent the voice of all parties in civil society.
4.34 While capacity within the state apparatus is fragile and over-burdened, the richness of civil activism at the national and some local levels is a valuable resource which can be compatible with state institutions. It is not certain that FRY will be able to sustain all third- sector institutions which have developed over the past few years. There will inevitably be a sorting out process and some institutions will fail to find a new purpose or sufficient funding for their activities. Most such institutions are heavily dependent upon donor funding, usually to support specific finite initiatives and projects and yet have had little access to resources to support capacity building and long term planning. In addition, some prominent NGOs have lost key personnel to government agencies during the transition. In the short term, donors must be conscious that there is a risk that NGOs and government institutions become competitors in a search for international resources. As the economy develops, local private sector sources of funding for civil society initiatives will grow. Serbian society has a long tradition of collective action and community philanthropy and there is evidence that some domestic resources can be tapped now, even in the present difficult times. But, the shift from international to domestic support for the third sector will take time.
4.35 In addition to the tangible contributions that third-sector institutions provide to Yugoslav society in terms of service delivery and analysis of public sector issues, they also play a key role in helping to set the stage for public dialogue on issues of concern to particular communities or to the society as a whole, such as economic reform, decentralization, and social assistance
78 Chapter 4. Governance reform. The government must make a range of difficult decisions during the transition period, many of which will have short-term costs for various groups in civil society. In this context, public dialogue can serve two purposes. First, it can permit the range of opinions and ideas which are present in society to influence government policy and offers the possibility of finding creative solutions to public problems which maximize the benefits of government action to society and minimize unavoidable costs to individual groups in the society. Second, such dialogue can enhance the sense of transparency in government operations and demonstrates the confidence of government leaders in the views of the people, and thus contributes to a reciprocal demonstration by the people in the actions of the government even where, in the short term, those actions seem difficult to understand or require sacrifices of some groups.
4.36 In this context, particular attention should also be devoted to the restructuring of the public media, both at national, provincial and city levels, with particular attention to the electronic sector. The presently state-owned Radio Television Serbia (RTS) should be transformed into a truly Public Broadcasting Service, based on a concept totally different from the one of the past. The national TV and radio, used by the former regime as a primary and powerful tool for disseminating hatred and political propaganda, maintains a very negative reputation among the population, and is still marred with huge debts, poor management, outdated equipment and old-style informative policies. The process of its radical transformation could start immediately, in parallel with the parliamentary approval of the related legislation. RTS could be de-politicized and the influence of State and governmental policies limited. The same could happen with the many existing electronic media at provincial and city level. Those media have played a very important role during the population’s struggle against the former regime, and this channel should be preserved. At the same time, though, the local government-controlled stations could become more independent from local politicians and transform themselves into professional and financially sustainable public broadcasting services.
4.37 Policy Recommendations
• A system of consultation on policy, regulatory, and legal drafting using standard methods of consultation could be developed, including: (i) open meetings, especially when regulatory decisions are discussed or taken; (ii) formation of non-government advisory boards to oversee decision-making of ministries and independent executive agencies; (iii) publication of draft policies, regulations, and laws; (iv) adequate periods for notice of and comments on drafts and methods for addressing these comments; and (v) particular efforts to involve ethnic minorities in the development of relevant legislation and instructions. An existing or new public-sector body should be designated responsibility for monitoring implementation of the policy.
• External monitoring of public-sector performance by civil society could be useful in strengthening the accountability of public servants. The government might request independent NGOs to monitor government performance, including the judiciary, in areas which are especially vulnerable to inefficiency and corruption. This monitoring activity could be used to measure the effectiveness of specific reform efforts over time.
• The government can help to promote a healthy environment by ensuring that the domestic regulatory environment is hospitable to the growth of third-sector institutions,
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with adequate provisions to ensure accountability. In the medium term, as accountability mechanisms become more developed, the government might consider contracting out some public service delivery to NGOs. Throughout, the government must protect and support vulnerable groups, in compliance with international treaty obligations and anticipated movement towards EU integration, which would not be adequately represented by existing NGO’s or governmental structures.
• The government can also strive to keep channels open for third-sector institutions to participate in public discourse on important economic and social matters, for example: economic reform, decentralization, and social assistance reform. Some ministries have already established senior advisory committees of experts from NGOs, think tanks and private sector groups to help them to review strategies in their sectors. This kind of initiative is important and could facilitate the institutionalization and sustainability of state-society links.
• The government can support the approval of modern media legislation, in order to fulfill all internationally accepted principles and standards in this field. It should also facilitate the reform of the public media sector, particularly that of RTS.
4.38 Recommendations to Donors
• A detailed assessment of the policy-making process could be conducted, with the aim of identifying specific actions that could be supported with donor funds.
• Donors could encourage a consultative process for the drafting of sectoral policies, regulations, and laws, when specific drafting is supported by donor funds, even if this takes longer than otherwise. Policies drafted with consultation will likely be easier to implement.
• Donors could emphasize the use of domestic human capacity, where possible, over international consultants to ensure that local institutions have a fair chance to grow and consolidate themselves.
• Donors could require the NGOs they finance to publish annual reports, which account for their use of resources.
Table 4.1: Estimated External Funding Requirements for Governance
Priority Estimated Financing Total Program Requirement US$ m CY01 CY02-04 Technical Assistance Needs Corruption prevention 0.45 2.8 Public Administration Reform 1.30 5.2 Judicial Reform 0.65 2.6
Totals 2.40 10.6 13.0
80 CHAPTER 5. PRIVATE SECTOR DEVELOPMENT
A. INTRODUCTION
5.1 This chapter addresses several key areas, the reform of which will be critical to stimulating private sector development in FRY.
• Enterprise Reform. It presents an overview of the condition of the socially- and state- owned enterprises and defines a reform agenda focused on hardening budget constraints and building mechanisms for dealing with the existing stock of these enterprises through privatization, restructuring and liquidation.
• New Entry and SMEs. It describes the situation facing new private enterprises, including Small and Medium-scale Enterprises (SMEs) and proposes a policy agenda designed to promote further growth of this key enterprise sub-sector through liberalization and the removal of barriers to entry.
• Other reforms to support both the restructuring of existing firms and the entry and development of new firms, with a near-term focus on the environment for FDI and a medium-term focus on the development of capital markets.
5.2 The real sector in FRY, in both Serbia and Montenegro, is in very poor condition. The crisis of the past decade brought in its wake macroeconomic instability, the loss of markets and contacts, and isolation from technological advances. In addition, it retarded greatly the evolution of modern, market-oriented ownership structures that had just begun to emerge at the end of the 1980s. The result is that FRY embarks on its current economic journey with a state-and socially- owned enterprise sector that is thoroughly accustomed to a regime of soft-budgets and, as a result, inefficiently organized, substantially loss-making and excessively indebted.
5.3 The private enterprise sector, mainly composed of SMEs, has been much more dynamic and profitable. However, it is small and severely constrained by repressive regulation and an uneven playing field tilted towards the larger and socially owned companies. Repressive regulation has led to much economic activity being pushed into the “gray” or informal economy, while the uneven playing field has resulted in a severe lack of investment and working capital. The significant share of the informal sector created a wedge between the measured and actual standard of living by providing employment and income, but imposes a long term const on society by its detrimental effects on economic efficiency, equity and the rule of law.
5.4 To deal with the severely deteriorated situation in the larger firms, and to unleash the potential in the private sector, reform is urgently needed in three areas:
• Launching a multi-track strategy to address the problems of socially- and state-owned enterprises. This will include the privatization sale of entire companies, the reorganization of some firms prior to privatization, liquidations leading to sales of assets, and “workouts;” that is, special efforts to identify and extract viable business lines from a Chapter 5. Private Sector Development
select set of failing firms -- generally the very large and those of acute social importance - - to put them back into production again.
• Liberalizing the business environment by removing unnecessary and damaging bureaucratic obstacles. The goal is to encourage the entry of new private firms, generally recognized in all transition countries as the primary engine of growth and job creation.
• Modifying the legal framework to conform FRY’s commercial laws to European standards. There is also an urgent need to draft and adopt a new privatization law. One important associated reform would be in strengthening the judiciary to ensure enforcement of laws on an equitable and predictable basis.
5.5 This chapter spells out the required policy changes in each area and suggests how they should be sequenced and assisted by the donor community. Donor programs and the technical assistance needs in each of these areas are addressed at the end of each section and summarized in table 5.4 at the end of the chapter. The external financing requirements for Private Sector Development are estimated to be US$328 million over three to four years. The financing requirement for 2001 on a commitment basis is estimated at US$112 million.
B. SOCIALLY-OWNED ENTERPRISES: PRIVATIZATION AND RESTRUCTURING Background
5.6 SOEs dominate the real sector: The bulk of the real sector in FRY is organized as socially-owned enterprises (SOEs). In SOEs, workers collectively hold ownership rights in their enterprise, mainly in terms of management and the rights to dispose of enterprise assets and residual income. This unique form of industrial organization contributed to Yugoslavia’s earlier economic successes, as an exception to the Socialist standard of state ownership. However, in the context of today’s globalized, market economies, social ownership is an inefficient and noncompetitive ownership structure. Dismantling this system and replacing it with more efficient and competitive forms of ownership is a key challenge for the new Government of FRY.
5.7 "Mixed" ownership category represents firms with both social capital and privately held shares: the majority of their share capital is usually socially owned; frequently the “private” stakes are held by other SOEs or other “mixed” enterprises, under a “system,” the term used in FRY to describe a “conglomerate” holding with many subsidiaries. The 7,550 social, state and mixed enterprises together account for about 83 percent of total employment in enterprises. In addition to the SOEs, mixed and private enterprises, a small number of utilities (electricity, post and telecommunications, water) and transportation companies (including the railways and the airline, JAT) are owned directly by the State.
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Table 5.1: Enterprise And Work Force By Ownership in Serbia and Montenegro (source: ZOP, Belgrade) Private Cooperative Mixed SOEs Total
Serbia – Number of 50,858 2,118 2,839 4,721 60,552 June 2000 enterprises Number of 210,700 23,000 440,400 704,900 1,379,000 employees Private Cooperative Mixed SOEs Total1 Number of 5582 92 435 166 6284 Montenegro – enterprises December Number of 18442 689 44520 23603 87546 1999 employees
5.8 Industrial production has collapsed over the last decade. Recorded industrial production fell by a staggering 60 percent from 1990 to 2000. Currently, most enterprises are operating in a range of 5 to 30 percent of capacity utilization, having lost both their traditional export markets and their links with industries in other former Yugoslav republics, which supplied them with raw materials, semi-finished products and finished components. The reorientation and revival of these trade and exchange links presents a great challenge.
5.9 The enterprise sector has been de-capitalized. Lack of access to markets, technological advances and new equipment, have combined with financial woes to produce an obsolescence of assets in FRY much worse than in the neighboring, comparator states of Central and Eastern Europe (CEE). Equally important, from the standpoint of re-integration into European and world markets, a number of industries have fallen far behind in terms of compliance with environmental protection standards. To compound the difficulty, the 1999 Kosovo crisis resulted in damage to a number of enterprises in important sectors – particularly the oil, metal working, chemical and metallurgical industries.2 These factors discourage investors and must be taken into account when determining the relative weights of privatization and liquidation in the strategy.
5.10 Enterprises have become accustomed to soft budget constraints. Several factors contribute to widespread soft budgets in SOEs, state and mixed firms. In the past, a principal cause was the lack of incentives to appraise properly and enforce the repayment of bank loans (discussed below in Chapter 6). A second cause has been the increasing tolerance of extended trade payables and other inter-enterprise arrears emerging as a result of overall real sector stresses. In the past, the government tried to use the State-owned payments system, ZOP, and its monopoly control over bank accounts, to enforce payment of trade arrears, but firms generally found their way around ZOP restrictions (see Box 5.1). The activities of the Development Fund, an agency designed to provide long- and short-term loans and grants to ailing enterprises, has
1 Include non defined ownership 2 Significant damages are reported in some 80 industrial enterprises employing 150,000 workers.
83 Chapter 5. Private Sector Development also contributed significantly to softening budget constraints.3 These loans tended to be casually appraised and easily extended and rolled over. Through swaps of non-performing debt to equity, the Development Fund has acquired substantial stakes in a number of enterprises, such as EPS, the railway, and several food processing enterprises. Unfortunately, no positive corporate governance seems to be exercised by the Development Fund in these holdings.
Box 5.1 The Bureau of Accounts and Payments (ZOP)
The role of ZOP in debt netting is relevant to the imposition of HBCs. ZOP, a public sector payments agency, functions partly as a financial clearing house and partly as an enforcer of obligations. As a rule, if creditors – usually suppliers – submit proper documentary evidence to ZOP that a debtor has not paid (normally within a 60-day limit), ZOP blocks the central settlement (gyro) account of the debtor. For the whole of year 2000, out of 60,552 firms and other legal entities reporting to ZOP, 31,850 (employing 542,000 people) had their gyro account permanently blocked. Total unmet obligations of this set of firms amounted to 68 billion dinars. The blocking of the gyro account obviously hinders enterprise operations; however, firms get round the blockage by: (i) barter; (ii) keeping and paying in cash; and (iii) paying with IOUs of their debtor or their debtor’s own debtors (through a cascade of bills that can also be discounted). ZOP is better able to maintain payment discipline of taxes and wage contributions: if those are not paid, the enterprise cannot pay wages out of the blocked gyro account.
5.11 The SOE sector is accumulating significant losses. Yugoslav accounting practices are not fully consistent with international standards; this makes it hard to interpret recorded figures. Nevertheless, financial results of enterprises for 2000 are likely to be significantly worse than the earlier figures presented in Table 5.2, since from December 2000, foreign exchange denominated assets and liabilities will have to be carried at the new exchange rate.4
5.12 Regardless of its technical shortcomings, the data reveal that poor financial performance is concentrated in the SOE, state and mixed firms. In the first half of 2000, these categories generated (90?) percent of the economy's aggregated losses. The 100 largest loss makers, all drawn from these categories, account for 63 percent of total losses. Energy companies and a few large holdings or systems5 are the principal culprits. To deal with this problem, the privatization/restructuring approach suggested below focuses separately on public utilities and large systems. Table 5.2 also shows that the more numerous -- but on average substantially smaller and far less capitalized -- private firms produce more than half of all profits generated. Profits in private enterprises exceed losses by a wide margin. Aggregate profits of the profitable SOEs and mixed companies are significantly lower than aggregate losses of the loss makers in these categories.
3 Aggregate, long-term figures are very difficult to determine, but in 2000 the Development Fund provided 2.27 billion dinars of financing (1.3 loans and 0.9 grants); in 1999 the sum was 590 million dinars (206 loans and 283 grants). 4 First, assets and liabilities are revalued differently because most assets are denominated in local currency while most liabilities are denominated in foreign currency. For assets the retail price index is used and for foreign debt the official exchange rate is used. The official exchange rate is used to value losses. Second, enterprises used the official exchange rate of 6 dinar to 1 DEM for June 2000, while the December 2000 statement should be based on the 30 dinar to 1 DEM rate. To this extent June 2000 losses are understated by five times. 5 Among those, the losses of the energy complex consisted of 25% and those of the 11 other, largest systems consisted of 10% of total losses.
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Table 5.2: Losses/Profits by ownership in 1999 and Jan-June 2000 (billions of dinars, current) in Serbia SOEs and State Private Cooperatives Mixed 1754 4133 134 2757 1999 Gross Profits
(as % of total) 20% 47% 2% 31% Gross Losses 17780 2505 178 8490 (as % of total) 61% 9% 1% 29% Net Losses -16,026 1,628 -44 -5,733
2000 (half) Gross 1,637 5,113 69 2,654 Profits (as % of total) 17% 54% 1% 28% Gross Losses -9,301 -2,373 -196 -4,891 (as % of total) 55% 14% 1% 29% Net Losses -7,664 2,740 -127 -2,237
Key Challenges
5.13 The striking difference in profitability (and by implication, productivity) between the private and the non-private sectors is the cornerstone for the proposed strategy of enterprise reform, which is to:
1. sell to strategic investors what can be sold;
2. impose hard budget constraints on loss-making enterprises (lest policies and finance to support them impact negatively on private sector growth and production); and
3. break up non-marketable, failing firms and put their assets to productive use.
The Priority Economic Reform Program
Selling What is Marketable
5.14 The past privatization programs in Serbia: In 1989, the first Yugoslav law was passed allowing experimentation with private ownership in formerly socially-owned enterprises. Under this law, workers received the right to purchase a substantial percentage of firm capital, at large discounts, using a generous installment payments plan. The law allowed firms to be privatized, substantially to insiders, if the employees wished; but they were not obliged to do so. Some privatization activity began, but progress was slow due to the evolving crisis of the Yugoslav state.
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5.15 In 1991, Serbia passed its own privatization law. Hyperinflation in the early 1990’s accelerated privatization, as it had the effect of easing the already attractive terms on which workers could acquire equity. However, in 1994 an amendment to the privatization law revalued capital to take inflation into account; because the law applied new, higher values to past transactions this had the effect of reversing much of the privatization that had taken place. The upshot was popular discontent, extensive litigation, and a completely failed attempt at privatization.
5.16 In July 1997, the Serbian Government adopted the Act on Ownership Transformation (the Law in effect up to early 2001). Once again, the employees were to decide whether or not to privatize, and again, the terms were generous. After obtaining the approval of the Valuation Agency regarding the price at which the company is to be sold, firms were permitted to distribute for free 60 percent of the shares to employees, former employees and pensioners. Then, in a second round, a further 30 percent of shares are first made available for sale exclusively to employees, for cash, with a discount related to years of employment. Ten percent of the shares in firms so privatized are transferred to the Serbian pension fund.
5.17 The 1997 Law provided for a “special privatization program” for some 75 companies of supposedly strategic importance, but the definition of “strategic” was not decided and details of this last initiative were left vague. No company has been restructured or sold under this Law. The 1997 Law has numerous features which render it unsuitable for efficient private sector-led restructuring and investment. They include the following:
• Potentially 90 percent of shares are reserved for workers or the state-owned and controlled pension fund.
• All firms are required to go through a complex, time-consuming process that produces artificial valuations, unrelated to any notion of a market price.
• There is great political pressure from the employees and their allies to keep the value as low as possible in order to facilitate the insiders obtaining as much of the equity as possible.
• Most employees will opt to pay for shares purchased using the available installment plan; which will tend to produce diffused and powerless owners with few incentives, rights or capabilities to make decisions regarding “their” enterprise
• The law allows for possible subsequent revaluation of the shares; this introduces significant uncertainty for the purchaser;
• There are no procedures necessary for dealing with insolvent firms.
• The State cannot initiate the privatization process; firms are not required to privatize within a defined period nor are they given any incentive to do so.
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5.18 The new government of Serbia recognizes the shortcomings of the existing privatization regime and has suspended operation of the 1997 law. However, approximately one thousand enterprises (out of a total of more than 7,000) that had begun their transformation will be allowed to complete the process. The government was not willing to annul the law totally and reverse the privatizations completed or substantially underway; to do so would have created major political problems. The new government believes it would be a profound mistake arbitrarily to reverse actions which have been legally performed. These high potential firms will most likely remain controlled by insiders and suffer from diffused ownership. Under the circumstances, it is unlikely they will attract any external investment unless the government succeeds in its intention to persuade the new employee shareholders to offer their shares for sale alongside the remaining socially owned shares..
5.19 Improving privatization in Serbia. A new Privatization Law is in preparation in Serbia. In close cooperation with the World Bank, DFID, EBRD and the EU, the Serbian government has already undertaken extensive preparatory steps. The first draft of the new privatization law has already been completed and the full legislative framework for privatization, as well as for the necessary prior enterprise restructuring and liquidation, will be in place by mid-June. The proposed Law has the following important provisions that need to be preserved during the consultation process scheduled to begin in late March 2001:
• The draft Law explicitly provides that that 70% of the total capital of the entity under privatization will be offered for sale to strategic investor. The capital remaining after the sale will be allocated to employees and a privatization account. Some 15 percent of capital of the enterprises sold in tenders will be distributed free of charge to enterprise employees, while another 15 percent will be placed in a privatization register for eventual distribution free of charge to citizens at large.
• The draft Law empowers the Ministry of Privatisation to privatise “assets” of the socially owned or state owned companies without court intervention (this article has not yet been incorporated).
• The draft Law does not allow legal entities in which socially owned and state-owned capital combined exceeds 25 percent to buy other companies.
• Bonds to be issued by the government as compensation for lost foreign currency deposits are not be allowed as means of payment for shares under this Law before the due date of the bond.
• Privatisation of state-owned utilities is to be implemented by the Privatisation Ministry; this is important as line ministries should not be in charge of the privatisation of the state-companies under their control.
Sales Methods: The proposed Law envisages four methods of privatization:
• Tender sales (envisaged for attractive, strategic and/or large companies)
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• Public auctions (envisaged for less attractive/medium size companies)
• Out-of-court asset-sales and sales of assets as ongoing concerns (e.g. corporate divisions) and assets sales after bankruptcy.
• Public offerings . 5.20 Tender privatization will be used for companies that are sufficiently large, important and attractive to require the case-by-case approach for their privatization. In companies selected for tenders, the distribution of shares offered for sale or free allocation will be as follows: 70% will be offered for sale to a strategic investor; 15% will be given free to employees/pensioners of the privatized enterprise: and 15% will be transferred to a Privatization Register, as described below.
5.21 Companies that are not of sufficient size or commercial attractiveness to be sold under the tender process will be privatized through an auction process. This sale will be based on highest price offered and the government has agreed that there would not be direct negotiations with buyers except if the auction process fails. In negotiation, concessionary terms may be offered but must be offered to all classes of local investors. In the companies privatized through auctions, the distribution of shares offered for sale or free allocation will be as follows: 70% will be offered for sale to a strategic investor; 30% will be given free to employees if the sale to the investor takes place within 1.5 years, 20% if the sales is within 1.5-2.5 years and 10% if the sale is after 2.5 years. It is important that the Law provides that there will be no free transfer of shares to employees unless the majority of shares is sold first to an investor. Also, the draft Law provides that residual shares not sold in auctions be transferred to a “Share Fund”, which has been established under the 1997 Ownership Transformation Law (see above). It is planned that the shares accumulated in this fund be divested as soon as possible. It is recommended that until divesture, the Law prohibit the State from voting the shares in the Share Fund or using them to exercise control in any other way over the enterprises.
5.22 It is highly advisable that there be no concessions for special groups, for example, existing management. Therefore, it is noted as a very positive development that the Government agrees not to allow Management Employee Buy Outs (MEBOs) as a separate method of privatization because they, as experience in the region shows, favor insider privatization. In the post-socialist countries, insider privatization has proven detrimental to good corporate governance and thus to efficiency and growth.
5.23 Given FRY’s recent history and present investment climate, however, it is clear that a large number of firms will not easily attract core external investors. The privatization strategy must therefore specify the approach to be used in this set of firms. Also, enterprises with clearly non-viable business prospects could not be privatized in this proposed first round; we discuss below the measures required to deal with these firms.
5.24 Three special issues should be noted regarding the privatization process in Serbia. The first concerns the role of vouchers, which have been popular with governments seeking equity in the public distribution of State assets in many Transition economies. While attractive in concept, vouchers have proven to be conceptually and administratively cumbersome. Their use has led to
88 Chapter 5. Private Sector Development abuses by enterprise and investment fund managers, poor corporate governance, and little or no return for the average voucher holder. It is therefore a positive feature of the proposed Privatization Law that it does not envisage the use of vouchers. However, the draft Law provides that 15% of the shares in enterprises sold through tenders will be transferred to a Privatization Register for eventual “distribution” free of charge to citizens at large; the exact form of this distribution has not yet been decided (e.g. the shares could be divested and the proceeds distributed in cash to eligible citizens). The shares accumulated in this Register will remain reserved but unsold and unallocated for a period of four years. The Law shall prohibit the State from voting these shares or using them to exercise control in any other way over the enterprises. The shares reserved for employees and the above mentioned Register will not be allocated until after the sale of capital (to an investor) has taken place. This sequencing is important because experience shows that a sale to a core investor should precede any free allocation of shares to employees or to the public.6
5.25 The second issue concerns debt-to-equity swaps. In other Transition economies, privatizations resulting from debt-to-equity swaps have proved troublesome. The problem is that none of the participants in such transactions have the incentives or the expertise needed to bring about an improvement in governance and a change in a business’s culture. Most of these creditors themselves are beset with severe governance problems. Firms “privatized” in this manner typically end up owned by other and similar SOEs and state-owned banks, with little or no improvement in management and performance.
5.26 The final special privatization-related issue concerns the need for a Privatization Agency. The Government of Serbia has recently re-organized its Privatization Ministry, which now is responsible for privatization, preparing enterprises for sale, enterprise restructuring pursuant to privatization, and assistance to SMEs. The primary role of the privatization Ministry is policy formulation, such as drafting the new privatization law and supporting regulations and ensuring that a robust privatization program is put in place and implemented. Complementing the Ministry, the Government has proposed establishing a Privatization Agency that would have implementation responsibility for the privatization program. This is an excellent idea. The advantage of creating such an Agency is that it could attract necessary talent from the private sector, pay market wages and be more easily dissolved when the substantial part of the privatization and restructuring agenda has been implemented. The Privatization Agency will in all likelihood need to operate for at least five years, even if the Government pursues an aggressive privatization and restructuring program.
5.27 The current privatization program in Montenegro. The privatization program in Montenegro is in some ways more advanced than that of Serbia, in the sense that a program has
6More generally, distribution of proceeds and/or shares to other parties (Pension Fund, employees, privileged groups of citizens) should take place after the sale to the core investor; not before. Investors will be wary of entering FRY, given its recent troubles and present uncertainties. They may be reluctant to invest in firms in which workers and citizens already hold a significant stake. Existing managers can easily alarm the worker/shareholders into opposing external investors, because of fears of restructuring and employment cuts.
89 Chapter 5. Private Sector Development already been adopted for the divestiture of a significant part of the real sector. The program has the following components:
• Tender privatization of 15-20 large companies;
• Mass privatization through vouchers (MVP) of 240 companies;
• Batch sale privatization of 33 medium-scale companies, using a grouped tender approach;
• Special privatization and management contracts in tourism; and
• Bankruptcy processing for approximately 30 companies.
5.28 Under tender privatization, financial and legal advisors have been appointed for Montenegro Telecom and Electric Power Supply Company. A Telecommunications Act is being drafted and a proposal for power regulation is planned, with the help of DFID. The establishment of a Regulatory Agency is underway. Under batch-sale privatization, the projected sale of 33 companies has been advertised (in the Financial Times) to gather information on initial interest
5.29 The MVP envisages the issue to the population of vouchers that can be exchanged for shares in companies or in Privatization Investment Funds (PIFs). Exchanges will take place at centralized auctions, which will last for a limited period of time, after which the vouchers expire. A list of 241 enterprises whose shares will be exchanged for vouchers, has been published. The list specifies the percentage of capital allocated for vouchers; for most companies this percentage is approximately 35-45 percent but it is lower for large companies.
5.30 Workers in the companies affected by MVP are to be allocated 20-40% percent of the shares. Legislation and regulations covering PIFs have been completed. A Central Register has been established, as has a Commission for Securities. The Government believes that the system of licensing and control governing privatization funds will enhance transparency and protect citizens in the MVP process. The timing of the auctions is now being debated in view of the upcoming elections and other political uncertainties.
5.31 Improving privatization in Montenegro. Just a few years ago, the Montenegrin proposals would have been considered “state of the art.” Disappointing regional experience with similar programs, however, justifies caution, particularly with regard to the mass privatization strategy. Mass privatization programs are appealing since they can process quickly a mass of assets in situations where external buyers will be difficult to locate. However, it is now known that MVPs, because they spread ownership widely among diffused shareholders, tend not to bring about significant improvement in corporate governance, especially where institutional development is incomplete. Firms privatized in this manner restructure much less than firms sold to core investors. It was often hoped that investment funds would substitute for external investors and lead the restructuring process, but they, too, have rarely provided the hoped-for improvements in corporate governance. In fact, most investment funds have had their own
90 Chapter 5. Private Sector Development corporate governance problems, because their ownership tends to be diffused as well. In addition, in a small economy such as Montenegro, there is a high risk that there will be a very small number of investment funds. The likely outcome would be significant power in the hands of two or three management companies. There is thus reason to be concerned about the central role played by the MVP in Montenegro.
5.32 A partial response to the problems presented by this approach would be stronger supervisory institutions. Special attention should be paid to the independence and capability of the recently established Montenegrin Securities and Exchange Commission (MSEC). To do its job and protect minority investors, the MSEC will need clear powers to supervise the Management Companies. In particular, the MSEC will have to ensure that there is full disclosure to the public about the performance, prospects and financial condition of the companies offered for privatization through vouchers.
5.33 The batch privatization planned is much more conducive to attracting core investors who might undertake needed restructuring. Despite apparently low interest expressed thus far, this program provides more data and performance indicators on the enterprises offered for sale by this method, as opposed to the minimal data released under the MVP. Montenegro is applying the batch privatization approach successfully pioneered in East Germany and Estonia; the Montenegrin Privatization Council should allocate more good enterprises to the batch privatization method.
5.34 A special problem in Montenegro is the giant KAP aluminum company, which in and of itself accounts for a substantial percentage - between a third and one-half - of Montenegrin GDP. KAP is heavily indebted, overstaffed, and in need of large modernizing investments to become internationally competitive. It presently receives technical assistance (funded by USAID) aimed at debt and managerial restructuring, but much more will be needed. The economic and social importance of KAP to Montenegro reveals the sensitivities and difficulties involved in privatization and restructuring in FRY.
Imposing Hard Budget Constraints
5.35 Enterprise reforms such as privatization and liberalization of entry for de novo firms have worked best when complemented by hard budget constraints. Since it will take a number of years to complete privatization, it is important that scarce government resources in the interim are not absorbed in subsidies to non-privatized enterprises. Also, inter-enterprise arrears are increasing. Unless hard budgets are imposed and payment obligations are enforced, there is likely to be a cascade of arrears through the system, severely damaging many productive activities. The reform agenda for strengthening financial discipline and promoting enterprise restructuring has four elements: (1) immediate measures to harden budget constraints, (2) the break-up of large units and the preparation of their core assets for sale, (3) asset sales of other non-viable mixed and socially owned enterprises and (4) strengthening and enforcement of the bankruptcy and liquidation system.
5.36 Immediate measures to harden budget constraints. The first step is blocking further credits to enterprises from the Development Fund. The second key issue is the enforcement of
91 Chapter 5. Private Sector Development collection by the state utilities; this has to be accompanied by measures to protect the access of the poor or disadvantaged groups to essential services. Specific measures to attack the flow of arrears include:
• Energy arrears. As the owner of the public utilities, the State has the power to instruct the suppliers of power, oil and gas to prevent the build up of new arrears of utility bills. Enforcing a strict policy of discontinuing service to nonpaying industrial consumers would do this. In the first instance the policy could be applied in a limited number of highly visible, well-publicized cases. This will not only serve as a demonstration effect, but it will help to separate those customers who truly cannot pay from those who choose not to.
• Tax and social contributions arrears. The State has the authority and a primary responsibility to announce and implement a policy that no longer tolerates tax delinquencies, at least for future payments.
• New bank credit. Particularly for working capital, bank credit should be provided only through private banks, without interference from the State, and only on commercial terms. The alternative preferred source of working capital financing for enterprises is private business partners (suppliers, clients).
• Financial reporting. In their financial reporting to ZOP,7 large enterprises should separately identify arrears from other payables and receivables. ZOP should be instructed to report, consistently and evenhandedly, all cases of delinquent enterprises to the commercial courts.
Break-up of failing firms and preparation for sale.
5.37 A critical problem in FRY is what to do with the large number, perhaps thousands, of socially-owned enterprises unlikely to attract strategic external investors. Here, as well, hard budgets are a critical first step. Over and above stemming the flow of new arrears, hard budgets encourage loss-making firms to raise money by selling underutilized and surplus assets on the market. Noncompetitive, hard-to-sell firms will only have a chance to play a productive role in the restructured economy if they are reconfigured into smaller and leaner parts, a process which will, at the same time generate spin-off business units more readily acquired and run by local entrepreneurs. Liquidation and asset sales are painful in the short run, but should be regarded not as the death of the enterprise, but rather as the best possible chance to provide a second life to many of the assets, as well as new or continuing jobs for at the greatest portion of the affected workers.
5.38 It is highly advisable that the proposed Privatization Law include an out of court settlement provision that allows restructuring outside the bankruptcy courts. This provision is important for privatization of companies that must be restructured before sale because they are too complex in organization (e.g., disparate lines of business attracting different buyers), or
7 At present, this reporting is done bi-annually. Ideally the reporting should be more frequent, perhaps quarterly.
92 Chapter 5. Private Sector Development companies encumbered by debt that must be worked out. The proposed Law allows for an out- of-court workout but does not give sufficient powers to the Ministry of Privatization to initiate a restructuring program. Unless the draft is amended, there is a high risk that the management bodies of the enterprises will be able to block the implementation of this provision.
5.39 The social costs of liquidations and asset sales are often overstated, as are the political benefits of continuing the existence of noncompetitive enterprises artificially. Many of the workers in chronically loss-making firms are presently working in the informal sector already and are only receiving minimal wages and benefits from their “official” jobs. Legal severance payments are potentially very expensive -- up to three times a worker’s annual salary and are likely to prove an obstacle to restructuring, unless some form of severance package can be negotiated for workers. The package would need to include up-front cash payments and some working capital, possibly through a micro-finance program, to support self-employment opportunities. Also, there would need to be a mechanism to recognize accrued benefits and to offer on-going social benefits to workers, now tied directly to the enterprise.
5.40 The Serbian Government has indicated that it may be willing to wait several years before dealing with firms not immediately attractive to strategic external investors. Such delay has elsewhere been a recipe for disaster, as a result of the negative incentives created for workers and managers. Firms sitting for a long time in a “to-be-privatized” category have proven to be prime targets for neglect, debt build-up, and asset-stripping. The proposed solution is to use enhancements to the insolvency law and procedure to allow creditors to restructure or liquidate these companies during a “second round.” Before discussing needed reforms to the bankruptcy regime in general, however, mention must be made of two specific groups requiring special programs:
• State-owned utilities. For these major companies, it is likely that the privatization authorities will be required to restructure enterprise debt prior to sale and arrange for unsustainable debt to be absorbed by the State. The Bank Restructuring Agency (see Ch. 6) needs to develop an informed view on the amount of debt that public utilities reasonably could sustain following the improvement of pricing and regulatory frameworks. In addition, the BRA or the privatization authorities should identify non- essential and underutilized assets owned by public utilities, take control over these assets, and organize cash auctions to sell them. Such sales will not only reduce these entities to their core business, thus simplifying divestiture, but should also raise cash to offset pre-existing debt.
• Socially-owned systems. Since the holdings or “systems” could not and should not be privatized in their present form, the largest creditors (most likely to be the BRA) should appoint a receiver8 for each system. Each receiver’s compensation should
8 Fearing the social consequences, many transition countries have been unwilling or unable to submit to receivership large firms employing many people, even when the firms are in dire straits. This reluctance has given rise to special programs of “isolation” (sometimes called “enterprise jails”) that freeze creditors claims and sometimes provide additional funds to allow the firm to meet variable costs, including the wage bill. The idea is that in the special and temporary “standstill” period the firm will be examined to determine whether the enterprise, or parts of it, should be reconfigured, and if so, how. Most of these programs have failed, in the sense that deadlines have been extended or ignored, mandated declines in subsidies have been violated, few firms have been sold, and consultants’
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include contingent bonuses and success fees designed to maximize the proceeds from asset sales.
5.41 Strengthening the bankruptcy and liquidation system. The forthcoming privatization legislation provides authorities with a chance to accelerate reorganization or liquidation of non- privatized enterprises that are insolvent, through out-of-court procedures that run in parallel with, or replace, formal bankruptcy procedures. This is potentially very important, given the mass of hard-to-sell socially-owned firms in FRY. Simple, transparent, yet efficient liquidation procedures allowed Poland quickly to transfer excess assets out of failing firms and back into productive uses; the Polish “privatization through liquidation” scheme was a success that needs to be duplicated in FRY.
5.42 Local lawyers active in asset recovery indicate that existing legislation and practice afford unnecessary opportunities for third parties to impede recovery by creditors, postpone enterprise restructuring, and gain time to strip assets. The basic problem, common to many transition economies, is the density and slow pace of bankruptcy and foreclosure procedures, with every step in the process taking far more time than is reasonable. Importantly, the mechanism can be employed only against private individuals and companies–never against socially-owned or State-owned enterprises. Local lawyers consulted estimate that even if it were allowed, it would take from 6-24 months to foreclose on the collateral of a large socially-owned enterprise. They also note that a relaxed attitude by judges to setting deadlines contributes greatly to delays. Foreclosure cases often drag on for up to three years. As the number of insolvent enterprises being subjected to these processes increases dramatically in the coming years, this delay is likely to increase dramatically if the process is not improved.
5.43 Delays are just as common in composition proceedings. Present legislation sets no time limit for convening the required three-judge composition panel, for ruling on a composition petition, or for appointing a composition administrator. The petition from the composition “sponsor” – usually the debtor – is supposed to be accompanied by an advance deposit. This can be a problem, especially for illiquid enterprises. The bankruptcy sponsor (e.g., creditor or ZOP) is obliged to deposit an advance payment in the amount specified by the bankruptcy panel to cover the costs of initiating the bankruptcy proceedings. If the sponsor fails to pay the specified advance, the court will reject the petition. Lawyers say that proceedings are often halted because ZOP fails to pay the fee – sometimes, allegedly, at the behest of debtors.
5.44 In short, the existing bankruptcy/liquidation system is severely tilted in favor of the debtor, and is slow, complicated, uncertain and expensive for all parties and in particular the creditor. Needed improvements9 include, in order of priority:
recommendations that a firm be liquidated have been rejected. FRY would do well to avoid a repetition of this normally costly and unproductive endeavor.
9 While it is clear that the current balance of legislation and practice excessively favoring debtors over creditors in the composition, bankruptcy and liquidation processes is needed, to increase the volume of underutilized assets which can be recycled to more efficient purposes, an equitable balancing of rights must still be maintained in this sensitive area. It is no more fair for creditors to be able to seize assets at will, without affording debtors an opportunity to be heard, than it is to permit debtors to frustrate the realization of creditors’ rights with frivolous
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• Easing foreclosure. The first priority is to make it easier and faster for creditors to foreclose on collateral without having to initiate formal bankruptcy proceedings. For example, pre-auction asset valuation could be eliminated; fixed timetables and deadlines for judicial rulings could be set and enforced, and better safeguards provided to forestall improper disposal of real or moveable property by the debtor.
• Introducing a “middle option.” An intermediate option between debtor-driven composition and administrator-driven liquidation should be considered. Current practice produces either complete shutdown or superficial financial restructuring. What is needed is efficient closure of loss-making businesses, employee layoffs, and sale of non-core assets. Such a “middle option” could be a rapid and creditor-driven workout process including: (1) a professional assessment of enterprise viability, projected cash flows, sustainable debt, and non-core activities and assets; (2) effective control over the debtor’s property and liquid assets during the proceedings; (3) equitable loss-sharing among creditors, management, and employees; (4) priority for new money; (5) tight deadlines so that the process could be completed in 3-6 months; and (6) clear criteria for conversion into bankruptcy proceedings.
• Making administrators more responsive to creditors by giving creditors (as opposed to judges) a greater role in overseeing administrators, and encouraging an element of incentive compensation to give administrators the incentive to focus on the timely maximization of creditor recoveries.
Donor Program (Table 5.4)
Privatization.
5.45 The Privatization Agency will be a non-governmental body authorized to channel trust funds and grants from donors and loan funds from the IFIs. It will be funded for five years on a declining basis, but much of the needs will be front-loaded with privatization receipts presumably able to cover costs after the second year. Training for Agency staff is also an urgent priority. The staff will require training with respect to, inter alia, understanding enterprise corporatization pursuant to privatization, alternative privatization methods and techniques, principles of enterprise valuation and alternative approaches to valuation, privatization processes and procedures, and how to work with financial advisors.
5.46 While the World Bank's funding under the recently approved TFFRY will assist the large privatizations (27 firms in total), there is a void in donor funding for the rest of the privatization program, at least in the short run. The thirty firms discussed are only part of the several hundred firms that need to be privatized through the tender privatization route, which has no funding, so far. The auction privatizations and the restructuring and privatization through out-of-court settlement are also unfunded.
defenses. Tipping the balance too far in favor of creditors will only serve to discourage entrepreneurs from borrowing, much as the opposite will discourage bankers from providing finance to them.
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5.47 There is also a need for advisors to assist in the initial group of socially-owned enterprise auctions -- setting up auction regulations and procedures, and preparing the firms for the auctions (including corporatization and balance sheet restructuring as necessary). Another important early requirement is a public education campaign to present the Privatization Program to the public and the “early wins” to prospective investors.
5.48 Legal Reform. The implementation of the program described above will require substantial TA resources. The government has set up a small team of local legal staff to start the drafting of new legislation and regulations relating to privatization. The government requires assistance in the review of the law and regulations to implement the new privatization law, particularly in the following areas: (1) the privatization program; (2) privatization agency; (3) tender procedure; (4) auction procedure; (5) IPOs; (6) liquidation; (7) valuation of companies; and (8) evaluators.
5.49 Strategic Enterprise Privatization. The privatization of 80-120 strategic enterprises will require assistance in funding the retainer (fixed fees) of investment banks. After the second year, retainer and other fees should be financed from earlier transaction proceeds. Nevertheless, the Government will need help in financing assistance for the “early wins” designed to create initial public credibility for the privatization program. To assist the government in its four initial privatization transactions, financing for advisor teams for retainers, technical consultants, accountants and lawyers is needed. The advisory fees would not include success fees paid to the advisor out of the proceeds of the sale. Privatization of public utilities and socially owned large systems will require significant TA, although the timing and sequencing of these activities need to be carefully considered. Privatization of utilities would be preceded by the introduction of regulatory frameworks; the resources for the regulatory work in energy, telecom, infrastructure and transport are discussed in other chapters of this report. When any of these companies (e.g., ESP, NIS) are ready for privatization, resources for retaining investment banks and independent regulatory work will be needed. The workout of the “systems” requires significant political commitment; therefore, it is suggested to start with feasibility studies and structural analysis for few cases in order to test the situation.
Hardening budget constraints.
5.50 Assistance in the bankruptcy process will be required for drafting legislation and regulations, but perhaps more importantly for training of trustees. The capacity of court appointed trustees has been a key obstacle to successful bankruptcy in other transition counties. The main technical assistance requirements, in order of priority, are as follows:
• Insolvency reform. In-depth examination of current impediments (legal, procedural, capacity) to creditor recovery and enterprise rehabilitation; identification of lessons from other transition countries; and development of detailed recommendations.
• BRA asset pooling and auctioning. Support from a financial advisor with relevant experience in a systemic crisis in helping the BRA form asset pools, market auction or joint venture partnering opportunities, support investor due diligence, and negotiate/document asset dispositions.
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• SME and safety net development. Localities with large, non-viable socially owned systems will require special programs to facilitate the winding up of these enterprises. This assistance may include special programs to provide worker safety nets and develop SMEs. Programs may need to be specifically tailored for each region or municipality.
• Commercial training of judges and administrators. The likely upsurge in compositions, bankruptcies, and creditor-driven restructurings will strain existing capacity.
• Utility company debt-service capacity. A financial advisor should be retained to develop projections of the financial position and cash flows of utility companies following pricing/regulatory improvements and privatization. The purpose would be to identify sustainable debt that can be left with each utility instead of being absorbed into the general pool of state liabilities.
• Privatization liaison and support. A financial advisor would help the BRA analyze sustainable debt of “good” social enterprises, expected returns from strategic sales and sales of non-core assets, and liaise with the privatization authorities.
C. PRIVATE SMALL AND MEDIUM NEW ENTERPRISES
Background – The Private Sector in Serbia
5.51 A small but vibrant private sector. Starting in the 1960s, but accelerating greatly in the 1990s, a small but vibrant private sector has grown in Yugoslavia. There are today an estimated 300,000 micro-enterprises in the country, mainly retail shops, service establishments, and other sole proprietorships; some 60,000 registered small and medium private firms and about 1,000 large private firms. In addition, there are many firms operating in the gray economy, but the assumption is that most of these are micro and small or at best medium sized firms. Therefore, the private sector can be considered largely as micro, small and medium sized firms (MSMEs).10 However, SME data and statistics also include some 10-11,000 socially, mixed and cooperatively owned small firms, which means that that not all SMEs are private. The total numbers of SMEs is approximately 70,000.
5.52 In Table 5.3 below Mitra and Selowsky (2000) compare the share of small enterprises (less than 50 workers) in a number of transition economies; the relevant available figures for Serbia have been added from recent estimates.
10 Yugoslavia uses three criteria to denote SMEs—workers, assets and sales revenue. Most statistics are compiled on the basis of workers, thus small enterprises are less than 50 workers, medium enterprise are 50-250 workers and micro we assume the standard definition is under 10 workers.
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Table 5.3: Employment and Valued Added in Small Enterprises, 1998 (Average for all enterprises = 100%) % SEs(<50) Employment Value Added KAZAKHSTAN 88.6% 15.6% 22.4% UKRAINE 69.2% 16.9% 30.0% RUSSIA 56.3% 18.6% 23.0% SERBIA 94.1% 22.2% 30.0%
5.53 The gray economy. From 1992 until the formation of the new government in December of 2000, high inflation, UN sanctions and the eventual Kosovo conflict added to Government neglect or overt hostility that had an adverse effect on SMEs. As a result, the sector largely stagnated in recent years with respect to both the entry of new firms and the development and growth of existing SMEs.
5.54 At the same time, however, a robust informal economy developed and began to absorb employment from the failing state and social sectors. While many workers were formally listed as working in state and social enterprises and even received nominal wages and, most importantly, benefits from these enterprises, a large number also held jobs or ran micro- businesses in the informal economy. Estimates are that by 1997 the informal economy accounted for over one-third of total employment, concentrated in trade (28 percent), agriculture (22 percent) and the retail and service sector (19 percent). 11 Closed internal markets favored the emergence and development of a very diverse population of entrepreneurs and firms, ranging from quasi-criminal12 traders and sanction-busters to dynamic honest SMEs; the latter can and should be the main engine of future growth.
5.55 A number of enterprises have evolved from trading to added value processing and manufacturing, largely to service the domestic economy. A sample of medium sized enterprises visited in January-February 2001, demonstrated that they had emerged from isolation and from the recent crisis with the dynamic capacity to grow and develop13. For example, virtually all of the firms visited had developed links with foreign suppliers and customers through earlier trade activities. Most had imported technology and equipment to add value through processing and manufacturing to their previously traded products, while several firms had diversified into new product areas, generally related to their prior activities. All of the businesses visited had clearly defined expansion plans and strategies. As a rule, the owners were well-educated and had managed their businesses over the last 6-10 years through difficult times, leaving them currently ‘lean and mean’ (agile and aggressive). The owners were generally optimistic about future prospects for their businesses. They expressed confidence in the new government with respect to business opportunities and the creation of a level playing field.
11 The Economics Institute, Analysis of the Grey Economy In FR Yugoslavia With The Assessments for 1997 And Recommendations for Its Legalization, 1997. . 12 For example, groups of private cement traders selling all the cement produced just at the gates of socially-owned cement plants, thanks to exclusive arrangements with the SOE’s management. 13 A joint World Bank/IFC team visited about 30 small and medium firms and a few larger firms. This was clearly a set of better firms and in no way a scientific sample. The team also observed focus group interviews with some 30 mainly smaller firms. .
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5.56 In contrast to the medium size firms visited, focus group interviews with some 30 small size firms indicated that these had suffered greatly over the last several years and many were reduced to operating in the gray economy. They generally experienced great difficulty in starting their businesses, struggled to meet a myriad of intrusive and costly government regulations, and had no access whatsoever to external finance.
5.57 Particularly onerous for small businesses is the taxation system. For example, social security and other contributions for employees equal $1.20 for each direct $1 of labor costs. Also, there are myriads of different taxes that are not only confiscatory for small businesses, but also extremely difficult to handle administratively. The financial (tax) police regularly harass small businesses, and are perceived as both arbitrary and corrupt. The customs authorities are another source of complaint. Until recently each import or export order required separate approval. Foreign exchange was often denied to small traders arbitrarily, with preference given to friends of the old regime. Finally, the banking system and ZOP came in for particularly hard criticism. Small business owners deeply resent that they can only withdraw 500 dinars at a time from their bank accounts and that ZOP watches over them. They claim that often money disappears from their account and is only restored with great bureaucratic difficulty.
5.58 The overall conclusion is that small businesses have found it extremely difficult to grow over the last several years and have instead largely resorted to operating in the gray economy or with a foot in both the formal and the gray economy. Businesses might be officially registered, but a number of employees were paid in full or in part in the gray economy in order to avoid the tax and social security contributions. Many transactions take place for cash or for barter and are never reflected in the official books. Profits, if any, are substantially understated. Also, many trade and foreign exchange transactions occur outside formal channels.
5.59 Limited access to capital. Existing private firms in FRY have little or no access to external finance and must raise working capital (from savings, family or friends) and suppliers credits in order to sustain their businesses. Large banks have served the mixed and social sectors and ignored the private sector in general and the MSMEs in particular. The financial difficulties of the major banks preclude them from servicing the growing demands of the private sector in the near-term. Over the last several years, a number of private banks have emerged, many of these established by private enterprises. But these banks are mostly small, thinly capitalized, and only offer short-term (1-3 month) working capital credits to a small number of best clients. Borrowing is prohibitively expensive, with interest rates at 6-8 percent per month, or the equivalent of 90-133% per annum. There is little in the way of financial infrastructure to service the private sector, with the exception of the small private banks. There is an absence of trade finance, micro-finance institutions, leasing companies, credit unions and private equity or venture capital. The financial-legal framework for private sector activity is deficient.
The Private Sector in Montenegro.
5.60 In general. Historically, private sector development has lagged in Montenegro. As in Serbia, the private sector mostly consists of MSMEs, but in Montenegro these are mostly micro- enterprises averaging 1.5 employees per establishment. Historically, the private sector was
99 Chapter 5. Private Sector Development constrained by policy and law, until a 1989 law partially liberalized private ownership.14 Until the 1989 Law, private sector activities were strictly limited to catering, handicrafts, transportation and agriculture. Private firms were limited to five employees, their assets were also limited as was the amount of arable land they could cultivate in the case of agriculture (10 to 20 hectares). As of end 1989, there were just 4,065 private firms in Montenegro, employing 6,325 or 7 percent of total employment. The share of private sector domestic product in GDP was only 2.9 percent.
5.61 As in Serbia, the private sector in Montenegro grew substantially from 1989 to 1992 and thereafter leveled off and actually declined in numbers. By 1996, sole proprietorships increased from 4,065 in 1989 to 5,514 (an increase of 35.5 percent), but down from a peak in 1992 of 6,819. The number of workers employed in the private sector increased 3.5 times to 21,080 from 6,325. By 1998 the private sector accounted for 33.5 percent of GDP (including agriculture and 19.7 percent excluding agriculture). Qualitatively the MSMEs remain mostly micro enterprises and are concentrated in trade, restaurants and other services. There are few medium size firms, few firms in manufacturing, little contracting between the social and mixed sector to the private sector and virtually no technologically dynamic firms.
5.62 Government and donor support for the private sector/ MSMEs. Government support for MSMEs has been scattered amongst several ministries and institutions. Development efforts have included a Self Employment Program from 1991-1997 directed by the Employment Office that disbursed some 10 million DEM, and a Program for Labor Surplus in 1992 that disbursed some 20 million DEM to some 475 projects. In 1998-1999, there was a special fund to promote SMEs with some DEM 10 million disbursed. These subsidized programs are clearly not a substitute for sustainable MSME financing from the financial sector and ideally should be phased out over time.
5.63 An Agency for SME Development has recently been established by the Government and its main goals are to create an overall strategy for supporting SMEs, policy initiatives, to improve the business environment, support for SME training and improving statistics on the private sector. The Agency manages three donor supported projects at present. In addition to the projects under the SME Agency, donors have offered significant assistance in a diversity of areas such as a Center for Entrepreneurship, micro-finance programs, advice on establishing dairy associations and support for the development of tourism.
5.64 Access to finance. State banks in Montenegro have similar problems to those in Serbia; they are burdened with non-performing loans and offer little to the private sector. There are a few (3-4) smaller banks reaching out to the private sector, mostly in the form of micro-credits or short-term working capital loans at an interest rate of 2-3 percent per month. Donors have offered a number of credit lines to supplement the capacity of the banks. In addition, several micro-finance institutions, both NGO and commercial bank supported, are now active in Montenegro. There remain two Government sponsored funds which finance SMEs -- the Development Fund and the Employment Fund. The Development Fund utilizes proceeds from privatization to fund the private sector. Its loans are from 3-4 year term loans, up to a limit of
14 The Law on Performing Economic Activities by Personal Work and by Means Owned by Citizens.
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DEM150,000, at an annual interest rate of 5-7 percent, clearly a subsidized rate. The Development Fund recently ran out of resources and has stopped funding.
5.65 Other problems encountered by the private sector in Montenegro. The problems are similar in most respects to those in Serbiaexcessive and complex taxation, rigid labor laws, and excessive regulation. But a major issue is also lack of entrepreneurs to support new entry and to grow small and medium enterprises beyond the micro stage.
Key Challenges for the Private Sector in Yugoslavia
5.66 Improving the business environment. In the near term the return to growth of the Yugoslavian economy requires a business environment conducive to the development of the private sector. SMEs are at present burdened by excessive taxation and social charges, inflexible labor legislation, and a myriad of regulations governing their operations which are inappropriate to the development of a market economy. Furthermore, they are subject to regular harassment by financial police seeking rents. Government action should seek to support the dynamic entry and growth of de novo firms in an environment free of burdensome regulations. De-regulation could provide the Government some early success in stimulating economic growth and earn it great support from the private sector.
5.67 Structural reforms to support growth of the private sector. In the next few years the private sector should also grow dynamically as a result of structural reforms, specifically privatization of the mixed and social sectors, liquidation of non-viable firms and the sale of their usable assets, and through the break-up and eventual restructuring of the large systems. Progress on structural reforms is inevitably linked to dynamic entry of new firms and the growth of the existing private sector. The social and mixed sectors have historically crowded out the private sector. Therefore, imposition of a hard budget constraint coupled with necessary structural changes in these sectors are important complements to liberalization of entry.
5.68 Government assistance to SMEs. In Serbia there is at present little state support for MSMEs, although the new Government is committed to assisting them. Training or capacity building programs are not yet available either through government, NGOs or the private sector. In Montenegro, by comparison, the Government has created a Small Business Agency and has developed the beginnings of a robust support program for SMEs with significant assistance from the donor community.
5.69 Enhancing access to capital. Complementary to this effort is the need to rapidly provide financing for the private sector, largely starved for capital in the last several years. Again, this problem is linked to that of maintaining a hard budget constraint on loss making mixed and socially-owned enterprises. Bank lending to these favored entities crowds out credit to the private sector. There is a need to provide institutional support and equity capital to the few private banks that presently service the private sector. There is also an urgent need to develop non-bank financial institutions such as credit unions, leasing companies and micro-finance institutions.
101 Chapter 5. Private Sector Development
Policy Priorities for Meeting these Challenges
5.70 Removing barriers to private sector development. Positive first steps would be the removal of restrictions on private sector entry and expansion and legitimization of the informal sector. Government could rapidly bundle a number of policy measures and other actions to improve the business environment in order to build business confidence. This can be done without external resources and would constitute an “early win” for the government with respect to pro-market reforms. Concrete efforts would include:
1. reform and liberalization of labor legislation and regulations, substantially lowering the rate of taxation and contributions on employees wages to encourage SMEs to pay their workers officially and not in the gray economy; flexible hiring for part-time, seasonal and casual labor; and relaxation of the current rigid benefits and severance packages which hinder job creation;
2. simplification and lowering of taxation of SMEs by developing a standard method for calculating lump sum tax payments for sole proprietorships and limiting tax inspections of private businesses;
3. simplification of all other areas of regulations and required reporting by SMEs to the Government;
4. elimination of maximum limits of withdrawal on SME bank accounts, presently set at 500 dinar per withdrawal; and
5. elimination of special privileges given to favored and selected firms by the previous regime.
5.71 Enhancing government support for MSMEs. The difficulty for the Government will be finding the correct balance. Many transition governments have moved to highly interventionist MSME strategies, including large bureaucratic machinery supported by donor funding. Most of these efforts have simply failed to work. On the financial side, governments often require banks to provide subsidized and/or allocated credits to SMEs. This also does not work. Subsidies are not sustainable, and most often the scarce resources offered through subsidies are allocated to the well connected or those paying bribes; not those with the best commercial potential.
5.72 The dilemma is how Government can best support the dynamic growth of the private sector, in particular MSMEs without introducing further distortions into the economy. An approach that has worked elsewhere is to establish a Small Business Agency15 that is initially supported by government, but operates on commercial principles. Its board of directors and management should be recruited from the private sector. While start-up costs generally come from loans or grants, clients should - from the outset - pay a portion of the costs. Over time, such an agency should become self-sustaining as a larger and larger percentage of its budget should come from fees for its services to its private sector clients.
15 Such an Agency has already been established in Montenegro and it has just recently been created in Serbia following Bank recommendations.
102 Chapter 5. Private Sector Development
5.73 Some early actions that would build support for the Government’s reform program include the following:
• establish regional branches of the Agency that works with SMEs, NGOs and municipalities supportive of an enabling business environment; create the sense of a public/private partnership with respect to SME development; lessons can be drawn from a number of European countries, such as Ireland and Scotland, as to how such agencies should operate;
• encourage transparency between the Government and the private sector; appoint an Ombudsman in the Agency to whom private businessman can address problems; open meetings should be held with ministers and their senior staff and the private sector on a periodic basis in order to transparently discuss changes in laws and regulations that affect SMEs prior to their enactment and to discuss recurring problems faced by the sector;
• advertise widely all proposed changes to laws, and do the same for regulations once implemented; and
• periodically survey small businesses to ensure that policy measures and other actions have actually addressed business needs.
5.74 Enhancing access to external capital. The private sector has been starved for capital in recent years. The legal and regulatory framework needs to be reformed to provide the correct incentives for banks and non-bank financial institutions to finance the private sector. Collateral laws need to be reformed, with a law on floating collateral (accounts receivable, inventory and equipment) and the establishment of a collateral registry as very high priorities. Banking and financial sector laws should be reviewed to ensure that: (a) regulations regarding leasing provide the right incentives with respect to taxation and amortization of leased equipment by the lessor; (b) they allow the development of micro-finance institutions such as NGOs or finance companies, but restrict their ability to mobilize deposits unless they are adequately supervised; and (c) the legal system currently heavily favoring debtors, is reformed to achieve a fairer balance between the interests of creditors and those of debtors.
5.75 Supporting financial institutions that service MSMEs. Donor support will be needed to assist in the institutional development of the small private banks that presently service the private sector and in the creation of non-bank financial institutionsleasing companies, credit unions and micro-finance institutions, that are critical to the long-term development of MSMEs. There is a danger that both government and donors, recognizing the urgent need, will rush to provide too much capital for such institutions and will be tempted to subsidize or even cap interest rates. Relatively immature financial institutions will need to receive technical assistance support to grow institutionally, as well as patient equity infusions and working capital lines at levels that can be readily absorb but which will not put the institutions at risk. Most importantly donors will need to insist that lines are offered only at commercial rates so as not to distort the market.
103 Chapter 5. Private Sector Development
Donor Program (Table 5.4)
Serbia
5.76 The MSME sector is an area where donors can make an important difference and contribute substantially to growth. This assistance should include the following over the next 18 months:
• legal advisory support to de-regulate and modify laws and regulations affecting SMEs with respect to: (i) taxation; (ii) labor laws; (iii) registration and licensing; (iv) collateral laws; (v) modification as required to the laws governing leasing, micro- finance institutions and credit unions;
• technical assistance to and equity investment in a select list of private banks presently serving the private sector;
• technical assistance support through banks and NGOs for micro-finance institution building; supporting lines for working capital loans to micro finance clients through qualifying micro-finance institutions;
• lines of credit, at market rates, to these banks for working capital loans to SMEs, once it is clear that the banks have the institutional capacity to absorb such lines;
• credit guarantees and insurance, covering working capital for export production and political risk insurance for foreign firms investing for productive purposes.
• assistance in establishing a credit union system;
• initial investments in the leasing sector;
• creation of an SME Agency established on commercial terms with declining support over a five-year period; and
• SME Advisory Centers at regional/municipal levels to provide business advice to SMEs with declining support over a five-year period.
Montenegro
5.77 Donor support for MSME development is well underway in Montenegro and it appears to address the critical issues.
• USAID is supporting some 8-9 projects, including support for the hotel/tourism sector; training programs for entrepreneurs on business planning and accounting/finance are soon to start; Land-o-Lakes, a major dairy cooperative in the U.S., is assisting in setting-up local dairy associations; Opportunity International has established a micro-
104 Chapter 5. Private Sector Development
finance NGO; and CIPE has established a Center for Entrepreneurship that is now supported by other donors such as the UNDP;
• The governments of Slovenia, Austria and Italy, together with the EBRD, have established the SME Development Program within the Agency for SMEs focused on business-to-business linkages with Slovenia, support for self-employment, SME education and training of consultants, rural SME development, and rehabilitation of SMEs; and
• KFW and the Government of Austria have set up SME credit lines.
The indicative list above indicates that this critical area of development is currently being addressed by donor programs.
D. OTHER REFORMS FOR PRIVATE SECTOR DEVELOPMENT
5.78 Several elements of the framework for private sector development are relevant for both the state and socially-owned enterprises discussed in Section 1 and the new private sector discussed in Section 2. This section deals with three such topics: (i) the framework for foreign direct investment (FDI); (ii) capital markets; and (iii) competition policy . Background and key challenges
Foreign Investment
5.79 FRY has received negligible amounts of FDI since 1990 and needs to modernize its investment legislation as well as its overall business environment. The current investment regime is ostensibly based on the following principles: (1) unrestricted access to the Yugoslav market; (2) full transparency of establishment and operation; (3) most-favored nation; and (4) national treatment. However, the current Foreign Investment Law requires reciprocity, so that such benefits are only available if the source country of the investment has similar provisions, which can be a serious impediment to FDI from some sources. Foreign capital may be invested in one of several ways--joint venture, equity investment, BOT and in cash or in kind. However, the law seems to presume that most foreign investment will come in the form of joint ventures or concessions, which was the norm in the Socialist past. In fact, most Central European countries today receive FDI through privatization, mergers and acquisitions, and greenfield investment.
5.80 Investment in public information, telecommunications, supply and heating systems requires a license and ownership must not exceed 49 percent. These restrictions on percentage of ownership will also need to change if the Government wants to attract high quality investors to these sectors. In addition, provisions for access to international arbitration are unclear and the Government will need to have a clear policy in favor of international arbitration, including a fresh application to join ICSID.
105 Chapter 5. Private Sector Development
5.81 Numerous incentives were provided including free access to imported equipment and various tax holidays and exemptions from profit and other taxes. Tax holidays are a problematic form of investment incentive, and are especially vulnerable to abuse. This is an area where further detailed analysis is warranted.
5.82 Montenegro enacted its own foreign investment law at the end of last year. The Montenegrin law follows the same principles as the federal law, but is more liberal in several ways. The Montenegrin law allows investment in all economic sectors, with the exception of the military sector where a license is required and ownership must not exceed 49 percent. The Montenegrin Foreign Investment Law does not require reciprocity.
Capital Markets.16
5.83 The Belgrade Stock Exchange (BSE) was established in 1989 as the Yugoslav Capital Market, taking its present name in 1995. The legal framework was set by the Federal Stock Exchange Law (1994). The BSE has 30 members (of which five are banks) and the largest 10 represent 80 percent of turnover. Turnover in the first half of 2000 was 5.4 billion dinars dominated by the commercial notes of banks and companies.17 Company shares are not currently a significant part of the business of BSE, representing only 5 percent of turnover in 1999 and 2000. The BSE’s information system is sophisticated, but its trading system is not. The BSE will need to develop more sophisticated trading, clearing and settlement systems if it is to cope with post-privatization trading as privatization expands. Based on the Federal law on Stock exchange, Montenegro established the Montenegrin Stock Exchange.
5.84 The Federal Securities Commission. The Stock Exchange is licensed and supervised by the Federal Commission on Securities and the Financial Market (Commission). The Commission was established in 1989 and is based on the SEC model of the United States. In practice, the Commission is not functioning as new members have yet to be nominated by the new authorities. The National Bank of Yugoslavia, the FRY Ministry of Trade, and the FRY Ministry of Finance also have a limited regulatory role over the capital markets. The legal framework governing the operations of the Commission and the Exchange is well established, including the Federal Securities Law (1995), the Federal Stock Exchange Law (1994), the Federal Law on Foreign Exchange Market Operations (1995) and the Regulation on the Federal Securities and Financial Markets Commission. Each of these laws is currently under review by the UK DFID and new draft laws are expected in early April. The new laws will strengthen the enforcement powers of the Commission, provide regulatory oversight of the embryonic derivatives and mutual funds markets, and generally harmonize these statutes with OECD and EU standards.
5.85 A new Investment Funds Act is also under preparation together with a new law to establish a central registry to facilitate the secondary trading of securities. The Exchange authorities are anxious to become involved in the Government’s ownership transformation program and could have a useful role to play in organizing and operating cash auctions and
16 The data in this section are based on DFID visit reports of November 1 December 4, 2000. 17 In 1999 turnover was 6.1 billion dinars, of which commercial notes were only 17 percent, with FRY and NBY bonds representing 54 percent, and company and bank bonds 23 percent.
106 Chapter 5. Private Sector Development supervising secondary trading in vouchers. In time, if the regulatory capacity of the Securities Commission is deemed adequate, Yugoslavia could use its capital markets to float shares of some of the companies being privatized. Poland did this consistently during the course of its privatization program and created one of the few robust capital markets of the region.
5.86 In Montenegro, the Central Register has been founded and the documents, procedures and basic software have been prepared. As mentioned above, a Commission has recently been established in Montenegro, initially under the auspices of the Privatization Council, with the intention of guaranteeing its independent status as soon as possible. Legislation and by-laws on privatization funds have been completed and some 70-market participants have been trained in 5 seminars.
Competition
5.87 The Federal Antitrust Law, enacted in 1996, seeks to control price collusion practices rather than influence and shape market structures, and there are no explicit provisions regarding mergers and non-economic barriers to entry. Furthermore, there is no distinction between regulation of natural monopolies and the protection of competition in competitive markets. Price ceilings apply to most goods and services produced by State enterprises, mainly in the non- tradable area. A Federal Anti-Monopoly Commission was established in 1997, but it has never been made operational. While a great deal remains to be done to modernize FRY’s competition laws, as pointed out below, it is not clear that experience in transition economies supports the assumption that an early emphasis on anti-trust has been successful.
Policy Priorities to meet these Challenges
Foreign Investment
5.88 In light of FRY’s prolonged isolation, and the acute need to attract good new owners and investors, priority should be given to development of a new Federal Foreign Investment Law that clearly guarantees the rights of all investors, and sets up a rational and competitive set of inducements and policies. Particular consideration needs to be given to the optimal institutional structures for investment and export promotion.
5.89 The World Bank’s Foreign Investment Advisory Service (FIAS) has been working with the Ministry of Foreign Economic Relations (MFER) on a revision of the Federal Foreign Investment Law. The main problem in drafting the new Foreign Investment law is the constitutional constraint, which requires "reciprocity" for foreign investment. Most Central European countries no longer limit the entry of foreign investors based on reciprocity. Subjecting a proposed investment to a “screening” provision, i.e. obtaining a permit, as stated in the current law, will restrict the flow of investments; these restrictions should be removed under the new law. The law should stick to basic, automatic registration applicable to domestic and foreign investors; i.e., it should minimize the discretion of government officials. To satisfy the constitutional requirement, the MFER will prepare a negative list of countries that do not require reciprocity. Investors from other countries will need to register (using an automatic, time-bound
107 Chapter 5. Private Sector Development and consent-by-silence approach) with the MFER before registering in court. If, in the future, the constitution is amended, this extra registration with the MFER can be dropped.
5.90 In the proposed new draft Law, the armaments sector is the only sector in which foreign investment is restricted. In this sector, FDI would be limited to 49% and will require a special approval. Also, there will be restrictions for FDI in a narrow zone along the border (similar to the Baltic countries until recently). The Government does not intend to pursue distortionary investment incentives, and the draft Law refers to the tax code/customs code, guaranteeing equal treatment for domestic and foreign investment.
5.91 The Serbian Government is in the process of establishing an Agency for the promotion of Foreign Direct Investment, under the Serbian Ministry of International Economic Relations (MIER). The intentions of policymakers are to make it a one-stop shop to facilitate entry for foreign investors. It will serve as an "investment support unit" that would focus on facilitation services, including a "hot line" for trouble-shooting. The agency will market the country to potential investors, improve its image by effective diffusion of true good news about improvements in FRY, and attract specific potential investors through a focused and pro-active promotional effort. The future investment promotion agency will not only function as a marketing agency, but will also provide the government with continuous and reliable feedback about potential difficulties or shortcomings in the policy, legal and administrative framework related to FDI. Through this policy advocacy function, such an agency will become an important element in the policy reform process.
Capital Markets
5.92 Changes to capital markets regulations are needed to improve the operations of the Exchange and to tighten regulatory requirements:
• The Exchange’s role ends with clearing and settlement: the depository/registration function should be brought within the jurisdiction of the BSE, and will constitute a major bottleneck if not resolved (see paragraph 5.90 below);
• The Exchange’s membership is currently dominated by political appointees. Ideally, the Exchange should be privatized in time and the member (brokers) should become its shareholders and form its board of directors;
• Corporate disclosure and reporting is currently weak, and does not conform to International Accounting Standards (IAS) or IOSCO principles. The Government should adopt IAS accounting standards and review carefully the disclosure and other regulations affecting the capital markets against IOSCO principles.
We list below recommendations for the medium term:
5.93 The Belgrade Stock Exchange should rethink its business model as the laws are reviewed. The BSE at present seems to be a universal trading place for everything from shares to commodities to derivatives. An exchange for securities trading (perhaps including options and
108 Chapter 5. Private Sector Development futures) should be separated from a place for the trade in commodities metals commercial paper, etc. Dematerialization and a central depository function should be adopted. Dematerialization, centralization, settlement and payment systems all form part of a share circulation model. The framework of this model should be decided upon and taken into consideration before the laws are changed.
5.94 Case by case privatization of some of the larger and better firms could and should be an important element in reshaping the stock market since: (1) the stock exchange could be used in floating the shares (IPOs); and (2) in many countries, shares of privatized firms are often the most actively traded. For large “blue chip” companies, the privatization program could allow for a small percentage of shares to be floated at the BSE after the sale to the strategic investor has taken place. This sequencing is important as the trade sale provides market participants with information about the value of the company. For medium-sized companies with good fundamentals, one could consider an IPO (as Poland did for a number of cases in 1990-92).
Competition Policy
5.95 In time, a proper competition policy will be necessary, but this is not an immediate priority, given the current state of the enterprise sector. The current institutional capacity of the civil service makes it unrealistic to entrust an anti-monopoly or anti-trust authority with powers to supervise anti-competitive conduct, such as price collusion, tie-in sales or market segmentation. Moreover, given the high concentration in some segments of the economy, it is hardly a priority to start with anti-competitive conduct rather than monopolistic structure. Although such prior break up may be necessary in some cases (the systems) and desirable in many others, it is doubtful that the Ministry of Privatization or any another government body in FRY presently has the capacity to implement such a de-monopolization prior to privatization.
Donor Program (Table 5.4)
5.96 Strong government commitment to devoting resources and giving institutional support to the newly established agency over a period of years is essential for its effectiveness and success. FIAS has been working with the MIER to assist in establishing the agency. FIAS will coordinate its assistance to the MIER closely with MIGA, the EBRD and the EU, which are also interested in the investment environment in Serbia. At the moment, there is an urgent need for (i) information technology and equipment support, including computer systems and establishment of an investor tracking system to facilitate investment promotion efforts; (ii) technical assistance to develop a targeted investment promotion strategy once the business environment is conducive enough and the investment promotion agency is active on the ground; (iii) hiring an international investment promotion advisor to provide international best practice solutions and guidance to the investment promotion agency on a quarterly basis; and (iv) hiring of high-caliber local staff with extensive private sector/marketing experience.
5.97 The next logical phase should be a full study of administrative barriers to investment using a “self-assessment” approach as much as possible. A number of items on the Government's
109 Chapter 5. Private Sector Development reform agenda could be handled more appropriately in an administrative barriers study and the sequencing would be more favorable.
5.98 Monitoring of the business environment is as an important tool to provide the Government with feedback about the effect of the deregulation policies discussed above. A set of periodical surveys of barriers to entry and expansion of SMEs should be conducted to provide such feedback and the progress identified by the surveys should be part of the benchmarks of the a policy dialogue with the Government. There is a need to finance such a monitoring exercise to prepare the ground for the future policy dialogue with the Government. The World Bank will likely lead this effort in the context of preparation for future policy lending.
5.99 A lesser priority at this time, is capital markets development, in particular disclosure and reporting requirements and the creation of a central depository. Training of managers in IAS accounting as well as training of members of Boards of Directors will contribute to greater awareness of disclosure and controls.
Table 5.4: Estimated Requirements for Private Sector Development
Priority Estimated Financing Total Requirement US$ m Program CY01 CY02-04 Credit/Equity Investments Small and Medium New Enterprises Equity investments in micro-finance, SME banks, 10.0 25.0 credit unions, leasing SME credit guarantees 20.0 30.0 SME credit lines 60.0 115.0 Subtotal 90.0 170.0 260.0 Technical Assistance Privatization Privatization Agency 2.25 2.15 Legal Reform 1.0 0 Strategic Enterprise Privatization (Investment 8.6 26.3 Banks) Hardening Budget Constraints 1.0 2.0 Small and Medium New Enterprises Legal Advisory support 0.5 1.5 SME Agency 2.0 4.0 Other Reforms for PSD Enterprise data base 1.0 0 Other Technical Assistance 6.0 8.5 Subtotal 22.35 45.45 67.8
Totals 112.35 215.45 327.8
110 CHAPTER 6. FINANCIAL SECTOR
A. INTRODUCTION
6.1 FRY’s financial sector is in a very profound crisis. Therefore, getting the basic financial sector policy decisions right emerges as a central challenge to policy makers. Across the region, there is robust evidence that achieving early reforms in the financial sector that lead to the effective functioning of banks and other financial institutions is rewarded with economic growth. Moreover, ensuring that these reforms are carried out with the minimum of crisis, cost, and disruption can also make a significant difference to the long-term development of the financial sector.
6.2 At present in FRY, there is no notable activity in credit markets, mobilization of resources for new investment is negligible, and public confidence in the financial sector is almost entirely lost. Governance and ownership of the banking system is in itself a serious problem, where the largest – so called 'old' – state institutions have a track record of poor performance and, either directly or indirectly, are owned by troubled state or socially owned enterprises which are at the same their largest borrowers. The new banks – mostly private – are small and commonly devoted to serve special interest groups to which they belong. The system as a whole – and particularly the largest banks – suffers from a severe problem of insolvency, and extremely poor performance. The underlying framework of creditor and property rights has long been abused and is deeply distrusted. In fact, despite what seems an adequate regulatory environment there is a largely weak institutional base unable to enforce the rules.
6.3 Needed reform of the banking sector has become evident since the recent change in FRY’s administration. Thus, in the near term, launching a well defined resolution strategy for the banking sector is a key priority that should be pursued without delay. This strategy should be implemented along with a methodical plan to bring the sector into compliance with prevailing laws and regulations. Banking resolution should also be seen in an integrated and coherent strategy to workout the large number of troubled assets. The latter calls for coordinated actions with the privatization and enterprise restructuring strategies that should be pursued simultaneously. In the medium-term, banking legislation requires a thorough evaluation with adjustments and amendments made to restore the banking system to a healthy stance and into compliance with international norms. Supervisory practice likewise, requires a full evaluation and a major overhaul. The organization of the function, its goals, policies and procedures require upgrading in order to effectively support banking reform and to protect the future assets of the system.
6.4 This report is not a comprehensive assessment of the financial sector or its vulnerabilities. It is however, an attempt to point at key goals and priorities that policy makers – hopefully with the support of the donor community at large – should focus on in the immediate future if the early efforts of financial reform are to be effective. In this context, if the experience across the region and in neighboring former SFRY republics is any indication of what works and what doesn’t in terms of financial sector policies, the design of the reform program in FRY should pursue, and be organized by, some key goals and principles: Chapter 6. Financial Sector
• Financial sector policies are a key development issue, and are a key determinant of growth. Thus getting the right policies to restructure the financial sector early on in FRY’s transition is an utmost policy priority that should be pursued without delay. • Procrastinating or designing half-measures to tackle the problems of FRY’s financial sector will only increase the cumulative price tag. • As experience in the region shows, the robust entry of foreign capital is a key catalyst that can largely defined the success of financial sector reform. Yet at the same time it further challenges the design of policies towards a potential replacement of domestic providers of financial services by international ones, and to limiting the role the government can play in the financial sector. • Public funds will be needed to rebuild FRY’s troubled financial system; yet they should be used to leverage the return of private capital and to provide incentives to limit undue risk-taking and fraudulent behavior. • Rebuilding confidence in FRY’s financial system will be the central priority that, to a large extent, will determine the re-establishment of financial flows. • Success in FRY financial sector reform will depend on having an effective legal and institutional infrastructure capable of enforcing clear rules, as well as on establishing an adequate and transparent system of financial information.
6.5 These endeavors require the dedication of significant resources, both financial and personnel. They also require a fundamental shift in the culture and operating procedures of the entire banking system. Recognizing these needs, the NBY, with the assistance of IFIs and donors, has undertaken initial diagnostic reviews of troubled banks, and key institutions are being revamped. Initial steps are also being taken to assess and improve regulations and supervision. Medium-term plans for institutional capacity building are being prepared, and currently, the NBY has positioned resources to begin the reform process. The external financing requirements in the Financial Sector, not including the costs of bank restructuring, are estimated to be US$45 million for technical assistance over three to four years (Table 6.5). The financing requirement for 2001, on a commitment basis, is US$18 million.
B. MACROECONOMIC ENVIRONMENT AND THE FINANCIAL SECTOR
Overview
6.6 The most notable event affecting the macroeconomic environment of the financial sector during the past decade was the hyperinflation period of 1992-94 when inflation peaked at 313 million percent in January 1994. In mid-1992, international sanctions were imposed, and all identifiable FRY accounts abroad and official reserves were frozen. Formal ties with the international economic and financial community were severed. After the signing of the Dayton Agreement in 1995, and the end of hostilities in the region among the former SFRY republics, the UN lifted sanctions on FRY in October 1996, but formal entry to the IFIs did not take place. During this period, the situation facing the financial sector was compounded by economic
112 Chapter 6. Financial Sector mismanagement and by the worsening effects of the Kosovo crisis that lead to the re-imposition of sanctions in 1997 and the imposition of a ban on oil sales. Following the change in government in October 2000 the lifting of sanctions started, and the normalization of international relations began. Discussions to clear FRY arrears to the IFIs, bilateral and private creditors are currently advancing.
6.7 The critical events of the last two years where compounded by a severe drought that affected the region and have taken an enormous toll on FRY’s overall economy and on the financial sector. Output growth had already come to a halt in mid-1998 and the Kosovo crisis erased the modest economic gains of the previous five years. The sharp drop in output in 1999 alone reduced real GDP by some 20 percent1 and overall economic activity hit its lowest level in the decade at about 40 percent of its 1989 level.
6.8 FRY’s economic situation is very fragile, and constrained by large macroeconomic imbalances, including imbalances on the external and fiscal accounts. The external debt at end-2000 exceeds US$12 billion (equivalent to some 450 percent of average annual exports in 1998-2000) and would require considerable donor support in the form of external debt relief and reconstruction assistance. Additional domestic liabilities also denominated in foreign exchange further threaten acute shortages of foreign exchange. All of these elements greatly complicate the situation in the financial system, as the majority of these debts are part of long time overdue obligations of commercial banks. In essence, reestablishing creditworthiness in FRY’s external position, both to its foreign and domestic creditors, is a necessary, yet not sufficient condition to starting a comprehensive restructuring program of the financial sector.
6.9 The present fiscal situation is also unsustainable and severely affects the financial sector. Moreover, it is a reflection of macroeconomic mismanagement carried over many years, much of which is still being fully appraised and understood. In the late 1990s, the explicit funding of the government fiscal deficit contributed remarkably little to recorded monetary expansion. However, most of the domestic credit expansion stemmed indirectly from the quasi-fiscal deficits of state and socially owned enterprises and government agencies, together with the creation of inter-enterprise debts and guarantees. Many enterprises faced soft budget constraints and financed their activities from arrears to the state, banks, suppliers, and workers. The accumulated operating losses and arrears of the large enterprises (some with cross-ownership in state and socially owned banks) have been sizeable, although no reliable estimate is available of the consolidated arrears and other outstanding liabilities of the enterprise and banking sectors. In addition to implicit credit expansion, the banking system (including NBY) was used to extend directed credits to state and socially-owned companies and the agricultural sector to help keep prices low, especially for food and utilities. The widespread partial indexation of pensions and wages has led automatically to claims for additional public expenditures, many of which were also satisfied from the banking system.
6.10 Over the coming years, there will be additional burdens on fiscal accounts arising from efforts to reform and reconstruct the economy while directly assisting the most vulnerable. Some of these costs will be directly or indirectly linked to the financial sector, and may have a significant bearing on the reforms of the financial sector. Among them, the resumption of
1 National Bank of Yugoslavia and Federal Statistical Office estimates.
113 Chapter 6. Financial Sector external debt servicing, the scheduled repayment of households frozen foreign currency deposits, the direct costs of troubled bank and enterprise resolution, this being either restructuring or liquidation. Taken together, these additional direct and indirect fiscal burdens will be substantial and are expected to rise in the short term. External assistance will be needed to help close the financing gap, including that which is directly or indirectly associated with reforms in the financial sector. These actions will be crucial as the economy moves from a system of fiscal mismanagement and soft budget constraints towards one of adequate fiscal management and hard budget constraints, including in the quasi-fiscal sector.
Development of monetary aggregates Table 6.1: Monetary aggregates (share of GDP) Currency in 6.11 During the 1990s, the growth rate of M1 M2 M3 circulation the money supply was extremely volatile. Following the break-up of the former SFRY Year 1995 6.99 10.98 33.90 3.05 and the hyperinflation that followed, nominal 1996 6.10 11.76 42.10 2.70 money supply soared in 1991-1992 and grew 1997 7.98 14.20 39.18 3.78 by some 1700 percent in 1994. In the second 1998 7.49 14.43 43.74 3.37 1999 7.69 14.26 34.96 3.60 half of the decade, growth in money supply 2000 ** 7.47 12.34 69.10 3.05 was somewhat slower but still rose by more than 700 percent between 1995 and 2000. Not Source: NBY surprisingly annual inflation for the period ** Excludes Montenegro 1995-2000 averaged around 50 percent. As percent of GDP, monetary aggregates show a very low level of depth of the financial system. On average, the main monetary aggregates have remained at almost half the levels reached in the 1980s. The only significant increase took place in the form of foreign exchange deposits while Dinar deposits plummeted. This situation is evidence of substantial distrust and risk perceptions in the currency, recurrent problems faced by financial institutions and ill defined lending practices due to poor governance, and an overall climate of instability that prevailed during the entire 1990s.
6.12 Among the major monetary aggregates, the background surrounding the so-called ‘frozen foreign exchange deposits’ deserves some attention (see Box 1). In 1991 these deposits accounts of households held with commercial banks were taken over by the government. By law, all foreign exchange savings held at commercial banks were re-deposited into the NBY. They represent assets on the commercial bank’s balance sheets in the form of claims on FRY. The corresponding commercial banks liabilities to the depositors remain in frozen foreign exchange accounts balances. At present, including accrued interest, they represent approximately DEM 7.4 billion.2
2 The Money Supply (M1) represents about 7 percent of GDP, but Broad Money (M3), including frozen foreign currency deposits valued at the current exchange rate, is around 70 percent of GDP.
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6.13 Domestic credits are mainly to enterprises; the share of net domestic credits Box 6.1: Frozen foreign currency deposits to government (excluding the frozen foreign About 2 million household account holders had their currency deposits) is less than 5 percent. foreign currency deposits frozen or confiscated by the state in During the 1990s, the authorities directed 1991. The total outstanding balance of these frozen foreign bank credits on a large scale to state and currency deposits, including 2 percent annual interest, amounts to DEM 7.4 billion. Under the 1998 Law, 85 socially-owned enterprises, including percent of the outstanding debt will be financed by the state ‘preferred’ sectors (for instance energy, (Federal Government, Republican Government, and NBY) railways, agriculture) with a view to and the remaining 15 percent will be met by the commercial banks. The NBY is appointed to co-ordinate payments. keeping utility and food prices low. Over the next five years, payments will be settled in cash (or Subsidies were provided indirectly through bonds after 2002) in semi-annual installments (April and distorted interest rate structures, and the September) according to the following yearly schedule: enterprises were not required to repay these loans. Interest rates on deposits and lending Year Payments per Annual fiscal account holder costs to the state vary substantially among the types of DEM DEM million savings and loans. Throughout the 1995- 2000 150 182 2000 period, deposit and long-term lending 2001 440 328 2002 540 327 rates were usually negative in real terms 2003 740 366 while the market rates (weighted interest 2004 1030 428 rate on commercial paper, bank bills and certificates of deposit) were usually above Scheduled total repayments over five years amount the rate of inflation. Since late-1999, the to DEM 1.6 billion. The remaining DEM 5.8 billion will be settled between 2005-2011 in cash, bonds (transferable at a NBY has refrained from extending or discount), or by real estate (earmarked state property). The refinancing directed credits to the economy. total cost of the rescheduled repayment of frozen foreign Lending rates remain negative but the currency deposits is about at 1.5 percent of GDP in 2001- authorities have been encouraged to offer 2004 and will increase to 2-3 percent of GDP in 2005-2011. new instruments (10-day and 15-day central bank paper to which commercial banks could subscribe) with higher interest rates to absorb the excess liquidity.
6.14 The low degree of financial intermediation and large amount of currency substitution make the conduct of monetary policy more difficult. The Republican government in Montenegro has introduced the DEM as the official currency in Montenegro, and the DEM is also widely used for transactions in Serbia. Domestic currency in circulation (Dinar) has fallen to a mere 3 percent of GDP. Given the low level of reserve money there is little scope for non-inflationary monetary financing of the economy by NBY. Required reserve deposits were only 1 percent of GDP in December 2000, and excess reserves available for bank lending had built up to 1.1 percent of GDP. Some further tightening of monetary policy has been agreed so as to control inflation and support the exchange rate. The authorities will issue domestic currency only against purchases of foreign exchange.
6.15 Available data for 1999-2000 show the net foreign assets (NFA) of the banking sector are negative, and the balance of payments gross official foreign exchange reserves are less than 1.5 months of imports of goods and services. Throughout the latter half of the 1990s, the foreign exchange rate was fixed substantially below the unofficial market exchange rate. The black market premium increased following the Kosovo conflict, and peaked in October 2000 when the unofficial rate was more than 430 percent higher than the official rate of exchange. Since the
115 Chapter 6. Financial Sector start of the transition, the foreign exchange regime has undergone a number of major improvements. In October 2000, the official retail and inter-bank exchange rates were unified at 30 Dinar/DEM, and at the beginning of 2001, a managed float subject to a floor on net foreign assets, was adopted. The government also has taken some initial steps towards removing quantitative and licensing import restrictions, and intends to reduce export quotas, and introduce a simplified tariff structure while safeguarding domestic food supplies.
6.16 Finally, monetary policy in the transition phase should be oriented towards restoring the public’s confidence in the currency and banking sector - through the reduction of inflation, the scheduled repayment of frozen foreign currency accounts, and bank restructuring (in parallel with the reform of state and socially owned enterprises). In April 2001, a phased plan to liquidate or restructure insolvent banks in Serbia, strengthen the legal and supervisory framework, and promote entry of reputable foreign banks will begin, based on detailed diagnostics. The Montenegrin authorities will continue their efforts to address the insolvency problems in their banks.
Table 6.2: Monetary aggregates
Dec 99 Dec 00 Dec 99 Dec 00
YUD billion Percent of GDP
Reserve Money** 8.6 18.7 4.6 5.2 Local currency in circulation 6.7 10.9 3.6 3.0 Reserve Deposits 1.9 7.8 1.0 2.2 Required reserves 1.2 3.7 0.6 1.0 Excess reserves 0.7 4.1 0.4 1.1
Broad Money (M3) ** 65.7 249.6 35.0 69.1 Money Supply (M1) 14.6 26.6 7.7 7.4 Currency outside banks 6.7 10.9 3.6 3.0 Demand deposits 7.9 15.7 4.2 4.4 Time and savings deposits 3.7 5.4 2.0 1.5 Foreign currency deposits 47.5 217.5 25.3 60.3 of which: Frozen Foreign Currency Deposits 41.1 185.2 21.9 51.3
Nominal GDP 188.0 361.0 100 100
Source: National Bank of Yugoslavia ** Excludes Montenegro
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Table 6.3: Structure of domestic credit
1995 1996 1997 1998 1999 2000
(Percentage structure)
Net credit to Government 3.4 2.6 3.1 2.1 1.5 1.4 Credit to non-government 57.1 59.0 60.9 62.0 62.4 51.4 Households 1.9 2.4 2.7 2.5 2.5 0.6 Non-profit and other sectors 6.5 6.3 6.9 7.0 6.9 6.2 Enterprises 48.7 50.2 51.3 52.5 53.0 44.5 of which: in foreign currency 27.5 27.5 27.1 27.8 27.7 36.7 Claims on Government on the basis of frozen foreign currency deposits 39.4 38.4 36.0 35.9 36.1 47.2
Total Domestic Credits ** 100.0 100.0 100.0 100.0 100.0 100.0
Source: National Bank of Yugoslavia ** Excludes Montenegro
C. THE YUGOSLAV FINANCIAL SECTOR
The legacy of the past
6.17 Following the reforms of the late 1980s, the SFRY’s financial sector appeared poised to take advantage of some of the early changes that introduced private ownership and enhancements to the regulatory and supervisory framework governing the banking system. In almost every respect, SFRY’s financial sector had comparative advantages over other countries in the region which were still locked into centralized policies and evidenced less modern systems and policies. A de-facto two—tiered banking system was established when all commercial activities of the NBY were transferred to the commercial banks. Banks were corporatized, new and modern governance structures were consolidated, and while accounting standards were not yet in line with international standards, they represented a vast departure from the systems used in most other CEEs.
6.18 However, these initial signs of change and modernization came to a complete halt after the breakup of SFRY resulted in regional conflicts that led to the UN sanctions imposed against FRY in mid-1992. The hyperinflation period of the first half of the 1990s seriously deteriorated the health of the banking system, washed-out all Dinar denominated assets and liabilities, led to defaults and payment arrears, including the freezing of virtually all foreign exchange savings deposits of the population.
6.19 While there were some improvements in FRY’s situation during 1995-96, the recovery was brief and insignificant. Sanctions were re-imposed in 1997 and the situation deteriorated rapidly, reaching its lowest point during the Kosovo war. During this period, the financial system operated under extremely harsh conditions of economic instability, high inflation, and massive defaults and arrears. Significant portions of the bank’s balance sheets were sterile or non-performing. Moreover, mismanagement of the large banks took the form of directed credits ordered by the government and was exacerbated by the ownership or control exercised on the
117 Chapter 6. Financial Sector large banks by some of the large and troubled state or socially-owned enterprises. As a result, the size, level of activity and overall significance of the banking system dropped quite significantly during this period. Total banking system assets declined by more than one quarter since 1994 to an estimated DEM12 billion in 2000. As a comparison, during the same period, banking system assets nearly doubled in Croatia and Slovenia to about DEM 28 billion in and about DEM 23 billion respectively.
Structure of the banking sector
6.20 At present, there are nearly 100 banks in FRY. These include 81 banks licensed by the NBY which operate predominantly in Serbia, as well as 11 banks licensed by the Central Bank of Montenegro (CBM). Aggregate banks statistics are somewhat confusing due to the de-facto fragmentation of the NBY and CBM reporting systems, as well as the unclear status of a handful of NBY-licensed banks that have some form of operation in Kosovo. Further confusion exists regarding the branches of certain banks operating across republican boundaries and the actual status of their respective branches and/or subsidiaries, as well as regarding the accuracy of the data of some of the banks that were forced into large mergers that have now been dissolved. NBY statistics also exclude newly created banks that operate in Kosovo under the auspices of the Banking and Payments Authority of Kosovo (BPK). Since the approval of the 1993 banking law, some 30 banks have been under court-driven processes of bankruptcy or liquidation. To date, one of these 30 cases has been concluded.
6.21 Whatever the exact numbers, FRY’s banking system denotes a large extent of fragmentation, a very low level of capitalization, and an extremely low level of intermediation capacity. The majority of assets are concentrated in the largest 6 (state owned) institutions. FRY’s banking statistics make a clear distinction between the so called ‘old banks’ and the ‘new banks’. According to this concept, old banks are those that were licensed before the 1989 Law on Banks and Financial Organizations, as well as their branches and subsidiaries. New banks are those licensed either under the 1989 law or afterwards under the 1993 Law on Banks and Other Financial Organizations.
6.22 Old banks carry most of the assets and liabilities associated to the legacy of the past. Like in other former SFRY republics, these are the largest banks and are primarily owned and controlled by large state or socially owned enterprises. They include most of the large loans denominated in foreign currency, many of which are long-term and associated to foreign borrowings, and that have gone unpaid for many years now. Accounts of the old banks also include most of the deposits of the system, mainly denominated in foreign exchange and which were frozen in 1991. Overall, these large loans and corresponding foreign liabilities, as well the frozen deposits and corresponding claims on the NBY represent more than two thirds of the balance sheet of the system. There is also a great degree of association between these large loans (and guarantees) and the largely state-controlled directed lending programs to industry or agriculture that prevailed during the past decade. The government directed lending policies were primarily aimed at protecting and subsidizing these sectors and played a key role in their price control mechanisms. The recipients of these loans have also been some of the largest state- controlled enterprises or socially owned conglomerates, many of which remain in control of large portions of the shares of the banks. Old banks have a large developed network of branches, which translates to high operating costs and large numbers of employees.
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6.23 As stated, new banks are those established after 1989 and are largely exempt from the heavy burden that plagues the old banks. In general, they are privately owned, small, more efficient, and some of them are reasonably profitable. Their activities are somewhat limited and are largely concentrated in short-term trade financing. Their client base is rapidly growing and is largely constituted by small and medium enterprises. They are also better rated in terms of capital adequacy and prudential limits. According to a 1999 banking sector study, the “new banks” have had a higher failure rate, but have demonstrated more consistent compliance with prudential regulation. This large number of small banks has limited potential due to their limited capital base. Again, if the experience of the region is of any use, one should not take for granted that this large number of small banks can survive in a competitive environment. To some extent these banks have also enjoyed a very distorted and non-competitive system that is not necessarily an indication of their long-term sustainability.
6.24 After the devastating decade of the 1990s, most FRY banks offer only basic banking services and their level of intermediation is extremely shallow. Excluding the frozen foreign currency deposits, savings had slumped to below DEM 100 per person in 1997 and never recovered. In both retail and corporate banking, deposits are predominantly short-term and lending is limited to retail trade transactions. Deposit interest rates have remained negative in real terms and discourage domestic savings. Large spreads ranging from 10 to 25 percent result in high lending rates and have resulted in a broad crowding out effect. It can be argued that the condition and abuses committed in the banking sector have contributed to the increasing presence of non-payments, barter agreements, and inter company arrears. Available data on payments transactions in 1999 denotes that bank credits are only 15 percent of total short-term company liabilities.
6.25 As stated, 11 commercial banks are located in the Republic of Montenegro and can also divided into two groups. The “old” banks are considered those existing prior to the advent of the 1993 banking law. These banks suffer from many of the same problems as the “old” institutions in Serbia. They house frozen foreign exchange deposits and are characterized by significant past political influence, high volume of loans to and transactions with shareholders, poor asset quality, and difficulty maintaining adequate liquidity. Four “new” banks were established since 1994 and apparently do not suffer as many of the problems existing in the old banks. They have few if any liabilities from the past, have selected shareholders, and possess better credit evaluation skills. They constitute an estimated 35 – 40 percent share of the banking business. These banks are seen as forming the base for the future Montenegrin banking system. A third group of institutions consists of some 12 branches of FRY-based banks.
ZOP and the payments system
6.26 The Bureau of Accounts and Payments, often called by its local acronym ZOP and formerly know as SDK in SFRY, was the institution in charge of providing control over virtually all financial transactions and related information in FRY. As its predecessor did across all former SFRY republics, ZOP has a vast physical network with highly standardized methods and computer systems that interconnect all FRY’s territory. ZOP plays a key role in ensuring government control over virtually all financial flows among economic entities -- including individuals – and possesses vast amounts of information. ZOP has about 7000 employees and
119 Chapter 6. Financial Sector since 1996 has been a department of the NBY, though in practice it appears to enjoy a great degree of autonomy.
6.27 ZOP performs numerous functions that far exceed its supposedly core activity of being the clearing and payments system. It has for instance been used to assure collection of government revenues, and has a legal monopoly over Dinar non-cash payments of enterprises. It also offers foreign exchange services throughout Serbia. Until recently, ZOP responsibilities also included those of the financial police and government auditing of legal entities. As a Department of NBY, ZOP also has operational responsibility for bank reserve accounts, and provides daily information to NBY for statistical and analytical purposes.
6.28 New policies in FRY and in NBY call for a major restructuring of ZOP. NBY has already launched efforts to establish a normal bank-based payment system where payments are made directly through banks and settled through NBY reserve accounts. Several functions of ZOP have been transferred to the Ministry of Finance or other agencies, and the implementation of the 1998 Law on Payments Traffic has been postponed and plans are underway to modify it. ZOP has assumed responsibility for modernizing the domestic payment system under a ZOP-led working group on payment system reform consisting of two representatives each from the NBY, commercial banks, and the Ministry of Finance.
6.29 Overall, these changes denote a significant reorganization of traditional institutional roles between ZOP and NBY over the medium-term. ZOP needs to structure a medium-term well designed plan for consolidating and deepening the separation of its various functions. In essence, these functions should be distributed between the NBY, ZOP, and MOF. NBY should narrow its functions to those of a central bank payment system, and the MOF should take charge of all treasury functions. ZOP has started a program of reform of the payments system which is reasonably consistent with international standards and BIS Core Principles. Nevertheless, the program needs to be accelerated and supported by the NBY for successful implementation in early 2002.
D. BANKING REGULATION AND SUPERVISION
Overview
6.30 Banks, both pre-1989 “old” (state) institutions and to a lesser extent, the new (post 1989) banks, have been subject to government interference and directed credit allocation. As a result, the prudent standards of management and sound banking practices were all but abandoned. The resulting poor condition of the banking industry and the overbearing political environment have made application of relevant banking legislation and proper supervision quite difficult. Bank supervision has been typified by regulatory forbearance and a “rules based”, compliance oriented approach. Enforcement actions have consisted largely of minor penalties prescribed automatically by law upon violation of required ratios or other rules. Since 1993, the licenses of some 30 financial institutions have been revoked, but only after lengthy legal proceedings. To date only one of these cases has completed and closed.
120 Chapter 6. Financial Sector
6.31 Notwithstanding this distressed economic environment and political setting, a basic legal framework was established in 1989 and further refined in the early 1990’s. The initial banking law (1989), established new rules for state banks and introduced the basis for a private banking sector. Thereafter, regulations and banking law amendments were adopted, establishing guidelines for allowable banking activities, licensing, capital limitations and requirements, basic enforcement actions, and license revocation powers. General powers of supervision were established including the ability to prescribe regulatory reporting, conduct onsite examinations, require compliance with fundamental financial indicator ratios, and administer some basic forms of remedial action.
6.32 The Republic of Montenegro has effectively separated much of its financial and regulatory system from that of FRY. In doing so, it has adopted the DEM as its national currency, consolidated the Central Bank of Montenegro (CBM), and is working toward resolving the distressed banks and setting up a system of bank supervision. While the banks suffer from many of the same ills as those in Serbia, Montenegro is faced with establishing a banking regulatory and supervisory system from a much more nascent point. With substantial assistance from the USAID, the Montenegrin authorities have already begun to evaluate the needs and to take steps to address regulatory and capacity building needs.
Banking regulation
6.33 FRY’s financial sector legislation is comprehensive and generally sound. In certain respects, however, revisions to key laws will be required to enable the financial sector to be fully supportive of a market driven economy and to bring the legislation into harmony with EU legislation and international best practices. The principal laws comprise (i) the 1993 Law on the NBY, (ii) the 1993 Law on Banks and Other Financial Organizations, and (iii) the 1989 Law on the Financial Rehabilitation, Bankruptcy and Liquidation of Banks. Other relevant financial sector legislation includes the 1993 Law on the Federal Agency for Deposit Insurance and Bank Rehabilitation (BRA), and the 1996 Laws on Accounting and Auditing.
6.34 The Law on the Central Bank of Montenegro, the Law on Banks, and the Foreign Investment Law were all passed by the Montenegrin authorities in December 2000. This represents a significant step in establishing a structured, independent banking system. Yet one of the key challenges facing the CBM is still the lack of recognition as the Republic’s central bank by the international community. While many important changes have been included in the new banking law, the CBM is now faced with preparing and adopting prudential regulation to support and further enable the banking law. With the assistance of foreign advisors, draft regulations for asset quality, liquidity, capital, licensing, regulatory reporting, and a number of other areas are currently being prepared.
The NBY Law
6.35 The NBY Law establishes the NBY as an independent legal entity, headed by a Governor. It provides generally for the organization and administration of the NBY, its powers in the field of monetary policy and its supervisory and other special powers. The NBY has the power to grant and revoke licenses and to decide upon bank liquidation. The minimum capital
121 Chapter 6. Financial Sector requirement for banks is USD 5 million. Banks that do not meet this requirement have been given time until June 30, 2001 to increase their capital. The NBY counts on ample powers to revoke the license of any bank which is considered insolvent3. The Council of the NBY decides appeals within 30 days. Appeals to the Supreme Court of Yugoslavia are possible in cases of procedural irregularity.
6.36 Containment of risks. A strong and notable feature of the NBY Law are the powers available to the NBY to deal with situations in which a bank has acted in contravention of regulations and monetary policy measures in such a way as to jeopardize its financial soundness. Under Article 54 of the NBY Law, the NBY may order the bank to remove the established irregularity, and simultaneously take “measures” against the bank. The content of such corrective orders and measures is wide-ranging and may be taken for a period of 30 to 360 days. If a bank fails to execute an order or measures from the NBY, or repeats the same offence within 180 days, the NBY is directed to revoke the bank’s license and initiate liquidation and/or bankruptcy procedures. Clearly, therefore, the NBY has the necessary tools to contain the damage to a bank by means of restricting its activities, “ring-fencing” transactions with related parties, and requiring measures to prevent further deterioration of its condition until rehabilitation commences.
The Financial Rehabilitation Law
6.37 The Financial Rehabilitation Law allows rehabilitation proceedings when potential losses amount to at least 50 percent of the bank’s capital and reserves. NBY decides when to place a bank under rehabilitation upon an application from the bank, its founders or creditors, or the BRA. The decision is based on the bank’s financial status and possibility for viable rehabilitation. When the decision for bank rehabilitation is made, the duties of the bank’s administrative bodies, the authorities of the bank’s executives, and the rights of the shareholders are terminated and the BRA assumes full control over the bank.
6.38 Methods of rehabilitation include (i) new investment in the bank’s capital, (ii) writing off claims, (iii) taking over potential losses with corresponding liabilities, (iv) temporary or permanent purchase of potential losses of the bank, (v) takeover of the bank by another bank, (vi) sale of all or a portion of the bank’s shares, and (vii) investment in the funds of the bank taking over the bank being rehabilitated. Financial rehabilitation is considered complete upon a decision to sell the bank’s shares, in whole or in part, the takeover of the bank by another bank, or a decision to place the bank in bankruptcy.
6.39 Liquidation and bankruptcy. A decision to place a bank in bankruptcy is made by the Governor of the NBY when, based on a finding and recommendation of the BRA, the rehabilitation is considered unfeasible. Liquidation and bankruptcy can also be triggered by revocation of a bank’s license by the NBY in cases where the bank has not gone through the rehabilitation process first. Under Article 30 of the Banking Law, the NBY has wide-ranging powers to revoke a bank's license. Liquidation presupposes that there are sufficient assets to pay off all claims. If that is not the case, the bank must be placed in bankruptcy. The final decision for license revocation and liquidation resides with the Supreme Court. While the Court is
3 As it is described in article 30 of the Banking Law and article 56 of the NBY Law.
122 Chapter 6. Financial Sector generally obligated to uphold NBY’s supervisory judgement, it has indicated in the past that it may not rule in favor of bankruptcy referred on the basis of significant violations of law. It is prone to base its decision on a more quantifiable measure such as capital depletion (reduction of at least 50 percent of authorized capital and reserves). In at least one case, an institution has been caught between the NBY’s license revocation action and a reverse decision by the Court, resulting in a very extended, iterative process.
Specific legal and supervisory issues
6.40 Judicial oversight of liquidation process. Under the current legal framework, liquidation and bankruptcy procedures involving banks are handled by the courts. This can be problematic, as courts seldom have the kind of expertise needed to perform this task. It would be preferable if such procedures were to be placed under an extra-judicial bank liquidation and resolution process under the control of, for example, the BRA, with the court’s role limited to hearing appeals from the NBY decision to revoke the license, under strict standards of judicial review.
6.41 Enhanced enforcement procedures. Enforcement measures may only be taken against banks themselves and not against the persons who effectively control them, including directors, management, significant shareholders and others who exert significant influence over the banks. Likewise, the NBY’s ability to impose severe penalties for fraud or mismanagement of banks is restricted. Although the NBY and Banking Laws provide for fines and bans on individuals participating in the banking industry in certain circumstances, these measures must be imposed by a court. The authorized fines are generally not very substantial in proportion to the seriousness of the given violation. NBY should be empowered to impose measures directly, subject to court appeal under well defined conditions for judicial review.
6.42 Licensing procedures. Articles 8 and 9 of the Banking Law provide generally satisfactory criteria for licensing new banks. However, an important element missing is the “fit and proper” criteria for founders, significant shareholders, and members of the bank’s board of directors and supervisory board. While the Law refers to the “credit rating” of founders as criteria for receiving a bank license, and NBY takes into account prior criminal records, a “fitness” evaluation requires further assessment of the applicant’s trustworthiness and soundness of judgement. In addition, the Law references “professional and moral qualities” of proposed members of a bank’s board and managers. However, it is not clear that the NBY can reject board members or managerial candidates who do not meet these criteria. “Fitness and propriety” of all persons who will effectively direct the business of a bank should be made an express legal requirement. This would be consistent with international standards as expressed through European Union directives and Basle Committee recommendations.
6.43 Changes in control or significant participation in existing banks. Article 12 of the Banking Law provides that persons who propose to acquire more than 15 percent of the shares of a bank must receive the approval of the NBY. The NBY gives approval for the purchase based on the credit rating of the proposed acquirer. Although these requirements provide a good start, more detail is necessary. It is quite possible, in practice, for a person to exert considerable influence over a bank even in the absence of formal share ownership (such as through proxy arrangements or surreptitious arrangements with the actual shareholders and managers), and it is
123 Chapter 6. Financial Sector important that such influence be subject to supervisory scrutiny. Recognizing this, many countries require supervisory approval not only at certain prescribed numerical thresholds (typically 10 percent, with additional approvals often required at increasing levels of ownership), but also in any situation in which a person would be in a position to exert a “significant influence” over a bank. Additionally, the criteria for approval should be broader, and as stated above, include criteria of “fitness and propriety”.
6.44 Transactions with related persons. Article 21a of the Banking Law prohibits banks from extending credits to their shareholders until at least one year after the bank has been entered in the court register. Moreover, Article 26 prescribes 5 percent (of capital) limit on credit to bank shareholders, members of bank bodies, and their related persons. While these restrictions are appropriate, the Banking Law should also expressly require that bank insiders not receive preferential treatment in any transaction undertaken with the bank. Any transaction between a bank and an insider should be approved by the supervisory board (with the exception of deposit relationships in the normal course of business) with the interested party in the transaction being precluded from participating in the discussion or voting on the transaction.
6.45 Governance. The responsibility for the prudent and responsible operation of the institution should be defined with clear accountability assigned. This could include, but not be limited to, the responsibility of defined parties to select qualified management teams, maintain adequate capital as required by the NBY, establish strong systems of internal control, set up legal compliance and risk management systems, and report and disclose accurate financial and related information. Furthermore, rigorous disclosure requirements for banks’ related parties and their interests (what they are, financial disclosures, etc.) should be considered. Meaningful penalties for failure to responsibly fulfil required responsibilities should be specified and applied to the subject individuals.
6.46 Consolidated supervision. Under the current legal framework, examination and enforcement authority is limited to banks themselves. However, to minimize the risk of contagion from problems in related entities, the NBY should be authorized to obtain information from affiliated entities of banks (i.e., entities that control, are controlled by, or are under common control with, banks), as well as from significant participants of banks and entities that are controlled by them. In the event that problems are discovered in these entities that could adversely impact the bank, the NBY should have the authority to require, or cause other regulatory authorities to require, that corrective action be undertaken so as to minimize the risk of harm to the bank or its depositors. However, these powers should only be exercised to protect banks, not for the purpose of supervising non-banking activities of related persons.
6.47 Capital Requirements. The application of the specified 8 percent capital requirements is not realistic in the current environment. However, as the system is resolved and fresh capital is identified and acquired, the given requirements should be enforced. A methodical plan should be prepared to migrate the system into compliance with prudent capital requirements. Until that time, the prescribed ratio should be reviewed and upgraded where appropriate.
6.48 Prudential Regulation. There is a need to evaluate the decrees and instructions which support and interpret law. In particular, the decree directing classification of assets requires review and improvement. Currently, classification of assets is driven by delinquency status of
124 Chapter 6. Financial Sector the given asset. The days past due before classification in the given category are very extended and outside of international norms. The loss provisions are likewise applied based on the classification assignment. Any consideration of underlying collateral is not clear and should be limited to only that allowed by the NBY. There are no rules for restructured credits, treatment of non-accrual of interest on loans or for capitalized interest. And, requirements for liquidity and other risk management are not yet fully developed. The law should also be changed to specifically allow the NBY to request financial reports whenever it deems necessary.
Accounting and auditing
6.49 The NBY has a certain level of authority over the accounting and audit standards for banks. Accounting rules adopted in the early 90’s resembled International Accounting Standards (IAS), yet practice gradually eroded in subsequent years. Now, it is broadly recognized that the quality of accounting and reporting is highly suspect.
6.50 As a medium term goal, the accounting standards should be reviewed and upgraded to ensure full IAS compliance and more accurate reflection of financial condition. This is particularly critical in the area of asset classification, loss provisioning, proper asset valuation, consolidated accounting (for bank and mixed group companies), treatment of restructured credits, interest recognition and reversal, footnotes to financial statements, and financial disclosure. The penalties for statement and disclosure of inaccurate financial position through institutions’ annual reports and through regulatory reporting should be evaluated and addressed to ensure this aspect of the NBY’s remedial action toolkit is effective. Likewise, audit requirements should also be brought to IAS compliance and thus require evaluation. External and internal audit processes should be evaluated and strengthened as part of licensing requirements, including their reporting lines, selection process, remuneration, and procedural requirements. Remedial actions in cases where audits have not met requirements should also be addressed.
Supervisory organization and practice
6.51 NBY’s current supervisory function is faced with significant challenges. It must play a key role in the banking sector resolution process while simultaneously upgrading its capacity and resources to keep pace with the sector’s change and to safeguard those changes for the future. A review of the current state of the supervisory function was conducted by the IMF in December 2000. The NBY has enlisted the assistance of USAID to support further evaluation of its processes and to develop a plan for capacity building. As a first step, diagnostic reviews of selected institutions are being performed, targeting primarily asset quality and adequacy of loss provisions. Strategic decisions on the future of these institutions will then be taken and the resolution process initiated. At the same time, the first steps in capacity building have begun through the hiring of additional supervisory staff to assist and be trained during the diagnostic reviews. Also, two new departments were established, a licensing and problem bank unit, to compliment the already established onsite, offsite, legal and policy development departments.
6.52 Supervisory Objectives and Culture. The nature and extent of the supervisory and regulatory change that is needed requires a close look at the existing organizational culture and
125 Chapter 6. Financial Sector management process. Evolving the function from one of extensive forbearance and compliance test-checking, to one which is responsible for the oversight and safety and soundness of the country’s banking system, requires new focus and objectives as well as change at all levels, including the management of the NBY, other governmental parties and the banking industry itself. Supervision’s organizational position in the NBY should likewise be evaluated and addressed to ensure that the proper level of authority and attention is given the function as a critical role in the Central Bank. Furthermore, the function’s relationship with the industry should be evaluated, including the current and needed degree of supervisory transparency and the need for and benefits of regular industry communication. These steps should provide the focus and direction to support further change in the process and needed changes in legislation. With consideration given to international experience and with the support of technical assistance, these objectives and mission can be established, made a part of legislation and operating supervisory policy, and promulgated.
6.53 Supervisory Capacity Building. Given the evolving role of supervision, a methodical, near to medium term plan for building both staff and capacity should be developed. Each of the functional areas should be evaluated and changes made to enhance focus, procedures, reporting, communications, responsibilities, and accountabilities. Regulatory reporting format and content should be evaluated and refined, ensuring that reports received are adequate to identify and assess the key changes in bank risk and condition. Building the examination function involves refinement of procedures, establishing examination cycles according to institutional risk profiles, compliance requirements, and information received through offsite monitoring. Internal reporting to NBY management, decision making processes, and IT also require evaluation and further development. Staffing should be enhanced, in terms of numbers, skills, and remuneration. Training, both classroom and on-the-job, should be started. And, consideration should be given to developing a code of conduct applicable to all supervisory staff and senior and executive level NBY management.
6.54 Supervision at the CBM. A new supervision department was recently established in the CBM. It houses the traditional functions of licensing, legal, onsite examination, and offsite monitoring with a total of 11 staff, possibly with 3 new hires. Pilot examinations of selected banks will be conducted with the support of foreign technical assistance. The first of these pilots was just completed in January 2001. The CBM has initiated additional capacity building steps with the foreign technical assistance. The program includes development of an offsite analysis and regulatory reporting program; development of the licensing department including manuals and enabling legislation; onsite examination training through the pilot review program; training in the areas of supervision techniques, asset liability management, bank accounting, and credit training.
Policy agenda
6.55 A number of issues are cited in the previous text which highlight areas preliminarily identified for evaluation and upgrade. These issues fall into essentially three higher level policy agenda areas: (i) Bank legislation and prudential regulation, (ii) supervisory organization, objectives, and internal governance, and (iii) supervisory capacity building. In summary, the sub-components identified so far are listed below. Dedicated assistance should be similarly allocated to both Serbia and Montenegro.
126 Chapter 6. Financial Sector
Bank legislation and prudential regulation:
• Bank resolution legislation: The legal framework and procedure deserve review in the near term to ensure all necessary tools are in place to facilitate the resolution needed in the banking sector. This includes bank rehabilitation, bankruptcy, and liquidation framework and procedures.
• A comprehensive review of the legal framework should be conducted, ensuring that legislation is upgraded to establish and promote safe and sound banking practice; the role, responsibilities, and potential liabilities of supervisory and statutory boards; the role of bank capital in the system (versus an overriding focus on liquidity management to determine bank solvency); licensing; changes in control; transactions with related parties and affiliates; consolidated supervision; and supporting prudential regulation. In concert with the banking legislation review, linkages to other laws such as the commercial code, criminal code, tax, accounting, and audit laws should be evaluated and strengthened to ensure the enforceability of each. This review should be initiated soon, with medium term objectives.
• Accounting and audit laws deserve evaluation to reflect current prudent practices and international standards. A schedule for upgrading the accounting law to reflect IAS should be prepared which maps a migration of existing standards to ones which more clearly reflect the true economic value and condition of the bank. This review should be initiated soon, with medium term objectives.
Supervisory Organization, Objectives, and Governance
6.56 The organization of the supervisory function, its goals and objectives, and its policies and procedures require upgrading in order to effectively support banking reform and to protect the future assets of the system. These endeavors will require significant resources. They also require a fundamental shift in the culture and operating procedure of both the supervisor and the banking system as a whole. An evaluation of the role of supervision in the system should be undertaken together with drafting a statement of objectives and mission for governmental endorsement and publication. Management decision making processes, internal procedures, and accountabilities should likewise be evaluated. A code of conduct for supervisors and executive management, including the Governor, should be prepared. A plan for internal change should be prepared with near term objectives.
Supervisory Capacity Building
6.57 The areas of regulatory reporting, offsite analysis, examination, licensing, IT, training and personnel, i.e. the supervisory building blocks, require evaluation and a plan of strengthening. Within these functions, aspects such as direction and focus, procedures, reporting, communications, responsibilities and accountabilities should be emphasized.
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E. PROBLEM BANKS RESOLUTION
Overview
6.58 In the short term, launching an adequate and comprehensive resolution strategy for the banking sector is a key priority that should be pursued without delay. This strategy should be implemented along with a methodical plan to bring the sector into compliance with prevailing laws and regulations, improve corporate governance in the banking system, and ultimately, strengthen competition. Banking resolution should also be seen in an integrated and coherent strategy to workout large number of troubled assets. The latter calls for coordinated actions with the privatization and enterprise restructuring strategies that should be pursued at the same time.
6.59 FRY authorities have put considerable emphasis on assessing the severe troubles of the financial sector. While it is widely accepted that the insolvency of many FRY banks is very deep, poor data and weak institutional support have made the early stages of an adequate assessment cumbersome and slow. In recent months, the NBY has launched a series of studies that have yielded preliminary information confirming that a large segment of the system is deeply insolvent. FRY authorities have also recognized that until these troubled banks are strengthened or removed from the system, it will not be possible to re-establish confidence in the banking system, and conduct appropriate economic management. Moreover, the reestablishment of adequate financial flows and thus the efficient allocation of financial savings into new investments is recognized as a cornerstone of FRY’s recovery. In this context, the authorities have started the preparation of a resolution strategy that seeks to strengthen both legal and institutional weaknesses, the design of which is expected to allow for decisive and comprehensive intervention to resolve all troubled banks of the system.
6.60 FRY’s banking system is governed by what appears to be a somewhat adequate regulatory environment. Yet in recent years it appears there has been significant infringements on the enforcement side. There is also a reasonably well defined framework for bank resolution centered on a law on bank rehabilitation. Specific problems exist in prudential regulations which have generous definitions of risk assets and are poorly enforced by NBY.
6.61 The condition and readiness of some key financial sector institutions pose a much more complex problem. The NBY has for a long time played a direct role in the allocation of credit and interfered with bank's interest rate policies. After a decade of mismanagement and distorted incentives, the NBY is critically short of skills, and its instruments to properly manage monetary policy are limited. Banking supervision has been under duress and was disrupted by external and political pressures. The BRA has been in operation for more than a decade, but in all this time it has dealt with the resolution of a few small cases, and it lacks qualified staff that will be needed to face up to the difficult tasks of implementing a comprehensive bank resolution strategy. Aside from the design of policies for bank resolution, upgrading the institutional capacity of the BRA will be central to the implementation of any resolution strategy. This matter is discussed later in the report.
128 Chapter 6. Financial Sector
Strategic considerations in development of a resolution strategy
6.62 With the assistance of key donors and the IFI’s, the NBY has developed the initial outline of a resolution strategy for the banking system in Serbia. Considerable technical work is underway to elaborate a more detailed strategy that would put forward specific proposals on the basis of an in-depth analysis of the costs of resolution options, the legal tools available, and the institutional and operational requirements of the resolution strategy selected by the FRY authorities. Efforts have been made to draw on the experiences of other transition countries in addressing similar bank resolution problems. Particular emphasis has been placed on using lessons learned from the successes and failures experienced in the execution of bank rehabilitation programs in Slovenia, FYR Macedonia, and Croatia (with similar inherited banking problems and legal frameworks).
6.63 One major lesson to be drawn from these relevant experiences is the importance of ensuring that solutions to the bank restructuring problem are fully integrated with solutions to the workout and resolution of the enterprise sector. In turn, it is now understood that the workout of bank assets is best carried when tackled as part of an integrated solution to the broader problem of arrears in the economy. Part of this understanding is that the weaknesses of legal frameworks - and particularly the operating weaknesses of transition country judicial systems - present much greater obstacles to the bank liquidation and workout processes than had been originally assumed.
6.64 Despite the lack of accurate information, preliminary information shows that FRY banks are in a severe crisis and that very large amounts of scarce financial and human resources will be required to restructure the system. Accordingly, the authorities should assess whether the resources required are best utilized in the rehabilitation process (rather than liquidation) and if the additional costs of bank rehabilitation versus liquidation can be justified once all direct and indirect costs are fully elaborated. The extremely tight fiscal situation in FRY will need to be carefully considered when decisions are taken on the finalization of a cost decision matrix for bank liquidation/rehabilitation.
6.65 Arguments traditionally advanced to justify rehabilitating rather than liquidating banks include: the risks of systemic impacts from the disruption and loss of confidence caused by a large bank failure; and, the macroeconomic impact of disruption of the banking sector. However, the potential for further reduction of depositor confidence (which is almost absent in any case) or for disruption in the payment system appears to be limited. While it can be argued that a short-term impact due to the loss of banking infrastructure may cause some problems, banks requiring resolution are not active lenders, so any impact on the real sector from a reduction in bank credit is not likely to be significant.
6.66 Structural problems in Serbia will present enormous obstacles to bank rehabilitation. These problems are still not fully understood or quantified, but early indications demonstrate that there is massive enterprise sector insolvency and a lack of domestic finance and skills with which to restructure the sector. This situation is further aggravated by severe budgetary constraints which make the availability of financing to enterprise restructuring and bank resolution processes extremely scarce and politically costly. The latter is reinforced by the inflexibility of costs associated to bank resolution which are linked to implicit or explicit state
129 Chapter 6. Financial Sector guarantees covering a high percentage of bank liabilities, including foreign debt. As in other transition countries, a weak and generally untested legal and institutional framework both for the workout of enterprises and for bank liquidation, a critical shortage of skilled human capital, and critically low levels of depositor confidence present additional obstacles to successful bank resolution.
6.67 In a nutshell, there are a few but important strategic objectives that need to be resolved in the development of a resolution strategy. These include:
• An adequate assessment of the alternative costs of resolution options.
• The definition of a workout solution for assets carved out of the banking system integrated with the broader workout of claims and arrears in the economy.
• The liquidation of insolvent banks must be integrated with the overall workout solution.
• Any attempt at bank rehabilitation must be based on an understanding that the purpose of the rehabilitation process is to create stable and viable banks which can be privatized by sale to strong strategic partners in the short term4.
An indicative strategy for restructuring the Serbian banking sector
Strategy for bank liquidation
6.68 A large number of banks will require liquidation in the course of the restructuring of the sector. Using court supervised bankruptcy as a tool for liquidating banks has proven to be inefficient, and the prospects for undertaking liquidation in Serbian courts would be expected to be equally poor unless time were to be available for significant restructuring of bankruptcy legislation and civil procedure5. In order to avoid using court-driven processes as the mechanism for bankruptcy or liquidation of banks, it is recommended that the NBY and BRA explore amending the existing Law on Bank Rehabilitation to allow the appointment of the BRA as a receiver and conduct the liquidation of banks as an out-of-court procedure6. Alternatively, or in the case that the timely approval of such amendment proves unfeasible, it is recommended that NBY and the BRA examine the possibility to conduct a de-facto liquidation of banks while they remain de jure in the status of rehabilitation. In concept, this would involve the following:
• Banks designated for liquidation would be placed in rehabilitation. Shareholders would be wiped out and management would be removed and replaced with a BRA-appointed manager.
4 Multilateral institutions dedicated to private sector development can play an important catalytic role in the early stages of the bank privatization process, as well as in the establishment of new banks and other financial institutions. The needs for this kind of support are indicated in chapter 5. 5 In the medium term, passage of appropriate legal reforms to allow the orderly liquidation of banks should be accorded a high priority by the government. However, given the need for fast action to restructure the banking sector waiting for new legislation before acting is not considered to be a practical option. 6 Substantial planning is already under way to revamp the capacity of the BRA, including TA from donors.
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• The bank would immediately cease accepting deposits of any kind.
• The banks would be “re-capitalized” using the mechanism of a carve out of assets to the BRA. All credit assets of the bank along with all fixed assets and equipment would be included in this carve out. The assets would be purchased by the BRA with a pass through note entitling the bank to receive any cash flow (net of expenses) received from liquidation of the carved out assets.
• Enterprise credit assets carved out would be transferred to the Ministry of Privatization or another specialized Government agency for management and disposition along with all other state claims against the same debtor.
• The physical assets of the bank, along with any retail credit assets and its retail deposits would be offered for sale by transparent auction. This would be intended to allow healthy banks to rapidly expand their networks and, also, reduce the cost of deposit insurance by transferring some of the liability to the new owners.
• The BRA would pay off any remaining insured deposit liabilities by means of an assumption of liability and payout.
• The remaining “shell” of the bank would be placed in bankruptcy with any remaining assets, and the pass through note. The powers of the BRA to declare a rehabilitation unsuccessful would be used for this purpose.
• This strategy leaves unresolved the crucial issue of the dismissal of the staff of each bank7. One option would be to leave severance payments as the responsibility of the bankruptcy estate. If the use of bankruptcy for this purpose is considered undesirable, specific budgetary provisions may need to be considered to deal with these social costs. Some form of financing through the BRA might also be considered.
Strategy for bank restructuring
6.69 Bank Rehabilitation. Where adequate fiscal resources are available, the bank rehabilitation process should be undertaken with the objective of stabilizing and restructuring the bank concerned to a point where it can be privatized by sale to a strong strategic investor (preferably another bank). The methods which have been shown to be effective in restructuring banks in the region are:
• Implementation of strong governance and controls over the operations of the bank. In the initial phase of rehabilitation this involves the use of tight restrictions on, and continuous
7 A skills audit may be a useful enhancement to the implementation of the resolution strategy.
131 Chapter 6. Financial Sector
review of, credit activities. Generally, a principle of zero net lending8 is applied and all non-retail credit activity is subject to case-by-case BRA approval.
• The BRA-appointed management of the bank is required to produce and implement a rehabilitation plan incorporating extensive cost reduction and reorganization of the bank. The financial objective of the rehabilitation process is, within 12 months, to achieve at least zero net quasi-operating cash flow9.
• The bank is closely monitored by the BRA for compliance with the financial and non- financial targets and deadlines contained in the rehabilitation plan. In the event that management fails to achieve targets specified in the plan, it is replaced. Incentives may also be offered to management for successful performance.
6.70 Bank Stabilization. Under the circumstances faced by the FRY Government it seems unlikely that the fiscal resources will be available to conduct the full rehabilitation process for all major banks seen in other transition countries. Accordingly, the concept of carrying out a less costly stabilization program for selected large banks rather than attempting a full rehabilitation program is being considered. Stabilization would involve the provision of a minimum (but still large) amount of assistance to key large banks followed by their rapid privatization, without the extended period of rehabilitation allowed for banks to achieve profitability before privatization seen in other countries.
6.71 While undertaking stabilization rather than rehabilitation appears to be attractive from a fiscal perspective, authorities should be cautioned that stabilization is inherently risky. The “stabilized” banks would lack sufficient liquidity to withstand a rapid reduction in liquidity (deposits, transactional balances) unless operating expenses were to be quickly and massively reduced, and provision must be made for payment of maturing guarantees. Accordingly, provision must be made in any stabilization-based plan for the banks to have access to emergency liquidity and, if required, to further injections of budget funds (possibly through a bond repurchase facility) to fund maturing off balance sheet liabilities. Needless to say, any emergency liquidity provided to banks should be within the framework of the monetary program, and injections of budget funds should be within the framework of the fiscal program
Costs of restructuring the banking system
6.72 As stated above, there are several technical, social and political implications, and indirect effects to the real economy that need to be fully integrated to the decision making process of choosing an appropriate resolution process. Nevertheless, despite the lack of proper information to fully develop this analysis, this section analyzes the main building blocks that need to be taken into account to build a useful resolution cost-matrix that allows depicting
8 This means that the funds available for lending can only be raised from collections from the existing credit portfolio and generating new deposits. All funds received from the BRA may only be invested in short-term high quality liquid assets for use as a defense against liquidity problems. 9 In essence this concept requires that a bank generate sufficient income in cash to cover its operating expenses, including interest expense.
132 Chapter 6. Financial Sector counterfactual scenarios. As imprecise as these scenarios may be, they represent an approach that may increase in usefulness as better and more recent data become available.
6.73 The magnitude of these costs indicates the challenge which is estimated will have to be faced by the FRY authorities. Costs have been estimated including the costs to the state of carving out frozen foreign currency deposits and state-guaranteed liabilities to foreign creditors, as well as, for illustrative purposes, including the costs of liabilities and assets carved out under state guarantees. Cost estimates are based on 31 December 1999 data provided by the NBY as a result of a recent bank survey10. The costs shown exclude losses which may be incurred by the NBY on liquidity credits extended to banks designated for liquidation assume that these are uncollateralized or collateralized with low quality or non-realizable collateral. The differences in costs between rehabilitation and stabilization options arise primarily from differences in the amount of cash that is assumed each bank may require to stand a possible run on its short-term obligations as part of its assistance package. Additional costs of BRA operations, costs of liquidating banks, and the costs of technical assistance support to the bank restructuring program are not included in the cost matrix presented below.
6.74 The implication of the use of 31 December 1999 data is that (with the possible exception of deposit insurance costs) the estimated costs are likely to be minimums. It is unlikely that the condition of the banks reported to be capital negative has improved in the intervening 12 months (more accurate reporting of deposit insurance liabilities would have no significant effect as this represents only a tiny fraction of total costs). It should also be borne very much in mind that the number of banks reported as insolvent is likely to increase once an accurate assessment of their condition is made by the NBY.
6.75 For illustrative purposes, three possible scenarios are presented in Table 6.4. These include liquidation, rehabilitation, and stabilization. In each scenario the costs of all banks presumed to be insolvent is aggregated. The actual costs of resolution are of course likely to emerge as a combination of the various scenarios on a bank by bank basis. An indicative scenario using average costs of resolution for nearly 30 Serbian banks points to budgetary needs Table 6.4: Estimated Direct Costs of Resolution Alternatives (a) Including costs of carved out frozen foreign currency deposits and state- guaranteed foreign liabilities
(DEM million) Liquidation Full Rehabilitation Stabilization Only 2001 2002 2001 2002 2001 2002
Total for 6 Big Banks 130 451 2,249 672 1,447 710
23 additional insolvent banks 139 261 139 261 139 261
Costs of Other Banks 78 216 78 216 78 216
TOTAL 347 929 2,466 1,149 1,663 1,187 o/w bank resolution only 35 0 2,154 220 1,351 259
10 The survey including the recalculation of banks’ financial statements for estimates of foreign exchange losses and adequate level of provisions.
133 Chapter 6. Financial Sector that may range at a minimum between 1-2 percent of GDP during the next 2 years. No specific estimates have been made for s similar intervention in Montenegro. Needless to say, there are indirect costs associated to the disruption caused on enterprises that may depend on one or more of the banks that are selected for intervention, as well as political and social costs. The latter are even more difficult to estimate, yet experience elsewhere shows these are by no means negligible.
FRY’s bank resolution strategy11
6.76 The FRY authorities are pursuing a three phase restructuring strategy for the banking sector commencing immediately and ending in 2002-2003 (Figure 6.1). This timetable is structured around the projected timetable for the availability of possible donor/IFI financing for bank restructuring.
Phase 1 – BRA Intervention and Implementation of Control (April/May – August 2001)
6.77 Upon suggestion of the BRA, the NBY would propose rehabilitation for all banks now known to be insolvent, as well as those shown by NBY inspections completed in April/May 2001 to be insolvent. One or more (depending on the size of the bank) persons would be installed in each of the banks to replace existing management. These persons would be installed by the BRA (and confirmed by NBY) according to the legal status of the bank concerned. The activities of these BRA-appointed persons would be directed to the objective of preserving the assets of each bank, exercise control and secure records, and severely limit the activities of the banks.
6.78 During this period the work of the NBY special inspection teams for the large banks would be completed in cooperation with the newly appointed management. The final results of these inspections are expected to be available by June/July 2001 at the latest. Based on the results of the inspections and the asset and liability inventories conducted in smaller banks, a cost estimate would be prepared to allow development of a decision cost matrix for use by the FRY authorities in determining which of the banks would be selected for stabilization and/or liquidation. Additional donor/IFI grant funding needs of at least DEM 15 million have been identified to support the operations of the BRA during this period.
Phase 2 – Launching of Liquidation and Stabilization (September 2001 – December 2001)
6.79 The FRY authorities would make a final decision on the selection of banks for stabilization. This decision would be made using the cost/decision matrix prepared using up to date information for all insolvent banks during the course of the Phase 1 inspections by the NBY. Donor/IFI funding technical assistance to the BRA would support the following two main activities: liquidation oversight and implementation for banks selected for liquidation; and (ii) development of stabilization plans and pre-privatization activities for those banks selected for rehabilitation.
11 A detailed draft of this strategy is under preparation with the assistance of key donors. .
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Phase 3 – Liquidations and Privatization of Stabilized Banks (January 2002 – Dec 2002)
6.80 The liquidation (in rehabilitation) process for all banks not selected for stabilization would be completed in mid-2002. At this point, all banks in this category should be under the jurisdiction of a court-supervised bankruptcy process. In the case of banks for which stabilization was launched, the privatization process (expected to take 6-12 months) should commence as soon as initial steps of stabilization have started. In the event that the privatization is unsuccessful for any bank, it would be liquidated using the liquidation procedure.
Figure 6.1: Implementation of Serbian Banking Sector Restructuring Strategy
2001 2002 03 Phase Activity Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
1 Bank Inspections Install BRA/NBY Managers Complete Cost/Decision Matrix Hire BRA Staff T/A Procurement Prepare Stabilization Plans
2 Deposit Insurance Payments Implement Liquidation Activities Cost Reduction Programmes Privatization Preparations Privatization Adviser Procurement
3 Privatization Implementation
Role of the BRA
6.81 It will be desirable that the BRA plays no operational role in the workout of assets carved out from the banks. The BRA would be focused exclusively on management and supervision of the bank liquidation, stabilization, and privatization processes, and should have an operational structure reflecting this role (Figure 6.2). This recommendation is based on experience elsewhere that has shown that the mixing of bank rehabilitation activities with the workout of assets carved out of banks has generally not been successful. The main reasons for this are that the skill sets required for performance of the two types of activities are not compatible and, that the amounts of management time and attention required for workout activities detract significantly from time required for the supervision of bank rehabilitation. Agencies in the region which have attempted to combine the two functions have generally not succeeded in aggressively dealing with their asset portfolios. Moreover, the BRA will be a relatively minor creditor as compared to other state creditors. Assets carved out to the state in the course of assuming liability for foreign credits, tax and other arrears, and inter-enterprise arrears are expected to be larger than claims to be transferred to the BRA. In the context of an integrated workout strategy it is recommended therefore that operational control of the BRA’s assets be transferred to the Government (i.e. the Ministry of Privatization or another specialized Government agency).
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6.82 The actual number of staff required by the BRA will be determined by the numbers of banks allocated to the stabilization and liquidation categories. Estimates of the number of staff which will be required by the BRA are based on the assumption that less than a handful of banks will be stabilized and privatized. It should be emphasized that the BRA should immediately commence the hiring process for these staff as this process will take some time, and that staff will have to be trained.
Figure 6.2: Possible BRA Organization Structure
BRA COUNCIL
Executive Director
Administration Deposit Insurance Stabilized Bank Bank Liquidation Oversight Oversight
Agency accounts Payments to insured Monitoring of Monitoring of activities depositors in liquidated activities of BRA of BRA managers in Legal support to banks managers in banks banks other divisions Development of a Credit approval Supervision of asset Technical sustainable deposit sales assistance insurance scheme Financial procurement and monitoring Financial monitoring payments administration Bank privatization Legal activities related process to bank bankruptcies
F. ASSET RESOLUTION STRATEGY
6.83 Recent preliminary studies by the NBY show that about 85 percent of financial sector assets are with banks that have negative equity. Almost all these assets are concentrated at the six largest banks. Working out this asset base will be a mammoth task. Moreover, any asset recovery program will also need to be sensitive to requirements for enterprise restructuring and privatization.
6.84 As experience elsewhere shows, a successful program of asset resolution will depend largely on (i) a faster and more reliable legal framework to enforce creditor rights and restructure viable but over-indebted companies, (ii) consolidation and joint resolution of bank and non-bank claims on enterprises, (iii) choice of recovery methods based on enterprise characteristics, especially in relation to privatization plans, and (iv) institutional arrangements that emphasize the outsourcing of implementation.
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Enforcement of creditor rights
6.85 Enhancement of the legal framework (i.e., laws, procedure, capacity) to provide faster and more reliable enforcement of creditor rights is a fundamental requirement. Without improvements to the legal framework, proper choices on claims consolidation, recovery methods, and implementation arrangements are unlikely to be effective.
6.86 Discussions with FRY lawyers active in asset recovery and review of the Act on Compulsory Composition With the Creditors, Bankruptcy, and Liquidation (“Act”) reveal numerous opportunities for impeding recovery by creditors, postponing enterprise restructuring, and gaining time to strip assets. Previously, gaps in the law did not matter because social enterprises were not allowed to fail. The prevailing assumption seems to be that current laws are adequate, that problems are only in implementation, and that the appointment of new judges will fix the problem. This assumption is almost certainly unrealistic. Experience from other systemic crises shows that in a situation where thousands of enterprises face imminent bankruptcy, debtors will use every opportunity to avoid loss, delay creditor recovery, and prolong their opportunity to divert assets. A rigorous assessment of laws, procedures, and institutional capacity is needed. Possible enhancements include the following:
• Make it easier and faster for creditors to foreclose on collateral or seize movable property without having to initiate bankruptcy proceedings.
• Introduce a “middle option” between debtor-driven composition and administrator-driven liquidation. This court-supervised middle option should enable creditors to drive (or at least heavily influence) the operational restructuring of a distressed company as well as its financial restructuring.
• Introduce clear, swift, and sure criteria for the commencement of debtor-driven composition, court-supervised restructuring, and bankruptcy.
• Eliminate opportunities for delays in proceedings.
• Make administrators more responsive to creditors.
• Provide additional trained judges and administrators to handle the likely surge in composition and bankruptcy cases.
• Develop a standard approach to filing fees. At present, filing fees may be an impediment to composition or – more likely – an excuse to avoid bankruptcy.
Consolidation of claims
6.87 In addition to claims acquired from banks by the BRA, enterprises will also face claims from non-intervened banks, republic and municipal tax authorities, other enterprises (e.g.,
137 Chapter 6. Financial Sector utilities and suppliers), and employees. It is important to consolidate and resolve claims on enterprises – especially for large enterprises – for the following reasons:
• Enterprises that successfully emerge from composition, court supervised reorganization, or purely voluntary restructuring should get a “fresh start.” The resolution of all outstanding claims would enhance enterprise values, an especially important consideration in the cases of social enterprises designated for sale to strategic investors.
• Resolution of all outstanding claims would reduce uncertainty over the enterprise’s future ability to service debt. This would enhance the value of loans that remain with banks under rehabilitation, or that are sold to other financial institutions by the BRA.
• Unconsolidated claims could disrupt BRA’s asset recovery and enterprise restructuring/privatization in unforeseeable ways. For example, unconsolidated creditors could seek to foreclose on collateral or seize movable property; workers could strike over unpaid wages; unpaid suppliers could cut off material inputs; and unpaid utilities could cut off service. Links between enterprise debt resolution and privatization
6.88 The work out institution’s choice of methods – e.g., voluntary financial restructuring, composition, court-supervised restructuring, or liquidation – for recovering on claims against enterprises will need to be sensitive to the status and condition of various enterprises. Is the enterprise fundamentally viable or not? Is the enterprise designated for privatization in the near term or the longer term, or is the enterprise already private? Discussions with the privatization authorities suggest a scheme for coordinating asset recovery with the government’s privatization program.
6.89 Public enterprises. Public enterprises are mostly utility companies. These account for a large portion of foreign-denominated credits. The privatization authorities indicate that plans for eventually privatizing utilities are under development and that a regulatory framework is expected to be developed shortly. In general, credits to these public enterprises could be restructured during preparations for privatization. Such restructuring could involve absorption of enterprise debt by the state or – depending upon an enterprise’s cash flow projections – rescheduling of the loan or its conversion into another debt instrument. Regardless of progress on utilities privatization, the work out institution should identify non-core assets, take control over these non-core assets, and auction them for cash as soon as possible.
6.90 Strategic sale candidates. According to the privatization authorities, 80-120 “good” social enterprises are candidates for privatization through share sales to strategic investors. Plans call for sales of 75 percent of shares to strategic investors through public auction or tender, plus sales of 10 percent to enterprise insiders and 15 percent to the public for vouchers. While there is no sufficient information on the financial position of these enterprises, if these are really “good” enterprises, they should be able to service debts taken over by the work out institution and there would be little or no requirement for debt restructuring. Non-core assets could be sold separately to raise cash for general government needs. Operational restructuring of the core business could be left to the strategic investor.
138 Chapter 6. Financial Sector
6.91 Highly distressed, socially-owned systems. According to the privatization authorities, 30-50 very large socially-owned “systems” (i.e., integrated conglomerates) are not viable as going concerns. These systems are believed to be the other large recipients of Paris/London- funded credits as well as large dinar-denominated credits. While these conglomerates are prime candidates for liquidation through bankruptcy, immediate liquidation is likely to be politically unacceptable. To wind up these enterprises in some reasonable manner, the government needs an alternative between debtor-driven composition and administrator-driven bankruptcy (liquidation). This alternative should facilitate (i) the immediate seizure of equity and management control on behalf of creditors; (ii) the safeguarding of real and liquid assets; (iii) the timely sale of productive assets; and (iv) the equitable distribution of sale proceeds among all creditors and claimants – including suppliers and employees. A new legal option for a fast-track creditor-driven restructuring ( which could eventually end in liquidation) could be particularly useful in winding up the highly-distressed socially-owned systems. An equitable claim on asset sale proceeds could also be useful in gaining employee acquiescence. Timely dissolution of non- viable socially-owned systems will also require support from programs to enhance safety nets for workers and promote small and medium enterprise (SME) development in hard-hit localities.
6.92 Other socially-owned enterprises. The business prospects and financial condition of the other 5000-6000 socially-owned enterprises is a great unknown. The privatization authorities wish to privatize these enterprises through public auction or tender. Their working assumption is that public enterprises and the 30-50 highly-distressed socially-owned systems account for the great majority of non-performing credits and arrears and that the other 5-6000 are mostly “clean.” If this assumption is correct, it should be safe to proceed with a first-round effort to privatize 5-6000 socially-owned under the following conditions – prior to any privatization transaction, (i) data on all claims against each enterprise should be assembled and publicized; (ii) needed improvements should be made in Yugoslavia’s legal framework for protecting creditor rights; (iii) the government should make clear that the work out institution will aggressively enforce its creditor rights; and (iv) the government should release the enterprise purchaser from liability for any unpublicized claims from government agencies (e.g., BRA, tax, utilities). Under these conditions, first-round privatization auctions/tenders could be expected to separate “good” from “bad” enterprises. Enterprises with non-viable business prospects or unsustainable debt burdens would presumably not be privatized in the first round. Using enhancements to insolvency law and procedure, creditors would restructure or liquidate these companies during a “second round.” For enterprises privatized during the first round, creditors would be able to rely on an enhanced insolvency framework to protect their rights.
6.93 Private enterprises. The enhanced framework for protecting creditor rights would also apply to Yugoslavia’s 60,000 or so private enterprises.
Implementation and institutional arrangements.
6.94 The asset recovery task facing the government, the NBY, and the BRA is enormous. Building an in-house asset resolution capability within the BRA (or some other government entity) is likely to be time-consuming, expensive, and not necessarily effective. Instead of developing major capabilities within the public sector for asset resolution, the government should use and develop private sector capabilities for asset resolution. Previous discussion
139 Chapter 6. Financial Sector suggests an indicative task segmentation and assignment of responsibilities. Further work to define this segmentation and assignment of responsibilities will be needed. More precisely:
• Public enterprises: The government agency responsible for a particular enterprise’s privatization would restructure enterprise debt and arrange for unsustainable debt to be absorbed by the state. • 80-120 “good” socially-owned enterprises: Any needed recovery should be left to an appropriately compensated financial advisor retained by the privatization authorities. • 30-50 “bad” socially-owned systems: Majority creditors (most likely to be the BRA) should appoint a receiver for each system. Each receiver’s compensation should include incentives to maximize the present value of proceeds from asset sales. A simple receiver- based approach to winding up these systems seems most appropriate. • Socially-owned enterprises privatized during the 1st round: The main burden would be on the privatization authorities to assemble and publicize information on claims on enterprises. BRA-held enterprise credits that are non-performing after privatization could be pooled by type (e.g., secured by real estate, secured by movable property, unsecured) and auctioned to private investors. • Socially-owned enterprises not privatized during the 1st round: These would presumably be the enterprises with un-viable business prospects or unsustainable debts/claims. The BRA or other work out institution could appoint incentive-compensated receivers for medium-sized enterprises. For BRA-held credits to smaller enterprises, the credits should be pooled and auctioned to private investors. • Non-performing loans to private individuals and businesses: These should be pooled and auctioned to private investors.
G. DONOR PROGRAM
6.95 ZOP reform. Immediate priorities to reform ZOP include (i) the formation of a National Payments Council under the guidance of senior NBY management, and including cross- institutional support from the legal and banking community, (ii) the replacement of the 1998 payments law and an immediate enabling provision for banks to handle internal payments; and (iii) the rearrangement of staff assignments between ZOP and NBY. In the medium term assistance to ZOP should also include (i) redesigning the payment systems computer applications to conform to international standards, and (ii) reevaluation and modernization of existing IT architecture12.
6.96 Regulatory Reform. The key short term priorities in banking supervision include (i) a review of banking intervention tools; (ii) review and modernization of secured transactions and registries; (iii) upgrading of accounting and auditing capabilities; (iv) capacity development and training of staff; and (v) information technology and equipment upgrades. The overall change process may be supported by consultants positioned for a defined period of time to advise management and coordinate overall efforts. Separate assistance may be needed to further refine
12 A detailed report on ZOP’s policy reform was prepared by the IMF in March 2001.
140 Chapter 6. Financial Sector regulatory reporting, develop IT capacity, and to implement a career planning and training effort. Currently, a program of short term (approx. 6 months) technical assistance has been positioned by USAID to initiate the bank diagnostic reviews and to begin selected steps in the capacity building process. Within the near term, a plan for longer term assistance may be prepared by the same.
6.97 Bank Resolution. The main features of support for Bank Resolution will be:
• Technical assistance: Based on the indicative strategy presented, it is expected that BRA will require extensive technical assistance support in order to carry out the restructuring of the banking sector. Technical assistance should be designed to respond very precisely to the restructuring strategy adopted by the FRY authorities. It is important that the donors ensure that their assistance programs are fully coordinated and that full account is taken of the limited absorptive capacity of the BRA. Given the urgency and the short-term nature of the bank resolution program, it is assumed that most of the donor assistance for bank resolution will be front-loaded. • Structural reform support13: Comprehensive reform of the banking system as illustrated above could have large direct and indirect costs. Precise costs are difficult to estimate due to the lack of accurate information regarding the troubled banks, as well as a definitive strategy that would define the resolution path that these institutions will follow. Overall fiscal constraints will be an important consideration in deciding the appropriate strategy. In any event, it should be highlighted that there are costs associated to the bank’s accounts that are likely to be treated within the budgetary sphere and that are independent from the bank resolution strategy that will be pursued. These costs are those related to the servicing of foreign liabilities and the frozen foreign currency deposits. There are, however, additional costs related to bank resolution that depend on policy choices for specific troubled banks and their uncovered potential losses. These costs relate to the treatment of deposits and deposit insurance, the carve-out of bad debts and the budgetary costs of servicing ‘rehabilitation’ bonds, the recognition of other creditors claims, as well as the direct social costs related to likely liquidation of a considerable number of troubled and unviable banks. Overall, as experience elsewhere in the region shows, these costs will have to be ultimately financed out of budget resources, which in turn could be indirectly financed from donor support.
6.98 Asset Resolution. Priority arrears of technical assistance in asset resolution are in (i) insolvency reform; (ii) advising the BRA on asset pooling and auctioning ; (iii) assistance to non-viable SOEs; (iv) commercial training of judges and administrators and (v) BRA liaison and support with the privatization agency.
13 As the costs associated with restructuring of the banking sector are as yet unknown, no estimates for external financing have been presented in this report. Once costs are further defined external financing requirements would be incorporated as part of the ERTP program.
141 Chapter 6. Financial Sector
Table 6.5: Estimated Requirements for the Financial Sector (US$ million) Activity Description CY01 CY02-04 Total
Technical Assistance ZOP reform Institutional reform 0.5 1.5 Legal assistance 0.5 0.5 IT/Planning Software/hardware 0.5 2.5 Regulatory reform Banking resolution: review of intervention tools for rehabilitation, 1.0 0.5 liquidation, bankruptcy Banking regulation: comprehensive review and modernization, 0.5 3.0 secured transactions and registries, EU/BIS standards Accounting and auditing: upgrading to IAS 0.5 2.5 Banking supervision and capacity building: upgrading of procedures, 5.0 2.75 regulatory reporting, it, training Bank resolution Cost/Decision Matrix (BRA/NBY): Detailed cost estimates for the 1.0 stabilization of large banks Operational support (BRA): Stabilization Oversight, Deposit 1.5 1.0 Insurance policies and operations, Liquidation Oversight Preparation of Large Banks for Privatisation: Management teams to 2.5 2.0 implement stabilisation and pre-privatization operations. Privatization of Large Banks: Investment banking and legal support 1.0 1.5 for the privatization process Privatization/Liquidation of small Banks: Management of bank 1.0 3.0 operations; Sale of branches and assets to strategic investors Asset resolution Insolvency reform: Examination of impediments to creditor 0.5 1.5 recovery, Development of detailed recommendations Asset pooling and auctioning (BRA): Advisor to form asset pools, 0.5 0.5 market auction, support investor due diligence SME support and safety net development: Assistance to non-viable 1.0 3.0 SOE systems, worker safety nets and develop SMEs. Commercial training of judges and administrators: Compositions, 0.5 1.0 bankruptcies, and creditor-driven restructuring Privatization liaison and support (BRA): compositions, bankruptcies, 0.3 0.25 and creditor-driven restructuring
Total financial sector requirements 18.3 27.0 45.3
142 CHAPTER 7. ENERGY
A. SUMMARY
7.1 Energy pricing during the 1990s. The energy sector is one of the largest sectors of the Yugoslav economy, consisting of electric power, coal production, district heating, and oil and gas production and imports. The sector plays an important role in the economy both directly and indirectly, accounting for about 5 percent of GDP. Total energy consumption is about 10 million tons of oil equivalent, with annual economic costs of about US$1.4 billion for electricity, US$400 million for petroleum products and US$400 million for gas. However, the prices charged for electricity, district heat and gas supply to households are well below the economic cost of supply, resulting in a quasi-fiscal deficit of about US$1.2 billion, of which roughly US$0.1 billion is attributable to electricity consumption in Montenegro.
7.2 During the 1990s the sector was to a considerable extent de-capitalized: energy prices plummeted during the period of hyperinflation (1993-1994), rose sharply during 1995-1997, but were thereafter not allowed to keep pace with inflation or international fuel prices. Although as recently as 1997 the electricity price was still 3.7 US cents/kWh, by October 31, 2000 the price was merely 0.9 US cent/kWh or about one-fifth of the estimated economic price level. Similarly, the October 31, 2000 price for district heating in Belgrade for households, schools and hospitals (5.0 US cents/m2/month) was at only one-eighth of the cost-covering level.
7.3 The impact of this pricing policy on the energy sector was threefold. Firstly, as revenues decreased energy sector enterprises invested less and eventually stopped investments altogether. Maintenance was reduced to well below acceptable levels. Furthermore, during the Kosovo conflict the energy sector was targeted, notably the refineries, generation plants, transmission lines and substations. As a result there is now a large backlog of reconstruction, deferred investments and maintenance that needs to be addressed as soon as possible. Whereas investments in an electric power sector the size of Serbia's should normally be in the range of about US$250 million per year, on average only about US$50 million per year was invested during 1990-2000, most of it during the first half of the decade. Secondly, as energy prices of electricity and district heating dropped excessive energy use was implicitly encouraged, especially since indigenous coal could meet much of the supply needs. In particular, consumers started to rely on electricity as a primary or supplemental source of heating, so that household electricity demand increased by about 50 percent over the last decade. At present almost 40 percent of electricity demand in the winter season is for heating. Thirdly, the lack of adequate revenues for district heating and natural gas distribution companies made it impossible for these companies to pay for their share of the FRY’s gas imports, resulting in a debt of US$303 million owed to Russia’s Gazprom. Gazprom, in turn, cut back on deliveries, leading to worries in FRY about security of gas supplies. Such concerns would be unfounded if prices were at the appropriate levels, which would also decrease the pressure on the power system to provide electricity for heating.
7.4 Primary energy production and imports. If adequate investments and maintenance are undertaken, domestic production of lignite, coal, hydroelectric power, fuelwood and other biomass should continue to be sufficient to meet demand during 2001-2005. As domestic Chapter 7. Energy production of gas is expected to remain at roughly 0.7 bcm/yr., substantial and increasing imports of natural gas will be necessary during 2001-2005. Domestic production of oil is likely to continue to decline, requiring either an increase in imports or a reduction in demand. Reportedly, about 40 percent of oil products are entering the country without being registered. In addition to large loss of revenue for the state budget, the illegal import of oil derivatives has major negative impacts in terms of underutilized refining capacities, harmful impact on equipment due to quality problems and environmental pollution due to the low quality of smuggled gasoline and diesel fuel.
KEY CHALLENGES
7.5 A number of critical issues need to be tackled virtually simultaneously both over the short-term as well as the medium term. These are: (a) energy price increases; (b) repair and rehabilitation of essential capacity in the electric power, coal, district heating and oil and gas sectors; (c) energy efficiency investments; (d) building up institutional capacities in the energy sector; (e) improving payment discipline; (f) policy making and regulation; and (g) sector restructuring.
7.6 Electricity demand and supply. The current shortage of electricity in Serbia is a result of two trends. The first trend is that the total annual demand for electricity during the last ten years increased 21 percent, driven by the 52 percent increase of electricity consumption in households. The second trend is the decline in electricity production due to the lack of maintenance and destruction of power facilities in 1999. Production in January 2000 was 23 percent below the production in January 1990. These two trends inevitably led to the current crisis in electricity supply which requires urgent actions on both fronts - suppression of demand through price increases and energy efficiency measures; and improvement of power generation and transmission through repair and rehabilitation programs and investments in lignite mines.
7.7 Price Adjustments. Major tariff increases are needed in the district heating, electric power and natural gas sectors in order to: (a) encourage efficient use of energy; and (b) improve the financial performance of the energy enterprises. The electricity capacity shortage will disappear once damaged power plants come back on line and prices are increased significantly towards economic levels, inducing a decrease in excess and/or distorted demand. These price increases should be combined with a program to encourage energy efficiency investments.
7.8 For electricity (and district heating) prices increases to the economic level should take place over a three-year period. Price increases during the first year (2001) would enable suppliers to cover their operating expenses only; operating expenses plus debt service would be covered during the second year (2002); and that plus a reasonable return on equity during the third year (2003). Lignite prices would need to be doubled in the short run to approximately US$6.4/ton to enable the sector to maintain production. Natural gas prices to households would need more modest adjustments in the order of 20 percent next year. The price adjustments in these various network fuels should be coordinated to avoid distortions in consumption and investment decisions. During this transition period policy makers should pay special attention to ensuring that wages in the energy sector do not increase faster than in other industrial sectors,
144 Chapter 7. Energy and that the proceeds of tariff increases are spent on improved maintenance and high priority investments, as well as on paying off debts to suppliers.
7.9 Electric power. The available capacity of thermal power plants in Serbia (which account for two thirds of power generation) is only 76 percent of installed capacity. This is the result of damage to generating facilities and equipment derating due to the lack of maintenance and/or design deficiencies. The 110-MW unit in Kolubara A was damaged during the Kosovo conflict in 1999 and the 210-MW unit in Kostolac A was damaged after its ceiling collapsed in 2000. If these two units are repaired before the next winter they will increase available capacity by 320 MW and reduce by half the need for imported electricity. Derating of generating capacity accounts for the loss of 200 MW in Kostolac B (29 percent of installed capacity) and 400 MW in Nikola Tesla A and B (14 percent).
7.10 Donor funding for selected generation and transmission equipment appears to be available, but not for installation. Therefore, there is a major risk that this equipment will not be installed this summer. In that case there would be a repeat of the extensive electricity shortages and associated outages that occurred last winter, which could potentially be much worse if the temperature is normal for the time of the year. This would then again require continued donor- funded electricity imports well in excess of the 2.5 TWh anticipated for 2001. Furthermore, improved donor coordination and donor/EPS coordination will be necessary to ensure that all necessary investments will be implemented on time.
7.11 While Serbia started the last decade with a significant reserve in generating capacity, Montenegro has been a net importer of electricity since the early 1970s. Currently, imports are about one-third of annual electricity demand. Hydropower plants account for 76 percent of total installed capacity in Montenegro. The increase of household electricity consumption by 83 percent (mostly due to electric heating) over the last ten years is caused by the same factors as in Serbia and had similar impacts on the power system.
7.12 Coal sector. Critical investments are needed to avoid a 5-10 percent drop in lignite production in Serbia during 2001/02, with the resulting need to further increase electricity imports. Auxiliary mobile equipment is urgently needed to ensure efficient operation and servicing of the main mining equipment. Mechanical and electrical spare parts, as well as materials for the workshops, are needed for overdue overhauls and for restoring stocks of parts and materials to a minimum level. To catch up with the backlog of overburden removal and allow the mine fronts to move, land must be acquired; this should be financed through an increase in the internal price of lignite. The situation in the coal mines in Montenegro is just as critical and a lack of equipment overhaul and new equipment could result in a serious drop in coal production which would further increase the need for electricity imports.
7.13 The oil and gas sector suffered from particularly heavy damage as a result of the 1999 bombing. The refineries have been the focus of some reconstruction, enabling about 70 percent of the capacity to be brought back online. However, the remaining required investments of about US$600 million can not be financed from internally generated funds or commercial credits. As a result, the product mix will not reflect market demand (more light products are needed) in the near- to medium-term. Immediate needs can be met by a combination of importing petroleum products and gas while the refineries’ medium-term financing needs can best be addressed by
145 Chapter 7. Energy private capital from strategic investors to ensure that investments are well targeted. The natural gas sector has suffered more due to payment problems than war damage. Natural gas is expected to increasingly meet the FRY’s energy needs because of price and environmental considerations. To enable this, considerable new investments in pipelines and distribution systems are required, which can best be met through private sector participation, possibly on the basis of concessions.
7.14 District heating and energy efficiency. Proper functioning of the district heating systems would significantly reduce electricity demand. Increased heat prices, combined with improved payment discipline, should enable the sector to pay its current gas bills. This would result in enhanced and stable gas deliveries, enabling the sector to increase the average heat level supplied to consumers. Major efficiency gains can be made in the district heating sector through energy efficiency investments on both the supply side as well as the demand side. For the latter to occur, however, a number of institutional and legal measures need to be taken requiring significant technical assistance and donor support. Protection of the poorest two deciles of the population from the effects of energy price increases will be an important consideration in the design of an overall social protection program (Chapter 13 – Social Protection).
7.15 Institutional capacities. The tasks of justifying tariff increases, drafting of energy laws, introduction of a regulatory framework, energy sector restructuring, and eventual privatization of parts of the different energy sub-sectors will place enormous demands on the Ministry of Mining and Energy in Serbia, the Ministry of Economy in Montenegro, and on the energy companies themselves. The Ministries cannot possibly handle these tasks, given their very limited staff resources. Indeed, at present the MoE (Serbia) consists effectively only of a handful of people. Donors should give serious consideration to providing extensive technical assistance to the two Ministries and to a lesser extent also to all energy companies, notably EPS and NIS in Serbia and EPCG in Montenegro.
7.16 Improve payment discipline. Beyond the need to increase tariffs, urgent attention needs to be paid to two issues: (a) rapidly increasing collection rates in the energy from an average of about 65-70 percent to near 100 percent; and (b) eliminating the share of barter payments, assignation and compensation within the collection total, now believed to be about 35-40 percent of collections. As part of a strategy to achieve the required increase in collections, the energy enterprises must be given legal and factual authority to cut off customers (both state-owned and private) that do not settle their utility bills within acceptable time frames and/or do not come up with a workable plan to pay off arrears. To the extent that central and local government entities are part of the collection problem, government budgets should contain adequate provisions allowing these entities to pay their utility bills at current rates. The adequacy of these budget provisions will require close monitoring during the transition period when utility rates can be expected to increase sharply and supplemental budgets or budget reallocations may be required to meet utility bills.
7.17 Policy making and regulation. In Serbia, the Ministry of Mining and Energy is entrusted with the development of energy policy. Major energy policy decisions are made by the Cabinet, which also sets electricity, coal, oil and gas prices. The price of district heat is set by local governments. In Montenegro, the Ministry of Economy develops the energy policy and also regulates energy prices. Neither the Serbian nor the Montenegrin authorities seem to apply transparent energy price setting methodologies and adjustment procedures. International
146 Chapter 7. Energy experience suggests that the role of the Cabinet should be restricted to the approval of the broad principles of electricity and gas price regulation. These principles should then be codified in a law. Before the end of 2002, an autonomous agency should be established in each republic to implement the regulation of electricity and (in Serbia) gas prices and to enforce third party access to the electricity and gas transmission systems. The regulatory agency should also provide guidance to the municipalities on setting district heating tariffs.
7.18 Sector restructuring. For both the electricity as well as the oil and gas sectors FRY would be best served by expeditious unbundling of the largest vertically integrated monopolies, NIS and EPS. This should be undertaken in line with existing EU directives for the electricity and gas markets. Such a sector restructuring would enhance financial transparency and competition in the sector by allowing third party access to the natural monopoly components. In the short term, new energy laws should be passed introducing a modern regulatory framework supporting the establishment of an independent regulator(s). Governance should be improved by ensuring that members of Boards of Directors are professionally qualified. Financial discipline and the reliability of financial statements would be much enhanced by improving accounting systems in accordance with GAAP and reintroducing annual external audits by qualified auditors in accordance with IAS. Longer term, however, good governance and financial transparency should come from privatization of a substantial part of these sectors. Preparation of a suitable program of sector restructuring will require considerable technical assistance.
7.19 Donor Program. This chapter reviews the current situation in the energy sector, examining in turn the Electricity, Coal, Oil and Gas, and District Heating /Energy Efficiency sub-sectors. A detailed donor program for three years, on a commitments basis, is presented in tables at the end of each section. These programs are summarized in Table 7.1, which indicates overall external financing requirements of US$945 million over three to four years. The estimated financing requirement, on a commitment basis, for CY01 is US$259 million.
Table 7.1: Overall financing requirements in the Energy Sector (US$ m)
Sub-sector CY01 CY02-04 Total
Electricity 168.5 466.0 634.5 Coal 39.4 83.3 122.7 Oil & Gas 24.8 33.4 58.2 District Heating and Energy 25.8 104.2 130.0 Efficiency
Total 258.5 686.9 945.4
147 Chapter 7. Energy
B. ELECTRICITY
I. SERBIA Background
7.19 The electricity sector suffered considerable damage during the 1999 Kosovo conflict with generation stations, transmission lines and substations being the targeted. The system has been able to remain stable by imposing rolling blackouts in addition to the import of 3.5 TWh of electricity from neighboring countries during 2000. While units are taken out of service for repairs this year, an additional 3.0 TWh of electricity imports will be required to meet demand, even assuming electricity prices are doubled. Hence, the priority needs for the near-term include continued donor support for electricity imports and emergency repair of generation plants, key substations and transmission reinforcement. Technical assistance will be necessary to support implementation of the reconstruction program as well as a broad range of reforms.
7.20 Attractive domestic resources in the form of low cost coal and hydroelectric potential account for almost all electricity production in the Serb electricity sector. However, the sector manifests many of the broader economic problems of FRY: supply is unable to meet demand; prices do not reflect costs; no access to capital to support new investments; deferred maintenance and lack of new investments over the past decade; and a contribution to the quasi-fiscal deficit of about US$1 billion per year. Both the sanctions and perverse domestic policies have distorted development of the sector. However, the combination of natural resources, a strong technical cadre and location advantages as a trading hub in the Balkans, bodes well for the future once reforms are implemented. The electricity sector also holds the potential for quick wins, both in terms of improved supply and reduced consumption due as a response to price adjustments.
7.21 Regional Perspective. FRY is located in the center of South-East Europe (SEE) making it a key conduit for trade. Its electric power grid was/is interconnected with power systems in all neighboring counties providing for the exchange of electricity on a regional basis. The power systems in Serbia and Montenegro were developed as part of the integrated power system of SFYR which was a full member of the then UCPTE. Due to damage to the 400 kV substations Ernestinovo (Croatia) and Mostar (BiH), the power systems of FRY remain disconnected from UCTE since 1992. Repair of these substations is critical to Serbia and Montenegro, respectively, as well as for the entire region. In 1997, the power systems of Albania, Bulgaria, Macedonia, Greece, Romania and FRY initiated synchronous operation according to UCTE requirements, but as a separate zone. The ultimate objective of this interconnection is to facilitate integration of all SEE power systems into UCTE. Because of its position in the region and size of its power system, the rehabilitation and modernization of the FRY power system is key to establishment and efficient operation of the future regional electricity market.
Current Situation
7.22 Prices. The January 1, 2001 electricity price to households was 0.9 US cents/kWh, 0.65 US cents/kWh to industrial customers, and 1.0 US cent/kWh to other customers. The average
148 Chapter 7. Energy economic cost of electricity in Serbia is estimated to be 4.5 US cents/kWh1. Taking into account differences in distribution costs, a rough estimate of the economic cost of electricity for household consumers is about 5.0 cents/kWh, and for industrial consumers 4.2 cents/kWh.
7.23 Electricity Market. The low electricity prices and the low quality and limited availability of district heat supply induced excessive use of electricity, particularly for space heating. A recent inflow of about 700,000 refugees further increased electricity demand. As a result, the total annual demand for electricity in Serbia during the last ten years increased by 17 percent, driven largely by the 52 percent increase of electricity consumption in households. The strong increase of household consumption was partially offset by the reduction of demand in industry, whose share in the gross electricity consumption in Serbia dropped from 42 percent in 1990 to 28 percent 19982. During this same period, the share of household consumption increased from 34 percent to 44 percent. The expanding use of electric heaters by households also contributed to the increase of distribution losses from 10 percent in 1990 to 16 percent in 2000.
7.24 Forecast of electricity demand. Pricing reforms and income growth will drive demand growth. The first trend is expected to result in the rapid reduction in the use of electricity for space heating. Currently, electricity demand for heating represents about 40 percent of daily consumption on an average winter day. It is estimated that the electricity used for space heating amounted to about 8 TWh in 2000, or about 25 percent of gross electricity consumption. A low demand scenario is based on assumption that the consumption of electricity for heating will drop to 2 TWh by 2005 due to a large increase in the price of electricity and improvements in the district heating systems. The second trend is the increase of electricity consumption as a result of real economic growth. Specifically, electricity demand for non-heating purposes is expected to grow by 3.5 percent per year (i.e., about half of the expected GDP growth rate). As a result of these trends, gross demand for electricity in Serbia in 2005 would be roughly at the same level as in 2000 (32 TWh excluding Kosovo) while the peak load would decline to 6,300 MW in 2005).
7.25 Electricity balance. A decline in electricity production due to the lack of maintenance over the last ten years, an increase in electricity consumption and destruction of power facilities during the Kosovo conflict turned Serbia from a net exporter of electricity (5.8 TWh in 1990) into a net importer (2 TWh in 2000). The current crisis in the electricity supply was exacerbated by the inability of EPS to pay for electricity imports and a decline in the regional surplus of electricity due to a dry year. Urgent actions are required on two fronts - price increases to provide incentives for energy efficiency measures; and improvement of power generation through repair of damaged facilities and rehabilitation of power plants. If successful, these measures should eliminate the current electricity deficit by 2003. The supply of electricity in Serbia for 2001 and 2002 will critically depend on EPS’s ability to finance electricity imports.
1 The estimated cost of electricity supply is lower than comparable countries largely due to the assumption that major new investments are not required until after 2005. This assumption is valid if electricity prices increase quickly to invoke a demand-side response and if economic growth averages roughly 5% per annum. These assumptions need to be updated at least annually. 2 This analysis is based on data in 1998 because the 1999 data reflect the strong impact of the Kosovo crisis and thus are not representative of longer-term trends.
149 Chapter 7. Energy
7.26 It is estimated that the need for electricity imports will increase in 2001 due to extensive maintenance activities and would amount to about 10 percent of total demand (3 TWh). Repair of generating units currently out of operation would reduce the need for electricity imports in 2002 by at least 50 percent, to 1.5 TWh. The expected increase in electricity production from refurbished power plants, coupled with the expected decrease in consumption due to price increases, should eliminate the need for electricity imports by 2003. However, the proposed price increases are not expected to fully cover the cost of electricity imports in 2001 and 2002 as the current price of electricity in Serbia is about four times lower than the cost of imports. Donor support for electricity imports would, inter alia, enhance the reliability of supply, thereby increasing public acceptance of the need for tariff increases.
7.27 Generation. The total installed generation capacity is 7,600 MW in Serbia (excluding Kosovo) and 850 MW in Montenegro. Lignite-fired power plants, representing 53 percent of the total installed capacity and 62 percent of electricity production in 2000, dominates the generation mix. The remaining production comes from hydropower plants (37 percent of production) and from combined heat and power plants (CHP) which use oil and gas. The relatively high cost of these fuels and supply constraints reduced generation by CHPs to very few hours during the winter of 2000/01.
7.28 The economic cost of electricity supply from the existing asset base is well below the cost of electricity imports even when the costs of reconstruction and deferred maintenance are included. The existing mines are low cost as they do not require much in the way of new investments. The sunk costs of the existing generation plants are considerable, relative to the size of the reconstruction and deferred maintenance costs. However, investment in new coal- fired plants may well exceed the cost of imports. Any such proposals should be considered very carefully, both in terms of electricity imports and alternative technologies. The litmus test for acceptance should be whether a private investor, willing to take all commercial risks, would be willing to go ahead with such an investment.
7.29 Transmission and distribution. Effective operation of the transmission network is key to the stability of the power system and to continue to support electricity imports (roughly 10 percent of demand in 2000). The need for strong transmission links with neighboring countries is acute for the next five years as existing generation plants are taken out of service for repairs. Thereafter, a strong transmission network will be key to supporting electricity trade among neighboring countries and interconnection of regional power systems with UCTE.
7.30 The transmission system was heavily damaged during the Kosovo conflict. About 100 km of high voltage transmission lines and 22 transformers with a total installed capacity of 3,700 MVA were damaged or destroyed. Although temporary repairs of substations in Belgrade, Nis and Novi Sad enabled reestablishment of power interconnections with neighboring countries, the transmission network in FRY is operating under very fragile conditions. Therefore, future outages are likely to happen more often, last longer and be more costly to fix.
Policy Agenda and Key Challenges
7.31 Price Reform. Electricity price adjustments should be designed to reflect financial needs as well as economic pricing principles. Urgent financial requirements of EPS and investment
150 Chapter 7. Energy needs must be addressed first. In addition, an appropriate price signal should be sent to households to encourage them to use less costly sources of heat supply and to discourage wastage.
7.32 Overall price adjustments should be undertaken in three steps, based on the following principles: (a) the first step, in 2001, should enable EPS to fully fund operating costs from internal cash generation; (b) the second price increase, in 2002, should enable EPS to fully repay revalued debt; and (c) the last step should enable a reasonable proportion of new investments to be funded from internal cash generation (roughly 30-40 percent), while ensuring a reasonable return on equity, setting the stage for private sector participation.
7.33 Three components of price reform should be addressed: (a) industrial prices; (b) household prices; and (c) technical aspects of supply (shifting some of the peak demand to off- peak periods). As industries rebuild it is important that they receive the correct price signals to guide their investment decisions. Furthermore, as electricity (with very few exceptions) represents a modest component of industrial total operating costs, these prices can be increased quickly to reflect the full cost of supply. Therefore, it is recommended that industrial prices be adjusted to reflect the economic cost of supply within two years with two equal sized price increases. Prices to households could be increased in stages to reflect the limited ability to pay and the time required for some customers to substitute electricity based heating with other alternatives. However, given the exceptionally low prevailing electricity prices, the price adjustments should be front-loaded, doubling the prices in 2001.
7.34 Policy-making and Regulation. The Ministry of Mining and Energy is entrusted with the development of energy policy. Major decisions are made by the Cabinet, which also sets electricity, oil and gas prices. International experience suggests that the role of the Cabinet should be restricted to the approval of the policy principles while implementation would be the responsibility of other agencies (regulator, anti-monopoly commission). A broad outline of the policy reform agenda and sequencing is outlined in Table 7.2.
7.35 The Government intends to strengthen its policymaking capacity through recruiting well qualified staff and a small group of advisors. It has initiated the first important steps in re- staffing the Ministry of Mining and Energy. The Ministry, guided by advisors with international experience, should establish the policy agenda which would then be codified in law. During 2002, an autonomous agency should be established to implement the regulation of electricity and gas prices and to enforce third party access to the electricity and gas transmission systems. Power sector restructuring should be guided by EU Directive 96/92, requiring the unbundling of generation and distribution from transmission and dispatch.
7.36 Privatization. Large inflows of capital for investments and development of real competition require the privatization of producers and suppliers. Equally important benefits of privatization are the strengthening of payment discipline and the elimination of explicit or implicit state guarantees against market risk. Private sector participation in the power sector will be driven mainly by investment needs and the requirement for efficiency gains. The Government’s first priority should be to obtain a strategic overview of the sector to determine a structure that will maximize the benefits to the country in general. The introduction of
151 Chapter 7. Energy competition is easier in power generation because it does not involve the natural monopoly components associated with transmission and distribution. However, various forms of private participation in all segments of the sector (except power dispatch) should be carefully studied. International experience suggests that in countries where payment discipline and corporate governance are weak, the highest priority is the sale of electricity distribution companies to reputable strategic investors. In these cases, at least 51 percent of the shares of the companies should be offered through competitive tenders. Chapter 5 offers a more extensive discussion of privatization issues in FRY.
7.37 Corporate Governance. EPS should be established as a commercial enterprise rather than acting partly as a provider of social assistance. The Government should clarify its mandate as part of the policy agenda and incorporate this into the company charter. The Board of Directors should evolve quickly to reflect this changing mandate with the majority of the Board members consisting of businessmen, lawyers, academics and specialists in the energy field.
Table 7.2: Priorities for electricity sub-sector recovery and reform
Item December 2000 2001 2002 2003
Price of 1 c/kWh 2 c/kWh 3-4 c/kWh Full economic electricity cost Sector State-owned Decide on Market Establish Separate IAS Audit; restructuring vertically Model, Policy Generation, Engage Advisor and integrated power Agenda; Transmission and on Privatization privatization company Prepare Accounts for Distribution Accounts, IAS Audit Management and Staff Legal and Existing Electricity Preparation of New Establish Electricity Implement Regulatory Law establishes Electricity and and Regulatory Law; Secondary Reform monopoly of state Regulatory Laws; appoint Legislation owned power co. & Establish Pricing Commissioners; (Market Rules, Government as a Principles & Prepare secondary Grid Code, etc.) regulator procedures legislation Investment Emergency fuel Reconstruction of war Rehabilitation of main Investments in Program and electricity damage and overhaul plants and replacement new generation supply of key capacities of retired capacities capacity by needed to secure private sector electricity supply during the winter 2001 Energy Very inefficient Establish incentives Implement pilot EE Broad-based Efficiency use of electricity for energy efficiency schemes and quick rollout of EE for heating up to 40 through price reform; fixes; program percent of total Establish Energy Establish EE Fund demand in winter Efficiency Agency Environment Emissions from Monitoring and Implement emission Eliminate use of existing plants assessment of reduction program; hazardous above the FRY emissions; identify Remove hazardous material; Reduce regulations hazardous waste; waste emissions Revise standards Social Low prices protect Protect poor through Improve targeting of Reduce subsidies protection everyone existing instruments subsidies by improving targeting
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Priority Investment and Assistance Program
7.38 EPS is currently preparing a medium-term investment program. The first phase (2001- 2002) would address the current energy crisis by repairing damaged power facilities (thermal power plants Kolubara A and Kostolac A and selected transmission substations and power lines) and attending to deferred maintenance. If successful, this program should ensure a normal supply of electricity during the winter of 2001/02. The second phase (2003-2005) would address the rehabilitation and life-extension of older power facilities which have suffered from lack of maintenance. The third phase, which starts in 2005, would address replacement of the oldest capacities and system expansion in accordance with the future load growth and other needs.
7.39 Thermal power plants. Thermal power plants and associated lignite mines were the most affected by the lack of maintenance during the 1990s. The deferred maintenance program will take about 3-5 years to compensate for the shortfall. Other than funding, the main obstacle for faster recovery of these plants is the expected deficit of energy in the Serbian power system, which severely limits the maintenance schedule. Therefore, the success of the program will principally depend on timely specification of required activities, procurement of necessary spare parts and materials and organization of works. In 2001, the main implementation risks are the availability of funds for spare parts and materials, as well as of qualified contractors.
7.40 Only 76 percent of the installed thermal generation capacity is available. This is the result of damage of generating facilities and de-rating due to the lack of maintenance and/or design deficiencies. The 110-MW unit in Kolubara A was damaged during the conflict in 1999 and the 210-MW unit in Kostolac A was damaged when the ceiling collapsed in 2000. Also, an old 30 MW unit in Kolubara A is out of operation due to lack of spare parts. De-rating of generating capacity accounts for the loss of 200 MW in Kostolac B (29 percent of installed capacity) and 400 MW in Nikola Tesla A and B (14 percent of installed capacity). De-rating of two 350 MW units in Kostolac B to 250 MW each is caused by boiler and reheater design problems which will require more time to resolve. The reduced rating of generating units in Nikola Tesla A and B is caused by the lack of maintenance and spare parts. Taking these units out of service for repairs and extended maintenance may exacerbate the supply shortfall and requires careful planning, possibly requiring an increased need for electricity imports.
7.41 The average age of thermal power units in EPS is 21 years and 6 units with a combined capacity of 426 MW (TENT A2, Kolubara A1-A4 and Kostolac A1) accumulated more than 200,000 hours of operation. In addition, 8 units with the combined capacity of 2,579 MW (TENT A1, A3-A6, TENT B1 and B2, and Morava) accumulated between 100,000 and 200,000 hours of operation, while a majority of remaining units has close to 100,000 hours of operation. Therefore, the rehabilitation of thermal power plants should start as soon as the program of deferred maintenance is complete, with some refurbishment activities combined with the deferred maintenance program.
7.42 Hydropower plants. Completion and/or improvement of several smaller hydropower projects would provide an additional 80 GWh per year by 2005. The main activities in this area include completion of two units (each 27 MW) at the Iron Gate 2 hydropower plant and completion of a water inlet tunnel for hydropower plant Pirot.
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7.43 Transmission substations. The median age of transformers and switching equipment in high voltage (400 kV, 220 kV and 110 kV) substations is about 20 years. The condition of high voltage substations significantly worsened as a result of damage during the 1999 conflict. . While most of the damage has been repaired, some of it temporarily, the reliability of substation equipment is limited. As a result, seven 400 kV and 220 kV substations (Beograd 5 and 8, Novi Sad 3, Nis 2, Drmno, Krusevac 1 and Srbobran) will require reconstruction and refurbishment in the next five years. Since the transmission network has not been upgraded for the past 20 years, it has reached capacity limits in the vicinity of large load centers (particularly where migration has taken place). The priority investment focuses on two existing substations (400/220/110 kV substation Pancevo and 220/110 kV Sremska Mitrovica) and the completion of three new substations (400/110 kV Beograd 20, 400/110 Jagodina 4 and 400/110 kV Sombor 3). It is estimated that transmission losses could be reduced by 20 MW during peak load conditions,.
7.44 A significant part of the 110 kV transmission facilities, owned by the ten distribution companies, are among the oldest assets in the system. During the next five years, three 110/35 kV transformer substations must be completed with a combined capacity of 83 MVA and two 110/35 kV substations will be expanded increasing their transformer capacity by 63 MVA. In addition, distribution companies are planning to construct 15 substations at 110 kV voltage level with a combined transformer capacity of 435 MVA, as well as increase transformer capacity at the existing substations by 650 MVA.
7.45 Transmission lines. Following the repair of transmission line river crossings near Pancevo, the next priority will be construction of a 75 km long 400 kV transmission line Sremska Mitrovica – Ugljevik (in Bosnia and Herzegovina). This line would enable interconnection of the Serbian power system with UCTE while the 400 kV Ernestinovo substation (in Croatia) is out of operation. Also, a 55 km long 400 kV transmission line should be built between the new substation Sombor 3 and the existing substation Subotica 3. Both lines would improve the reliability of power supply in northern Serbia, alleviate voltage problems and reduce losses in this part of the network, as well as improve stability of the Bajina Basta pumped storage plant.
7.46 The rehabilitation of 220 kV transmission lines will include re-wiring and replacement of insulators on six transmission lines with a total length of 422 km. A similar refurbishment will be carried out on 237 km of 110 kV lines (older than 30 years). Also, about 200 km of new 110 kV transmission lines will need to be constructed to connect new substations and improve the utilization of existing substations.
7.47 Dispatch control. The replacement of the dispatch control system started in 1991 but the project was interrupted due to lack of funds. The new dispatch system would comprise Supervisory Control and Data Acquisition (SCADA) and Energy Management System (EMS) and associated telecommunication systems. The improvement of power dispatch facilities is a prerequisite for establishment of the electricity market and to enable power trade in the region, as well as between South-eastern European power systems and UCTE.
7.48 Distribution systems. EPS includes ten distribution companies which are responsible for distribution systems at 110 kV and below. Migration into the larger cities of refugees and of
154 Chapter 7. Energy others from rural areas has created a problem for the distribution companies. Transformers are overloaded, resulting in supply failures which exacerbate the reliability problems. Furthermore, the distribution companies are hard-pressed to extend services to new housing areas. The main investment need of distribution companies is the construction of new distribution transformer stations (20/0.4 kV and 10/0.4 kV). It is estimated that about 300 new distribution transformer stations need to be added to the system annually through 2005. In addition, extension of the distribution network necessitates construction of about 500 km of medium and low voltage lines.
7.49 Technical Assistance. Technical assistance ranks among the most urgent needs. As the institutional capacity of the Ministry of Mining and Energy improves, focused advisory services will be necessary to address the energy strategy. Key issues such as the relative roles of competition and regulation, ownership of assets, and risk allocation need to be addressed urgently. These efforts must be followed immediately by assistance in the establishment of the legal and regulatory framework. Implementation should follow with assistance focusing on the establishment of an independent regulatory body and relevant secondary legislation. In parallel, EPS needs technical assistance to enable it to improve its financial accounts to international standards and to establish effective financial management. Some assistance should also be provided to enable the efficient implementation of the reconstruction program.
II. MONTENEGRO
Background and Current Situation
7.50 The electric power industry of Montenegro is the responsibility of EPCG, a vertically integrated utility. Montenegro experienced similar problems to those in Serbia during the past ten years, including low prices resulting in a lack of funds and a deferral of maintenance and new investments. However, the Government of Montenegro has already initiated steps to address this problem by increasing the price of electricity to 2.4 cents/kWh in 2000. In addition, the Government began preparation of a new Energy Law and engaged an investment bank to prepare a program for power sector restructuring and privatization. The intention is to establish an independent energy regulator and opening up the electricity market to third party access in accordance with EU directives. Modalities of eventual involvement of private investors in the power sector will be decided by the Government Privatization Council, which was created in 2000 with a mandate to prepare privatization of large enterprises in Montenegro.
7.51 Electricity balance. The largest consumer of electricity in Montenegro is the aluminum smelter plant in Podgorica (KAP), which accounts for about 45 percent of gross demand. The increase of household consumption by 85 percent (mostly due to electric heating) over the last ten years is caused by the same factors as in Serbia. Gross electricity demand in Montenegro is expected to remain at the present level of 3.8 TWh per year and peak demand at 650 MW during 2001-2005. The electricity balance is characterized by a high percentage of import of electricity for the last twenty years3. In 2000, the deficit of electric energy was 1.3 TWh or 34 percent of
3 The import of electricity in Montenegro varies between one quarter and one third of total demand depending on the production of hydropower plants which account for 75 % of installed capacity.
155 Chapter 7. Energy the total consumption. This deficit is addressed by the import of electricity based on a long-term contract with EPS and annual contracts with other suppliers. The price of electricity (at the wholesale level) is about half of the price of electricity imports. Electricity prices are expected to meet full cost recovery targets by 2003, necessitating the need for donor funding support in the interim.
7.52 It is clear that the import of electricity will remain an important part of the energy balance in Montenegro, at least in the next five years, as no new generation facilities are likely to come on-line in this period. Investments in new generation facilities are not a priority in the near-term because the current price of imported electricity (2.5 to 3 cents/kWh until 2005) is lower than the cost required to pay for the expansion of thermal power plant Pljevlja. However, in the longer term, investments in new power generation may be justified, including development of hydropower projects, such as Buk Bijela on the river Drina, which is shared with BiH.
Priority Investment and Assistance Program
7.53 During the next five years, EPGC’s priority investments will focus on deferred maintenance and rehabilitation of existing facilities. In addition, significant investments are needed in the Pljevlja coal mine, a separate company with 75 percent state ownership and 25 percent private ownership (voucher privatization). The mine supplies 1,350,000 tonnes of lignite to the Pljevlja thermal power plant, which has one 210 MW unit. The operation of the open-pit mine is hampered by an increasing stripping ratio, lack of investments in maintenance of aging equipment and slow expropriation of land (see Coal Section).
7.54 In 1994, the single unit in the Pljevlja thermal power plant, was destroyed due to a short circuit fault. The generator was replaced and the plant (which originally started operation in 1982) came back on-line in 1996. While the plant produced about 1 TWh in 2000, this level may not be sustainable unless the boiler and other auxiliary systems are refurbished as planned this year. Most of the equipment needed for this refurbishment (which requires about 3 months to complete) has been delivered. However, a shortage of about US$2 million for dismantling of the old equipment and installing the new equipment poses a risk of significant delays. This funding need should be urgently addressed. 7.55 Rehabilitation of the 34-year-old Perucica hydropower plant is one of the priorities in EPCG’s investment program. The Perucica plant has seven hydroelectric units with a combined capacity of 307 MW, but is operating below 250 MW due to hydraulic problems. A refurbishment of valves and associated hydraulic equipment would enable the plant to reach its full capacity again and produce an additional 40 GWh of electricity per year. Due to the age of the equipment a detailed engineering study should be completed before refurbishment starts. That study should also address possible plant expansion.
7.56 Montenegro’s high voltage transmission system is closely integrated with the transmission networks in Serbia and BiH. Therefore, some improvements in the transmission system which are of high priority for EPCG need to take place outside of Montenegro, such as repair of the 400 kV Mostar substation and re-establishment of synchronous operation with BiH and Croatia. The main investments at the 110 kV level consist of the construction of a transmission line from Podgorica to Cetinje (31 km) and the addition of one 20 MVA
156 Chapter 7. Energy transformer at the existing substations in Bijelo Polje, Budva and Cetinje. The distribution systems have deteriorated in the last ten years due to lack of maintenance and load growth. Therefore, investment in distribution systems is also a high priority for EPCG. The scope of this program should be established through a study that would include analysis of demand-side management opportunities as well. Finally, the construction of a new dispatch center and improvement of telecommunications facilities (which started in 1991 but stopped due to lack of funding) is long overdue and should resume as soon as possible.
EXTERNAL FINANCING REQUIREMENTS
7.57 The external financing requirements in the electricity sub-sector, including both Serbia and Montenegro, are estimated to be US$634.5million over three to four years (Table 7.3). The financing requirement for 2001 on a commitment basis is US$168.5 million.
Table 7.3: Investment and Assistance Requirements – Electricity Sub-sector Figures represent overall requirements for Serbia, Montenegro, and at the Federal level
Activity CY01 CY02-04 Total Recurrent Costs Electricity Imports 80.0 45.0 Subtotal 80.0 45.0 125.0
Investments Regular and deferred maintenance 38.0 101.0 Generation 26.5 113.0 Transmission 21.0 82.0 Distribution 0 115.0 Subtotal 85.5 411.0 496.5
Technical Assistance Power sector TA 3.0 10.0 Subtotal 3.0 10.0 13.0
TOTAL 168.5 466.0 634.5
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C. COAL
I. SERBIA
Background
7.58 The coal sector in Serbia proper4 comprises two large lignite mining operations and eight small underground mines. Table 7.4 shows production data during the last five years and in 1990. The lignite produced in the Kolubara and Kostolac mines is of the same quality (7.5 GJ/ton) and practically the entire production is used for power generation. Underground mines produce brown coal (10 GJ/ton) which is sold on the market for general purposes. All coal mines are wholly-owned subsidiaries of the state owned Serbian electric power company (EPS).
Table 7.4: Coal production (million tons) Coal basin 1990 1996 1997 1998 1999 2000 Kolubara 29.1 24.1 26.8 27.2 22.7 26.6 Kostolac 5.0 5.0 5.7 6.7 5.7 5.4 Underground mines 0.9 0.7 0.7 0.6 0.6 0.7 Total 35.0 29.8 33.2 34.5 29.0 32.7
7.59 The misguided policies of the past decade have led to an unsustainable financial situation of the mines and major inefficiencies in their operations. Productivity of open pit mines suffers from overstaffing5, lack of investments in maintenance and spare parts, as well as difficulties in acquiring new land for expansion of mines. Nevertheless, there is no doubt that lignite mining in Serbia is economically viable and has the potential to remain so for a long time to come.
Current Situation
7.60 During the last decade the amount of overburden removed in Kolubara and Kostolac mines declined by 30 percent. As a result, in both mining areas, the ratio of overburden removed to coal produced is significantly below the level needed for a sustainable mine operation. Increasing the rate of overburden removal must be a prime goal of mine management in the immediate future. The reasons for the currently lower rate of overburden removal are: lack of mining equipment (bucket wheel excavators, conveyors, stackers, auxiliary mobile equipment) due to neglected maintenance and, more recently, lack of new land for mining. The seriousness of the situation is evident from steep front slopes in the mines (which risk sliding), cannibalized equipment and complete lack of spare parts and materials. These constraints must be removed through the urgent provision of equipment and funds, otherwise coal production will suffer, which will have an impact on electricity generation.
4 Excluding Kosovo. The production of the Kosovo lignite mines (about 8 million tons per year during 1990-1998) significantly decreased after the 1999 conflict since the output is primarily used by thermal power plants Kosovo A and B, which have experienced major outages. 5 The main mines in Kolubara and Kostolac have a labor productivity 3 to 6 times lower than comparable Western mines
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7.61 The financial condition of the mines is a particular area of concern because the present internal price of coal (in EPS) is about 50 percent below the short-term cost recovery price, which is estimated at US$6.4 per ton (or US$0.8/GJ)6. In the medium term, the costs of lignite production will increase due to the capital costs connected with the replacement of major mining equipment and the opening up of new mining areas. As there are, at this stage, no firm plans for such investments, estimates of the medium term production costs are not reliable but should be in the order of US$11 per ton. Considering that geological conditions are likely to become more difficult and that there is also a need to cover additional environmental costs of mine closures, the long-run costs of production may approach the costs of coal imports, estimated at US$14 per ton (or US$2/GJ), but are unlikely to exceed that ceiling.
7.62 While the lignite mines of Kolubara and Kostolac certainly have the potential to provide economic fuel for thermal power generation during the next 20-30 years, their exploitation poses major challenges. The most pressing issues at this stage are: (a) non-transparency of financial results, exacerbated by widespread use of barter, complex institutional setups and a history of inflation and exchange rate controls; (b) a backlog of maintenance for mining equipment, exacerbated by cannibalization of mobile equipment and temporary repairs; (c) a backlog of land acquisition, exacerbated by increasing demands of landowners; and (d) insufficient revenues from electricity sales to allow larger internal transfers for coal and, hence, sustainable operation of the mines.
7.63 In the longer run, the mines will face increasing difficulties because of their use and subsequent deterioration of large areas of valuable land, and because of mounting pressure to reduce costs. The cost pressures will be due to: (a) a gradual deterioration of geological conditions (the overburden/coal ratio increases and the coal quality decreases as the better portions of the deposits are being depleted); (b) an increase in real wages as the economy develops; and (c) the need to cover the capital costs of major equipment replacements and development of new parts of the coal deposits. Only restructuring of the coal mine operations can secure their long-term viability. Subsidization of the uneconomic underground mines should be stopped. Mining should concentrate on a few large and efficient open pits only and most non- core activities should be divested.
Policy Agenda and Key challenges
7.64 The objectives of the sectoral transition and recovery program for the next 18 months are to: (a) gain control of the costs of coal production; (b) increase coal production from economic mines; and (c) prepare the necessary restructuring of the coal sector. In the medium term, the objective would be to implement a sector restructuring program to be developed in conjunction with overall power sector reform, with the final goal of consolidating coal production in viable mines and divesting most non-core activities.
7.65 The first short-term objective (control of production costs) includes the improvement of cost accounting and financial management, the raising of cost awareness among mine personnel
6 Excluding depreciation and financial charges, as well as subsidies for underground mines, but including deferred maintenance, overburden removal and land acquisition.
159 Chapter 7. Energy and the reduction of barter trade, subsidies and other non-transparent transactions. This can be achieved through improved internal communication and procedures, supported by technical assistance for financial management and information. The second objective (increasing coal production from economic mines) includes fast restoration of an appropriate level of equipment maintenance, acceleration of land acquisition and provision of sufficient cash for sustainable operation of the mines. This can be achieved through Government support for the acquisition of land, paid for by the mines from higher revenues as coal prices increase pari passu with increasing electricity prices, and through donor support for the purchase of critical equipment, spare parts and materials. The third objective (sector restructuring) includes elaboration of plans for: (a) the closure of uneconomic underground mines and divestiture of remaining underground mines; (b) the closure and environmental restoration of depleted surface mines; (c) divestiture of non-core activities; and (d) reduction of surplus personnel.
Priority Investment and Assistance Program
7.66 To achieve the short-term objectives outlined above, a program is proposed consisting of increased internal cash transfers to the mines, donor support for the purchase of critical equipment, spare parts and materials, institutional strengthening and the provision of technical assistance. The components of this program are described below:
• Increased internal cash transfers. The internal price of lignite should be increased to cost recovering levels as electricity tariffs are raised. Payments should be made in cash and not through barter. Critical payments, such as for land acquisition, should be given priority. • Donor support. Donor support should be provided for high priority imports, consisting of spare parts, materials and critical auxiliary equipment for mine operations and equipment maintenance. EPS should provide all required information and equipment specifications. • Institutional strengthening. The accounting and management information systems should be improved to capture all costs and cash transfers in a transparent way, enabling sound day-to-day control and rational management decisions. International accounting standards should be introduced. Internal communications should be improved to raise the awareness of staff with regard to the costs of production. The restructuring function should be strengthened and suitable assignments of responsibility should be made. • Technical assistance. Consultancy services should be provided in the following areas: (a) cost accounting, financial management and divestiture of non-core activities by an experienced accounting and management consulting firm; (b) technical audit of operations, efficiency increases and review of longer-term mine plans by a firm experienced in the operation of lignite mines with continuous surface mining technology; and (c) restructuring of the underground mine operations, closing uneconomic mines and possibly improving the output and costs of one or two of the best mines, by a firm experienced in underground coal mine restructuring.
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7.67 It has been assumed that all recurrent costs, as well as investment-type expenses for overdue land acquisition and river deviation, can be covered through an increase of electricity tariffs and of the internal lignite price. To pay for all necessary local expenses, it is proposed to increase the internal lignite transfer price to US$5/t in the spring of 2001, and to US$6.4/t in 2003. The financing gap in 2001 and 2002 relates to the purchase of auxiliary equipment, spare parts and materials, as well as to technical assistance. The financing gap during 2003-2005 (tentatively estimated at US$40 million per year) relates to mine extensions and major replacements, as well as to technical assistance for implementation of a restructuring program. The costs for mitigation of the social and environmental impact of a restructuring program are not included.
7.68 The benefits of the program exceed by far its costs. Even in the critical first two years, the costs of the program amount to only about US$1.3/t of lignite produced. In the absence of the program coal production would likely collapse, with significant damage to the national economy.
7.69 There are no issues related to the implementation of the program. Kolubara, in particular, has developed a good local implementation capacity, including procurement, ensuring that no logistical or procurement constraints would occur. With minor institutional strengthening, EPS should be able to ensure good donor coordination and financial project management.
II. MONTENEGRO
Current Situation
7.70 The open pit Pljevlja mines in Montenegro supply about 80 percent of its coal (9 GJ/ton) to the nearby thermal power plant and the rest is sold on the market. The Pljevlja mine is a joint stock company, of which 75 percent is owned by the state and the remaining 25 percent by private (voucher) investors. The mines suffer from the same problems as the mines in Serbia. The main differences with Serbia are the smaller size of the coal deposits, the “discontinuous” mining method (with truck and shovels instead of the bucket wheel excavators used in Serbia), a greater backlog of overburden removal, higher production costs and poorer mine planning and operation. Most of the easily accessible coal (under an overburden/coal ratio of 2 or less) has been exploited from the Sumani mine. The bulk of the remaining reserves (about 70 million tons) are in the Potrlica mine, where the average overburden/coal ratio is 4.2. However, due to neglected overburden removal in the past, the present ratio is about 7. The priority for the near future will be to bring the ratio of the Potrlica mine back to the average level, while depleting the easily accessible reserves in the Sumani mine (about 6 million tons).
Priority Investment and Assistance Program.
7.71 The first priority is to unblock the mining of shallow coal reserves through the acquisition of the required land. Also, a river deviation can no longer be delayed. Another top priority is the overhaul of trucks and of the conveyor at Potrlica. In addition, 6 new trucks, 5 dozers, 1 excavator and auxiliary equipment are needed with high priority.
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7.72 It is recommended that, in parallel with these top priority investments, the plans for implementation of the Cementara project be reviewed, as well as the plans for the mining of other parts of the Pljevlja deposits and for overhaul and renewal of equipment. Also, assistance is needed to improve the management information system. The objective would be to optimize the mining plans and keep the investment and operating costs at a minimum. Due to the poor condition of the mines and the lack of international exposure of their personnel, it is strongly recommended that from the very beginning hands-on management assistance be obtained from an experienced international mine operator.
EXTERNAL FINANCING REQUIREMENTS
7.73 The external financing requirements in the coal sub-sector, including both Serbia and Montenegro, are estimated to be US$122.7 million over three to four years (Table 7.5). The financing requirement for 2001 on a commitment basis is US$39.4 million.
Table 7.5: Investment and Assistance Requirements for the Coal sub-sector (US$ millions)
CY01 CY02-04 Program Total Investments Equipment Overhaul 8.5 2.6 New equipment 5.7 6.6 Aux equipment, spare parts (EPS) 22.8 36.5 Mine extension and replacements 0 35.0 (EPS) Subtotal 38.0 81.7 119.7 Technical Assistance Information system 0.1 0.1 Review of plans 0.2 0.2 Other 1.1 1.3 Subtotal 1.4 1.6 3.0
Total 39.4 83.3 122.7
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D. OIL AND GAS
I. SERBIA
Background.
7.74 The oil sector suffered particularly heavy damage to the refineries as a result of the 1999 Kosovo conflict. Some refinery reconstruction has taken place, enabling about 70 percent of combined capacity to be brought back online. However, the reconstruction needs remaining are considerable and cannot be financed from internally generated funds or loans. Secondary refining remains a problem and the domestic consumption of petroleum products has shifted toward the lighter products, so that considerable new investment in the refineries will also be required. In the interim, the product mix will not reflect market demand. Immediate needs can be met by a combination of importing petroleum products and gas, while the refineries’ medium- term financing needs can best be met by strategic investors to ensure that investments are well targeted.
7.75 The natural gas sector did not sustain war damage but has major deferred maintenance needs. Natural gas is expected to increasingly meet Serbia’s energy requirements because of price and environmental considerations. To enable gas to increase its market share, distortions in energy prices must be addressed, payment discipline improved and infrastructure developed. To enable this, major new investments in pipelines are required, which can best be met through private sector participation.
7.76 The oil and gas sector is the responsibility of NIS, a conglomerate of nine formerly independent companies, forced together under one umbrella by the Government in the mid- 1990s. NIS is involved in exploration and production of oil, gas and thermal water, oil refineries, marketing of oil products and natural gas, and a wide variety of support activities, including seismic acquisition and processing, drilling of oil & gas wells, logging, cementing, maintenance, etc.
7.77 Serbia has produced natural gas domestically since 1952, and oil since 1956, but has always been a net importer of both. Since 1996, production of natural gas has averaged around 0.7 billion cubic meters (bcm) per year. Domestic production of oil has been on a declining trend, from 1.02 million tons in 1996, to an estimated 860,000 tons in 2000. In both sectors, substantial investments would be needed to maintain production at the level of recent years during 2002-2005. In the case of oil production such investments might not be economically justifiable. Domestic production of natural gas is expected to recover in 2001, and to remain at the level of recent years during 2002-2005. Domestic production of oil, however, is likely to continue to decline.
7.78 Natural gas is imported from Russia via the Ukraine and Hungary. Approximately 2.0 bcm were imported in 1996 and 1997; 1.7 bcm in 1998; only 1.0 bcm in 1999 and 1.5 bcm (estimated) in 2000. The transportation and distribution of natural gas is carried out by NIS-Gas (essentially in the Vojvodina region only) and Energogas (in the region south of the Danube) . The total length of gas transmission pipelines in Serbia is 2,160 km, including 1,650 km owned
163 Chapter 7. Energy by NIS-Gas and 510 km owned by Energogas. NIS-Gas is only responsible for transmission, while Energogas is responsible for transmission and distribution in their respective service areas. The transmission mains have the capacity to transport 3.5 bcm of gas per year.
7.79 The main problem regarding natural gas is the outstanding US$303 million debt to Gazprom, which has created concerns about the reliability of supply. This debt for past gas consumption (1995-October 2000) is owed by the FRY’s Progress Gas Trading Company, which lost its exclusive license to import gas in December 2000. Settlement of the debt to Gazprom is complicated by the fact that the former USSR owes about US$2 billion in barter trade to the SFRY. This debt needs to be allocated between the successor states to the SFRY and then settled between them and the successor states of the FSU. The extent to which Gazprom, now a private company although still 40 percent Government owned, is willing to be a party to this settlement is another issue to be resolved.
Current Situation
7.80 The oil refineries need new investments of about US$600 million to repair the assets in a manner that reflects current and future needs. During 2000 about 157,000 tonnes of crude oil and 2,060,000 tonnes of petroleum products were imported Current operations manage to address the majority of the market needs, thus reducing the level of petroleum product imports by more than 50 percent in 2000 over 1999, primarily as a result of quick fixes. However, the next investments will require considerably more money which is neither available from internally generated funds or from the Government.
7.81 Gazprom has increased gas flows to meet current demand, despite the debt for past gas imports. The October 2000 agreement to that effect is based on a Russian credit of US$70 million equivalent which covers the barter portion (65 percent of the monthly bill) of the current gas imports through June 30, 2001. The terms provide that Serbia should repay in food and services or, if that is not possible, in cash. The Government is reportedly paying the remaining 35 percent of current gas bills, even though municipal district heating companies can pay on average only about 17 percent of their gas bills. The importance of not falling behind on payment of current bills cannot be sufficiently emphasized.
7.82 The US$303 million debt to Gazprom and initial problems with payment of current bills created uncertainty about gas supplies that hampers development of the gas and downstream electricity and heating markets. Reportedly, there are also pre-1995 arrears to Gazprom, but the exact amount of these arrears could not be established. The Government has tried to reduce these pre-1995 arrears by establishing a joint venture between Energogas and Gazprom in 1996 (called JugoRosGas) for the construction of gas transmission mains in the extreme southern part of Serbia. So far, a 65-km, 20-inch diameter pipeline has been built by Energogas between Pojate and Nis; the pipeline is not in operation and the debt of Energogas to Progress Gas Trading Company has not been decreased. This kind of debt-equity swap is not considered to be a desirable arrangement (paragraph 7.71).
7.83 Regional perspective. As Yugoslavia produces gas, there has only been a need for one import source through Hungary. However, the physical distance from the Yugoslav system to
164 Chapter 7. Energy the Romanian gas system is less than 50 km in very easy terrain. The most likely connection point is Mokrin in the north-east. Due to the large gas production and potential for cheap storage in depleted gas fields in Romania, it would be one of the most obvious interconnections to establish. This would allow physical and commercial diversification of supply for FRY, since Romania now has a connection to Hungary. At present there is a looped pipeline to the Romanian city of Timisoara, and the Romanian gas system has recently been strengthened with an interconnection to the Ukraine system in the north. Hence, it is judged that gas supply from Romania to Yugoslavia, and possibly further to Bosnia and Herzegovina could be established for rather limited investments in a 50 km pipeline and a border meter/regulator station. The southern part of the Yugoslav system could easily be connected to the Bulgarian gas system via an approximately 100 km long interconnector, as is being planned by JugoRosGas. In addition, a new gas pipeline from Skopje in FYROM to Pristina in Kosovo is being planned. This would open the way for a future southern connection from FRY to Bosnia and Herzegovina. However, the distance is around 250 km in very difficult terrain.
7.84 Crude oil and petroleum products prices. The wellhead price of domestically produced crude oil -about US$205/t equivalent following the almost doubling of the nominal price in November 2000 – was about 25 percent below import costs in mid-December 2000. The ex- refinery prices of oil products are about US$283/t for gasoline, US$334/t for diesel oil, and US$156-209/t for fuel oil (depending on the sulfur content). The retail prices of gasoline and light (diesel) oil were about US$0.57/liter and US$0.45/liter, respectively, in mid-December 2000, and seemed to cover marketing expenses and taxes fully. Some scope exists to increase petroleum product taxes (and budget revenues), since retail prices of automotive fuels are relatively low compared to neighboring countries.
7.85 Natural gas. The wellhead price of natural gas was almost doubled and reached US$122/tcm equivalent in early December 2000, a level that was about the same as the cost of imported gas at the Hungarian-Serbian border (US$125/tcm). Gas prices were increased considerably in January 2001, bringing prices to US$148/tcm for district heating companies and households and to US$180/tcm for other consumers. Gas distribution takes place primarily in Vojvodina, with 80 towns serviced by 20 distributors and most of the assets less than 20 years old. South of the Danube there are an additional nine local distribution networks operated by Energogas. Due to constraints on capital, customers have paid about half the cost of the distribution network as customer contributions. Taking into account the cost of domestic transmission (estimated at US$15/tcm) and distribution (estimated at US$100/tcm), the current price to households is estimated to be about 75 percent of the economic cost of supply. The price of gas to large customers appears to fully cover the cost of supply.
7.86 Financial Situation of NIS. For many of NIS’ companies, pricing, billing and collection appear not to be a problem, since prices have been set relatively close to market prices and billing and collection are often simultaneous. The notable exception in this regard is in the gas sub-sector. The stock of accounts receivable of NIS-Gas was about US$164 million in November 2000, 70 percent of which was due from district heating companies (who consume about 1/3 of all gas) and the rest was due from industry. NIS-Gas' overall collection rate was reportedly about 60 percent.
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Policy Agenda and Key Challenges
7.87 Refinery Investments. The goal of the refineries is to conform with Euro 2005 standards, reflecting a vision of becoming a competitive component of the broader EU oil market. This approach would drive the nature of new investments in an appropriate, but expensive, direction. Given limited access to new capital, Serbia should try to attract private investors to get involved in oil and gas exploration and production (“upstream”) activities. Private investors will insist on knowing how this sub-sector will be regulated prior to committing significant funds. Therefore, modern legislation – an Oil & Gas Law, a Law on Production Sharing Contracts, etc. – will need to be adopted and an “upstream” regulatory agency will need to be created to collect and store exploration and production data, assess the development plans of operators, and provide technical regulation over upstream operations. A department in the Ministry of Energy should handle the conducting of licensing rounds for the award of new acreage to explorers. Given the long lead-time required for adjusting the legal and regulatory framework, novel approaches to induce private sector participation may be required initially.
7.88 The debt to Gazprom should be dealt with separately from the current bills. Local prices for electricity and district heat should be sufficient (after the required tariff increases) to cover all operating costs so that current gas bills can be paid fully in cash. The stock of arrears can be dealt with using one of the following options: (a) selling the debt in secondary markets, based on advice from experts in this field; (b) offsets on payments due to FRY by Russia; or (c) reschedule remaining debt based on the cost of gas in Russia plus transit fees through Ukraine and Hungary. Any debt-equity swaps should be approached with caution as the value of the equity in the current assets would be difficult to assess. Furthermore, with the disequilibrium in the local markets, the assets may be valued lower than what they would be under improved circumstances, resulting in an unusually low valuation. As a general principle it is preferable not to have gas suppliers control gas distribution because this could potentially preclude other gas suppliers from competing in a given market.
7.89 Gas distribution investments. Natural gas is expected to have an increasingly important role to play in the provision of energy over time because of its relatively favorable environmental impact. Substantial new investment in distribution networks will be required to meet space heating needs as electricity prices are adjusted. Natural gas is expected to be the primary substitute for electric-based heating either through district heating in densely populated areas or individual boilers in the rest of the country. Extension of gas distribution networks could be offered to private investors.
7.90 Market opening. New legislation should require the introduction of regulated third party access on both gas transmission and distribution pipelines. This would permit large consumers to have an option to either buy gas directly from foreign or local producers or from the distribution company and provide some competition in the market place. The choice of suppliers for small consumers – the final step in market opening – should be postponed till a sufficiently mature market develops.
7.91 Privatization. The need for fresh capital and the development of real competition requires the privatization of producers and suppliers. Equally important benefits of privatization are the strengthening of payment discipline and the elimination of explicit or implicit state
166 Chapter 7. Energy guarantees against market risk. International experience suggests that in countries where payment discipline and corporate governance are weak (as is currently the case in FRY), the highest priority is privatization at the point of interface of the supply industry with the consumer: distribution. As a result, the Government should seriously consider restructuring NIS to foster competition, followed by increasing private sector participation to improve the effectiveness of these new entities.
7.92 Private sector participation in the oil sector is as much driven by the considerable investment needs (particularly for oil refineries) as the requirement for efficiency gains. The Government’s first priority should be a strategic overview of the sector to determine a structure that will maximize the benefits. The introduction of competition is easier in the oil sub-sector because it does not include natural monopoly components (with the possible exception of oil pipelines). Crude oil and oil product import liberalization and the competitive sale of at least half of the service stations of NIS to private investors in 2002 will create the conditions for the full liberalization of oil prices.
7.93 As is the case for oil, considerable new investments are required to support the extension of the gas distribution networks. Private sector participation in gas distribution7 is recommended to establish commercial discipline at the interface point with customers to ensure adequate liquidity for gas suppliers. The Government should assess a broad range of options for private sector participation, including partial or full divestiture of current ownership, concessions, leasing or management contracts. The legal and regulatory framework must be addressed in parallel to ensure that the incentives are put in place to maximize the benefits to the Government and customers.
7.94 Taking into account the steps that need to be accomplished, private sector participation in the gas sub-sector should not be launched before 2003. A tentative schedule could look as follows: during 2001, the Government should focus on its policy agenda so that the legal and regulatory framework can be established by the end of the year. In parallel, accounts should be prepared in accordance with IAS principles. Gas production, transmission and distribution should be established as separate and separable accounts consistent with EU principles. By the end of 2001, the Government should adopt pricing principles and procedures. Initially they would be implemented by the Government, but transferred to an independent regulator by 2003. The Government should separate the role of policy setting from operations by establishing Board of Directors consisting of business, legal and academic representatives. The Government would set the policy agenda through laws and regulations while the corporate entities would operate in a purely commercial manner. In 2002, the separate functions should be established as separate legal entities, each with their own accounts (based on explicit transfer and/or services prices), management, staff and Board of Directors. By 2003 qualified investment banks should be engaged to assist the Government with the tendering process for privatization. A broad outline of the policy reform agenda and sequencing is outlined in Table 7.6.
7 Most local distribution networks are owned and operated by consumer associations. Reportedly, it costs about $1,000 for a household to connect to the gas distribution system and join one of these associations. In order to speed up the gasification of the country, the Government may want to tender exclusive distribution concessions to strategic investors with an obligation to extend service to households at a reduced connection fee, while allowing recovery of the investment cost through the household gas tariff.
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Table 7.6: Priorities for Oil and Gas Sector Recovery and Reform
Item December 2000 2001 2002 2003
Price of crude Domestic Prices 25 Increase domestic Liberalize crude oil oil at wellhead percent lower than wellhead prices to import prices import parity parity net of transport costs Price of Domestic Prices very Increase domestic prices Phase out emergency Liberalize petroleum petroleum close to import parity to import parity oil product import product prices products (2) Install emergency oil controls to stimulate product import controls competition Price of Domestic price is 7 Increase domestic Liberalize gas prices natural gas at percent below import wellhead prices to import wellhead parity parity Price of gas to US$120 per thousand (1) Determine full cost Increase prices to full district cubic meters recovery tariffs cost recovery. heating (2) Increase price to companies reduce difference between current prices and full cost recovery by 50 percent Price of gas to US$156 per thousand (1) Determine Full Cost Increase price to Increase prices to households cubic meters Recovery Tariffs reduce difference full cost recovery. (2) Increase price to between current prices reduce difference and full cost recovery between current prices by 50 percent and full cost recovery by 33 percent Legal reform Existing laws Conduct restructuring Prepare new laws (1) New legislation established NIS as studies of both oil and needed to institute passed State-owned gas sectors. recommended industry (2) New regulator in vertically integrated structures place de facto monopoly in oil & gas production, oil refining, gas distribution, etc. Privatization NIS as State-owned Conduct restructuring (1)Begin pre- Commence private vertically integrated studies of both oil and privatization program sector participation de facto monopoly in gas sectors. by selection of for remaining oil and oil & gas production, privatization advisor gas sector assets. oil refining, gas (2) Begin selling NIS’ distribution, etc retail service stations Investment Emergency fuel and Limited reconstruction of Continued Investments in new Program electricity supply war damages to oil and reconstruction of war facilities by private gas facilities. damages to oil and gas players in the oil and facilities. gas sectors Environment Soil and groundwater Initiate decontamination Complete Initiate major contamination from of soil and groundwater decontamination of soil investments to the conflict. and groundwater enable refineries to meet EU environmental standards
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Priority Investment and Assistance Program
7.95 Assuming the Government intends to privatize one or more refineries, potential investors should be involved at an early stage. They should buy the refinery(ies) in an “as is” condition before major investments have been made so that all incremental investments, whether for refurbishment or expansion, are undertaken by the new owner. This would enable a strategic investor to put investments into a broader, market-oriented context which would minimize costs and increase effectiveness of new investments in an open market economy. The same principle should be applied to the investments planned by NIS in petroleum exploration, production, and storage. As privatization will take a few years to implement, cleanup of contaminated soil and wastewater, will require external assistance by donors in the near-term. These investments include repairs to piping to stop leakage, excavation and storage of contaminated soil and contaminant removal. In addition, the refineries have a list of equipment (vacuum distillation, revamping, cat cracking, catalytic reformer, power plant reconstruction, etc.) that needs to be replaced due to war damage. The individual components range in cost from roughly US$500,000 to US$100 million, for a total of about US$600 million. However, it is assumed that these investments would be funded by the private sector.
7.96 The gas sub-sector also has considerable needs for new investment, both for deferred maintenance for the existing assets and to extend the distribution networks to meet heating and other needs. Emergency needs such as pipe replacement, maintenance of existing pipe, etc. require about US$3 million through 2002. Extension of the gas networks is extremely important for Serbia’s overall energy and environment strategy and should preferably be undertaken by private investors. These funding needs are estimated to be about US$340 million through 2005, including US$10 million to establish LPG bottling capacity to meet the energy needs of the rural population in southern Serbia.
II. MONTENEGRO
7.97 Yugopetrol. The petroleum sector in Montenegro is currently limited to oil product distribution, although some offshore oil and gas exploration is being carried out by two UK companies. Reportedly there are reserves of 600 billion m3 of gas and the first well is expected to start in 2001. During 2000, Yugopetrol-Kotor (the state-owned oil product retailer) sold automotive fuels at prices that did not cover its purchase costs, because the price limits established by the Ministry of Economy assumed a US$25/barrel crude oil price. Yugopetrol was losing DM700,000/month at the end of 2000. However, Yugopetrol made a profit in the last 3 years, so that merely breaking even in 2000 should not seriously affect its financial viability. The primary goal for Montenegro in the oil sector would be the liberalization of petroleum product markets and pricing, with Government oversight focusing on anti-monopoly practices. Technical assistance of about US$250,000 per year through 2002 would help the Government address this issue.
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EXTERNAL FINANCING REQUIREMENTS
7.98 The external financing requirements in the oil and gas sub-sector, including both Serbia and Montenegro, are estimated to be US$58.2 million over three to four years (Table 7.7). The financing requirement for 2001 on a commitment basis is US$24.8 million.
Table 7.7: Investment and Assistance Requirements - Oil and Gas (US$ millions)
CY01 CY02-04 Total Investments1 Refinery Investments 20.0 26.0 Gas system rehabilitation 3.3 1.5 Subtotal 23.3 27.5 50.8 Technical Assistance Oil Sector Restructuring 1.0 3.7 Gas sector TA 0.5 2.2 Subtotal 1.5 5.9 7.4 Total 24.8 33.4 58.2 These figures do not include substantial outer year investments that are expected to come from the private sector.
E. DISTRICT HEATING AND ENERGY EFFICIENCY
BACKGROUND
7.99 Heating is one of the most problematic energy sub-sectors in FRY. The low level of prices for electricity and district heating distorts demand, as there is little incentive for efficient use. About 14 percent of all households in Serbia use district heating as their primary means of heating, 33 percent use electricity, 39 percent coal, 7 percent fuel wood and 7 percent natural gas. Pricing distortions among various fuels drive customers to use energy sources that are cheapest but not economic least cost8. The January 1, 2001 cost of heating a 60 m2 apartment with various fuels is shown in Figure 7.1, which clearly demonstrates these distortions. 7.100 Low district heating prices and poor payment discipline has limited the availability of imported natural gas, lowering supply temperatures. As a result, even those who have access to district heating use electricity for supplemental heating. The principal issue in the heating sector is, therefore, to raise the price of district heating so district heating enterprises can pay for a steady and adequate supply of gas and take other measures to increase the reliability and comfort level of district heating. Simultaneously the price of electricity should be raised at least as fast, so consumers don't have an incentive to use electricity for heating where not absolutely necessary. The long-term objective should be to establish heating as a competitive market on a
8 As of January 2001, the relative monthly cost of heating a 60m2 apartment -expressed as a percentage of the equivalent cost of heating with electricity- was 0.93 for district heating; 1.00 for electricity; 2.29 for natural gas; an average of about 2.50 for various coal qualities; 3.40 for fuel wood; 6.49 for LPG; and 8.83 for heating oil.
170 Chapter 7. Energy commercial basis, where district heating and gas compete on a level playing field in urban areas and where gas competes with other fuels in more rural areas.
7.101 Correcting the price incentives can be fairly easily addressed, as long as the poor are protected. The Government's priority should be to focus on providing incentives to reduce heat energy demand, since the returns can be high. Not only will an energy efficiency investment program have significant direct economic benefits, but it could also have considerable employment benefits. In countries that have embarked on similar programs, a local manufacturing capacity often developed to meet equipment needs.
DISTRICT HEATING
I. SERBIA
7.102 There are 43 cities and towns in Serbia that have district heating systems. The total installed capacity of heat sources in 1999 was 6,597 MW, of which 1,028 MW (16 percent) was cogeneration plant; 4904 MW (74 percent) heat only boilers (HOBs); and 664 MW (10 percent) industrial boilers. Fuel consumption was 361.5 million m3 of natural gas (56 percent); 125,650 tons of fuel oil (24 percent) and 108,252 tons of coal (20 percent), for an estimated total value of US$85 million at end-2000 prices. Most heat-only boilers (HOBs) are gas-fired, although many also have dual-firing capability.
7.103 The total number of flats served by the DH system is about 400,000 (14 percent of all flats in Serbia) of which only about 56,000 receive also domestic hot water. In addition, the space of about 180,000 dwellings equivalent (hospitals, schools, commercial and office buildings) is served by DH. About 250,000 flats (9 percent of the total) have central heating installations with heat produced by basement boilers not connected to the DH network.
Figure 7.1: Monthly Heating Expenses by Energy Source
8000 6803
6000 4998
4000 2621 2619 2315 DINAR/MONTH DINAR/MONTH 1820 1762 2000 1584 720 770
0 Gaz Wood District Coal - heating Banovici Heavy oil Electricity Coal - Coal - Propan butan Coal - Pijevlja Kolubara, raw Kolubara, raw 171 Chapter 7. Energy
7.104 District heating is primarily concentrated in the three largest cities, Belgrade, Novi Sad and Nis, which have a considerably higher heat load density than the average city. Together, these three cities consume about 70 percent of the district heat generated; the Belgrade DH system alone accounts for about 45 percent of all district heat generated in Serbia, serving about half of the capital's 2 million inhabitants. District heating is generally installed in areas with a high heat density where DH is the least cost heating solution. However, while the three largest cities have a heat load density of 5.2 MW/km2, making DH attractive, the average for the remaining 40 district heating systems is 3.0 MW/km2 . For some of these smaller systems DH may, therefore, not be the optimal heating solution.
Current Situation
7.105 The principal problems in the Serbian DH systems are: (a) the poor financial situation of the DHCs due to inadequate tariff levels; and (b) major heat and hot water losses both on the supply side and the demand side. However, there is significant upside potential for introducing energy efficiency measures that would lead to reduced energy consumption and help keep energy bills at a reasonable level.
7.106 Financial. The financial situation of most DHCs is very poor. In real terms prices went down by a factor of 3 over the last 10 years and prices were not adjusted at all between 1998 and 2000. As of December 1, 2000, the price for heat in Belgrade was at one-eighth of cost-covering levels (cities like Novi Sad had already sharply increased heat prices in October 2000). However, the price for district heating in Belgrade was doubled effective January 1, 2001 and the price of heat for households, schools and hospitals (US$0.10/m2/month) is now at one-fourth of the cost-covering level (US$0.40/m2/month). District heat, together with water, waste removal, and about nine other services/charges is being paid by households living in apartment buildings as something similar to rental overhead (condominium charges) based on equal monthly installments. A separate company, Infostan, collects household bills monthly. The DHC gets about 40 percent of what is being collected (pro-rated depending on the overall collection ratio). Infostan charges 6.4 percent of the amount collected for its service. Commercial and industrial consumers pay directly to DHC. Most of them are metered and have capacity and energy charges and their heat prices average US$0.37/kWh.
7.107 At the end of 2000, households in Belgrade were about US$150 million in arrears, equal to 6 months of billing. Disconnection of household consumers is legally possible, but difficult to do unless more than 50 percent of consumers in a building are in arrears. The collection rate for commercial consumers averages 70 percent, and arrears for that category are 3 months of billing. Government payment ratio is 100 percent, due to offsetting of heat bills against amounts the DHC owes on fuel to NIS and for the tax payable on salaries; only about 25 percent of Government bills are settled in cash. The Belgrade DHC’s overall bill collection ratio was about 80 percent.
7.108 Most of the accounts payable of the DHCs are due for gas supplies. DHCs account for one-third of all gas consumption in Serbia. However, due to their poor financial condition, they could not pay for their gas supplies and Gazprom decreased the amount of gas supplied to Serbia. Because of this, DHCs had to reduce heat production in recent years by 20-30 percent.
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However, since the heat losses throughout a network are more or less constant, significantly less heat comes to the final consumers. Many consumers have supplemented their heat level by using electric space heaters. Even assuming that only 50 percent of the reduced heat production is replaced by electric heating, the electricity system is being burdened with an additional load of 675 MW.
7.109 Heat losses. Inadequate insulation of buildings is a major source of heat losses; some buildings do not have any insulation other than the limited insulation provided by the construction materials themselves. As in other CEE countries, windows and outdoor walls seem to be the main problem. Depending on the building condition, about 20-40 percent of the heat supplied to apartments can be saved by improving insulation. Substations generally lack efficient control and regulation devices that would allow a rational use of the heat supplied to the substations. A rough estimate is that heat losses in substations constitute 20 percent of total heat production (less than 2 percent would be normal for an efficient system).
7.110 Hot water losses. External corrosion of the pipes is one of the biggest problems; all cities located at rivers or lakes are believed to have this problem. A rough estimate is that heat losses in pipes due to bad insulation and corrosion constitute 15-20 percent of total heat production (7-10 percent would be normal). Larger transmission lines have been installed as over-ground pipes, while the distribution system consists of steel pipes with different types of insulation laid in concrete channels. An estimated 5-10 percent of all pipes need to be replaced as soon as possible, preferably with pre-insulated pipes. Hot water losses in buildings are also significant. A substantial part of these losses stem from the internal hot water pipes, which are often leaking and not insulated. If the substations are of the type that connect the primary (supply) system directly to the secondary (demand) system, these losses affect the entire district heating system. In such cases the DHC has to continuously refill the water in the network at enormous cost. For example, the Novi Sad DHC must refill its entire network about 35 times per year, while the Belgrade system must do the same about 20 times per year.
Policy Agenda/Key Challenges
7.111 Price Reform. Along with the need for general DH tariff increases, the current single rate tariff system should be replaced by a two-part tariff system (energy and capacity charges) as soon as possible. A two-part tariff will provide incentives to reduce both heat consumption and capacity demand, the latter by installing flow limiters. With the upgrading or replacement of substations and the introduction of two-part tariffs, thermostatic valves and heat cost allocators should be installed, but current heat price levels may require that graduated subsidies be extended for this purpose.
7.112 Billing and Collecting. As tariffs are being increased towards their economic levels, the collection performance of DHCs will tend to deteriorate. Depending on the magnitude, this could significantly negate the benefits of the tariff increases. Hence, it is vital for each DHC and municipality to enforce payment discipline, while putting at the same time adequate measures in place to help all consumers reduce their heat consumption.
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7.113 Ownership. DHCs used to belong to municipalities, but when the regime lost the municipal elections in 1995 it transferred all DH assets to the Ministry of Construction (MoC). Hence, these assets belong strictly speaking to the Republic of Serbia, with the municipalities (the "founders") acting as de facto owners. Abolition of the 1995 Act on asset ownership should be a high priority. In addition, a change in the Constitution may be required, since it recognizes only State and private ownership, not municipal ownership. DH companies own very little, mostly their offices and office equipment, since they are essentially operating companies only. Nevertheless, the district heating system owns everything up to the substations. Heat exchangers, pumps, building internals and substations are owned by the apartment buildings but are being serviced under contract by the DHC. The DHCs are reportedly in favor of a transfer of substation ownership from flat owners to the utilities, because the current situation has led to a lack of investment in substations.
7.114 Policy and regulatory matters. MoC is theoretically still responsible for setting policy in the district heating sector. Until recently prices could not be changed without the consent of MoC, but an October 2000 decree transferred the responsibility for price setting back to the municipalities. Although the Serbian District Heating Association has issued guidelines for tariff setting, resulting in price differences of "plus/minus 10 percent" between cities, this is clearly a sub-optimal arrangement. As part of proposed new district heating legislation, the asset ownership, regulatory framework and policy-setting responsibility in the DH sector should be clarified and regularized as soon as possible.
7.115 Social consequences of tariff increases. Heating is already difficult to afford for the poorest FRY households; following the proposed tariff increases, it is estimated that at least the poorest two deciles of the FRY population – or about 500,000 households – will find the cost of heating during the 2001-02 winter difficult to afford. Providing direct social assistance to segment of the population will be an important element in an overall social protection program (Chapter 13: Social Protection). In addition, an estimated 18-20 percent of FRY households live in apartments which are not connected to natural gas or district heating networks and are not ready for the installation of individual stoves or boilers. The conversion of these apartments away from heating with electricity would require a relatively costly investment that would furthermore require co-ordination amongst building residents. Additional assistance to enable all such households to meet the investment cost of switching away from heating with electricity would be desirable.
7.116 Governance. It is important that the district heating assets be transferred to the DHCs and included in their balance sheets. The DHCs should be established as soon as possible as municipally owned corporations that function autonomously and on a commercial basis, with Boards of Directors consisting of qualified professionals. Given the current financial situation of most DHCs it is unlikely that privatization will occur soon for lack of investor interest. However, gradual improvements in their financial situation and improvements in the overall management could make selected DHCs ripe for private sector participation during the second half of this decade.
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Investment Strategy
7.117 Reduce over capacity. The district heating systems in Serbia are oversized. Average peak load duration hours are 650-690 hours/year in Belgrade compared to 2,500-3,000 hours/year in Western European countries. A major reason for this is the system "design philosophy": by designing the system for extremely low outside temperatures huge reserve capacities have been installed that will only be used for a few days during the most severe winters. The total overcapacity is conservatively estimated to be as much as 30-50 percent of the currently installed capacity. Modern, more efficient technologies, such as pre-insulated pipes and controls, can help to reduce the capacity needs. In addition, demand-side management investments would reduce heat demand even more so that, in the end, a much reduced system capacity will guarantee a comfortable indoor temperature. Adjusting the capacities of all components will be an extremely important task to avoid wasting scarce financial resources. This will require technical assistance, as Serbian DH experts are not yet acquainted with new technologies and their impact on heat consumption and production. Capacity should be reduced gradually, e.g., by using smaller diameter pre-insulated pipes when old corroded pipes need replacing.
7.118 Increase the share of cogeneration. Out of the 43 district heating systems in Serbia, only 7 can be supplied by cogeneration plants. The share of cogeneration in the total installed heat generation capacities is only 16 percent, while their share in energy produced in 1999 was 25 percent. This low level of utilization of existing cogeneration facilities stems from the fact that these facilities are mostly operating on kerosene, fuel oil or gas, which must be bought at world market prices. Hence, EPS considers these plants too expensive to dispatch on a regular basis, since its lignite-based power plants can produce electricity (ostensibly) much cheaper. The most extreme case is the 105 MW kerosene-fired cogeneration plant in Belgrade, which has been used only about 3,800 hours (for cold start) during its 30 years of existence, i.e. only about 130 hours per year. Similarly, the 235 MW natural gas-fired cogeneration plant in Novi Sad has been used only about 25,000 hours during 30 years, as a peaking plant only. Operating these plants at base load during the heating season would considerably reduce the combined fuel consumption of the heat and power systems. A proposal to convert the cogeneration plant in Novi Beograd from kerosene to gas-firing would make sense provided that: (a) there can be certainty that Serbia will keep current on its payments to Gazprom and, hence, that gas will continue to be delivered regularly; and (b) EPS will sign a power purchase agreement guaranteeing the plant's dispatch during the heating season.
II. MONTENEGRO
7.119 There are no district heating systems in Montenegro, although three are in the planning stage, notably one in Pljevlja where the lignite-fired power plant is located. That project would consist of converting power-only units into cogeneration units and would serve about 15,000 inhabitants (i.e., about 5,000 connections) in the center of the city. Since the main justification of this project is reportedly environmental rather than economical, it would be highly desirable for donors/lenders to review the feasibility study since at first glance this project may not be viable. The other two proposed DH projects would be considered only if gas were to become available, either via Serbia or from Montenegro's own hoped-for offshore production. In
175 Chapter 7. Energy general, however, the low heat densities make DH an unlikely economic heating solution in Montenegro.
ENERGY EFFICIENCY
Background
7.120 Given the urgent need for major electric power and district heating tariff increases to decrease energy consumption and strengthen the financial position of the energy enterprises, there is an equally pressing need to start preparing and implementing energy efficiency measures prior to the winter of 2001/02 in order to: (a) help consumers to offset the effects of rising energy prices, particularly the poorest consumers; (b) further reduce demand on the overloaded electric power system; (c) economize on gas and oil consumption for balance of payments reasons; and (d) reduce environmental pollution. However, no significant energy efficiency programs have ever been implemented in Yugoslavia. Therefore, a great deal of institutional, legal and other work, will need to be done to lay the foundations for an effective program.
7.121 Major energy savings potential exists both in the residential electricity sector as well as in the heating sector, on the supply side as well as the demand side. Supply side improvements are dealt with in the respective energy chapters. Energy efficiency improvements in industry are to be financed by these industries themselves, as they have a clear economic interest to do so and borrowing for this purpose should be generally feasible. The bigger problem is to effectively address the energy efficiency needs of the household sector, mostly in connection with heating. Therefore, this section deals only with the household sector; though many of its conclusions are also applicable to municipal and government buildings. Donor support is being sought for both technical assistance and provision of equipment and appliances in the field of energy efficiency.
I. SERBIA
Current Situation
7.122 Residential electricity use accounts for about 70 percent of Serbian electricity use. Much of the electricity (about 40 percent of demand during the heating season) is being used for heating, either to provide supplemental heating or as a sole source of heat where other fuels are either nonexistent or considered too expensive. For many consumers in areas where there is neither district heating nor central heating, electrical space heating is or has become the only heating method. For these consumers, there are essentially two options, which will take time and money to implement. First, they could switch to alternative fuels such as oil, gas, coal or wood, all of which may require investments in suitable heating appliances. Secondly, where no such alternatives exist, consumers should be given the option to buy the most efficient electrical space heaters possible.
Policy Agenda/Key Challenges
7.123 Energy Efficiency Agency. Given the lack of information about energy efficiency the Government needs to establish an independent Energy Efficiency Agency as a transitional
176 Chapter 7. Energy measure. The Agency should give priority to disseminating information on demand side energy efficiency measures, guide energy audits and implement energy efficiency pilot schemes, and design an energy efficiency strategy that focuses on the highest priorities and the greatest needs. The Agency would also manage the Energy Efficiency Fund (paragraph 7.108). Technical assistance will be required to help the Agency in formulating a comprehensive energy efficiency strategy and program, identify barriers and solutions for their removal, formulate incentives, draft legislation where appropriate, etc. Even in the absence of such a strategy there are a number of things that should be done as soon as possible, notably: (a) starting an energy efficiency campaign; (b) ensuring that high quality energy-efficient products and goods are available on the market; (c) ensuring that financing is available on suitable terms and conditions; and (d) embarking on a pilot scheme to demonstrate the impact of energy efficiency investments.
7.124 Energy Efficiency Education Campaign. - Given the lack of familiarity of Yugoslav energy consumers with energy efficiency it is important to educate them about cost-effective ways to reduce energy use. Consideration should be given to starting a national energy efficiency campaign of TV commercials, newspaper advertisements, editorials, radio spots, utility bill stuffers and pay center displays. Such a campaign could advocate a program consisting of: (a) important no-cost solutions (behavioral changes) such as turning out the lights, unplugging appliances, etc. (b) low-cost measures such as using timers on water heaters, energy- efficient light bulbs, reflectors behind radiators, plastic on the windows; and (c) higher cost measures such as efficient appliances, building insulation, insulated windows, metering, internal controls, substation improvement, etc.
7.125 Availability of energy-efficient products and goods. For an energy efficiency program to be effective, products and goods of the requisite quality must become generally available on the market during 2001 and thereafter. Few of these products are now available and, even if they were, would not be affordable to many consumers. Hence, incentive programs may need to be devised and provision of the highest priority equipment for the poor would be a priority area for donors attention.
7.126 Energy Efficiency Industry. A strong energy efficiency program would also create a vibrant new industrial activity along with significant employment opportunities. In order to save scarce resources available for energy efficiency measures, and to make these measures cost- effective and widely accepted by consumers, product quality must be high. Some relatively small industries exist already in this field (e.g., energy-efficient light bulbs, simple meters, insulation, windows and other goods) but produce low quality products. It would require substantial investment, possibly through joint ventures or foreign direct investment, and opening up the market to competition, to get them up to world standards. Opportunities for public- private partnerships between the manufacturing industry and the Government or the electricity companies exist and should be encouraged.
7.127 Financing options. Financing is important especially for investments that reduce the cost of heating. Assuming energy efficiency credit lines can be made available by Government, IFIs and donors, on-lending could take place through: (a) local banks. However, local banks are generally not willing to lend for housing rehabilitation or energy efficiency because they have little experience with these types of loans and see borrower default, contract enforcement, and/or
177 Chapter 7. Energy investment performance as prohibitive risks; (b) local district heating companies. However, a DHC may not be interested in reducing its heat sales and may need to be licensed as a financial institution; (c) energy service companies (ESCOs), which would prefinance the investments for consumers, who would repay them from the energy savings guaranteed by the ESCO. This method is beginning to take hold in some CE countries but may still take several years before it can be successfully introduced to Yugoslavia; and (d) given the drawbacks of the preceding options the creation of a special Energy Efficiency Investment Fund may be the most appropriate solution.
7.128 Barriers to Energy Efficiency Investments. Experience elsewhere has shown that energy efficiency investments may not occur even if the financial returns are acceptable and the proper incentives exist (high tariffs; high degree of apartment privatization - about 90 percent of all apartments in Serbia are privatized; consumption based metering). One of the most common barriers is the inability to collectively reach decisions where collective investments are required. In this regard, strong homeowner associations (HOAs) are a prerequisite in multifamily buildings. In particular, HOAs need to have the right to sign a loan without unanimous agreement among members, using the first right in all apartments in the building as collateral for any borrowings for energy efficiency investments. A form of HOA, called Tenants Association, exists in Serbia.
Investment Strategy
7.129 Most apartment buildings are poorly insulated and poorly maintained, and individual heat controls and meters do not exist. This leads to a specific heat consumption that is much higher than in Western Europe under similar climatic conditions. Packages of energy efficiency measures can reduce the energy consumption of a residential building by 25-30 percent and even up to 50 percent, at attractive economic and financial rates of return.
7.130 Automated building heat substations and heat meters for interfacing with the DH network have proven very efficient, enabling savings of 25-35 percent of the heating energy. The internal rate of return of these investments is usually around 30-50 percent. The automated and metered heat substations affect energy savings in the following ways: (a) overheating is eliminated; (b) it becomes easy for consumers to adjust the level of heating comfort they wish to have and pay for; (c) automation restores the DH network's hydraulic balance, enabling even heating in the whole network; and (d) automation saves in pumping costs, allows for lower DH water temperatures and thus reduces heat losses.
7.131 Investments in heat metering and controls are of special importance and include: (a) building-level heat meters, valves, and automatic control systems for controlling the heat entering the building; and (b) apartment-level heat meters and thermostatic radiator valves for controlling the heat in individual apartments. Building-level meters for measuring total building consumption are an essential part of any retrofit strategy. Controls are equally important, both for comfort and to enable control over the amount of heat consumers actually use. There is little doubt that households with building-level meters consume more heat per m2 than households in buildings with apartment-level meters. However, the latter is relatively expensive. For that
178 Chapter 7. Energy reason, a more effective strategy in Yugoslavia would be to combine building-level meters with cost allocators.
II. MONTENEGRO
7.132 Given the absence of district heating in Montenegro and its generally milder climate compared to Serbia, energy efficiency measures to be taken in Montenegro relate mostly to improvements in electricity usage and weatherization of buildings, including improvements in building insulation and installation of insulated windows, both to protect against the cold in winter as well as the heat in summer.
Priority Investment and Assistance Program
(a) District Heating
7.133 The proposed program includes rehabilitation of the district heating supply systems consisting of relatively minor investments for generation and larger investments for transmission and distribution pipes and substations. All investments aim at improving the efficiency and reliability of these systems significantly.
7.134 HOBs. Essential repair and deferred maintenance to keep these plants in good operating condition, plus installation of new regulators. The heavy fuel-fired HoB in Nis would be converted to gas firing.
7.135 Cogeneration. Includes repairs and deferred maintenance and installation of the necessary equipment to allow the least-cost use of the existing cogeneration plants in Belgrade (Novi Beograd) by converting the turbines to natural gas firing and in Novi Sad to enable the plant to be used for base load dispatch. Specific investment requirements for other plants still need to be identified. Conversion to gas firing implies a continuous and reliable supply of gas. If this is not possible then a large transmission pipeline would need to be built to supply Novi Beograd with heat. That 30 km pipeline would run from the Teszla Power Plant and would cost an estimated US$140 million.
7.136 Pipes. Implementation of a program to replace 10 percent of the most corroded pipe in the network with pre-insulated pipe, where possible of smaller capacity in order to reduce energy consumption.
7.137 Control equipment, pumps, etc. Includes such items as frequency speed controls to enable adjustment of pumping to real energy needs
7.138 Kreditanstalt fuer Wiederaufbau (KfW) is currently appraising a program focusing on urgent repairs of selected distribution networks and substations of the DH systems in Novi Sad, Nis and Belgrade. The rehabilitation works are complemented by advisory services supporting legal and institutional reforms of these utilities. The program aims at improving the supply of district heating as well as its energy efficiency. Total costs are estimated to be DM 23 million, to
179 Chapter 7. Energy be financed through a grant of DM 15 million from the German Stability Pact for Southeast Europe and local contributions amounting to DM 8 million. Most of the rehabilitation works should be completed by October 2001.
(b) Energy Efficiency
7.139 A priority activity is reducing the heat demand of buildings by improving the building insulation and building internal technical equipment and insulation of the buildings.
7.140 Another priority is to reduce the heat consumption within buildings by installing valves and heat cost allocators.
EXTERNAL FINANCING REQUIREMENTS
The external financing requirements for district heating/energy efficiency, including both Serbia and Montenegro, are estimated to be US$130 million over three to four years (Table 7.8). The financing requirement for 2001 on a commitment basis is US$25.8 million.
Table 7.8: Estimated External Financing requirements for District Heating/Energy Efficiency
Activities CY01 CY02-04 Total Investments Generation HOB 0.9 4.3 CHP 0 17.2 Distribution Pipes 7.9 17.6 Control equipment, pumps, etc. 2.0 5.7 Energy Efficiency - Substations 11.2 23.9 EE - Valves and cost allocators 0 10.7 EE - Weatherization 0 16.9 Subtotal 22.0 96.3 118.3 Technical assistance Heating strategy, market analysis, pricing, regulation 2.8 3.6 Engineering and procurement 1.0 4.3 Subtotal 3.8 7.9 11.7
Total 25.8 104.2 130.0
180 CHAPTER 8. TRANSPORT
INTRODUCTION
8.1 There are major deficiencies as well as opportunities in Yugoslavia’s transport sector. On the whole, the sector is much weaker today than it was ten years ago. Its inefficiencies and emerging bottlenecks are bound to slow down economic recovery if not addressed soon. They also affect people’s living standards in many direct and indirect ways.
8.2 Because of the collapse in industrial production and personal incomes, transport demand is now much lower than in the 1980s. In 2000, aggregate transport volumes were only about one third of those in the 1985-1990 period. This reduction is even higher than that in most former socialist countries. In addition, because of past and foreseeable changes in the economy, the structure of demand has changed, and will continue to do so, giving more importance in particular to road rather than rail transport.
8.3 Supply of transport has been deeply affected by misguided policies over the past ten years. Unsustainable financial policies and inadequate use of existing funds have resulted in a significant de-capitalization of the sector. In general, the quality of infrastructure and equipment is now significantly lower than in neighboring countries. The capability of institutions has also been weakened, as systems and procedures for planning, monitoring, and managing transport activities have been neglected or even misused, and institutions often have had to focus on coping with emergencies, and not on developing and implementing long term plans based on economic realities.
8.4 The potential for the sector to rebound is strong as it has great human resources, knowledge and in some cases a tradition of market relationships, strong organizational capacity, and links to the outside world. As explained below, how much and how fast the sector does rebound will depend essentially on the quality of the market based incentive framework that the new Government establishes for operators and investors in the sector, and the restoration of institutions.
8.5 The assessment below describes present conditions and main issues in the transport sector, and key measures necessary for transition and recovery. It deals in sequence with the following sub-sectors: (a) Road and road transport; (b) railways; (c) maritime transport; (d) river transport; and (e) trade and road transport facilitation. The assessment is based on existing data, often incomplete and, in some cases, not fully reliable, as well as on available analyses which often lack economic grounding. As a result, findings and recommendation below are tentative. They nevertheless provide a framework for formulating priority actions. The external financing requirements in the transport sector are estimated to be US$668.4 million over three to four years. The financing requirement for 2001, on a commitment basis, is US$218.7 million. Details of financing requirements are presented in Table 8.2 at the end of the chapter. Chapter 8. Transport
A. ROAD AND ROAD TRANSPORT
Present Condition and Main Issues Serbia 8.6 Condition of the Road Network: Serbia has a well developed intercity road network1, comparable in terms of density and pavement type to that of the most advanced Central and East European countries. However, because of the inadequate maintenance of the past ten years, this network is in poor condition and in some places deteriorating rapidly. On the basis of pavement condition surveys carried out in 1997/98, the Serbian Road Administration (SRA) estimates that about 25 percent of the main and regional roads are in good condition, 19 percent in fair condition, and 56 percent in bad or very bad condition. In a typical West European country, these percentages would be 80 percent, 15 percent, and 5 percent respectively. In Croatia, they are 32 percent, 46 percent, and 22 percent respectively according to a recent survey. In Central and Eastern Europe, in an assessment sponsored by the World Bank in 1991, these percentages were 37 percent, 41 percent, and 22 percent respectively. Poor road condition translates into expensive, slow, and unreliable road transport. The Government therefore needs to begin to catch up with the heavy backlog of deferred maintenance.
8.7 One important example of the poor condition of the road network is the semi-motorway from Belgrade to Novi-Sad, a strategic road for Serbia and a key branch of the Trans-European Corridor X, the pavement of which has reached the end of its service life and is now substantially distressed. Another example is the link from Nis to the border with Bulgaria, another key part of Corridor X, which is heavily rutted and would probably fail within a short period if international transit traffic were to increase significantly. Numerous bridges and tunnels have also deteriorated to unsafe condition.
8.8 Traffic: Although traffic is substantial on the main inter-city roads2, there is presently no obvious road capacity problem and no need for new construction in the short to medium term. However, with rapid economic growth, and given that the strategic location of Yugoslavia in South-Eastern Europe may bring back a significant amount of international transit traffic, road capacity could become an issue in the longer term, particularly on the international corridors. This will need careful assessment. With a few major exceptions (the most sensitive being the Sloboda bridge in Novi-Sad), the damage caused during the Kosovo conflict has been repaired through truly extraordinary efforts and no longer represents a bottleneck.
8.9 Road Sub-sector Funding and Cost Recovery: The funding of road maintenance, which was satisfactory until the early 1990s, has decreased dramatically and been substantially neglected since then. Annual maintenance expenditures on main and regional roads have been of the order of 0.3 percent of GNP in the past years while (Table 8.1), at Yugoslavia’s level of economic development, a country should usually spend about 1 percent of its GNP on road maintenance.
1 With about 14,500 Km of main and regional roads and about 22,500 Km of local roads (excluding Kosovo) 2 About 30 percent of traffic on the main roads is above 5000 vehicles/day and 46 percent between 2000 and 5000 vehicles/day.
182 Chapter 8. Transport
Table 8.1: Road Expenditures (1990 - 2000)3 in US$ Million.
1990 1995 1998 1999 2000 Routine Maintenance 72.0 7.7 15.7 9.4 15.0 Periodic Maintenance 94.2 4.3 1.6 0.5 7.3 and Rehabilitation Improvement and 151.6 8.4 25.5 5.8 8.2 Construction Total 317.8 20.4 42.8 15.7 28.5 Maintenance 0.62% 0.24% 0.31% 0.19% 0.39% Expenditures as % of GNP
8.10 Insufficient funding is the main reason that the condition of the road network has become so poor. This has been compounded, however, by two other factors. First, a substantial part of available funding has been spent on improvement and construction projects that, in most cases, should not have received priority. The few construction projects, which are presently in progress, should be re-evaluated on the basis of their economic justification, and probably deferred. Second, maintenance funds have not been allocated to specific projects on the basis of an objective analysis of priorities, but much more as a result of political concerns. Their use has therefore not been optimized.
8.11 The recovery of the cost of road use (i.e. of the loss of value of road infrastructure assets due to the wear and tear inflicted by road users) is also insufficient. This cost is usually recovered mainly through taxes on gasoline and diesel fuel, annual vehicle registration taxes, and tolls on motorways. In Serbia, total fuel taxes are relatively low (about 50 percent and 37 percent of the production and distribution cost of gasoline and diesel fuel respectively) which results in the implicit ‘user charge’ part of these taxes to be of the order of US$0.1 for gasoline and US$0.05 for diesel fuel, which is far too low. The registration taxes paid by trucks (about US$100 for medium size trucks and US$200 for large ones) are also insufficient, while the system for calculating these taxes seems unnecessarily complex and not related to the potential damage vehicles may create to the road. Moreover, tolls paid by domestic vehicles are at less than one-tenth the levels paid in Western Europe. These factors result in an implicit subsidy by the Serbian society at large in favor of road transport4.
8.12 Institutional Performance: The general organization of the road sector in Serbia is sound, with a lean central administration responsible for the main and regional roads and most of the planning, design, supervision, and research work contracted out to independent technical institutes. Road works are also contracted out to independent commercial contractors with a legal obligation to use competitive procurement methods. The capability of the institutions involved in the road sector was good until the early 1990s. Modern methods were being
3 For 1995-2000, actual expenditures in Dinar have been expressed in constant 2000 terms and divided by the rate of exchange of 63 Dinar = US$1. To some extent, this rate of exchange makes expenditures artificially low. For 1990, actual expenditures have been divided by the then prevalent rate of exchange of 11.9 Dinar = US$1. 4 Data in this paragraph are preliminary and only provide an indication of the issues. There is presently no reliable study of road use cost recovery.
183 Chapter 8. Transport introduced to monitor road condition and road use, and to prepare expenditure programs and budgets on an objective economic basis. Western European technical norms and standards were being used. Procurement was conducted on a competitive basis for large works and was governed by sound regulations. There were also competent organizations and well-trained staff.
8.13 This capability has unfortunately much weakened throughout the 1990s as most decisions have been taken on a political rather than technical basis. Most problematic today are the lack of sound systems and procedures for planning and budgeting expenditures, insufficient monitoring systems, and a staffing of the Road Administration that does not seem consistent with the requirements of its workload. The procurement and work supervision functions have also probably much suffered from past practices.
8.14 Road Construction Industry: There is a well-developed construction industry in Serbia. This industry had the competence necessary to be active and successful on the international markets until the early 1990s. Given the lack of demand in the past ten years, however, the industry’s capacity has declined considerably and it would have difficulties carrying out a substantially increased program of road works, particularly one that would involve complex and equipment intensive works5. It would have less problem with the relatively simple pavement strengthening works that are the priority in the short term, although there will undoubtedly be a capacity threshold that can be raised only gradually6. Given past practices, many firms may also have difficulties operating effectively and profitably in a competitive environment.
8.15 Road Transport Industry: There is a dynamic and entrepreneurial road transport industry in Serbia with experience and know-how. Enterprises involved in international transport have for example rapidly taken initiatives to organize themselves and enter into productive relationships with the new Government. There seems to be few impediments to market entry and the trucking business appears competitive. Competition in interurban passenger services in restricted, however, as operators need to obtain a route license from the Chamber of Commerce and supply is limited. This has negative effects on the price and quality of services.
8.16 Another important issue is that most regulations affecting road transport (technical and environmental standards, vehicle weights and dimensions, licensing) need to be revised to better serve their technical purpose7 and appropriately enforced, which would require a change in the basic laws and regulations on road traffic and safety. Vehicle weight regulations, for example, are not consistent with those of the European Union, and maximum axle loading is not strictly enforced due to a lack of resources. The enforcement of technical and environmental standards is also not rigorous, which results, in particular, in a serious air quality problem in Belgrade. There is a justifiable belief in the Government that affordability of road transport, including private car use, should have priority in the short term over the enforcement of standards. Yet, unsafe and polluting vehicles have a cost in terms of accident and health that needs to be taken into account.
5 Implementation constraints would be a main concern for domestically funded works. With foreign funding, international contractors would likely be involved. 6 Production of aggregates is for example said to be a potential bottleneck at present. 7 They provided ample opportunity in the past for extortion from most transport operators or granting of favors to those well connected.
184 Chapter 8. Transport
8.17 Many road transport enterprises are still under public ownership. They should be privatized since road transport is a business well suited to private entrepreneurship. This, however, is not an urgent priority as long as market entry is not restricted and a healthy private sector has the opportunity to develop in parallel and in competition with the public sector.
Montenegro 8.18 Condition of the road network: The road network8 of Montenegro is unusual in many aspects. It is very well developed with a density of main and regional roads about twice that of Serbia in terms of road kilometers per habitant. It also has to cope with an exceptional geography which constrains road geometry and therefore speed and capacity, necessitates numerous bridges, tunnels, and works for slope protection, and makes improvements expensive. In brief, the road network is a precious but very costly asset for the Republic. Traffic is significant on the main coastal road and the north-south axis with its connection to Niksic. However, apart from in-city traffic in Podgorica, no serious capacity problem may be expected in the near future.
8.19 Road Expenditures: The maintenance of the road network has been neglected in the past years. On average, only about a third of necessary routine and winter maintenance and a quarter of periodic maintenance has been carried out recently. With planned total expenditures of US$6.3 million in 2001, the road budget is below needs.
8.20 To serve the economic development of Montenegro and, in particular, its tourism industry, the Government has promoted three major road construction projects: (i) the Sozina tunnel on the Podgorica- Bar road; (ii) the Podgorica by-pass; and (iii) the Kotor Bay bridge. These projects, which would provide transport standards much above those of the rest of the network, would be extremely expensive for the country: projected costs are about US$76 million for the tunnel, US$95 million for the by-pass, and US$50 million for the bridge.
8.21 Institutional performance: As in Serbia, there is a small central administration that manages the network and contracts out most of its activities. This administration appears well organized and efficient although it badly needs systems and procedures for monitoring the condition of the road network, and for planning and budgeting expenditures. An issue is that most road works are carried out by a State-owned enterprise (Crna Gora Put). Although this enterprise has an arm’s length relationship with the road administration and seems efficient, this is not a sound situation for the long term.
8.22 Road Transport Industry: The Montenegrin road transport industry is dynamic and operating to a large extent under a competitive regime. Issues are similar to those in Serbia. There are, in particular, unnecessary controls on passenger transport, and regulations (the bulk of which are set at the Federal level) need to be modernized and better enforced. The alleged scarcity of international permits is a major issue for Montenegrin truckers.
8This network includes about 850 Km of main roads, 950 Km of regional roads, and a very extensive network of 5,300 Km of local roads. There is unfortunately no data base on road condition. The network south of Podgorica seems in relatively good condition.
185 Chapter 8. Transport
Priorities for transition and recovery (Table 8.2) Serbia 8.23 The objectives of the Government should be to: (i) increase the funding of road maintenance and rehabilitation considerably in order to prevent bottlenecks developing and stop the long term deterioration of the road network, (ii) set up an efficient system of road user charges, (iii) reinstate the quality of the Road Administration, (iv) develop the road maintenance and construction industry, and (v) improve the regulation and competitiveness of the road transport industry.
8.24 Funding of road maintenance and rehabilitation: During the next five years, the Government and foreign donors need to ensure that sufficient funding is available for the following priority activities: (i) routine and winter maintenance of the full network; (ii) periodic maintenance of those roads that are presently in good condition; and (iii) rehabilitation of the motorways and main roads that are presently in fair or bad condition. Given the Government’s tight fiscal constraints, foreign donors would have to provide a large part of the funding required for these activities. An assessment needs to be prepared on the basis of an objective technical and economic methodology. The rehabilitation of regional roads particularly those that carry less than 2000 vehicles per day should be postponed until after 2005. Projects for increasing road capacity, including on-going by-pass projects, should be submitted as soon as possible to a rigorous economic analysis. New motorways on the Trans-European Corridor X may require more comprehensive analysis due to their special importance for enhancing regional transport and trade.
8.25 The scope and timing of reconstruction of the Sloboda bridge in Novi-Sad is a particularly difficult question. With six lanes for only about 10,000 vehicles per day, the bridge was over- designed mainly because its construction was connected to other developments that did not take place9. Given the shortage of resources in the road sector and the high economic returns of other expenditures (especially road maintenance), it is doubtful that the bridge should now be reconstructed to its original size. Yet, transport capacity across the Danube in Novi-Sad is limited, and the pontoon bridge built in 1999 needs to be removed as soon as possible, which implies that a new bridge is necessary in Novi-Sad. The final decision on the location and standards of this new bridge needs to be based on the comparison of a wide range of options, including traffic and economic analysis, taking into account all transport needs, both in the city and in the context of regional development.
8.26 Road user charge system: The recovery of the cost of road use (particularly by heavy trucks and buses) needs to be significantly increased. The main tools to do so should be (i) a substantial increase in the taxation of gasoline and particularly diesel fuel, and (ii) a simplification of the annual vehicle registration system with the imposition of higher taxation levels for trucks and buses. As the information basis for these measures is lacking, a study of road user charges should be carried out rapidly.
9 A beautiful modern cable structure, the Sloboda bridge was not only a transport facility but also a symbol of Yugoslav engineering prowess.
186 Chapter 8. Transport
8.27 Quality of the Road Administration: The new management of SRA is determined to restore the previous quality of road sector management. This should be achievable within a few years. What is needed in the short term is, first of all, to reinstate previous systems and procedures and to ensure that decisions are taken on purely technical and economic bases. Priority should go to ensuring that procurement and roadwork supervision are done in the best possible way. Also important are the completion of a proper road database and the revamping of the planning and budgeting processes. The fulfillment of these two objectives will require a rather fundamental adjustment of staffing with an increase in the numbers of staff involved in implementation and planning/budgeting/monitoring activities and a reduction of those in other areas. To collect information and references and help implement these changes, SRA’s management should also be given the opportunity to visit road agencies in West European countries. Donor assistance for all of these activities will be important.
8.28 More fundamental questions regarding (i) the organizational and financial independence of SRA (and behind this the relevance of re-establishing a road fund independent from the national budget) as well as (ii) SRA’s role in monitoring and assisting local governments in the management of local and municipal road networks, are also important. Consideration of these questions is not essential in the short term, however, and would distract from the necessity of rebuilding strong institutional capability. It is recommended that they be addressed only when SRA has made significant progress in its organization and effectiveness.
8.29 Development of the construction industry: An assessment of contractors’ capacity should be carried out rapidly. It would show the volume of road works that can be efficiently carried out by the industry in the coming years, as well as identify measures to promote needed investments in the industry. Also, given that competent firms have in recent years had a level of activity much below normal, contractor pre-qualification rules should be carefully relaxed in the coming years.
8.30 Improvements in the regulation and competitiveness of the road transport industry: The Government is already actively taking measures to streamline road transport laws and regulations. These measures deserve support. In addition, it is important that existing constraints to entry into the passenger road transport business be removed and that sufficient funding be allocated for the enforcement of axle load regulations. The road safety and environmental impacts of the present poor quality of the vehicle fleet also need to be assessed, with measures identified to step up enforcement of technical standards and emission regulations with the objective of eliminating the worst offenders as soon as possible.
Montenegro 8.31 Expenditure priorities: The main priority should be to increase the funding of road maintenance and rehabilitation. Annual expenditures needs are of the order of: US$5.5 million for routine and winter maintenance, and US$10 million for periodic maintenance and rehabilitation of roads, bridges, and tunnels. This is unusually high (of the order of 2.5-3 percent of GNP) but is a consequence of the geography of Montenegro. If amounts of such magnitude are not spent, the network is bound to deteriorate rapidly and bottlenecks and costly accidents such as landslides will become more frequent. A thorough assessment of the condition of the network and the needs for expenditures is required. As in Serbia, a substantial part of the
187 Chapter 8. Transport funding for deferred road maintenance and rehabilitation will need to be provided by foreign donors.
8.32 The three major road projects presently contemplated cannot be a priority given the modest current road traffic and therefore limited potential benefits of these investments, the urgency of focusing resources on the existing network, and, more generally, the projects’ major cost in relation to the size of the economy. These projects would become justified only when the economy has developed significantly. In the near term, the Government is rightly submitting these projects to in-depth economic and financial assessments. It should give full consideration to their opportunity costs.
8.33 Road administration and construction industry: Also a priority is to develop the road administration and the road construction and maintenance industry. The road administration needs a sound road database and systems and procedures for monitoring the condition of the road network, and for preparing road plans and budgets. Road works should also systematically be put to tender, with some small size bidding packages used to promote local firms, and others openly tendered to non-Montenegrin firms, to ensure that Crna Gora Put operates in a competitive environment.
B. RAILWAYS
Present condition and main issues Serbia 8.34 Assets: In 1990, the Serbian railway was a medium size railway by European standards with assets appropriate to meet transport demand requirements in a technically effective way10. It was already in need of modernization, however. Since then, the lack of funds, poor expenditure policies followed by the Government in this sub-sector, and the economic sanctions have resulted in inadequate maintenance and almost no renewal of assets. The consequences are striking. The condition of the track has much deteriorated, especially in the curved sections which are common due to the difficult terrain over much of Serbia. There is a total of 122 speed restrictions now on the network (including on 87 Km where the permissible speed is below 40 Km/h) which creates major operational problems, as well as compromising safety.
8.35 There is also a serious problem with the fleet of locomotives, freight wagons and passenger coaches. About two thirds of the wagons and three quarters of the coaches are over twenty years old. Only about one third of the locomotives and wagons and half of the coaches are regularly available for service, although there is also a reduced need for motive power and rolling stock due to the current reduced demand for railway transport. In sum, the shortage of equipment and its poor reliability make railway operations unusually difficult and will increasingly affect the
10 The length of railway lines is 3,809 Km, which is comparable to that of the adjacent countries’ rail networks. This includes about 874 Km for Corridor X, a major road-rail trans-European corridor that links Greece and Turkey to Western Europe.
188 Chapter 8. Transport railway’s customers. As with the road sub-sector, most of the damages incurred during the Kosovo conflict have been repaired11.
8.36 Transport demand: Traffic has declined dramatically since the 1980s. In 2000, freight traffic was 1,925 million Ton-Km or about 27 percent of its 1990 level. Passenger traffic was 1,308 million Passenger-Km or about 29 percent of its 1990 level. As in most of Central and Eastern Europe and the former Soviet Union, these changes have resulted from the drop in industrial production, the change in structure of the economy, and greatly reduced income levels, and they will most likely be sustained. However, traffic declines in Serbia, unlike in Croatia, have been higher than the average of around 40 percent seen in most of the former socialist countries.
8.37 There are some important features in railway traffic. First, as in most adjacent countries (Bulgaria for example), international traffic is a major part of the railway business. About 60 percent of freight traffic is for import/export or for transit transport, which highlights the key importance of the railway for international trade. Second, much of freight transport demand is generated by a few industries12. The railway is highly dependent in particular on activities (such as the iron smelter in Smederevo) which have an uncertain economic future. Third, passenger demand is currently boosted by unrealistically low fares. Given the availability of cheap and faster bus transport, demand would likely prove price elastic and traffic decline further if fares were set at cost recovery level. These features call for a careful examination of traffic prospects in the assessment of investment projects.
8.38 Finance: The railway’s financial situation is not sustainable. Only about 31 percent of revenues from operations13 is paid by freight and passenger customers. Most of the rest (or about US$105 million in 2000) is provided by either the budget (about US$14 million) or a general sales tax earmarked for the railway (about US$91 million). This unique situation is due to extremely low tariffs for domestic traffic. Domestic freight tariffs are presently about US$0.007 per Ton-Km, which is about 40 percent of average freight tariff on the Bulgarian railway, possibly the least expensive of the adjacent railways. Domestic passenger fares are about US$0.0053 per Passenger-Km14, about 60 percent of fares on the Bulgarian railway, which highly subsidizes passenger transport, and only 25-50 percent of the fares on the railway’s main domestic competitor, bus transport.
8.39 There is little justification for such tariffs. In almost all European countries, railways are free to set freight tariffs at the market level and fully recover costs. Passenger fares are generally subsidized for social reasons, but not to the extent found in Serbia.
8.40 There are also indications that the cost of railway services is higher than it could be. For example, in 2000, on the basis of an exchange rate of 41.6 Dinar=US$1, the average transport
11 Major exceptions being the Ostruznica bridge south of Belgrade, the destruction of which greatly disrupts traffic through Belgrade, and the new road-rail Zezelj bridge in Novi Sad which has limited capacity. 12 About 50 percent of the tonnage is produced by the twelve largest clients. 13 Or about 35 percent of operating costs since revenues from operations, including subsidies, exceeded operating costs by 10 percent in 2000. 14 Given the complexity of the tariff structure, the numbers for domestic freight tariff and passenger fares are only indicative. Tariffs for international traffic are much higher.
189 Chapter 8. Transport cost of one Traffic Unit (i.e. one Ton-Km or Passenger-Km) was US$0.043 on the Serbian railway15. This is 87 percent higher than the cost of the Bulgarian railway, despite low costs for fuel and energy in Serbia, and low depreciation. This appears due less to the wage bill, which, because of low salaries, is not excessive compared to other railways, than to general expenses and contracted services.
8.41 The railway is, in addition, saddled with a high debt burden. Its foreign debt amounts to about US$424 million. The railway does not have the financial capability to repay this debt.
8.42 During this past period of financial shortages and de-capitalization of the enterprise, the Government has given priority to expenditures for which it is doubtful that there is any economic justification. A striking example is the construction of a technically remarkable suburban passenger transport system in Belgrade with modern passenger stations and about 20 Km of tunnels, probably at a very high cost. This system is presently underused because there is insufficient equipment to operate it and weak coordination with the other urban transport modes.
8.43 Institutional performance: The railway is a monopoly enterprise owned by the Serbian Republican Government. Although efforts have been made to modernize its organization, the railway does not operate as an autonomous, commercially driven company, but as a public agency dependent on the Government for its essential resources and key decisions, and therefore is not fully accountable for its results. The railway has a traditional organization by functions, and not one based on business lines as modern railways do. It lacks systems and procedures to assess its operating costs for specific traffic, and to guide its commercial strategy and investments decisions. It has been deeply affected by the turmoil of the past ten years during which its focus has necessarily be on survival.
8.44 With about 32,800 employees, the railway is also highly overstaffed. Its productivity (in terms of ‘000 Traffic Unit per one employee) is 98, compared to about 158 for the Croatian railway, 227 for the Bulgarian railway, and 422 for the Polish railway. Even the latter, although four times more productive, is already considered overstaffed. Since 1990 the railway has only decreased staff by 29 percent in response to a 72 percent decline in its total traffic. By comparison, the Bulgarian railway has lost about 58 percent of its traffic and reduced staff by 53 percent. As about three quarters of the staff in Serbia are below 50 years old, attrition cannot be relied upon to adjust manpower.
8.45 Most activities that can operate independently from the railway and submitted to competitive pressure (such as heavy maintenance workshops, railway institute, and civil works units) have been established as separate enterprises. In general, however, they are still fully owned by the railway and have the railway as their dominant, if not only, client.
15 The exchange rate uses the official rate for 1/3 of transactions and the unofficial rate for 2/3 of transactions. Even at the favorable rate of 63 Dinar=US$1, the Serbian railway’s cost would still be 20 percent higher than the Bulgarian railway. The railway’s financial situation in 2000 was distorted, however, by the high inflation and the exchange rate policy.
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Montenegro 8.46 Assets: Perhaps even more than its road network, the railway system of Montenegro is constrained by geography16. As a result, it is a very costly system to maintain and operate. Essentially built in the 1960s and 1970s, the railway has had only limited repairs and renewal of assets since then. The main north-south line, that links the port of Bar, Yugoslavia’s only maritime port, to Serbia, is in barely satisfactory condition overall, and old rails and sleepers need to be replaced on about 40 Km of line. The east-west line from Podgorica to Niksic is deteriorated beyond acceptable technical standards.
8.47 Transport demand: As in Serbia, railway traffic has decreased dramatically (by about 73 percent since 198917). The railway is dependent on a few clients, the most important, by far, being the bauxite mine in Niksic and aluminum complex in Podgorica which both generated about 60 percent of the freight traffic in 2000. The railway’s future is also tied to the political relationship between Serbia and Montenegro, the performance of the Serbian railway (the cost and quality of which are essential for many potential customers of the Montenegrin railway), and the use of the port of Bar. Although the railway has a potential comparative advantage over road transport for traffic to and from Serbia, it has not been able to exploit this advantage in the recent past.
8.48 Finance: The Montenegrin railway is highly subsidized. 41 percent of its 2000 revenues of US$12.1 million came from the Republican budget and from an earmarked general sales tax. This is due mainly to passenger fares which at US$0.015/passenger-Km on average were much below actual costs. Freight tariffs on the contrary were probably around cost recovery level. Also, as for the Serbian railway, there are indications that the operating costs of the Montenegrin railway (at US$0.055/Traffic Unit in 2000) are unusually high, although this may be explained by the required high cost of infrastructure. In addition, the railway has a foreign debt of about US$25 million, which is significant in relation to its turnover, and has not been serviced in past years.
8.49 Institutional performance: The railway is 80 percent owned by the Montenegrin Government and highly dependent on it for provision of essential resources and for major strategic decisions. The railway also lacks modern management systems and procedures, especially for cost accounting and investment planning, and does not have a medium term business plan to guide its development strategy. It is overstaffed. Its productivity is about 100, 000 Traffic Unit per employee, similar to that of the Serbian railway, and much below that of adjacent railways. Since 1989, while traffic has declined by 73 percent, staff has been reduced by only 21 percent.
16 It is limited in size (with only 240 Km of line), but includes numerous bridges and tunnels, in particular the 6,172 m long Sozina tunnel between Podgorica and Bar. 17 Freight traffic has declined from 570 million Ton-Km in 1989 to 51 million Ton-Km in 2000. Passenger traffic has declined from 370 million Passenger-Km to 200 million Passenger-Km over the same period.
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Priorities for transition and recovery (Table 8.2) Serbia 8.50 The objectives of the Government should be to: (i) address the railway’s most serious operational constraints through a targeted program of investments; (ii) put the railway on a sound financial footing; and (iii) reorganize the railway into an autonomous enterprise able to compete successfully on the internal transport market.
8.51 Program of investments: During the next three to four years, the Government and foreign donors need to provide sufficient funding for the following priority investments: (i) deferred maintenance and rehabilitation of the track and signaling/telecommunications system, with priority given to Corridor X and including reconstruction of the Ostruznica bridge; (ii) repair and rehabilitation of motive power and rolling stock; and (iii) rehabilitation of information systems. A deeper assessment is required of the deterioration of the railway’s assets and the benefit/cost of rehabilitation. These investments would alleviate today’s most serious bottlenecks and enable the railway to operate on a technically sound basis. Given the Government’s tight fiscal constraints, and the need to continue to provide heavy operating subsidies during a transition period, most of the funding for investments will need to be provided by foreign donors. Once this initial re-capitalization of the railway is achieved, and a better knowledge has been gained of the demands that a restructured economy will place on the railway, additional investments are likely to be necessary. These should be motivated by commercial goals and funded out of the railway’s own cash generation.
8.52 Financial restructuring: A comprehensive program to put the railway on a sound financial footing is urgent. It should include: (i) the increase of freight tariffs to the full cost recovery level phased over a period of about two years18, followed by the termination of Government controls on such tariffs; (ii) the gradual but substantial increase of passenger fares so that subsidies become the exception rather than the rule after about two years, accompanied by a social assessment to provide information about railway passengers, their poverty status, and the impact of higher fares; (iii) the termination of the earmarked sales tax as soon as possible, its replacement by a general budget subsidy for operations for an interim period of two years, and the provision of financial support solely through public service obligation contracts after these two years; (iv) the resolution of the railway’s foreign debt question, and the clarification and rescheduling of its domestic debt; and (v) the transfer to the Government of all main railway- owned commercial enterprises, for their privatization, as a way to partially address the debt question, and to enable arm’s length, commercial relationships between the railway and these enterprises. These financial measures should be coordinated within the scope of a realistic business plan.
8.53 Reorganization: The railway also needs urgently a plan of actions to lower its costs and create incentives for increased efficiency. These would first include measures to reduce staff by as much as 50 percent over a few years through early retirement, severance payments, and retraining. Measures currently underway in the Polish railway, which, despite a productivity four times higher than that of the Serbian railway, is currently reducing its staff by about 20
18 Any subsidy that may be deemed necessary for any ailing industry that is a customer of the railway should not be provided through low railway tariffs but through direct support to that enterprise.
192 Chapter 8. Transport percent, could offer a model. As in Poland, foreign donors may need to fund the bulk of severance payments if the Government is willing to implement a credible and thorough reform plan for the railway. Other actions to reduce costs should also include elimination of low volume stations, reduction or termination of low volume passenger services, and reduction in the number of workshops. Lines of business should be given much more importance in the organization of the railway and the management tools necessary to operate on a commercial basis (appropriate costing systems, especially) should be established. Finally, measures that ensure autonomy and accountability of the railway as well as independence from political pressures should be instituted.
8.54 Deeper restructuring of the railway, for example through the institutional separation of infrastructure and operations, the establishment of separate operating companies, and the concessioning of some services to the private sector is important but should probably not be considered in the first few years. Indeed, these changes are likely to be successful only when the railway’s productive capacity has been restored, its financial situation is set on a sustainable path, its institutional capacity is strengthened, and the economic environment has stabilized. However, changes could be initiated through accounting separation and by adopting legislation to open track access to any willing rail operator.
Montenegro 8.55 Measures required for the Montenegrin railway are similar to those mentioned above for the Serbian railway.
8.56 Investments: During the next three to four years, the Government and foreign donors should provide sufficient funding for the following priority investments: (i) deferred maintenance and rehabilitation of the track and signaling/telecommunications system, urgent repairs of tunnels and bridges, and provision of track repair equipment ; and (ii) repair and rehabilitation of motive power and rolling stock, including information systems. As with the Serbian railway, a deeper assessment is required of the benefit/cost of rehabilitation of assets. Foreign funding is likely to be needed for a substantial part of the re-capitalization of the railway.
8.57 Finance: Necessary financial measures include a gradual but substantial increase of passenger fares, the termination of the earmarked sales tax and its replacement by budgetary support provided solely on the basis of public service obligation contracts, the resolution of the railway’s foreign debt question, and the formulation of a realistic business plan.
8.58 Reorganization: Reorganization measures include a reduction in staff by as much as 50 percent, the setting up of adequate management tools such as cost accounting and proper investment planning systems, and the establishment of governance systems that ensure that the railway is autonomous and accountable for its results.
8.59 The future of the line towards Niksic deserves special attention. Given the high investment cost in relation to potential benefits, its rehabilitation should not be a priority for the State despite its poor condition. Since the line benefits only a handful of customers, letting them take it over
193 Chapter 8. Transport under a long term concession contract and decide on appropriate investments could be the most economic approach.
C. MARITIME TRANSPORT
Present Condition and Main Issues 8.60 There is only one major facility in FRY in the maritime sub-sector, the Port of Bar on the Montenegrin coast close to Albania. It is a well run and well equipped facility, operating at only 20 percent of its capacity. The Port is a commercially-managed joint stock company looking forward to a privatization of its activities. While the port offers good performance to its users, its large debt burden and the poor hinterland connections affect its overall competitiveness.
8.61 Traffic. The Port of Bar handles more than 95 percent of FRY maritime transport. As shown on the graph below traffic fluctuated heavily over the past 10 years to reach 1.3 MT in 2000, down from 2.7 MT in 1989. The Port has traditionally been used for imports (80 percent in 2000-peak of 1.8 MT in 1989), for exports (15 percent in 2000-peak of 0.8 MT in 1998) and for transit and local distribution (less than 8 percent in 2000). Exports represented 40 percent of traffic in 1998. Current exports consist mostly of aluminum products and timber. The share of general cargo has increased to about 50 percent in recent years with a corresponding decrease in dry bulk (from 35 percent in 1996 to 9 percent in 2000). Liquid cargo, consisting primarily of imported oil products, also increased to 41 percent of total cargo in 2000. The Port handled about 10,000 TEU containers and 10,000 Ro-Ro units in 2000, a fairly small amount given it is the only seaport of FRY.
Figure 8.1: Port of Bar – Turnover of Goods (1985-2000)
3,000,000
2,500,000
2,000,000
1,500,000 IMPORT EXPORT TRANSIT 1,000,000 Loc.distrib. TOTAL (t) 500,000
0 19 19 TOTAL (t) 19 19 85 86 19 19 87 88 19 19 TRANSIT 89 90 19 19 91 92 19 93 94 19 19 IMPORT 95 96 19 19 97 98 20 99 00
8.62 Port Assets. The Port of Bar has an overall capacity of 4 to 5 million Tons with its present infrastructure and additional room to expand as required. The port quays and breakwaters are in
194 Chapter 8. Transport relatively good condition. Its warehousing and handling capacity does not create a constraint to accommodate the current traffic of 1.3 million Tons and foreseeable demand. Only timber warehousing space is used at 100 percent of its capacity. A damaged breakwater was repaired last year, but funding for this rehabilitation (US$5.7 million), which was expected from the European Investment Bank and the Republic of Montenegro, has failed to materialize to date.
8.63 The port spreads over 200 hectares, with a potential extension to 600 additional hectares. It has 3.5 km of quays with a maximum draft of 14 meters for vessels up to 100,000 tons, and 120,000 m² of closed warehousing. It can handle almost any kind of cargo. While most of the handling equipment is relatively old (20 years and more), it has been sufficiently maintained to offer robust handling performance with limited equipment breakdowns. The Port includes terminals for the following: general cargo, oil product, liquid cargo, containers, Ro-Ro, timber and passengers.
8.64 Port Organization and Privatization. The Port of Bar is a joint-stock company with 80 percent ownership by the Republic of Montenegro and 20 percent distributed among its 1700 employees. The company owns the infrastructure, superstructure and all handling equipment. Some of the warehouses are leased to private operators, but handling operations are carried out by the Port company. Staff receive performance-based salaries, with a range of salaries from 1-3 depending on gang productivity. The company is commercially operated and has been preserved from political influence despite the high level of state ownership. Tariffs are decided on commercial terms taking into account the significant local and foreign competition, in close coordination with shipping lines and forwarders. The Republic of Montenegro is represented in the Board of Directors and monitors applicable tariffs accordingly.
8.65 The Republic of Montenegro and the Port want to explore various solutions to privatize all operations, with a preference for a landlord port organizational scheme. Existing infrastructure would belong to the landlord authority, new infrastructure would belong jointly to the landlord authority and to private operators during concession periods, superstructure and port labor would be private, and other port functions would become progressively private. This would be appropriate. Shipping line operators expressed doubts, however, on the feasibility of privatization of port activities rapidly due to remaining political uncertainties and the low and erratic traffic.
8.66 The Port expects to shortly sign its first major concession agreement to expand the container facility, based on a competitive tender launched in August 1999. The tender documents were prepared by Louis Berger International in cooperation with the National Maritime Institution (Washington) and the National State Institute (Louisiana). This 25-year concession foresees an investment of US$25 million within the next three to four years to upgrade the existing facilities, add an additional quay and modernize the equipment in place. The main focus will be on transshipment of containers for the Adriatic sea since current domestic traffic of 10,000 TEUs does not require significant additional capacity. This strategy, aimed at making Bar a regional hub, will need to be supported by high performance, since the weak domestic market and poor hinterland connections place Bar in an unfavorable position.
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8.67 Port Competitive Position. The Port compares favorably with other ports in the region in terms of efficiency, availability of services (365d/year-24 h/d) and coordination with border agencies. Some examples of standard performance include: 185 containers unloaded and brought to storage in 12 hours with total dwell time of 6 days, between 1,200 and 3,000 tons of palletized aluminum products per day with a usual output of 500 tons/gang per day, and 600 tons per hour for liquid acid. Port users consider the facility as well run and efficient, given the traffic, but would appreciate better clarity of tariff policies and lower tariffs. Official tariffs are relatively high by regional standards partially due to low volumes, but with some room for negotiations on long term arrangements. These tariffs were being fully recast in February 2001 with an expected reduction of 30 percent in the average tariff.
8.68 Difficult Financial Situation: The port overall turnover reached an estimated US$16.5 million in 2000, down from US$23 million in 1998. This is equivalent to US$12.4 per ton inclusive of all port charges (vessel and cargo dues, handling and warehousing), a reasonable average given the high proportion of general cargo. The port suffered from severe reductions in traffic both during the 1992-1995 embargo period (turnover below US$4.5 million) and after the 1999 conflict. These events weakened the Port’s relationships with the international community, and led to a large build-up of debt arrears. Port assets, according to FRY accounting and reevaluation standards19, amounted to about US$167 million in 2000. The use of large reevaluation accounts in the 1999 financial statements makes their analysis difficult. The Port carries debts of US$60 million. Although an analysis of 2000 financial data will be required to assess the Port repayment capacity, this large debt substantially affects its financial viability and ability to attract foreign investors.
8.69 Poor Rail Hinterland Connection: While the services within the Port are efficient, the hinterland rail connection to Serbia significantly hinders traffic growth. About 250,000 Tons in 2000 came to or from Serbia. The rail connection to Belgrade includes numerous sections where trains have to slow down considerably due to poor track conditions. Shippers emphasized that the railway offers neither the service quality required to handle time-sensitive goods in containers, nor sufficient capacity to carry large volume of goods to Serbia and beyond. Railway costs are on the high side (US$30 per ton to Belgrade with loading/unloading (550km) due to the high transport costs that result from the mountainous terrain of Montenegro and southern Serbia. As a consequence, limited traffic leaves the Port by rail whereas rail was predominant 10 years ago.
8.70 Difficult Road Hinterland Connection: Road connections are also expensive and slow due to the difficult roads trucks need to use to reach Serbia. A number of bottlenecks on these roads require prompt action. About half of the traffic leaves the port via truck making international transport through Bar relatively expensive, notably for the transport of dry bulk cargo. It is currently more advantageous to send a container from Belgrade to Europe by road (US$1700- 1900/4 days) than by the alternative sea route through Bar (US$1700/9 days).
8.71 Other Barriers to Port Traffic: Traffic is also affected by the relationship between Montenegro and Serbia, and by political decisions concerning neighboring countries. Traffic to
19 The financial statements are not currently available according to international standards or in DEM. The fiscal year 2000 statements in DEM will become available by the end of April 2001.
196 Chapter 8. Transport or from Serbia dropped both for political and economic reasons in recent years. This may be further aggravated by new border checkpoints between Serbia and Montenegro linked to the differential in duty rates between the two republics. The taxation of goods in transit from Albania (3 percent ad valorem) to increase the Republican budget also leads to further diversion of traffic.
8.72 Strategic Opportunity: The Port is strategically located in the region, but political uncertainty has limited its capacity to capture regional traffic. The Port’s primary target markets are within 4 hours driving distance: Montenegro, Southern Croatia, Bosnia Herzegovina, Northern Albania (Shkoder), and part of Serbia inclusive of Kosovo. The region is highly competitive port-wise with, notably, Rijeka, Koper, Thessaloniki and Constanta competing for Serbian traffic, and Ploce and Durres competing for local traffic. The Port places its hope and efforts in the development of local traffic from the current depressed level, in significant development of its transshipment capacity for other Adriatic ports, and in the development of its Free Trade Zone. Given the low applicable duty rates in Montenegro, investors in the Free Trade Zone will rather be looking for good positioning of the of the port facility in the Zone. Partnership with shipping line companies will be critical for this purpose and will require political stability and a sound privatization policy.
Priorities for Transition and Recovery (Table 8.2)
8.73 Attract Traffic: The Port’s future will depend on its ability to attract additional traffic. In the near term, the Government will need to ensure that sound policies are in place throughout the administration to facilitate the capture of traffic from neighboring countries and to ensure that traffic from Serbia is not hindered by cumbersome customs checkpoints. This entails the immediate removal of the 3 percent tax ad-valorem on Albanian traffic and a continuous focus on trade and transport facilitation within FRY and with the Port’s main commercial partners. While broad reforms of border agencies will take place in the mid term, the Montenegrin Customs Administration should continue its modernization effort actively, supported by external consultants.
8.74 The Port also puts its marketing emphasis on traffic generation through the development of its Free Trade Zone and strengthening of its transshipment capacity targeted at the Adriatic Coast. This is important in the mid to long term. Given the Port’s financial standing, these investments will need to come from strategic partners, preferably well connected to shipping lines to establish continuous and sustained traffic flows.
8.75 Attract Investors/Partners: To attract external partners, the Port will need to quickly reduce the current level of financial uncertainty by addressing the question of its debt. Both the persistence of debt arrears and the potential for tariff increases due to debt service are likely to deter foreign partners. The Republic of Montenegro will also have to review the various options available to privatize port operations progressively, with a careful analysis of the regulatory implications of such privatization. The Port and the Ministry of Transport should receive outside support in the near term for defining their privatization plan.
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8.76 Improve Hinterland Connection: Aside from the soft measures mentioned above, the existing road and rail infrastructure is in serious need in the near term of periodic maintenance and rehabilitation. Major new investments in the Bar-Belgrade corridor should be delayed, however, until better political clarity emerges. This should nevertheless not prevent FRY applying in the near term for the inclusion of the Bar-Belgrade corridor in Trans-European Corridors V or X, to ensure that both Bar and Montenegro are better integrated in European transport networks.
D. RIVER TRANSPORT
Present Condition and Main Issues
8.77 Traffic: In 1998, traffic in FRY river ports (12.6 million Tons) comprised domestic traffic (63 percent), imports (30 percent), and only a small amount of exports (7 percent). Transit traffic (about 6 million Tons), mainly on the Danube, was equivalent to about 44 percent of river ports traffic and predominantly upstream. River transport was the mode of transport most affected by the 1999 Kosovo conflict, due to the destruction of bridges, unexploded ordinance, and sunken vessels that have prevented normal use of the river since that time20. In 1999, river ports traffic dropped 50 percent and transit traffic dropped 80 percent. In 2000, transit traffic virtually disappeared, dropping an additional 80 percent. On the contrary, import and export traffic increased in 2000 to a level comparable to that of 1998.
Figure 8.2: National and International Goods Transport on Inland Waterways.
8.78 P oor Con ditio n of Rive 15000 r National Net transport 10000 Exports wor k: Imports The 5000 Transit rive 10^3 tons r 0 Total con ditio
n 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 and navigability are the most significant concerns today for river transport. FRY is endowed with
20 These objects also create a significant environmental hazard due to the use of the river for the transport of oil products.
198 Chapter 8. Transport
1300 km of rivers and canals accepting vessels of up to 1,500 tons. The Danube (588 km) carries most of the traffic and, until recently, was a major transit corridor connecting the Black Sea to the North Sea through the Main and Rhine rivers. The authorities have initiated a mapping of the river bed to locate unexploded ordinance through an EC funded contract. This work will enable the preparation of a contract to clean up the section of the Danube close to Novi Sad, to be funded by the EC. River traffic is further hindered by a temporary pontoon bridge in use at Novi Sad for road traffic. The authorities have designed a scheme to let convoys of vessels go through the temporary bridge at specified times, charging a US$1.5/ton cost-recovery fee.
8.79 The Sava was also seriously affected by the destruction of a railway and road bridge at Ostruznica, the destruction of a power plant, whose transmission cable fell into the Sava, and unexploded ordinance on the river bed. Even after the breakup of Yugoslavia, this river was carrying 2 million tons of goods annually. The river connects important industrial centers such as Srmeska Mitrovica, Sabac, Valjevo, Loznica or Obrenovac to the Danube. As these centers have strong chemical, metal processing and food processing industries, the availability of cost- efficient transport modes makes a significant difference in their competitiveness. The Sava flows through Slovenia, FRY, Croatia and Bosnia and Herzegovina. Traffic has disappeared completely due to existing obstacles and deficiencies.
8.80 In addition to war damages, maintenance of the river bed has been significantly reduced over the past ten years. In 1990, FRY was considered by the Danube Commission as having the best maintained section of the Danube. The US$1-2 million annually available for the river bed maintenance were allocated exclusively to the most critical elements of maintenance or rehabilitation on the most trafficked waterways. As traffic resumes, FRY will need to invest an estimated US$1.5 million a year for the next ten years in addition to its normal budget to upgrade the waterways to normal standards, both in terms of navigation conditions and signaling. Under the Belgrade Convention, which regulates navigation on the Danube, no charge for the use of waterways is applied to river vessels, and thus maintenance has to be funded from the budget.
8.81 Old Fleet and Ports: The river fleet, which is the third in size in the region after the Romanian and Ukrainian fleets, transports mostly domestic goods, about 15 percent of international traffic, and virtually none of the transit flows. The river port equipment and the river fleet are in most cases more than 25 years old. The ports are making limited use of information technology. River fleet operators are satisfied by the performance of ports, given the current constraints and low traffic level. Equipment obsolescence prevents the rapid unloading of vessels, however, and may become a source of bottlenecks as traffic picks up. The acquisition of second hand equipment should also be facilitated to ensure that existing shipping lines renew their fleet, with vessels allowed to travel further on the full Trans-European Corridor VII (Danube-Rhine).
8.82 Telecommunication Requirements: As part of the Regional Agreement on Radio- telephone Service on Internal Waterways (Basel, April 2000), FRY needs to develop a radio- telephone service providing information to improve the general safety of people and goods on its waterways. This system is required for the unhindered, safe and secure navigation of vessels from all countries using the 588 km section of the Danube in FRY. FRY is to date the only
199 Chapter 8. Transport country among the signatories that has not set up such a system. Its main emission antenna on Mount Avala was destroyed during the conflict.
8.83 Privatization: Ports and river fleet operators are looking forward to their privatization. They were until recently fully State-owned joint-stock companies. The Port of Belgrade, however, had initiated the process of free share distribution among its employees and some closely affiliated individuals. The process used for this would lead to a very diluted ownership, a worrisome solution given the need for the port to attract traffic again. This privatization has now been postponed until the new law on privatization is ready. Any privatization will also have to address the potential issue of the monopoly situation in the river ports. Most traffic arriving in ports consist of low value goods destined to local markets. While government oversight of port tariffs has been loose until now, renewed scrutiny will be require in the future, without impeding the marketing flexibility of ports. Loading and unloading of goods (US$10/ton) typically cost the equivalent of 1000 kilometers of transport by river vessel.
Priorities for Transition and Recovery (Table 8.2)
8.84 Most river operators expect traffic to resume rapidly once the river beds have been cleaned up. They consider river transport as a highly competitive mode of transport21 for some type of bulk cargo (cereal, construction material, oil products and crude oil) and one much needed to offer a complete spectrum of transport services. The absence of river transport services for companies located on the Sava translates into excess transport cost of the order of US$5 million annually. The Government strategy should consist, in the near term, of restoring safe navigation on the Danube and the Sava, and allowing the privatization of ports and the river fleet under sound conditions. In the mid term, the strategy should focus on upgrading river navigability and signaling to offset the past ten years of reduced maintenance and adapt waterways to new international standards. Restoring the river network would benefit not only FRY but also neighboring countries, such as Romania or Bulgaria, which have been affected by the loss of this competitive mode of transport to Western Europe.
8.85 Making navigation safe: In addition to the EC funded clean-up of the Danube, the first priority will be the clean up of the Sava. This includes the inspection of the Sava the clearance of unexploded devices from the river bed and river banks the removal of debris from two destroyed bridges, parts of the destroyed electric power system and three sunken ships, urgent dredging works along the waterway, and setting up a waterway marking system and navigational safety objects.
8.86 The clean-up of the rivers should be urgently supplemented by the setting up of an appropriate radio system meeting the requirements of the Regional Agreement referred above. This safety system would enable round the clock monitoring of the waterway and provision of nautical information at regular intervals or upon request. It would include notably the setting up of aerial masts and of radio relay system equipment at 20 locations.
21 With a transport cost of about US$0.01/Ton-Km
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8.87 Supporting the privatization of ports and river operators, and access to second hand equipment: The privatization of river ports, preferably through the award of concessions to competent operators, will enable the progressive upgrading of current handling equipment, port facilities and telecommunication equipment. This process will significantly alter the current institutional setup and create some new regulatory needs. The Federal Ministry of Transport will require external technical assistance (about US$0.4 million) to ensure that ports and/or operators do not abuse their monopoly powers, that the distribution of state ownership, if and when appropriate, takes place in a fair and transparent fashion, while allowing room for strategic private partners to acquire significant stakes.
8.88 This issue will be less significant in the privatization of the river fleet operators since the FRY fleet is exposed to intense foreign and internal competition in a context of highly depressed traffic. To help renew the fleet, the Government would have to examine its customs code and importing regulations for second hand equipment in order to ensure that there are as few constraints as possible.
8.89 Upgrading Navigability: Delayed maintenance, notably on the national river network, will require significant incremental annual investments to bring the network up to proper navigation standards. FRY will also attempt to comply with new guidelines from the Danube Commission increasing the depth to 2.8 meters. In the current economic context, it is unlikely that FRY will manage to secure these resources since there is no cost recovery mechanism allowed on the Danube.
E. TRADE AND ROAD TRANSPORT FACILITATION
Present Condition and Main Issues
8.90 A total of 12.8 million passengers crossed the borders of FRY in 1998 coming mostly from FRY (32 percent), BiH (18 percent), Germany, Bulgaria, Macedonia and Romania. In 1997, a total of 3.7 million Tons of freight were transported by road over the borders. About 50 percent of incoming freight traffic and 33 percent of outgoing traffic were carried by FRY trucks. About 95 percent of transit (1.5 million Tons) was carried by foreign vehicles mostly from Macedonia (32 percent), Bulgaria (31 percent) and Turkey (11 percent). One third of transit traffic was between Hungary and Bulgaria, 19 percent between Macedonia and Croatia, and 17 percent between Hungary and Macedonia. Imports by road included some crude petroleum and derivatives (23 percent), chemical products (16 percent), wood and cork (11 percent). Exports included notably mineral goods and cement (30 percent).
8.91 Traders in FRY, like in most of Southeast Europe, face excessive logistical costs for their export, import and transit operations. Long delays and costly procedures increase the logistical costs and force companies to carry excess inventories to ensure timely deliveries. These non- tariff barriers have the same impact as protectionist measures and come in addition to the plethora of other restrictions (quotas, high tariffs, licensing: refer to chapter 3 - Trade) that are still partially applied to traders. This environment enabled only the fittest, heavily subsidized or best connected companies to survive in the past.
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8.92 Excessive logistical costs are linked not only to the deficiencies described above in each transport mode but also to the international dimension of trade which brings its own set of issues and costs. The crossing of borders (2 to 4 hours), proper preparation of trade and transport documents, the clearance of goods at inland terminals (4 to 10 hours) are examples of such costs. With the currently depressed trade situation, road transport operators face delays at border crossings slightly below delays in neighboring countries, but as trade and transit through FRY resume, longer delays will have to be expected given existing procedures and facilities.
8.93 The strategic implications of these impediments are significant. While road transport through Yugoslavia was the normal route from Turkey to Europe ten years ago, an estimated 30 percent of Turkish trucks now completely by-pass the region using Ro-Ro ferries between Turkey and Italy. The Turkish ferry fleet’s rapid expansion may lead to up to 60 percent of Turkish traffic opting for maritime transport within the next two to three years. Attracting traffic again will require sustained efforts from FRY and neighboring countries. Beyond simple transit activities, the opportunity for a country to add value by providing processing services for goods in transit can become a significant tool of economic recovery.
Box 8.1 Examples of Excess Costs • High excise goods or suspicious goods require a mandatory escort (about US$450 for a truck for the Bulgaria-Hungary transit). • At inland terminals, forwarders or truckers need to pay duties prior to 1:00 pm or have to wait until the next day. Trucking operators estimate average time at the terminals is six hours with a lot of variation. • Terminals are often privately owned and expensive (about US$40 per truck for 12 hours in Belgrade). • Once a declaration is accepted at the inland terminal, a broker needs to pay the duties at another location (several kilometers away in Belgrade) for the goods to be released.
8.94 The main issues in trade and road transport facilitation can be broken down into: (i) local road operators’ competitiveness; (ii) transit issues; (iii) quality of transport operators and freight forwarders; (iv) public-private dialogue; and (v) need for reform of the Customs Administrations and Border Agencies.
8.95 Local Road Operators’ Competitiveness. Local road transport operators face significantly increased costs due to the incomplete reintegration of FRY in international spheres. For example, the Federal Transport Ministry has an insufficient number of road permits for Austria, Hungary, Croatia, Slovenia, the Netherlands, Belgium and France. For some of these countries, half of the annual quota was requested in the single month of February. Under the previous regime, these permits were traded on the black market. The Federal Transport Ministry recently took over the distribution of permits. The Ministry is working on the establishment of a fair and transparent system of distribution, based on the characteristics of each company. Nonetheless, the increase in the number of permits will be essential for local operators. Local operators also face some difficulties in obtaining visas compatible with their frequent trips. For example,
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Croatian visas are valid for two entries only and German visas are valid for only three months, generating considerable vehicle idle time, excess cost and hassle for drivers.
8.96 FRY road insurance is also not recognized in a number of countries forcing operators to get supplemental insurance at a cost of about US$500 per annum. In addition, special road user fees are levied in some countries (about US$285 per trip in Slovenia) on FRY trucks. These external constraints, to a large extent political, disrupt the normal operations of local road transport operators, enabling only a partial use of their western-type trucks (120,000 km per year against 200,000 km for German trucks). It in turn increases costs and artificially forces traders to use foreign transport companies.
8.97 International and Internal Transit Issues. All transport operators are affected by the non- recognition of FRY as an active member of the TIR convention, which facilitates transit in international road freight transport. This system managed by the International Road Transport Union and a pool of guarantors enables transit traffic carrying a TIR carnet to cross borders with limited control at the transit borders. Controls takes place in the departure and arrival countries and is recognized in transit countries. This non-recognition imposes the issuance of a FRY transit document at the border, with its associated cost and time lost, and sometimes results in the breach of the TIR seal for a cursory visual inspection. Once the seal is breached a new carnet has to be reissued when the truck leaves FRY and enters the next country. All this adds to the long delays faced at border crossings in the region. The Federal Customs Administration experiences a significant number of transit consignments that never complete their transit and avoid paying duties.
8.98 The differential in duty rates between Montenegro and Serbia creates significant smuggling opportunities. The Federal Republic of Yugoslavia has consequently reestablished internal check points at the border between Serbia and Montenegro. De facto these points create an additional bottleneck for internal transit and reduce the competitiveness of transport through the Port of Bar.
8.99 Uncontrolled Quality of Transport Operators and Freight Forwarders. FRY has seen the emergence in the recent past of a large number of small transport operators and freight forwarding companies (400 companies) as there are no qualitative or quantitative restrictions to market entry. This has brought both costs and quality of services down. Delays linked to the inappropriate preparation of documents are frequent (18 percent). About 10 percent of declarations undervalue the goods, 5 percent misstate quantities and 3 percent misstate classifications. As the penalties associated to the submission of faulty documents are minimal, there is little incentive to present appropriately prepared documents. The free access to the freight forwarding profession has also created some unhealthy competition. Small one-person companies can easily disappear if one of the guarantees they have issued is called, while more established forwarders are fully accountable.
8.100 Currently private and public operators in transport and forwarding co-exist. Many public operators want to be privatized as soon as feasible, to benefit from additional flexibility and better opportunities. This positive approach will need to be accompanied by drastic staff
203 Chapter 8. Transport reductions to compete with already established lean private competitors. This will add in the short term to already significant social difficulties.
8.101 Public-private Dialogue. Consultation between government agencies and transport operators was until recently very limited, with no established structure. The new administration appears committed to integrating the opinion of operators in the future. In February 2001, discussions for the establishment of a FRY-PRO committee were initiated. PRO-committees, in existence in all surrounding countries, aim at facilitating trade, transport and their related procedures, as per the recommendation of the UNCEFACT on public-private dialogue. These committees gather members of the various border agencies and ministries, members of the trading and transport community, and professional associations usually under the leadership of the Chambers of Commerce. They hold meetings and carry out actions of shared interest such as the production of booklets on border crossing procedures or the setting up of region-wide working groups on e-commerce or facilitation of procedures. These committees are also important partners of international agencies in the implementation of the Trade and Transport Facilitation Program in Southeast Europe (TTFSE).
8.102 Need for Reform of the Customs Administrations and Border Agencies. Federal Customs: The Federal Customs Administration (FCA), although isolated for ten years, and despite erratic staff policies, has maintained reasonable standards, but adaptation to market economy requires significant changes to take place as soon as feasible. Even though current performance ratios (e.g., workload and result indicators) apparently put FCA in the lower part of the bracket for the region, this is probably due more to reduced trade than lack of professionalism, and the approach to Customs operations compares quite favorably with other countries in the region, notably in terms of clearance delays. It is however unlikely that clearance time will be sustained when foreign trade starts growing again. The FCA current objectives reflect strong commitment to large scale modernization. Its human resources management, however, over-emphasizes academic qualifications to the detriment of performance or merit-based promotions.
8.103 Montenegrin Customs: The Montenegrin Customs Administration has been operating independently since August 1999. Montenegro established its own Customs administration while retaining the same personnel. Collections by this administration accrue to the budget of Montenegro. All regulations in Montenegro regarding customs are being revisited, independently from FCA regulations. External support from the USAID and European countries support this effort. Duty rates were reduced to a low level. The intention of the Montenegrin Customs Administration is to evolve rapidly toward an EU compatible framework that provides for active cooperation among public and private parties. The Government’s interest in using the existing Croatian law as a model should be considered with caution, however, since it would not enable a complete modernization of the administration.
8.104 Legal/Institutional Environment: The present Customs law - which is very detailed, to the extent of determining opening hours of Customs houses - imposes 100 percent physical verifications, and does not provide for post clearance checks and investigations, controls outside approved points of clearance, or adequate enforcement and prosecution to produce a deterrent effect. This law needs to be revised to enable modern customs procedures to be introduced.
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Changes in the legislation will require strong support at Government level, because they will also affect other agencies such as the police. Throughout the process, close coordination with the Republic of Montenegro will be required to avoid setting up divergent legal frameworks causing corruption and smuggling opportunities.
8.105 Inappropriate Customs Procedures: Many of the procedures in place will not enable the FCA to perform the duties of a modern customs administration. Declarations are reviewed and often corrected by Customs, thus not encouraging brokers to provide a professional service to the trade, while offering opportunities for manipulation. All imports are physically checked, but legal provisions impose clearance within five hours of the lodging of a proper declaration, thus preventing more in-depth checks, encouraging routine inspections, and resulting in extremely limited detection of fraud. In addition, the duty payment bureau has no branch in Customs terminals, closes at 1 P.M., and money transfers and pre-assessed payments are not possible.
8.106 Customs Information System: The current computer system, which was introduced in 1995, is based on a mainframe architecture. The system is reliable but needs to be upgraded due to the obsolescence of some of the equipment. The system covers all aspects of clearance and is also used for management purposes, but does not provide yet with the necessary integration of customs functions and has no elements of risk analysis. Insufficient staffing and weak human resource management for information technology experts will need to be rapidly addressed.
8.107 Border Infrastructure: The existing infrastructure at border crossings on major European corridors enables present traffic to be processed. With the foreseen increase in transit and recovery of trade activity these infrastructure will rapidly become insufficient and lead to significant bottlenecks. Five border crossings are in urgent need of overall upgrading : Batrovci, Presevo, Horgo, Gradina and Sremska Raca. The first four are located on main international corridors, while the last one is a major border point with Bosnia and Herzegovina.
Priorities for Transition and Recovery (Table 8.2)
8.108 Addressing trade and transport facilitation issues will require an integrated effort entailing : (i) regional reintegration; (ii) strengthening of transport operators and freight forwarders, and entry to market; (iii) border agency reforms; and (iv) border crossing improvements.
8.109 Regional reintegration: FRY wants to actively reintegrate into the international community. FRY will pursue the softening of conditions regarding visa regimes for FRY transport operators and businessmen. The Federal Ministry of Transport is trying to increase the allocation of road permits, a critical element in supporting FRY efforts to recovery and enabling its transport industry to develop. FRY is actively working on re-accessing all international agreements, considering the TIR convention as a priority, with clearance of backlogs and updating of standards. FRY will need to receive support for accession to new instruments (such as the EU-driven Common Transit Convention).
FRY is also seeking to increase its involvement in the existing Regional Road Transport Committee, a forum led by the UNECE in the region seeking to harmonize all road transport
205 Chapter 8. Transport requirements and transit charges to facilitate transport. The setting up of a FRY PRO-committee and its active participation in regional meetings will further ensure a strong focus on main facilitation issues and FRY reintegration in the region.
8.110 Strengthening of transport operators and freight forwarders, and entry to market: The capacity of FRY to integrate in the EU economic space will depend on the quality of its service providers. The introduction of proper licensing requirements for road transport operators and forwarders, based on competence, reputation and financial standing, will be an essential part of this process. The creation of a Road Vocational Training Center in partnership with the International Road Transport Union (IRU) is a matter of priority to be considered by donors to ensure compatibility with EU standards in the certification of road transport operators. In addition, mechanisms such as prepayment and differentiation of procedures according to the degree of dependability of forwarders should be considered.
8.111 Border agency reforms: The Federal Customs Administration has formulated a strategic plan including seven core priorities: (i) introduction of efficient selective controls; (ii) introduction of simplified procedures; (iii) construction of border crossing points; (iv) precise definition of customs powers; (v) modernization of the customs information system; (vi) introduction of TIR-based transit procedures; and (vii) improvement of laboratory facilities. The first stage (near term) will consist of defining in detail the implications of these priorities on the legal framework, existing procedures, human resources, and requirements in terms of facilities and equipment.
8.112 In the second stage (mid-term), the FCA will implement this strategic plan. The FCA will need foreign support for this implementation to be effective. Main recommended actions are as follows:
• Legal Changes. The legislative and regulatory environment should be amended to allow Customs to operate according to EU/OECD standards, in view of balancing facilitation of legitimate trade with improved methods of detection, surveillance, and prosecution. A significant effort will be required in ensuring that the overall legal framework in Serbia and Montenegro remains compatible.
• Procedural Changes. New procedures should be introduced allowing: (i) acceptance of declarations under the responsibility of the importers as soon as the documents are lodged; (ii) selective, risk-based examinations; (iii) immediate release of the goods after clearance; and (iv) subsequent review of declarations, in particular to detect and investigate the allegedly numerous cases of under-valuation. These aspects would require large technical assistance inputs, including exposure to EU practice, and close coordination between administrations.
• Human Resource Management. Modern management tools, based on workload, with the emphasis on training, ethics, and responsibility, should be introduced, allowing flexibility in the deployment of staff. A reward and compensation policy for staff, within a pre-allocated budget envelope, could also provide an incentive for professionalism. Predictable budget support and allowances would be necessary.
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• Interagency Cooperation. Cross-training and awareness across all border agencies would eventually lead to delegation of competence for certain checks, or regrouping of all verifications using the Customs declaration data. The Customs, police, tax administration, and other ministries, in particular health, agriculture, and industry would gain from stronger coordination to optimize controls and streamline procedures, without delaying unnecessarily the clearance of goods.
• Information System. The current system will need both some upgrading and additions. It will need to support features such as (i) selectivity, (ii) management information data, and (iii) data exchanges between administrations. These features are essential in a modern customs administration.
8.113 Border crossing improvements: The expected growth in traffic will soon require the upgrading of border crossing facilities on main European Corridors. In the near term, detailed design and bidding documents should be prepared for improving such facilities taking into account new procedures and cooperation with other border agencies. The upgrading of the five priority crossings should be carried out in the mid term (by the end of 2003). This would support the envisaged operational and procedural changes, and prevent bottlenecks. At these sites, a pilot site approach, in particular for testing selectivity and inter-agency cooperation, would help the authorities in refining their action plan for modernization.
8.114 The impact of the above program should be substantial. Customs reform coupled with proper facilities and information technology will lead to transparent customs procedures, a more reliable business environment, and economic growth as a result of lower prices for imports and more competitive prices/services for exports. The benefits are likely spill over to government agencies and private companies in other trade partner countries. This would translate into:
• cheaper import goods / inputs for consumers and industries; • better and more reliable business environment for private sector activities, particularly for the trade activities of SMEs; • a more predictable and reliable economic setting for foreign companies; • improved facilitation for transit traffic; • reduction of corruption and smuggling opportunities; • improved revenue collection by the FCA; • uninterrupted services of information systems and better integrity of data; • overall enhanced regional integration in Southeast Europe; and • closer approximation with EU standards and procedures, as part of the European integration process.
8.115 The beneficiaries of these reforms would be transport operators, importers, exporters, freight forwarders, other trade industries, foreign investors, and ultimately, consumers and producers inside and outside the region.
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Table 8.2: Projected External Financing Requirements in the Transport Sector
Priority Estimated Financing Total Program Requirement US$ m CY01 CY02-04 Investments Road Transport 172.5 340.0 River and Maritime transport1 15.0 16.5 Railways 15.5 60.5 Urban Transport 0 8.0 Border infrastructure 10.0 15.0 Subtotal Investments 213.0 440.0 653.0
Technical Assistance Needs Customs administration TA 1.7 2.7 Other technical Assistance 4.0 7.0 Subtotal Technical Assistance 5.7 9.7 15.4
Totals 218.7 449.7 668.4
1. Required investment in the Port of Bar is expected to come from private sources
208 CHAPTER 9. WATER, WASTEWATER AND SOLID WASTE
INTRODUCTION
9.1 The following note provides an assessment of the water and sanitation sectors and outlines a strategy for possible support for 2001-2005. It is based on information provided to missions that visited FRY in December 2000 and March 2001. A summary of the federal structure, federal and local water and sanitation institutions, and FRY legislation initiate the discussion. This is followed by discussion of the main issues facing the sector, with an analysis of sectoral priorities and main areas for possible donor support, and implementation issues and policy conditions which should accompany support. An estimate of needs in the short- and medium-term, are presented in Table 9.4. The external financing requirements for water and sanitation sector are estimated to be US$155.3 million over three to four years. The financing requirement for 2001 on a commitment basis is estimated at US$38.0 million.
A. BACKGROUND ON ORGANIZATION AND THE QUALITY SITUATION
9.2 Truly urban settlements in Serbia and Montenegro are relatively few. The population of Belgrade has exceeded one million due in part to the influx of refugees from conflict areas. Apart from Novi Sad and Niŝ, both with populations in the order of half a million, other urban areas are mainly market towns and centers of regional administration. Nucleated settlements of 5,000 to 10,000 inhabitants are common in the Vojvodina and Montenegro areas. Although they are larger than other rural settlements, they lack the non-agricultural activities and amenities that would classify them as urban.
9.3 As a result of past investments, almost all urbanized areas in FRY have rather sophisticated and advanced water and sanitation systems. A largely top down approach to sector development has led to cumbersome institutional arrangements, including administrative borders and water utility coverage area that usually do not coincide. While most utilities have a municipal focus, there are several regional water supply systems that serve more than one municipality. For example, the water company Rzav serves Cacak (regional center with population 150,000), Gornji Milanovac, Pozega, Lucani, and a few other towns1.
9.4 The water supply and sanitation sector was well developed in the former Yugoslavia, but has deteriorated significantly in recent years. After ten years of limited investment, water supply and sanitation services have avoided collapse owing principally to two factors: the high initial quality and broad coverage of existing infrastructure and the technical capacity of sector professionals and their professional pride in maintaining the services. Most areas have high per capita water consumption, well above rates in comparable and more developed European neighboring countries (figures of the order of 300 lpc/d are not uncommon). Physical losses,
1 The Jaroslav Cerni Design Institute developed a long-term strategy for water supply of Serbia in the mid eighties. This strategy envisaged 18 reservoirs for all regional systems in whole Serbia. The core idea being that each system takes water from one reservoir. Only few of the proposed reservoirs were completed (Gruza for Kragujevac and Kraljevo; Celije for Krusevac, Trstenik, Cicevac, Varvarin; Zavoj, for Nis; and Selova for Prokuplje and its suburbs). Chapter 9. Water, Wastewater and Solid Waste lack of demand management, inadequate pricing policies and misuse of water supply for non- household activities (i.e. irrigation in peripheral areas) are common. The upside of this situation is that there is significant scope for reducing consumption, increasing service quality and securing water safety while lowering operating costs with low levels of urgent investments.
9.5 Physical and infrastructure problems can be better analyzed by framing the sector’s systems into three groups: Serbian cities (with differences between the three larger Serbian cities and other Serbian medium size cities), Montenegro urban systems and rural areas in Serbia and Montenegro. An additional section is devoted to Solid Waste Management and the issues and challenges faced.
9.6 Serbian Large and Medium Size Cities2. The large water supply systems of Belgrade, Novi Sad and Nis are still adequate in both quality and quantity, despite some areas being periodically affected by supply cuts during the summer. However, all of them are now operating below capacity and are in a difficult financial situation. In medium-size water supply systems the situation is significantly worse. A long period without proper maintenance and almost no investment has resulted in significant operational problems. Most are in critical condition, and requiring urgent rehabilitation.
9.7 Water Quality. Water quality in larger systems seems to be guaranteed by adequate treatment facilities and regular monitoring, although some concerns about the reliability of the monitoring program were voiced to the mission. In comparison, in most medium-size cities water quality is largely inadequate, with bacteriological and chemical contamination common. Available data shows that out of 153 municipal systems in Serbia, 78 did not meet microbiological standards in more than five percent of samples and 2.66 million people in Serbia are supplied with water that is contaminated with nitrate, nitrite and/or ammonia. In addition, 44 percent of municipal systems have only intermittent supply, at least during the summer3.
9.8 Utility Performance. Water and sanitation utilities in FRY were and are, by international standards, overstaffed, fairly inefficient, and lacking in modern management and control systems and governance. Although many are legally independent entities on paper, generally, these enterprises have little autonomy and no control over crucial aspects of their business. Investment decisions have usually been taken at the municipal or national government level, with a strong bias towards new infrastructure, disregarding improved maintenance and rehabilitation of existing assets. In most cases, the collection of charges for water services is carried out by municipal companies jointly with other municipal services (solid waste, heating, electricity, street illumination, etc). In many cases (but not all) revenues are then distributed among the different
2 The population of Serbia is about 8.65 million. Approx. 50 percent (or 4,325,000) are receiving water from public water supply systems (WSS). From this, about 2,000,000 receive water from the three larger water supply systems (Belgrade, Novi Sad, and Nis), while about 2,325,000 receive water from medium-sized public WSS 3 The situation in Vojvodina is particularly complex. During the most recent period, 1993 – 1998, the percentage of public water supply systems with inadequate water from the standpoint of microbiological quality was between 62.50 percent and 83.33 percent. The percentage of public water supply systems with inadequate water from the standpoint of physical and/or chemical quality was between 72.50 percent and 73.81 percent. Finally, the percentage of public water supply systems with inadequate water from the standpoint of both, microbiological and physical and/or chemical quality was between 54.05 percent and 69.05 percent.
210 Chapter 9. Water, Wastewater and Solid Waste services in an arbitrary manner, without correlation to the amounts really billed. Water companies have had little control of bills paid by domestic consumers and are unable to use proper commercial practices. Revenues are also normally complemented with direct transfers by the municipalities from their budget. For example, Novi Sad Water Company has a budgeted contribution of 206 million dinars for 2001, against a projected revenue from billing of 360 million dinars (see Annex 4 on Novi Sad’s water company).
9.9 Institutional Set up. A major issue facing the sector is that there is no federal or national agency that regulates water utilities, plans service needs or channels support in a coordinated manner. Several ministries (agriculture, forestry and water management, civil engineering, health, and finance) control utility operations in the areas under their authority: all of them are involved (including ministries that have no logical involvement with the sector, such as Justice), but none have real sector responsibility. This, combined with the ‘de facto’ complete decentralization of service provision to municipalities, has resulted in fragmentation, and a lack of planning and advocacy for the sector4. The multitude of uncoordinated laws and regulations applicable to the sector further contribute to its fragmentation.
9.10 Urban water and sanitation services in Yugoslavia are decentralized and delegated to the municipal level. A typical utility provides water supply, wastewater services and sometimes solid waste management. Their responsibilities may also include street lighting, parks, cemeteries, and green areas in the city. Currently all water utilities are municipal publicly-own companies that are managed by the local authorities. Each of them has a managing board, comprising representatives of the most important municipal stakeholders.
9.11 Asset ownership is not clearly assigned between the municipalities and the republics5. In some cities (i.e. Belgrade) the authorities report that production and main transport system asset belong to the Republic, while secondary networks belong to the municipality; in others (i.e. Novi Sad) all assets apparently belong to the Republic, while in a last group (i.e. Kragujevac) all assets are claimed by the municipality, although no legal basis for this claim was provided to the mission. Tariff approval powers, on the other hand, seem now to be fully under the municipal assemblies, which review and eventually approve tariff proposals submitted by the managing boards.
9.12 Role of municipalities. Until 1990, municipalities were in charge only of the day-to-day operation of water utilities. The republican authorities were responsible for investment identification, financing and implementation. Since 1990, these republican functions were also largely transferred to the municipal level, and direct investments with support from the federal or
4 Some coordination between water utilities is conducted by the NGO Yugoslav Waterworks Association (YWWA). YWWA and the Institute of Statistics are the only sources of information for the sector as a whole. The technical capacity of the YWWA members and information levels are quite high, however it lacks administrative functions which would allow the association to play an important role in water sector planning or coordination. The Government is in the process of developing a Draft Water Management-Plan intended to change the existing institutional structure and establish new coordination agencies in water sector (ref. Bulletin of Yugoslav Water Works Association, No. 42, November 1999) 5 The mission could not get the legal basis for ownership, which was presented as a "de facto" situation. The mission met with several government officials, including the Minister of Water Resources, but could not get the laws, decrees, or regulations in which these changes were based.
211 Chapter 9. Water, Wastewater and Solid Waste republic government nearly stopped (particularly in the municipalities controlled by the opposition parties). At the same time the Government kept control over the tariff policy and subsidies, making political use of both and driving water utilities to near financial collapse.
9.13 Pricing. The tariff system in FRY is based on the cost-plus scheme with cross subsidies for the population by industries (Table 9.11). This scheme results in minimum profit to the utility. The economic crisis resulted in substantial reduction of water consumption by industries. The revenue ratio (population/industry) fell from 20/80 in 1990 to 50/50 in the mid-1990s, and even further later on. Additionally, population poverty and industrial decline reduced collection rates to below 50 percent, despite the existing low tariffs. Economic decline reduced the scope for continued cross-subsidization. Currently, revenues of water utilities do not even cover operational costs. Utilities are running down their facilities resulting in deteriorating water and wastewater services. Although tariffs were raised in October 2000, they remain below production costs, without consideration of proper allocations for amortization and payment for electricity. In addition, electricity cost are expected to rise soon.
9.14 Summary. Municipal water and sanitation services in Serbia are in deep financial and technical crisis. This is preventing utilities from initiating the rehabilitation of works that are urgently necessary to diminish the threat of collapse of water/wastewater/solid waste services. The international private sector has shown interest in the management of large water systems in Belgrade, Nis and Novi Sad, and their involvement in service delivery will probably be the most efficient way to address current problems in larger systems in the medium term. The main pending issues of asset ownership, sector regulation and assignment of responsibilities need to be resolved and governance assured for international private sector involvement to be forthcoming. The local private sector could also be a very effective instrument for improving solid waste services if an adequate regulatory framework and oversight capacity are established and implemented. On the other hand, water companies in medium size and small municipalities, that represent more than 50 percent of the urban population, have limited access to financial resources and are not expected to immediately attract private sector interest, and will likely continue to operate under municipal control. These companies will require support (both technical and economic) to address urgent needs and avoid an impending crisis, and modernize their management and operations.
9.15 Montenegro Urban Systems. Although both Republics have shared common sector development and institutional arrangements and problems (management practices and system operation are largely deficient, especially on the commercial side --non-billed water exceeds 60 percent of production in some areas), the situation is different in Montenegro due to the adoption of some initial sector reforms (including the involvement of the private sector) and specific infrastructure deficiencies that affect the coastal region. As in Serbia, water sector infrastructure in Montenegro was in generally good condition, but not in the coastal region, which suffers from regular shortages and bad water quality, particularly during the summer when tourists more than double the area’s population to over 500,000. Low tariffs and a lack of maintenance over the last ten years has further exacerbated the situation, jeopardizing the potential of the coastal region for growth and preventing needed investments elsewhere.
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9.16 As in Serbia, information on water quality in Montenegro is not comprehensive. Available information indicates that water quality problems, both bacteriological and chemical, are widespread. In the municipal systems in Montenegro, more than 10 percent of the samples exceed microbiological standards and about 17 percent exceed physical-chemical standards. In the capital Podgoriça, although most sources have good quality and the majority of supply complies with standards, some local sources have been polluted by industrial discharges, leaving important areas of the Zeta valley without adequate supply. The situation has been aggravated by the influx of refugees to Montenegro, 60 percent of whom are living in poor conditions settled in and around the capital.
9.17 In Montenegro all water sector infrastructure is clearly understood to belong to the Republic. The Republic delegates its use and responsibility for service provision to municipalities, with each having its own water company. The Ministry of Urban Planning and Construction has taken the lead for sector planning and organization, including the involvement of the private sector.
9.18 Services in the Coastal Region. In the coastal region and the municipality of Cetinje, sector efforts are carried out by the Public Enterprise for Water Supply, Wastewater Treatment and Solid Waste Disposal (Crnogorsko Primorje – PEW). PEW has entered into a consortium (Monte-Aqua) with private partners selected through international competitive bidding to rehabilitate, upgrade, extend and manage water supply and sanitation services to the area under its responsibility. Phase I of this program began on January 16, 2001, with financing from KfW and GTZ (14.5 million DM) for technical assistance and urgent investments in rehabilitation and operational improvements. Six of the seven coastal municipalities have signed letters of intent to participate in the program, based on the concept of public/private ownership. The government has initiated the preparation of legislation that would permit the creation of mixed-capital (private-public) water companies and the consolidation in the coastal area of all municipal water companies and the regional provider. Regulation mechanisms for this company are being developed to be incorporated in the service contract of the consortium.
9.19 Rural Areas. Rural areas in Serbia and Montenegro have a much lower level of water supply and sanitation services than urban areas, and the same is true for solid waste disposal. The data presented in Tables 9.2 and 9.3 was obtained from a Multiple Indicator Cluster Survey (MICS) that was conducted by the Government with support from UNICEF in the 2000. Similar information can be found in data provided by the Statistical Office.
9.20 At present rural water supply is carried out in a legal and institutional vacuum, completely relying on the tradition of self-reliance and without any regulatory assurance that the rural population receives an adequate quantity of water and is not exposed to severe health risks. The priority objective for the rural water sector should be to create the required legal and institutional environment to monitor, regulate and support the sector. Only if an adequate policy framework is in place will support for rehabilitation of and investment in dilapidated systems be cost-effective and sustainable. Rural drinking water systems are facing even more severe problems than urban areas and will require substantial technical assistance.
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9.21 In rural areas6 only 40 percent of the population have piped water supply, compared with 98.5 percent in urban areas. Unprotected wells have been eliminated in urban areas, but a small part of the rural population continues to rely on these unsafe systems for supply. Regional differences can be observed: In Belgrade, urban water piping system are extended and cover about 43 percent of rural areas, whereas the urban systems cover only 28 and 30 percent of the rural areas in the Vojvodina and central Serbia regions respectively. Not only have rural areas a lower level of service, they also experience more frequent interruptions to water supply. Table 9.8 indicates that 54 percent of people in rural areas experience service interruptions, compared to 44 percent in urban areas.
9.22 Data presented elsewhere in this report shows that inadequate water quality is common in regulated water utilities. Unfortunately, rural water supply systems (systems not run by a municipality, but obtaining water from private systems, wells or other sources) are not under regulation by the Institute of Public Health and therefore no monitoring of water quality is conducted. These unregulated systems cover about 50 percent of the population (OCHA 2001). Despite the lack of consistent data there are strong indications that the water quality of rural water systems can be expected to be even worse than the already health threatening situation in urban systems: (i) The Serbian Institute of Health, based on sporadic measurements, estimates that about 90 percent of rural water supply systems do not comply with the bacteriological standards7; and (ii) the Montenegrin Institute of Health, which also has no empirical data on water quality in rural areas, conducted an epidemiological survey last year which showed that of 194 wells that were analyzed in rural areas, 120 did not comply with bacteriological standards (62 percent). It can also be assumed that high nitrogen levels, widespread in urban water supplies, are very common in rural systems.
9.23 For sanitation, in urban areas 97.6 percent of the population is connected to sewerage systems or septic tanks, while 77.7 percent of the population in rural areas has the same level of disposal service. About 20 percent of the population in rural areas still relies on the traditional pit latrine, compared to only two percent in urban areas (Table 9.9).
6 Approx. 50 percent (4,325,000 people) are considered "rural" in Serbia. Of these, 60 percent (or 2,575,000 people) are using individual wells. Assuming an average of 5 persons per households, this gives about 500,000 wells. Another 40 percent (or 1,750,000 people) receive water through small, uncontrolled WSS. 7 It is estimated that approximately 20 percent of population is being served by small systems, and approximately 30 percent is using water from individual wells. Since these water sources are not under regular water quality control, data is scarce. During a survey conducted in 2000, 151 samples were taken from individual water supply systems in several different locations in Central Serbia (Belgrade and vicinity, Mladenovac, Kragujevac, Smederevo and Krusevac) and analyzed for physical, chemical and microbiological parameters. Results are as follows: Samples with adequate water quality 15 Samples with inadequate physical and chemical water quality 32 Samples with inadequate microbiological water quality 30 Samples with inadequate both analyzed qualities 74
These figures indicate that only about 10 percent of supply is of good quality. Most common reasons for inadequate water quality are excessive concentrations of nitrates, nitrites, ammonia and organic matter, and contamination by Fecal coliforms and E. coli.
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9.24 Solid Waste Management. Solid waste services suffer from similar problems to those of the water companies. Although collection covers most urban population (Table 9.10), collection equipment has not been properly maintained in recent years and is close to collapse. Disposal sites are in many cases open uncontrolled dumps, which represent an environmental hazard and pose a sanitary threat (it is safe to state that there are no adequate sanitary landfills in FRY). Collected solid waste is simply dumped, mostly at locations which are not prepared and which are, in most cases, fully inadequate (in irrigation channels that are out of use, along river banks, and, generally, in zones where the possibility of groundwater contamination is significant). Solid waste in all major cities, including Belgrade, Nis and Novi Sad, is collected and disposed at dump sites, not at properly operated landfills, without adequate control of the type of waste or specific facilities to receive and treat hazardous wastes. While in urban areas 98 percent of solid waste is collected by a public utility, in rural areas 44 percent of solid waste is either disposed of in illegal landfills, burned, disposed of near the home, buried or thrown into a river (Table 9.10).
9.25 Organization. Each municipality, through its public cleansing enterprise, is responsible for the collection and disposal of its solid wastes. Each enterprise has a General Manager and a Board of Managers (which are relatively apolitical as employees are hired through an open process). In most of the cities, this enterprise is an independent Public Utility Company, but in some cases, as described above, it is part of a larger Public Utility Company, that also has responsibilities for waterworks, markets, parks, etc.
9.26 Each public cleansing enterprise is organized and empowered to provide collection and disposal service according to guidelines set by the republic governments. Beyond this, there is no regulation on solid waste management, including waste disposal, from the federal or republican level of government. Each municipality is allowed to site and operate its disposal systems as it wishes, without being accountable to environmental or public health impacts on either its own community or to neighboring communities. In addition to being unaccountable for disposal practices, monitoring systems (e.g., air or water quality monitoring system) which might enable evaluation of the impact are rare or non-existent.
9.27 The organization of each public cleansing enterprise displays a clear focus on the supervisory, administrative and financial systems necessary to provide daily operations. There is no organizational emphasis on long-range planning or rationalization of operations. Little or no resources are allocated to activities such as public education, inspection, and enforcement.
Table 9.1: Sample Cleansing Service Fees
Location Fee (din/m2) Belgrade 0.75 Novi Sad 0.60 Nis 0.60 Subotica 0.75
9.28 Finances. Revenues available for each public cleansing enterprise were obtained from three sources: (1) municipal cleansing service fees; (2) general revenues in communal funds; and
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(3) Direct user charges. The cleansing service fee is collected from residents based on the household surface. The fee is established within a range set by the republican government (Table 9.1).
9.29 The communal fund provides resources to each public cleansing enterprise for cleaning the streets, parks, beaches, etc. The amount provided depends on the local political priority being placed on cleansing relative to other urban services needs. For the last ten years this source of income has existed in theory only. Direct user charges are in some cases charged directly by the public cleansing enterprise to large commercial and industrial establishments.
9.30 Solid Waste Characteristics. Solid waste is collected from buildings by either compaction trucks or liftable container truck. Streets are cleaned manually and with the use of mechanical sweepers. All waste thus collected is disposed on land. Municipal solid waste includes: street sweepings; refuse collected from residential establishments, commercial enterprises, and institutions; pharmaceutical and surgical wastes from medical clinics and hospitals; refuse and processing waste from industrial manufacturing facilities; demolition waste, etc (Table 9.2).
Table 9.2: Solid Waste Characteristics
Constituent Belgrade, % Novi Sad, % Nis, % Paper 23.44 28.35 20 Wood 0.30 2.04 5 Textile 1.70 3.65 10 Plastics 3.10 7.78 2 Glass 8.30 7.79 5 Vegetable material 5.26 4.80 10 Metals (ferrous, non-ferrous) 2.02 3.26 2 Food wastes 2.52 27.49 3 Miscellaneous 24.12 14.68 12 Moisture 28.59 30.00 16 100 100 100
9.31 Data on solid waste quantities is rather poor. Since there is no measurement of waste being disposed, local officials have only an approximate idea of the amount of waste which they are collecting. This estimate is based on the number of trucks which they have in their fleet, the size of these units, and the number of trips made by each truck daily. The amount of waste currently being collected and disposed by the public cleansing enterprise is estimated at 0.5 kg/person/day. There is relatively little recycling accomplished at source. Based on information obtained from local officials, recycling activities remove less than 10 percent of the waste stream prior to collection.
9.32 Collection Methods. The methods and types of equipment used for solid waste collection are broadly similar in all municipalities, which use locally manufactured collection vehicles and containers. For door-to-door, curb-side collection, containers of 80 liter or 1.1 m3 are provided in most cases. Rear-loading compaction trucks of 9 to 15 m3 are commonly used for collection.
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9.33 Collection of general refuse from most sources is done three times per week. However, in the central urban areas daily service is common. The collection fleet is mostly undersized for normal waste loads and poor maintenance and overuse of vehicles is widespread, due to a lack of investment. The average age of the fleet ranges from ten to twenty years old. Public cleansing enterprises usually do not own container washing equipment, except in Belgrade and Novi Sad, further reducing the usable life of containers (from four years to two years). Street cleaning is performed daily in the central city zones, and at a lower frequency in less urbanized areas. However, the frequency of street cleansing has been decreasing.
9.34 Disposal. Disposal of general refuse is primarily done by open dumping, except in some of the larger cities where soil cover is regularly applied (every 2-3 days in Belgrade, Subotica, Kotor). Bulldozers are operating at most of the dump sites. Bulldozers are used to spread and grade the waste, and maintain open access to collection vehicles discharging their loads. Some sites also operate without bulldozers, using an unloading platform, from which trucks discharge their load without any management. Most of the dump sites employ open burning. None of the sites have systems for gas or leachate management. The Roma (Gipsy) population collects material from most of the sites. There is no separation of waste according to hazardousness or need for special handling. Medical and industrial waste are co-disposed with other categories of general refuse.
9.35 Needs. Although in practically every city there are no sanitary landfills, quite often detailed designs do exist and in some cases construction of sanitary landfills had been started but stalled due to lack of resources. Investments required for sanitary landfills should be considered as a medium-term need. Table 9.3 provides some estimates of financial requirements in some selected cities on the basis of existing designs. Overall sector need are estimated at US$10 million for urgent closing and containment works in existing dumps and collection equipment, and US$ 30-50 million for medium term investments in improved disposal sites and collection systems.
Table 9.3: Investments planned for landfills.
Location Population Total planned Invested served investments already (106 DEM) (106 DEM) Novi Sad8 280,000 1.4 - Uzice 67,000 5.2 - Smed. Palanka 30,000 4.0 1.8 Vranje 70,000 4.1 2.0 Cacak 90,000 6.5 - Pancevo 100,000 2.8 - Raska 40,000 4.8 - Ivanjica 25,000 3.8 - Bujanovac 50,000 3.2 - Sjenica 35,000 3.6 -
8 Only closure of the old dump site and its revitalization is included.
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B. POLICY REFORMS NEEDED FOR THE SUCCESS OF THE DONOR PROGRAM
9.36 A clear conclusion is that any action plan aimed only at the reconstruction of damaged water supply and sanitation infrastructure, or to the expansion of current coverage, would face great risks of failure if it did not simultaneously strengthen the sector’s institutional capacity and policy environment. Donor support for investment in the sector could be used as a key incentive to move forward with the necessary measures needed to create an enabling environment for strengthened water and sanitation utilities. Additional donor support in the form of technical assistance could thus be considered to advance and facilitate a policy reform package in synergy with urgent rehabilitation investments.
9.37 Regulatory Oversight. Linked to the transfer of assets to municipalities and in parallel with the development of a regulatory framework and capacity at the republican level, local government should have a clear commitment to hold water utilities accountable for their performance; e.g. using performance contracts which clearly define performance and quality targets to be achieved, and the support to be provided by local government. Technical assistance will be required to prepare contracts with appropriate incentives and sanctions to encourage efficient service provision, as well as a requirement to issue regular reports to the public on progress in achieving performance targets. To be more effective and advance in the efficiency front, whenever possible donor’s support should be conditioned to the commitment by local authorities to these policies and the adoption of oversight mechanisms that allow its implementation.
9.38 Efficiency in the use of scarce resources and in the selection of investments. Limited financial resources must be allocated to achieve a cost-effective mix of institutional strengthening, rehabilitation, improved efficiency and service expansion. Any expansions of water and wastewater systems should be fully justified with proper economic analysis and take place only after existing systems are operating at maximum efficiency. Governments (Federal, Republican and Local) should rethink past resource allocation policies that did not pay sufficient attention to maintenance and operation and cost-efficient selection of investments. The following actions will help in this respect:
• Make better use of existing systems. Before spending scarce resources on capacity expansion, emphasis should be placed on making better use of existing systems by: (i) reducing network leakage through a combined effort of reducing pressure, identifying and fixing leaks, and replacing or rehabilitating pipes and house connections; (ii) improving the hydraulic efficiency of pipe networks; (iii) improving the efficiency and reducing energy consumption of pumping and treatment facilities; (iv) improving maintenance to increase the life of facilities; and (v) adequate demand management.
• Choosing the appropriate level of service. The level of service provided should depend on a community’s capacity and willingness to pay, as well as the economic return. In this respect, proper demand management procedures should be in place to avoid waste and improper use of water supplies (i.e. in irrigation), before any expansion of the current capacity is considered. Wastewater treatment investments (if any), either in rehabilitation, expansion or new facilities, should be cost-effective, with treatment levels
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decided upon assessment of economic benefits to be achieved and the assurance of sufficient operation and maintenance capacity.
9.39 Financial capacity to secure sustainability. If water supply and sanitation services are to improve and be sustainable in the long run, the municipal or regional sector institutions that provide these services must be put on a sound financial footing. International experience shows that financial self-sufficiency --the ability to charge full cost-recovering tariffs for maintenance, operation, and capital investments-- is a key condition for success and efficiency of utilities. Proper regulation is essential to this end. The following initiatives will help ensure the financial viability of water utilities:
• Reduce consumption through water demand management. Reducing water consumption lowers operating costs and delays investments in additional capacity, thereby improving the financial situation of a utility. Demand reduction programs require: (i) a cost-effective consumption metering strategy; (ii) consumption-based billing; (iii) tariff levels that are sufficiently high to induce consumers to use less water; and (iv) public awareness on water conservation. In most medium-size cities of Serbia and Montenegro small investments to strengthen the capacity of utilities to properly manage demand could have a quick and high return and help avert most of the current shortages. However, these actions would only be effective if accompanied by adequate pricing policies and support from the municipal authorities.
• Adopt adequate commercial management systems. Although many utilities in FRY have in the past had good experience with the adoption of meter based billing and bill collection, most of them now collect less than 50 percent of their bills. Barter is still common which does not directly help the utilities rehabilitate the system. The policy of disconnection of services for non-paying customers is not common, and even in areas where such a policy exists, it is not implemented because of technical reasons (multi apartment buildings under one meter), political interference or the existence of intermediary collecting companies that break the commercial relationship between the water companies and the client/consumer. Poor collection, together with erroneous investment planning, is often the single most crucial obstacle to financial viability. The use of such intermediary collection companies should be reviewed with a view to strengthening the commercial relationship between the water company and its consumers.
• Tariffs. Priority in the reform package should be given to replacing the current “basic cost-plus” tariff formula with one that provides incentives for cost reductions, allows for an acceptable level of profits and reduces large differentials in tariffs between household, industrial, and other users. This will likely encourage more rational water use by those who are currently cross-subsidized, and reduce resistance to paying water bills by those who currently pay very high tariffs. Accounting systems that conform with international standards should be introduced as part of the process of strengthening water utilities.
• Improve efficiency and reduce operating costs. Consumers rightfully object to paying for inefficiencies in management and operations of water utilities. Hence, utilities policy should explicitly aim at improving financial management and control, streamlining
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personnel, making plant and network operations more efficient through rehabilitation and adequate maintenance, reducing water consumption and energy use, using quality materials, and insisting on quality civil works. Efforts in these areas need to be shared with customers as part of a more general effort to improve client orientation.
C. DONOR PROGRAM FOR WATER SUPPLY AND SANITATION
9.40 The priorities for international assistance in the short and medium terms are as follows:
a) Urgent challenges (to be addressed before the end of 2002):
• Health risks due to serious pollution of sources, insufficient water supply and growing environmental problems associated with industrial pollution, and inadequate disposal of solid wastes. This challenge affects mainly the medium size cities and rural areas in Serbia and Montenegro9. Normally simple, limited investments, coupled with adequate policies and water demand management, should form the core of an urgent program for 2001-2002 to address urgent shortages.
• Technical assistance to develop a basic institutional and policy framework specific for the sector to clarify asset ownership, regulate function, introduce economic pricing and increase governance, within a policy package that sets the foundations for a medium and long term reform process. These actions are essential for the involvement of the private sector in water supply services in larger cities in Serbia and to advance the implementation of the coastal rehabilitation program in Montenegro. Transferring asset ownership fully to the municipal level, while retaining and developing planning and overall regulation responsibilities at the republican level should: (i) clarify amortization and proper commercial functioning; (ii) bring service decisions close to final consumers; and (iii) properly regulate services, separating the functions of providing the service and regulating it, thus allowing water utilities to concentrate on their core business10
• In Serbia, Technical Assistance to help eliminate current sector fragmentation and clarify responsibilities, identifying and empowering an institution or government entity at the republican level to act as the sector’s lead agency, particularly for planning and resource mobilization for both urban and rural systems. Linked to this, create baseline sector information that will be required for planning, resource allocation and decision making in the medium term (i.e. benchmarking water utilities, assessing water quality and solid disposal sites in urban and rural areas and validating current quality monitoring
9 The coastal areas in Montenegro face problems of insufficient water supply and environmental degradation that should also be urgently addressed because this region has been identified as a key element for the country’s growth through the tourist industry. In this region, some urgent investments, mainly in the area of sanitation, are needed to complement the Program being implemented by PEW and Aquamundo, through the consortium Monte-Aqua, with support from KfW. Support in this area would benefit from the current institutional development taking place. Also urgent in Montenegro are water quality problems in the Zeta valley, next to the capital Podgoriça, due to industrial pollution of sources 10 One example of the need for function clarification is the recommended separation of the construction and service functions in Podgoriça’s water and sanitation company, so that each can concentrate on core business.
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programs). The monitoring conducted by the Institute of Public Health (IHP) has to be adequately expanded to rural areas, not only to protect the rural population from severe health risks, but also to provide information to central and local governments (and the Donor Community) for planning and decision making.
• Technical Assistance to define and assign the role of central and local Governments, to facilitate service improvement in rural areas and monitor progress. Both functions have been largely neglected in FRY. The Governments should develop a Rural Water and Sanitation Strategy and create the enabling legal and institutional framework to implement this strategy. b) In the Medium Term (to be addressed between 2003 and the end of 2004):
• Technical Assistance to improve the financial situation of water and solid waste utilities through appropriate pricing policies, management strengthening and improvement of operating procedures. To address this challenge proper incentives and mechanisms for the transfer of resources should be introduced in coordination with the development of institutional and regulatory capacity. The involvement of the private sector in large cities could become an important instrument to address this challenge and have a demonstration effect on the sector as a whole.
• Address water quality problems and service deficiencies due to deferred maintenance and lack of rehabilitation. Although improved financial capacity of utilities would ease demands, external support will be needed to improve service quality and reliability and overcome years of neglect, particularly in medium size cities. In rural areas, the Government, assisted by the donor community, should facilitate the rehabilitation and improvement of the rural water sector.
• Investment and Technical Assistance to provide a comprehensive response to the environmental problem. Although priority should be given in the short and medium term to improved water supply, the full impact of these actions would be lost if a comprehensive response to environmental problems is not adopted. This would mean increasing sewerage coverage in those cities that suffer a deficient service and improving wastewater and solid waste disposal systems to avoid environmental deterioration (see Chapter 12 - Environment)
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Table 9.4: Water Supply and Sanitation Investment Support Needs (Million US$)(a,b)
CY01 CYO2-04 Total Investments Larger Cities 8.0 35.0 Medium size Cities and Regional Systems 12.0 35.0 Montenegro 7.0 14.0 Rural areas(c) 3.0 14.0 Solid Waste Management 6.0 15.0
Total Investment Needs 36.0 113.0 149.0
Technical Assistance for Sector Institutional Development Services benchmarking, training for efficiency 0.2 0.2 Development of regulation capacity 0.3 0.7 Water quality assurance survey 0.2 0.5 Expand water quality monitoring to rural areas 0.9 2.5 Develop an Overall (incl. Rural) Water & 0.4 0.4 Sanitation Strategy, incl. Enabling framework 2.0 4.3 6.3 Total TA Needs
38.0 117.3 155.3 Total External Financing requirements
(a) Needs in the three large systems (Belgrade, Novi Sad and Nis) are differentiated from those in the medium size cities: this has been calculated by extrapolating information from some of the largest/most representative systems about which it has been possible to obtain information, and rural systems not served by the municipal water companies (calculated from randomly selected villages). Data on investment needs is calculated on the basis of assessments made by OCHA and others and information provided by the water companies.
(b) Only investments for rehabilitation and essential new systems are presented here. In most cases, with adequate commercial management and policies, including adjusted tariffs, water and sanitation utilities should be capable of covering operation and maintenance costs from revenues.
(c) Initial rough estimates for rural areas are based on an assumed number of 500,000 private wells, of which not more than 50 percent would need to be repaired in the medium term (a study has been completed which has assessed about 300 wells, of which 140 required repairs, for an average cost per well of about US$150, giving a total budget of US$ 37.5 million, most of it to be financed outside the program). Another 20 percent of the rural population (about 1.7 million people) is supplied from small, uncontrolled systems, whose rehabilitation would require about US$13 million (another survey has been completed for several small systems, serving about 500 people each, showing needs in the order of US$7,500. Assuming that 50 percent are inappropriate; i.e. 3,500 systems, rehabilitation costs would be 3,500 x 0.5 x 7,500 = US$ 13,125,000).
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Annex 1 General Information
Territory: 102,173 sq. km11 Population: 10,500,000 (9,779,000 or 94.1 percent in Serbia12, and 721,000 or 5.9 percent in Montenegro) GDP pc: US$1,800 (1999 est.) Urban-rural: urban 51.2 percent; rural 48.8 percent (1991 data) Coastline: 199 km (all in Montenegro) Largest cities (over 100,000 inhabitants): Belgrade: 1,600,000; Novi Sad: 180,000; Nis: 175,000; Kragujevac: 147,000; Pristina: 108,000; Subotica: 100,000.
Table 9.5: Rivers in FRY
Danube 588 km (total 2783 km) Zapadna Morava 308 km (308 km) Juzna Morava 295 km (295 km) Ibar 272 km (272 km) Drina 220 km (346 km) Sava 206 km (945 km) Timok 202 km (202 km) Velika Morava 185 km (185 km) Tisa 168 km (966 km) Nisava 151 km (218 km) Tamis 118 km (359 km) Begej 75 km (244 km)
More than 90 percent of Serbia's river flow belongs to the Danubian system and flows into the Black Sea. Rivers in Kosovo and Montenegro are within the Adriatic drainage basin. The Tisa River is the most prominent tributary of the Danube in the Vojvodina, entering the province from Hungary south of the city of Szeged. The river flows from the southern slopes of the Fruska Gora flows into the Sava River, a major western tributary of the Danube. The Velika Morava River is the largest stream entirely within Serbia. Tributaries of the Vardar River tap a small section of southeastern Serbia; the river itself flows southward across Macedonia to the Aegean Sea.
Besides reservoirs behind hydroelectric dams, Serbia has no appreciable lakes. Its largest natural body of water is Lake Palic in Vojvodina, with a surface area of less than 2 square miles (5 square km).
11 Including Kosovo (10,849 sq.km). 12 Including Kosovo (population of about 2,000,000).
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Annex 2
Table 9.6: Water Supply Coverage in FRY
Population Served 1,000-10,000 10,000-100,000 100,000-500,000 >500,000 Number of utilities 7 72 11 1
Table 9.7: Water supply service levels
MAIN SOURCES OF WATER (PERCENT)
Piped Piped Tubewell/ into into yard Public Borehole Protected Unprotected Missing/ dwelling or plot tap with pump dug well dug well Other DK FRY excl. K & M 83.8 2.8 0.6 4.4 6.8 0.7 0.5 0.3 100 Republic of Montenegro 85.1 6.0 1.0 1.1 3.0 0.4 2.2 1.2 100 R Serbia excl. K&M 83.7 2.6 0.6 4.6 7.0 0.8 0.4 0.3 100 Central Serbia 81.3 2.6 0.6 4.4 9.6 1.0 0.3 0.2 100 Vojvodina 90.4 2.5 0.7 5.2 0.1 0.0 0.7 0.5 100
AREA
Urban 97.0 1.0 0.1 0.4 0.4 0.0 0.3 0.3 100
Rural 68.0 4.8 1.3 9.1 14.1 1.6 0.8 0.3 100
Table 9.8: Interruptions to water supply
Yes, during Territory No. Yes, sporadic Yes, on daily the summer basis season Number FR Yugoslavia excl K&M 51.7 28.4 5.0 15.0 5730 Republic of Montenegro 41.5 29.9 7.1 21.4 350 Republic of Serbia excl. K&M 52.3 28.3 4.9 14.6 5380 Central Serbia 57.4 23.5 5.8 13.4 3849 Vojvodina Area 39.6 40.3 2.6 17.6 1531 Urban 55.9 26.8 3.7 13.6 3270 Rural 46.0 30.4 6.7 16.8 2460
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Table 9.9: Sewage disposal methods
Territory Flush to Flush to Improved Traditional No Missing/ Total sewage septic pit latrine pit latrine facilities DK system tank FRY excl. K & M 57.2 31.1 0.7 10.5 0.1 0.3 100 Republic of Montenegro 60.6 28.2 0.6 8.4 0.7 1.5 100 R Serbia excl. K&M 57.0 31.3 0.7 10.7 0.1 0.3 100 Central Serbia 61.7 25.6 0.8 11.6 0.1 0.2 100 Vojvodina 44.1 47.2 0.3 7.9 0.0 0.5 100 Area Urban 87.5 10.l 0.1 1.9 0.0 0.4 100 Rural 22.2 55.5 1.3 20.4 0.2 0.3 100
Table 9.10: Solid waste disposal methods
Territory Taken Disposed of Left at Burned Buried Dumped Thrown Other away by at a public an near the at the public dump illegal house river utility dump FRY excl. K & M 54.7 25.3 6.4 6.3 0.3 5.4 1.1 0.5 Republic of Montenegro 41.7 38.1 6.2 4.9 0.1 0.9 5.9 2.2 R Serbia excl. 55.6 24.4 6.4 6.4 0.3 5.7 0.8 0.4 K&M Central Serbia 49.7 25.4 8.2 8.2 0.3 6.8 1.1 0.3 Vojvodina 70.4 22.1 1.9 1.9 0.2 3.0 0.1 0.4 Area Urban 79.6 18.3 0.5 0.3 0.0 0.9 0.1 0.3 Rural 21.9 34.4 14.2 14.3 0.6 11.3 0.7 0.7
Table 9.11: Main data from selected utilities
Nis Mitrovica Sombor Belgrade Kragujevac Pirot Tariff Domestic(din/m3) 3.75 3.22 3.18 6.00 4.47 5.95 Tariff Industry (din/m3) 11.25 9.67 9.05 23.00 20.71 17.85 Dom/Ind consumption 70/30 80/20 63/37 72/28 50/43 62/38 Production (Mm3) 40 8.3 6.3 245 25 6.9 Billed (Mm3) 25 5.9 4.8 163 14 4.8 Losses (%)604030334530 Total cost (Mdin) 116 29 34 1840 200 24 Labor cost (Mdin) 43 9 5.6 325 31 9.6 Energy cost (Mdin) 8.6 2.5 2.8 93 10 1.8 Revenues (Mdin) 99 14.5 38 664 81 23 Investments (MDM/y) 0.7 (81-90) 0.15 (81-90) 10 (2000) 1.7 (90-00)
225 Chapter 9. Water, Wastewater and Solid Waste
Table 9.12: Investments and employees in public water supply systems in the years 1988 to 1997. (From the Institute of Statistics)
1988 1990 1992 1993 1994 1995 1996 1997
Employees 6913 6100 5344 4985 4590 4378 4406 4381
Investment (1994 prices) mill. new din. .. 97 50 36 32 28 21 27
Table 9.13: Quantities of wastewater generated and treated in settlements in Serbia and Montenegro in 1996 (Statistical Yearbook of Yugoslavia, 2000)
Yugoslavia Montenegro Serbia Central Vojvodina Kosovo and all Serbia Metohia Domestic wastewater quantities (mill m3) 663 41 622 487 94 4.1 Domestic wastewater quantities, purified 79 18 61 33 19 8.9 (mill. M3)
References:
Federal Statistical Office Statistical Yearbook of Yugoslavia, 2000 Belgrade, 2000
OCHA (UN Office for the Coordination of Humanitarian Affairs) Humanitarian Risk Analysis No. 15, Federal Republic of Yugoslavia January 9, 2001
UNICEF Multiple Indicator Cluster Survey II The Report for the federal Republic of Yugoslavia Belgrade, 2000
World Summit for Children National Report on Follow-Up to the World Summit for Children Federal Republic of Yugoslavia
226 Chapter 9. Water, Wastewater and Solid Waste
Annex 3. Table 9.14: Water Company Estimates and identified pledges (Million US$) Corresponds to plans prepared by the water companies(a) Short term(b) Donor Pledges Medium term(c) Long term(d) Identified Larger Cities Belgrade 58 7 (KfW) 50-75 per year Novi Sad 12 2.4 (KfW 10-15 per year Nis 10 2 (KfW) 10-15 per year Total Larger Cities 80 ~1513 70-105 per year 250-375 Medium size Cities Kragujevac 3.5 1.5 (dif. donor) 9.3 55 Savak 19.6 13.3 10 Smederevo 0.4 3.2 s/d Kraljevo 0.9 7.6 70 Subotica 10.9 17.2 35 Total Medium-Cities14 ~160 ~225 ~950 Montenegro Podgoriça 1.5 0.15 (GTZ) 3-5 12 Coastal Region 10 7 (GTZ, KfW) 10 15 Other cities 2 ~10 ~15 Total Montenegro 13.5 ~25 ~40
(a) In the mission’s opinion, most needs reported by the water companies are more medium term than short term. However, there are several exceptions. For example, in Kragujevac, there is an urgent need to rehabilitate wells and substitute water being drawn from a surface source subjected to heavy eutrophication that requires high use of aluminium sulphate and other chemicals. Even with improved demand management, there will not be sufficient water in Kraljevo during the coming summer (last summer 280 l/s were available against a normal demand of 560 l/s).
(b) Short term investments are those for urgent rehabilitation, efficiency increase, commercialization and system management. These include investments to quickly restore infrastructure, lower operating costs, provide operational and management information and deal with immediate problems of water quality. They generally do not include additional production and transport capacity, apart from that resulting from rehabilitation of existing systems that are not operational because of lack of maintenance. Although not disaggregated in this table, information in the project files for short-term support are whenever possible categorized as: (i) investments needed for network rehabilitation; (ii) investment in production facilities rehabilitation; (iii) efficiency improvements, management and control related investments; and (iv) other urgent support needs.
(c) Medium term investments are those needed to improve service quality and reliability, to be carried out in the medium term (between 2003 and 2004). These include investments needed to secure long term supply, address quality problems at the source, additional rehabilitation or address upgrade needs.
(d) Long term investments are those contemplated in plans that, because of their scope and objectives, do not correspond to the scope defined above for medium term investment and that would most probably be undertaken after 2005, outside the framework of the Economic Transition Program.
13 Includes about 4 million by CFA (French Cooperation) 14 Extrapolation to all medium size cities
227 Chapter 9. Water, Wastewater and Solid Waste
Annex 4: Novi Sad Water Supply and Sewerage Company
The Public Utility Company “Waterworks and Sewerage” provides water supply and sewerage services to the city of Novi Sad and to rural communities of this municipality.
Table 9.15: Novi Sad Water Supply and Sewerage Company data
Population Served 300,000 Refugees 60.000 Sewerage coverage 85-90 % Tariffs: Domestic consumers 3.6 dinnar/m3 (0.12 DM/m3) Industrial consumers 9 dinnar/m3 (0.30 DM/m3 Collection efficiency 60% Consumption 380-400 lpc/d Losses 30% Network Failures In the network 210 per year In the connections 25-30 per month Energy consumption in pumping 3 MW Energy expenses 700,000-750,000 dinar/year Income From billed services 360 million dinar (12 MDM 2001) From municipal contribution 206 million dinar (7 MDM 2001)
Bill collection is carried out by a municipal company that distributes income among the different services according to their needs. There is no cadastre of unpaid bills among domestic consumers. Disconnection because of non-payment is not done on domestic consumers because of technical difficulties (multiple apartment buildings served through one single meter).
Main problems facing this system are related to the contamination of the source (the aquifer next to the Danube river) because of the release of industrial contaminants during the conflict. Interconnection of the system between the left and right banks of the river Danube was damaged during the conflict. This has been largely restored recently with support from donors. Additional support has been pledged by KfW for improvements in the network and metering, for about 4.8 million DM.
The company has prepared project to protect the sources and increase production (despite the current high consumption rate). The overall budget estimate for these projects is 25 million DM.
228 CHAPTER 10. COMMUNICATIONS
10.1 This chapter focuses on urgent reform and institutional strengthening priorities in the broad communications sector: telecommunications; broadcasting; postal services and the ICTs and the Information Society. Following a discussion of the sector an indicative donor program is presented and summarized in Table 10.3 at the end of the chapter. External financing requirements in the Communications sector are estimated to be US$64 million over three to four years. Requirements in the first year, on a commitments basis, are estimated to be US$18 million.
A. TELECOMMUNICATIONS
Overview of the current situation
10.2 Structure: Table 10.1 below summarises the basic structure of the telecommunications sector in the FRY. One operator in each Republic has been licensed to provide the full range of public fixed telecommunications services, including local, long distance and international services.
10.3 Fixed line teledensities are slightly lower than those in Slovenia and Macedonia (38). The basic structure – one fixed operator and two mobile operators – is common to transition economies. This structure is present in Croatia and Slovenia whilst in Macedonia there is only one mobile operator. Data on mobile customers is very fluid and is subject to different interpretations, nevertheless it appears that the number of mobile customers in Montenegro exceeds that of the fixed network. In Serbia the rate of mobile network capacity expansion has not kept pace with the growth in customer numbers. As a consequence there is severe network congestion in the mobile market in Serbia.
10.4 The most striking feature of the structure in Serbia is the scope and duration of the exclusive (monopoly) rights of Telecom Serbia (TS) resulting from the sales contract signed in 1997. There does not appear to be any investment or quality of service obligations, and the contract does not provide investors with full management control. Exclusive rights in the EU were largely terminated in 1998, except in some cases where transition periods were granted. The last EU member state liberalized on January 1, 2001.
10.5 A second feature of the structure is that the respective governments hold substantial stakes (around 50 percent in Serbia, 9 to 100 percent in Montenegro) in competing mobile operators. Best international practice would require only one holding for reasons of good governance and competition law. The tender process for the partial privatisation of Telecom Montenegro (TM) is beginning in the second quarter of 2001. It is possible that the Republic of Serbia may further dispose of its holding in TS. The matter of disposals needs to be placed on agenda for the next 18 months on the reform agenda with appropriate donor support. Chapter10. Communications
Table 10.1: Structure of Telecommunications in FRY
Serbia Montenegro Fixed Line Teledensity = lines per 100 <25 >35 inhabitants Operator Telecom Serbia (TS) Telecom Montenegro (TM) Ownership of Operator Govt of Serbia 51% Govt of Montenegro Telecom Italia 29% 89% OTE (Greece) 21% TM employees 11% Fixed line exclusive rights Yes Yes Service scope of fixed line Without limit* Extensive** exclusive rights Duration of exclusive rights to June 2005 31 December 2003 Number of employees 13,000 1,400 Digitalisation < 50% > 60% Mobile Services Number of operators: 2: Mobtel; Telecom Serbia 2; ProMonte; MONET
Ownership Mobtel: 51% Braca Karic ProMonte: 91% private (private) & 49% Govt of (including Telenor 40%) & Serbia 9% Telecom Montenegro Telecom Serbia – as parent MONET – Telecom Montenegro
Approximate customer > 1.25 million 275,000 numbers (Feb 2001) Internet Number of ISPs >20 2 * it is understood that these rights include both existing and new services ** includes ‘call back’ and ‘voice over the Internet’
10.6 Tariffs: The tariff structure in FRY slows the development of market relations and is a source of quasi-fiscal pressure. Both fixed (monthly access) charges and local tariffs are below costs. High international tariffs retard economic growth and could negatively impact the spread of the Internet. Tariffs charges are linked to the DM. Basic access costing at US$1 (US$10 is nearer the norm) and local calls at charges of US$0.01 do not support the financial viability of the companies. There is an urgent need for tariff re-balancing but in recognition that re-balancing may cause a reduction in the number of customers, particularly in rural areas and the most needy, the re-balancing should be accompanied by an innovative and appropriately funded Universal Access mechanism. Table 10.2 summarises the tariff situation.
10.7 Regulatory environment: A new framework Telecommunications Law has been enacted in Montenegro which establishes an independent regulatory authority and provides for a very clear demarcation between the duties of the Ministry and the regulatory authority. The new Montenegrin framework law complies in general with EU Accession requirements but secondary legislation and directives are required for full implementation of the acquis
230 Chapter10. Communications communautaire. In comparison, there is a regulatory void at the Federal level and in Serbia since the existing laws are obsolete and are, in any case, not applied. A new telecommunications law is currently being drafted for the Federal level/Serbia with the support of DFID.
10.8 It is possible to benchmark the regulatory environment against the key characteristics of the WTO Regulatory Reference Paper1. These key characteristics are:
• an independent regulatory authority. • transparency in general. • competitive safeguards of the type that would flow from competition law. • Objective, non-discriminatory and transparent allocation of scarce resources (e.g. frequencies, numbers, rights of way. • public availability of licensing criteria. • equitable interconnection regime.
Table 10.2: Fixed Usage Tariffs – Serbia and Montenegro Serbia Montenegro Connection US$ 200 200 Monthly Access charges US$ 1 1 3 minute local call Residential US$ 0.011 0.011 Business US$ 0.022 0.022 1 minute Germany dinars 30.78 1 minute UK dinars 30.78 1 minute USA dinars 56.00 1 minute Germany Dmark (US$) Residential 0.9 (0.45) Business 1.8 (0.90) 1 minute UK Dmark (US$) residential 1.64 (0.82) business 3.28 (1.64) 1 minute USA Dmark (US$) residential 2.30 (1.50) business 4.60 (2.30) Call Back rates 1 minute US$ Germany 0.41 0.41 UK 0.41 0.41 USA 0.40 0.40
10.9 Given the regulatory void currently at the Federal level and in Serbia, it is not surprising that these regulatory environments currently do not meet the WTO criteria. However Montenegro post-2003 would be acceptable, provided current timetables are
1 EU requirements are more demanding than those of the WTO.
231 Chapter10. Communications adhered to. The regulatory void in Serbia requires the urgent attention of the relevant authorities.
10.10 Montenegro has enacted a framework modern regulatory regime, which is also foreseen in Serbia. Afterwards there will be a need to draft and implement a regulatory ‘tool kit’. The elements of this ‘tool kit’ are summarised in Box 10.1. It would also be opportune to draft necessary regulations conforming to the UNCITRAL2 model law on electronic commerce and to modernise protection of intellectual property rights and data protection laws, which would also benefit the ICT and broadcasting sectors. Regulators in both republics will require appropriate capacity building in the use of the ‘tool kit’. Donor support is required for both activities and capacity building would be most effective in a regional centre of excellence.
Box 10.1 Elements of a regulatory ‘tool kit’ and required capacities • a modern licensing procedure and the means of revoking or modifying licenses. • procedures to monitor and enforce timely compliance with legislative and license provisions. • a detailed, timely, effective and practical means to resolve network interconnection issues, including technical, capacity, compatibility, routing, price, billing, and other related matters. • a capability and methodology to assess the costs of the provision of telecommunications services provided to the public and to other operators for tariff approval purposes. • a radio spectrum (frequency) monitoring and management capability, allocation plan, radio authorisation policy for public and private networks, and a radio authorisation process. • a telephone numbering plan and procedures for the allocation of blocks of numbers. • a capability to specify standards for different classes of telecommunications equipment and for testing compliance with these standards. • appropriately defined Universal Service Obligations and costing of such obligations. • procedures to monitor service quality and resolve disputes related to quality between operators and between operators and customers. • criteria whereby the tariffs for particular services gain “unregulated” status.
10.11 Exclusive rights & regulation: The Montenegrin Law on Telecommunications provides regulatory certainty for the current period and the transition to a competitive multi- operator environment. Article 27 grants TM with extensive exclusive rights (including leased lines, call back and voice over the Internet) until 31 December 2003. The law also provides for competition in services.
10.12 In Serbia the regulatory environment is uncertain except that TS is granted exclusive rights until June 2005. The sale contract with the strategic investors Telecom Italia and OTE is not public. It seems that the contract severely limits the scope for regulatory reform as required by WTO membership and EU accession, as well as the prospects for market
2 United Nations Commission on International Trade Law.
232 Chapter10. Communications development (e.g. the issuance of a 3rd mobile license). A competitive communications environment is a key contributor to economic growth, consequently the sales contract may handicap economic development, particularly those developments associated with the ‘New Economy’. While recognising the importance of legitimate contracts to the foreign investment community, the sale contract for TS deserves serious and urgent attention.
B. BROADCASTING
10.13 The Federal Government and the Government of Serbia face an acute and immediate problem in the broadcasting sector where over 1,000 largely unlicensed radio and TV stations are currently transmitting. The radio spectrum is a key resource that must be managed in an efficient manner for the benefit of all. In the current un-managed environment not only is there interference between broadcasting stations, but also cross border interference and interference with other activities such as air traffic control.
10.14 The source of the problem lies in part with the necessary development of the independent media and its role in the democratic transformation. The solution to the problem lies with the enactment and enforcement of a new broadcasting licensing law which provides for effective frequency allocation, assignment and frequency management and monitoring (FMM) which supports independence and pluralism in the media. A law is under preparation, but this is certain to require new and immediate capabilities in FFM, funded by donors, if it is to be implemented effectively.
C. POSTAL SERVICES
10.15 Information on FRY postal services is very fragmentary. Postal traffic is extremely low and the range of services is very limited. There are less than 12 letter mail items posted per inhabitant per year (Slovenia 198, Hungary 107, Poland 40, Macedonia 10). The FRY Postal Services, with 17,000 employees, are a source of quasi-fiscal pressures. Productivity levels are low, quality of service (speed, reliability) is poor, equipment is outdated and postal services lack the necessary resources to develop the postal business. Furthermore, the future reimbursement system for incoming international mail (“terminal dues” which are an important revenues source) requires specific appropriate delivery standards which are unlikely to be met in FRY. The economic recovery of the country creates major challenges and opportunities for the postal industry. In order to meet future market demands and to take advantage of new business opportunities, a significant transformation of the postal sector is urgently required. The post, a crucial element of a modern and reliable infrastructure, is in need of fundamental restructuring and operational improvements. Consequently, a comprehensive postal modernization is necessary that would a) allow for solid postal services, b) secure financial viability for the incumbent, c) stimulate the entire postal sector and d) prepare the postal system for the ‘New/Information/Web Economy’.
233 Chapter10. Communications
10.16 A donor funded assessment study is required which would prepare the grounds for a feasible and sustainable postal reform program. This assessment study should a) evaluate the existing operations; b) analyse the current market situation (supply and demand) and future trends; c) identify possibilities for immediate measures for operational improvements; d) define the outline for a modern policy framework (legislative, regulatory and institutional setting); d) outline an enterprise restructuring program (strategy, structures, systems); and e) draft a business and investment plan for the postal operator.
D. ICT/INFORMATION SOCIETY
10.17 FRY is rich in human capital but poor in terms of the Information and Communications Technologies (ICT) and their application. The global telecommunications sector has been characterised by recent dramatic changes; the landscape has been transformed from being dominated by state owned entities functioning under a ministry to one in which privatised commercially oriented companies compete in a multi-operator environment with pro-competitive regulation. These forces will impact FRY, irrespective of any actions undertaken by the authorities. For the authorities in FRY, the issue is whether they wish to manage the process of change or ignore them.
10.18 A new form of economic organisation – ‘the Web Economy’ – is transforming the nature of global development with startling speed, scope and mobility. At the same time we are becoming aware of a new division between rich and poor in terms of access to and benefit from information and communication systems, referred to as ‘the Digital Divide’. The Web Economy is based on competing telecommunications networks, the Internet, computers (collectively known as ICTs) and the falling costs of communications.
10.19 In this take-off phase it is already clear that if a country does not participate in the Web Economy at an early stage, it may never participate. There is a real risk of being left behind possibly forever. Here there are implications for emigration of skilled workers and the depletion of FRY’s strategic advantage – its human capital. Non-participation will seriously threaten the fundamentals of any economy because the inherent mobility of the Web Economy means economic activities can shift at will to any location.
10.20 There are three principal components that drive the Web Economy:
• Basic connectivity provides the primary source of economic advantage and social inclusion. Connectivity is low, particularly in Serbia • The internet provides both a new form of transparent and efficient market for existing economic activities and the basis for entirely new business ventures. The Internet has be constrained in FRY. • Applications are instruments for improvements in education, health, environmental management and thereby poverty alleviation in general. Tele-medicine can be used to provide vital services in a timely manner whiles distance learning can be used to
234 Chapter10. Communications
enhance skills, thereby facilitating advancement even in the most remote locations. These applications have thus far had limited impact in FRY.
10.21 The score card for FRY is poor for each of the key contributors. The challenge is to ensure that FRY does not fall on the wrong side of the Digital Divide. In this regard the central features of the agenda must be(a) a policy to promote basic connectivity within FRY and between FRY and other States; (b) to facilitate the expansion of the Internet (where it has previously been restricted); (c) to encourage applications such as tele-medicine and distance learning; and (d) to promote private sector involvement. These elements should be central to a donor funded comprehensive ICT strategy.
E. SECTOR PRIORITIES FOR TRANSITION AND RECOVERY
10.22 The donor program outlined in Table 10.3 identifies technical assistance needs and indicative seed investment amounts that will facilitate recovery in the sector over the next three to four years. It is expected that the seed investments will most likely take the form of lines of credit or equity. Detailed investment requirements have not been possible at this stage due to a dearth of available analysis upon which to make such recommendations. The program is also based on the assumption that a high and increasing share of this investment can be financed by the private sector, at least in the telecommunications sub-sector. Donors should not disregard the communications sector, however, as it has a significant potential to contribute to overall competitiveness, economic growth and social inclusion.
10.23 An advisable sequencing of events is as follows:
Immediate • Examination of Sale Contract for TS – Government of Serbia (GoS). • Draft new telecommunications law (GoS). • Enact new Broadcasting licensing law (GoS) and FMM capacity start up.
Near-term (18 months) • Implementation of FMM capability – first phase (Federal). • Drafting of Regulatory “Tool Kit” (GoS and GoM). • Regulatory capacity building in “Tool Kit” (GoS and GoM). • Study to determine Universal Access mechanism (GoS and GoM). • Drafting of Minimum e-commerce & modern IPR/data protection laws (GoS and GoM). • Postal Reform Study (GoS and GoM). • ICT Strategy Policy –first phase (Federal).
235 Chapter10. Communications
• Seed money to implement ICT Strategy and encourage private sector involvement. • Investment Bank assistance for further disposals of assets.
Longer term (over 18 months) • Continuation of regulatory capacity building (GoS and GoM). • Implementation of FMM capability – final phase (Federal). • Implementation of Postal Reform (GoS and GoM). • Second phase seed money to implement ICT Strategy and encourage private sector involvement. • Implementation of ICT policy (GoS and GoM). • Implementation of Universal Access mechanism (GoS and GoM).
Table 10.3: Estimated External Financing Requirements in the Communications Sector
Priority Estimated Req.US$ Total m Program CY01 CY02-04 Credit/Equity Investments Equity stakes to catalyze private investment 15.0 40.0 55.0 Technical Assistance Needs Technical Assistance requirements 3.0 6.0 9.0
Totals 18.0 46.0 64.0
236 CHAPTER 11. AGRICULTURE
A. INTRODUCTION
11.1 Agriculture has always been an important component of the economy of the Federal Republic of Yugoslavia (FRY). Prior to 1990 it accounted for 10 percent of GNP and 24 percent of the work force. The sector also made a significant contribution to international trade, with 12- 13 percent of total exports, 9-10 percent of total imports and a positive contribution to the trade balance.
11.2 More resilient than most sectors of the economy, agriculture has contracted less in response to the difficult economic conditions during the last 10 years. Its importance to the economy has thus increased, with 22 percent of GNP in 1999, and 22 percent of total exports. Although the official balance of trade in agriculture products went from positive to negative, barter trade in cereals has become an important means for securing energy imports. The sector has deteriorated significantly nevertheless. As a means to preserve stability, the government kept producer prices and food prices very low, which severely compromised enterprise viability. Public support for agriculture also plummeted. The sector nevertheless continued to produce an adequate supply of basic food commodities and to absorb a growing number of unemployed.
11.3 In contrast to Serbia, the scarcity of fertile land and the relatively harsh climate in Montenegro limit the potential for agriculture. Domestic production provides only 30 percent of aggregate food requirements. Food until recently was imported from Serbia (60 percent) and foreign countries (10 percent), but with the interruption of trade with Serbia, 60 percent of food imports have recently come from foreign countries, often on highly concessional terms.
11.4 Approximately half of the total population in Serbia live in rural areas, although not all are farmers. Only 8 percent of rural households earn all their income from agriculture. A further 24 percent are mixed households, which earn their incomes from both farm and non-farm sources, and the remainder are non-farm households. In Montenegro, approximately 40 percent of the population live in rural areas. Migration of younger cohorts out of the rural areas in the last several decades has led to a significant aging of the rural population and accounts for the high percentage of farms owned by urban residents (23 percent). Full-time farm households were just 4 percent of all households, while households with some farming income were 22 percent.
11.5 This report describes the agricultural sector in FRY, and then discusses the main constraints and challenges to be overcome for effective recovery of agricultural production. The chapter then discusses priorities and investment needs for possible external financing and an indicative donor program is summarized in Table 11.2 at the end of the chapter. The estimated external financing requirements over three to four years in the agricultural sector are US$218 million. The estimated requirements, on a commitments basis in 2001 are US$71 million. Chapter 11. Agriculture
B. BACKGROUND
11.6 The Agricultural Resource Base. In Serbia, conditions for agriculture are generally favorable. Of the total land area of 102,173 km2, 55 percent is agricultural land. This is equivalent to 0.55 ha/capita, compared to 0.28 ha/capita in Europe. Almost 80 percent of this land is cultivable, including the rich arable land of Vojvodina. On a per capita basis (0.44 ha/capita), the availability of cultivable land also compares favorably with Europe (0.18 ha/capita). A continental climate prevails in most areas, with annual rainfall of 600-800 mm. There is an abundance of river and underground water resources and irrigation schemes have been developed for approximately 130,000 ha. But they operate on only 31,700 ha (a fourth of the total and less than 1 percent of all cultivable land).
11.7 Of the total area of 13,812 km2 in Montenegro, 37 percent (517,300 ha) is agricultural land, equivalent to 0.18 ha/capita. Approximately 10 percent of agricultural land (52,500 ha) is cropped due to low soil fertility and low rainfall. Most cultivable land is used for pastures (331,100 ha) and meadows (119,400 ha) with a smaller area in orchards and vineyards (14,300 ha).
11.8 Farm Structure. Farms and agro-enterprises are of two main types: small, privately owned farms, agri-businesses and processors; and larger socially-owned agro-kombinats, co- operatives and agro-processors. The private sector accounts for most of sector output, with approximately 80 percent of the Gross Social Product for agriculture in 1998. Socially-owned enterprises dominate marketing and processing however, and so exert a much greater influence than their contribution to production indicates.
11.9 Private farmers own approximately 80 percent of agricultural land and 85 percent of cultivable land. They typically farm 2-5 ha1, usually in several plots. They also own 80 percent of pigs, more than 90 percent of poultry and cattle, and 98 percent of sheep. Most households practice mixed, low intensity management systems with 1-2 cows, some sheep or pigs, and enough cereal and vegetable production to meet their own needs for animal feed and human consumption. Incomes are low as a result, and most private farms must also rely on non-farm income. Cash income comes from the sale of animal products and fruit and vegetables on local markets.
11.10 In Montenegro, the majority of agricultural land is owned by private farm households, with an average farm size of 5.1 ha, 80 percent of which on average is used as meadows and pastures. Animal production is composed of cattle and sheep.
11.11 Despite government policy to keep product prices very low in Serbia, private farms have continued to meet most of the country’s needs for food consumption. They have survived by reducing the use of fertilizer and agricultural chemicals, foregoing repairs and maintenance on tractors and equipment, and by selling their breeding livestock. Remittances provided a further source of income. Survival has come at a high price, however, in that their capital base is now severely depleted.
1 More than 75 percent of private farms are less than 5 ha, and less than 5 percent are more than 10 ha (1991 census).
238 Chapter 11. Agriculture
11.12 The remaining land and livestock are farmed by 460 agro-kombinats and 400 co- operatives2. Most are medium-scale enterprises. More than 90 percent of co-operatives farm less than 1,000 ha, and more than 95 percent of agro-kombinats farm less than 5,000 ha. Prior to 1990 they practiced modern, capital-intensive management systems and accounted for two-thirds of marketed surplus. Their objective was to maximize employment rather than profits, typically by diversifying into processing and marketing activities. This compromised their financial viability and made them heavily dependent on public support.
11.13 Most of these enterprises are now financially insolvent and barely functional. They have incurred significant losses as a result of low producer prices, the loss of traditional markets and the reduction of public support for agriculture. The collapse of the banking system has also left socially-owned enterprises with little access to credit. The consequent breakdown of the marketing and processing systems, which they controlled, is a major further constraint to sector recovery. As with private farms, the agro-kombinats have been forced to defer maintenance on tractors, plant and equipment, and to sell off breeding livestock in order to survive. Their capital base is even more depleted in relative terms than that of the private farmers. Staff numbers have also been reduced, although they are still too high. The agro-kombinats are now kept operative by government provided fuel, fertilizer and seed, which are repaid on a barter basis after the harvest.
11.14 Crop Production. Cereals dominate crop production, with corn and wheat output typically high enough to meet domestic requirements, plus a small surplus for export. Industrial crops account for 10 percent of arable land use, with sunflower and sugarbeet predominant before 1990. Soybeans have now replaced sugarbeets in importance. Vegetable and forage crops are the next most important component of land use. Plums are the main fruit crop. Even before 1990, crop yields were low by Western European standards, despite a significant investment in plant breeding. Yields have fallen further since 1990 due to lower use of fertilizer and chemicals, inadequate cultivation due to fuel shortages and inability to maintain tractors and equipment. Fertilizer use alone fell from 995,000 tons in 1990 to 356,000 tons in 1998. The inability to maintain extensive drainage systems on the flat, fertile land of Vojvodina has been a further cause of low and declining crop yields and production.
11.15 Conditions during the last ten years have thus led to significant changes in the level and composition of crop production. Total production fell markedly for most crops. Private farmers also switched from crops for which producer prices were kept very low, such as wheat and sugarbeets, to crops where there was less control of producer prices (vegetables) and/or more active marketing and processing outlets (soybeans). A severe drought followed by floods occurred in 1999-2000. Wheat production was adequate nevertheless, but corn production for livestock feed was severely reduced.
11.16 In Montenegro, grain production has been sufficient for home consumption. Total grain production in 1998 was 22, 470 tons. Corn (9,360t) and barley (6,448t) accounted for 70 percent of total grain production. Fruit, vegetable and grape production has been an important source of farm income in the republic, with the total production of 247,000t. Production decreased
2 These co-operatives differ markedly from those found in the west in that they are designed to further the interests of employees rather than users.
239 Chapter 11. Agriculture somewhat in recent years, due to lack of working capital for fertilizer and other inputs. Farm machinery and plastic houses (for early vegetables) are old and need replacement. Fruit trees, such as olive and plum, have had to be destroyed because of virus infection. Except for grapes, production of fruit and vegetables was done predominantly by private farmers. There is a need and opportunity to revitalize vegetable production by supplying plastic houses, replanting fruit orchards and supporting the recent development of berry production for export.
11.17 Livestock Production. The livestock sector has also been hit hard during the last 10 years, with livestock numbers falling for all animals except pigs. Available statistics suggest that this decline has been most pronounced for socially-owned enterprises, although these enterprises own less than 10 percent of all livestock. In most cases, production has fallen even more than livestock numbers, due to the additional difficulty of providing adequate feed and veterinary care. Productivity has always been low by western standards, even before 1990, in any case.
11.18 The decline in livestock numbers can be attributed to the fall in demand for livestock products, as disposable incomes have fallen, particularly for more expensive beef and lamb, and to the disposal of breeding stock in order to obtain cash income. These trends have been exacerbated in the last two years by the poor corn crops, consequent animal feed shortages in 2000/2001, and the fall in European beef prices as a result of BSE. This decline is of particular concern to private farmers in the hill and mountain areas for whom livestock is the mainstay of farm income.
11.19 As natural conditions in Montenegro favor extensive livestock production, cattle and sheep farming predominates. Some 68 percent of farmers own cattle, with an average herd size of 2 cows, and 22 percent own sheep. Animals are fed on forage, supplemented by concentrates during the winter. Milk yields are low (1000-1500 litres/cow), due to poor animal nutrition and the predominance of native Busa cattle, procured under EC Obnova, which are hardy but low- producing animals. Holstein and Swiss Brown cattle are demonstrably more productive in the setting but have yet to be widely accepted
11.20 Montenegro has a long Adriatic Sea coastline, and sea fishing used to provide considerable income, export earnings and employment. Now the local catch is limited due to obsolete fishing facilities and lack of investment. Private fish farms were developed in the mid- 1990s, but their number has decreased due to lack of working capital to purchase fingerlings and feed and a drop in demand due to the slowdown in the tourist industry. With political stability, tourists will return and the production of fish and greenhouse vegetables will add positive attraction to this industry.
11.21 Agricultural Markets and Agro-Processing. Socially-owned agro-kombinats and agro- processors have traditionally dominated the markets for cereals, meat and dairy products, fruit and vegetable processing, oilseeds and sugar. Many operated on a very large scale, with substantial processing and storage capacity and market outlets throughout former Yugoslavia, Western Europe and the COMECON countries. The private sector was more active in smaller- scale activities, such as bakeries, flour mills, feed mills, slaughterhouses, the marketing of fresh fruit and vegetables, and input supply. Their activities typically focused on local markets. Some
240 Chapter 11. Agriculture larger, private enterprises were also active in dairy processing, fruit and vegetable processing (including berry fruits for export), and meat processing for both domestic and export markets.
11.22 This system collapsed during the 1990’s. Demand fell dramatically as a result of the 50 percent fall in GDP and the consequent fall in disposable incomes, the loss of traditional export markets in former Yugoslavia, Western Europe and the former COMECON countries, and the financial difficulties experienced by the banking system and the agro-processors. On the supply side the collapse of the agro-kombinats and lower production from private farms also reduced the marketed surplus. Market activity contracted severely as a result. Marketing efficiency also fell due to a substantial reliance on barter trade and the higher transport and transactions costs caused by sanctions. 11.23 Most agro-processors now operate at 30-50 percent of technical capacity, with sugar and meat processors operating at less than 30 percent of capacity. Actual capacity utilization is probably higher given that much of their plant and equipment is worn-out and obsolete due to lack of capital for maintenance and replacement. But their ability to compete is still severely impaired. The situation is less serious where private enterprise is more active and/or the scale of operation is smaller. For instance oilseed processing firms and those processing and marketing berry fruits for export have been more adept at handling the prevailing economic conditions. A small core of private sector marketing agents have even managed to expand their activities, profiting from their wide contacts in former export markets, the collapse of socially-owned enterprises, and the distortions created by the price and trade policies extant before 2001.
11.24 In Montenegro, most processing plants are operating at very low capacities, due to outdated equipment and lack of working capital3.. Exceptions are dairies and a large winery, which are operating at 75-80 percent of capacity. . In the case of dairies, however, the relatively high capacity utilization is heavily influenced by the directed producer subsidies to this sector currently operated by the Government. The Plantaze winery, a state-owned agrokombinat slated for privatization, produces a well-known brand for export and is vertically integrated from irrigated vineyards to modern processing and storage.
11.25 Milk and meat products are the major marketed output, although the marketed surplus is small. Most of this output is processed on the farm and marketed through informal channels such as local green markets, restaurants and sales to friends and neighbors. Public entities dominate formal marketing and processing channels, especially in the dairy sector. Socially-owned dairy processors account for 90 percent of processing capacity and dominate the retail markets for liquid milk, although they process less than 10 percent of total milk production. Municipality- level marketing organizations and co-operatives serve as collection and distribution centers and link private farmers to the socially-owned agro-processors and agro-kombinats. The privatization of socially-owned enterprises was begun in the early 1990’s through the establishment of joint stock companies and partial ownership transfer to employees. But government still retains majority ownership, the approach to management remains the same, and there has been little foreign investment.
3 For example abattoirs are operating at an estimated 15 percent capacity and feed mills at 50 percent.
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Polices and Institutions
11.26 Isolated for the last 10 years, FRY has had little exposure to the process of economic transition occurring elsewhere in Central and Eastern Europe. Socialist policies and institutional structures thus still prevail. As a consequence, the people and institutions responsible for policy formulation and regulation of the private economy do not have experience in how government should operate in a market economy.
11.27 The Ministries of Agriculture. Three ministries of agriculture are responsible for the formulation and implementation of agricultural policy. As their respective roles and responsibilities are a source of dispute, with significant consequent overlap, a more rational basis for allocating resources and sharing responsibilities is sorely needed.
11.28 The Federal Ministry of Agriculture (FMA) is responsible for agriculture policy at national level, for the management of Federal budget resources and for drafting and enforcing phytosanitary and veterinary inspection laws for agriculture products. Currently, poor co- operation and co-ordination between the Federal and Republican phytosanitary inspectorates is reducing the effectiveness of preventive and disease eradication programs. There are also long delays at the border, due to inadequate infrastructure and equipment, which inhibits agricultural trade. On a more positive note, FRY has three ISTA-certified seed-testing laboratories and has recently applied for UPOV membership. This is an important step given that FRY is the largest producer and exporter of seeds and seedlings in the region. Within the veterinary department, border inspection is constrained by inappropriate quarantine facilities, insufficient sampling and storage equipment and lack of information technology.
11.29 The roles and responsibilities of the Ministry of Agriculture, Forestry and Water Economy (MAFWE) of the Republic of Serbia. are similar to those of the FMA. It has a much larger budget than the FMA, however, most of which is used for subsidies. The ministry has four departments: Agriculture, Forestry, Veterinary and Water Economy; and is highly decentralized. A small staff of 25 people in Belgrade is responsible for policy formulation, legislation and quality control. But as most of them are assigned to inspection and subsidy administration, the ministry’s capacity for policy analysis and formulation is very limited. The remaining 900 staff members are inspectors at 25 regional offices. There has been no attempt to improve the ministry’s cost-effectiveness by out-sourcing inspection functions to private veterinarians or to streamline other functions by investing in information technology and staff training.
11.30 The Ministry of Agriculture, Forestry and Water Economy of Montenegro currently employs 83 staff organized in 5 departments. Like those of the Serbian ministry, the Montenegrin ministry’s structure and staff composition reflect the roles the ministry had in socialist times (command and control, distribution of subsidies). Thorough changes are therefore needed to develop capacity to better serve the needs of the emerging market economy. With assistance from the European Commission's Food Security Program, the Ministry is planning to reorganize in the near future.
11.31 Public Financial Support for Agriculture. The agriculture sector received substantial public financial support in the former Yugoslavia through subsidies for production, processing, farm inputs, exports and credit. Socially-owned enterprises invariably received a
242 Chapter 11. Agriculture disproportionate share of these subsidies, in addition to having Table 11.1 preferential access to foreign Budget Support for Agriculture, 2000 (mil. DM) exchange and an exemption from Federal Budget 5.3 Republic of Serbia Budget 53.7 sales and land taxes. Of which, ag. programs &subsidies 30.4 Republic of Montenegro Budget 17.2 11.32 Direct public financial Of which, ag. programs& subsidies 13.5 Total FRY Budget Support for support for agriculture is now 76.2 minimal. The Federal budget for Agriculture agriculture was only 5.3 million DM (136 million dinar) in 2000, and was used for export subsidies. The Serbian Republic agricultural budget provision was less than 5 percent of total budget expenditure during the last three years, and less than 2 percent of all public expenditure (including off-budget items). It has also fallen dramatically in absolute terms, from 237.5 million DM in 1998 to 53.7 million DM in 2000, due to the collapse of the economy and contraction of public expenditure. Agricultural programs and Subsidies were 56 percent of the agricultural budget for 2000, most of which were used for milk production4. Support for various public institutions accounted for the balance. The agriculture budget in Montenegro was 3.8 percent of total government budget, amounted to DM17.2 million for which 78 percent (DM13.5million) was for agriculture support programs and subsidies.
11.33 The Directorate for Commodity Reserves (DCR) in Serbia is the other main source of support to agriculture. This agency, which reports to the Ministry of Commerce, is responsible for holding strategic reserves of food and fuel and for stabilizing consumer prices. To this end it buys wheat at the official floor price and carries any losses associated with storage and disposal. Currently most wheat is obtained on a barter basis in return for fuel, fertilizer and wheat seed. No information could be obtained on the size of this transfer to agriculture, but its total amount has been constrained by the Serbian DCR’s limited access to resources. Officially, there also a DCR at the federal level, but it is not a major player due to a small budget.
11.34 In Montenegro, the State Institute for Commodity Reserves (SICR) is responsible for: maintaining strategic reserves of all basic food commodities and fuel. It also charged with keeping consumer prices for basic food commodities stable and low. To achieve these objectives it buys farm products (either on the world market, or locally at government-determined prices) and sells them locally at lower, subsidized prices. Due to its widespread activities on domestic and international markets, the SICR is also the principal agricultural marketing agency for Montenegro. Exemption from import duties reinforces this position. For the year 2000, the cost of these operations was DM 19 million, equivalent to 5 percent of all public expenditures. The SICR is also responsible for distributing food aid.
11.35 Most public support to agriculture is now indirect, in the form of soft budget support to socially-owned agro-kombinats and agro-processors. The losses that these enterprises initially accumulated in the banking sector (DN 1,570.8 million) were written off in March 1998. Losses have since continued to accumulate in the form of inter-enterprise arrears. Thus, while the form of public support to the sector has changed, the principal beneficiaries remain the same.
4 The arrears to milk producers were reported to be about DN 82 million.
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11.36 Trade Policy. Before 1990 agriculture made a significant contribution to the trade balance of FRY. Live animals, meat products, cereals, fruit and vegetables were the major exports and the EU was the major export outlet. The sector became a net importer after 1990 due to the loss of traditional export markets and declining domestic production. Trade patterns also changed after 1990. Any trade with Western Europe was shipped via Macedonia and Republika Srpska to avoid sanctions, and barter trade became increasingly important (90,000 tons of wheat, for example, was bartered for Russian natural gas in 2000). Illegal trade also became more widespread.
11.37 Current trade policy in Serbia is based on a complex system of import tariffs, export subsidies, import and export licenses and import quotas; which together creates a highly distorted, non-transparent environment for trade. Tariffs range from 0-40 percent. The effective level of import protection was increased further in late 2000 by new policies which require the purchase of foreign exchange at market rates. Export subsidies are paid by the Federal government. In the past these were set at 16 percent of the value of exports, but they have now fallen to 1-3 percent due to lack of public funds. As a means to improve the environment for trade, the government is now planning to remove most of the non-tariff restrictions (licenses and quotas) and to reduce tariffs.
11.38 As agriculture is heavily protected and controlled, it is subject to severe distortions. A high proportion of commodities are subject to the maximum tariff of 40 percent, and almost all are subject to licenses and/or quotas. Agricultural commodities are also subject to additional variable levies -- unit tariffs which are reviewed and modified every 3-4 months in response to changes in world prices. If tariffs were lower, the current tariff regime, which mostly fails to differentiate levels of protection for raw materials versus semi-processed and processed commodities, would avoid an element of distortion. However, with many raw materials subject to the maximum tariff, agro-processing industries are disadvantaged in exporting some products.
11.39 In Montenegro, trade policy is now based largely on import tariffs; 0-5 percent for 90 percent of all products and 10-15 percent for the rest. Although some quantitative restrictions remain, and additional seasonal tariffs are levied on certain food and animal imports during the summer, Montenegro has now a very open and liberal trade regime. There may nevertheless be some case for refining the tariff regime to allow for establishing countervailing duties in cases of unfair import competition. This would, however, require carefully considered technical assistance.
11.40 Price Policy and Subsidies. Agricultural price policy is based largely on the use of floor prices for the main products: wheat, corn, sugarbeets, sunflower, soybeans, tobacco, milk, beef, pork, and sheep meat. Wheat floor prices are supported directly through purchases by the DCR, and other floor prices are controlled administratively through oversight of the processors who purchase these commodities. In principle, the absolute level of all floor prices is determined on the basis of production costs. These prices are then adjusted to reflect a “parity system,” which fixes all input and output prices relative to the price of wheat. In fact, floor prices have fallen markedly compared to production costs, as government has kept producer prices low, and the parity ratios no longer apply. The parity system is now used only for barter trade.
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11.41 Floor prices of crops have been reduced during the last few years, as a means to keep consumer prices low. Prices were well below border prices, particularly in the year 2000. As most of the processors were (and are) substantially in arrears to producers, the effective floor prices were even lower after allowing for exchange rate depreciation. Note also that for wheat, oilseed crops, sugarbeets and milk, market prices differed little from floor prices. Producers were thus heavily taxed during the period prior to 2001 in favor of consumers. The new floor prices announced for 2001 represent a substantial increase for all commodities. They are close to border prices, however, and so are not a potential source of market distortion.
11.42 Current subsidies in the FRY agricultural budget are directed towards milk production, livestock breeding and rural development. The milk subsidy (DN1.92 /milk fat unit) is used to increase producer prices without raising the cost of raw milk for processors. To encourage farmers to breed and retain high quality cattle and sheep, farmers receive a modest, one-time subsidy payment after the first birth from approved animals. The rural development subsidy is a form of support for Agrobanka. For every two dinars lent by Agrobanka for rural development, the ministry provides one dinar to Agrobanka on the condition that this too is lent for rural development. The entire sum is then repaid to Agrobanka, at subsidized interest rates. The latter reduce the amount of the subsidy to Agrobanka by an unknown amount.
11.43 In Montenegro, until recently, agricultural price and trade policy, together with the activities of the SICR, caused severe distortions in producer and consumer prices and in the composition of processed output. Trade policy used the system of tariffs, quotas and licenses extant in FRY, but additional import subsidies were use to lower consumer prices. Import tariffs are low, however, without any peak tariffs. Producer prices were raised to levels above import parity by a combination of administratively controlled floor prices and subsidies, and consumer prices were then lowered by further subsidies to processors for bread and milk. Production quotas also applied to certain types of bread and milk. Total agricultural subsidies amounted to 5 percent of the agricultural budget and less than 2 percent of GDP. The intervention of the SCRI, which adds an additional 5 percent of the State budget to the subsidy flow, is not included.
11.44 In 2000 the EC initiated a 1 million Euro program of technical assistance to reform this incentive structure, and. some progress has also been made in liberalizing the prices of bread and milk, and removing production quotas and rationalizing the activities of the SICR. Full food price liberalization is planned for August 2001. A parallel program to introduce targeted social assistance is also being implemented to offset the hardship created by increased food prices. Further assistance will be provided to re-organize the ministry and strengthen its capacity for policy analysis.
11.45 Rural Credit. Agrobanka, a socially-owned rural bank, has traditionally been the major source of credit, deposit facilities and financial services to farmers and agricultural enterprises. Most of its credit goes to larger socially-owned, co-operative and private enterprises, but it is also involved in a small program for rural infrastructure. Commercial banks are a further, potential source of working capital for the socially-owned agro-kombinats and agro-processors.
11.46 As with most banks in the Federation, Agrobanka is now in serious financial difficulty. Loan default has been extremely high due to the low and declining profitability of agriculture
245 Chapter 11. Agriculture since 1990, and the associated collapse of socially-owned agricultural enterprises. Deposits have also fallen due to declining confidence in the banking system. These trends have also affected the other commercial banks involved in agricultural lending, with similar results.
11.47 Farms and rural enterprises thus face a severe credit shortage. There is no medium term credit, and short-term credit is available at interest rates of 5 percent-8 percent per month for those able to find it. The agriculture sector thus lacks access to working capital as well as the means to re-capitalize and invest.
11.48 Privatization. This was initiated in the early 1990’s and has proceeded on two fronts. A program of land restitution was implemented among the agro-kombinats in 1992-1993, which led to the return of some 250,000 ha of land appropriated after World War II. This program had the additional benefit of significantly down-sizing most agro-kombinats. A concomitant program was initiated to convert the socially-owned agro-processors and agro-kombinats into joint stock companies and to privatize their assets. This involved the transfer of 60 percent of the value of the enterprise to managers and employees and sale of the remaining assets on the open market.
11.49 Many of the agro-processors, both in Serbia and Montenegro have completed this process, although their approach to management has changed little. Progress has been minimal among the agro-kombinats due to uncertainty as to the future status of state-owned land. Existing legislation allows for this land to be held under a vaguely defined use right, and so lacks the clarity essential for private use or ownership. Prospective purchasers are thus unsure what land rights they are acquiring and what rights they will have in the future. Unfortunately, the proposals for new privatization legislation do not appear to address this issue. Note that not all of the land held by the agro-kombinats is in this category. An estimated 50 percent of their land was purchased from private owners and so can be transferred relatively simply from the state to private enterprise.
11.50 Land Policy and Administration. In principle, the predominance of privately owned land provides the basis for an active land market. In practice, widespread deficiencies in the “two book” system of land administration make it difficult to establish ownership and so to transfer property efficiently. While the cadastre is complete for all land, the land register is only complete and up-to-date for one third. In response to this problem, a sophisticated, computerized system has been set up to reconcile and update the cadastre and the land register. This will eventually replace the land register with a “Real Estate Cadastre” which will be the repository for a wide range of digitized information. Only 10 percent of the total land area has been subjected to this process however, and priority has been given to urban areas.
11.51 There are no restrictions on the maximum area one person can own (a previous law to this effect was repealed in 1992), and land transfers are subject to a moderate 3 percent tax. A modest land tax is levied on private farmers based on eight categories of land type and land use. Agro-kombinats are exempt from this tax.
11.52 Agricultural Extension. In Serbia, the Institute for Applied Research in Agriculture (IARA) is responsible for agricultural extension. Established in 1996, it is highly decentralized, with a small headquarters in Belgrade which co-ordinates the activities of 33 autonomous
246 Chapter 11. Agriculture regional offices throughout Serbia. IARA's headquarters are also the focal point for co-operation with research institutes and academia. Most of its financial support comes from the MAFWE budget.
11.53 In addition to extension activities, such as crop demonstration trials, the Institute is also responsible for plant disease forecasts, the testing of soil, fertilizer, agricultural machinery, animal feed and milk, plus rural development programs, yield estimates, animal husbandry, herd books, progeny testing, agriculture fairs, etc. To implement these tasks, the regional offices have substantial physical resources (413,500 ha of land, 21,170 m2 buildings, about 140 vehicles), plus laboratory facilities for soil and seed testing, plant protection, chemistry, product quality control and animal feed testing. In 1999 they employed 730 staff.
11.54 In the past IARA activities focused on socially-owned enterprises. These enterprises then served as the main link for support for private farmers. However, the prevailing emphasis on specialized, high-technology management systems was of limited relevance to small-scale private farmers. As the agro-kombinats are barely functional, there is no longer any formal structure for agricultural extension in both Serbia and Montenegro. Thus, the agricultural extension system needs to increase its capacity to support the diversified farming systems of small farmers.
11.55 Agricultural Research. The agricultural research system consists of numerous research institutes that vary in size from small spin-offs of the agro-kombinats to the “Agriculture Research Institute – Serbia” that employs 580 staff. The main institutes led national research programs in the former Yugoslavia. The Republican Ministry of Science and Technology (MST) is responsible for all research, including agriculture research. Most of the limited research funding comes from MAFWE. In the past, research was also funded by the agro-kombinats and commodity boards.
11.56 FRY has a strong tradition of agricultural research, particularly in the area of plant breeding, and long-standing links with many western research programs. A number of corn varieties are included on the EU variety list, and domestic sunflower varieties have a large share of markets in Italy and France. Most of this research has been directed towards output- maximizing technologies for the socially-owned enterprises, however, with little attention to the needs of small-scale private farms, including their profit maximization. Funding is also based largely on scientific merit, with little consideration of the farm-level impact of the research. These incentives need to be redirected to promote research that will lead to higher productivity in small farms.
11.57 Despite the scientific isolation and lack of resources during the last 10 years, the largest institutes have managed to maintain their technical capacity in terms of both equipment and skilled staff. They have also been quick to re-establish the international links they had in the past and are developing closer ties with the international seed companies. Due to the non-enforcement of intellectual property rights and the lack of public funding, the larger institutes have also developed large-scale seed and seedling production operations, which generate 90 percent of their income. If the institutes are privatized, there would appear to be scope for commercial collaboration with international seed companies.
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11.58 In Montenegro, agricultural research is carried out at the Biotechnology Institute of Podgorica, which is part of the University of Montenegro. There is also an Institute of Marine Biology there, which provides services to fisheries. There is no formal structure for agricultural extension to extend new technologies from research. Research results are disseminated through the Institute’s own journal and through the media.
11.59 Agricultural Education. There are five faculties of agriculture and 35 vocational agriculture and animal science secondary schools in the FRY. The two largest agricultural faculties, in Belgrade and Novi Sad together employ 860 staff and are attended by some 5000 undergraduates. The faculties in Krusevac and Sombor were established recently to cater for staff and students from Kosovo and Croatia, respectively. These four faculties all follow the Soviet model of education, in which students specialize very early in their programs. Only in the small faculty in Cacak is a more general education provided. All of these programs are oriented towards output maximization. Training in farm management and agri-business is weak. There are veterinary faculties in Belgrade and Novi Sad. All institutions are financed by the Ministry of Education, with supplementary funding from MST for research.
11.60 Food Security and Rural Poverty. Aggregate food supply has remained adequate throughout the last 10 years, and government programs to distribute basic food commodities to vulnerable groups have been sufficient to prevent severe hunger. Low, controlled prices for basic food commodities and utilities have further mitigated the impact of economic hardship. Household poverty and food insecurity have increased nevertheless, due to the significant fall in real incomes. Recent analysis shows that 29.4 percent of all households fell below the poverty line5 in 1999, compared to 23.1 percent in 1992.
11.61 Urban wage earners and welfare beneficiaries have been hit hardest by the deterioration in economic conditions. Only 13 percent of agricultural households (those that rely wholly on farm income) were below the poverty line in 1999, a level similar to that observed in 1992. These are most likely to be older farmers, or farmers with limited land and capital resources. Among mixed households the level of poverty increased from 16.5 percent to 27.6 percent from 1992 to 1999, due to the fall in the urban component of their incomes. No extreme poverty (measured as 50 percent of the poverty line) was observed among either agricultural or mixed households. Among non-agricultural households, approximately 33 percent were below the poverty line in 1999, and 3.3 percent were in extreme poverty.
11.62 The economic reforms initiated in October 2000 have hit urban households hardest, as food prices have increased markedly in response to the liberalization of price and exchange rate controls. Farmers gained from these reforms through higher producer prices. As a market-based exchange rate is now in place, and producer prices are now close to border prices, any further increases in food prices are unlikely to be major. Indeed, the proposed liberalization of trade will help consumers, as food prices should fall as a result of increased trade flows and lower levels of protection. There is considerable pressure to further raise farm incomes however, through increased subsidies and/or higher producer prices. The upward pressure that this puts on consumer prices will depend on future policies for trade and agricultural subsidies.
5 Defined as the value of a consumer basket of food and beverages, as determined by the Federal Office of Statistics.
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11.63 The immediate issue for aggregate food security is the level of the wheat and corn harvest for 2001. A poor harvest would create considerable hardship for rural households. Their reserves of food and capital have been depleted by ten years hardship and the drought and floods of 1999/2000. With a good harvest, production will probably be sufficient to meet domestic requirements and even allow farmers to rebuild stocks. Donors and government should, however, take care to avoid food aid and farm inputs at a level that would disrupt normal markets for these commodities. The building of commercial trading networks, after all, is one of the objectives of agricultural development.
C. SECTOR CONSTRAINTS AND CHALLENGES
11.64 Agricultural production and productivity are low despite a favorable natural resource base. Crop yield is low by western standards and production has fallen markedly during the last 10 years. Product quality is low and less marketable. This is largely due to structural problems extant before 1990. Sanctions, war damage, deteriorating physical infrastructure and drought and floods have worsened yield substantially. Modern, profit-oriented farming systems, suited to small-scale agriculture, are needed to increase production, productivity and marketability. However, the development of private sector faces the following constraints:
11.65 A distorted incentive structure has inhibited production and marketing, taxed producers and led to a severe depletion of the sector’s capital resource base. Traditional price, trade and subsidy policies distorted incentives, allocated most public support to socially-owned agro-kombinats and agro-processors, and inhibited private sector activity in the markets for key agricultural commodities. Policies since 1990 have increased these distortions and heavily taxed agriculture in order to keep food prices low. The associated collapse of the socially-owned agro- processors and agro-kombinats, which dominate agricultural markets, has paralyzed the markets for major commodities. Farmers and agro-processors have survived by reducing their level of input use and running down their capital base (livestock, machinery, soil fertility and processing plant).
11.66 A substantial reform of agricultural trade and price policy is needed in order to create a more appropriate incentive structure. Such reforms would also establish a strong basis for negotiating membership in the WTO. Many of the reforms to the incentive structure could be carried out rapidly and would induce a correspondingly rapid (“early-win”) increase in agricultural production. In the case of some reforms, however, the need to phase in adjustment for social reasons or the existence of other constraints may force a more deliberate pace.
11.67 The collapse of the rural finance system limits the capacity of producers and processors to restore their capital base and respond to improved incentives. The problems of the banking system (see Chapter 6) have severely reduced the availability of working capital and credit for investment. With some past exceptions related to directed credit, banks do not offer medium term credit to agriculture and agriculture-related firms. Short-term credit is available only at high interest rates. The system where agro-kombinats would pass through working capital to small farmers by advances of inputs has faltered under the enterprises’ financial stress, and input use has consequently fallen drastically. Improved access to credit is thus essential for recovery and transition.
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11.68 The access of the agricultural and rural sectors to credit needs to be increased through strengthening of financial institutions, including commercial banks, savings and loan associations and micro-credit institutions, and through a pass-through of working capital from well-financed processors and suppliers.
11.69 Most public institutions still operate on socialist principles. They were isolated for the last ten years and are ill-suited to a market economy. Because of the turmoil of the last decade and the continuation of socialist government, public agencies have not adapted to the economic transition as have their counterparts elsewhere in Central and Eastern Europe. Socialist policies and institutional structures (albeit with a distinctive Yugoslav flavor) thus have continued to the present. A consequence of policies and structures not changing is that ministry and agency staff have not had experience with a liberalized market economy and are not equipped to deal with it.
11.70 A wide-ranging reform of public agriculture institutions, strongly supported by staff training on the role government should play in a market agricultural economy, is needed to establish a more appropriate institutional framework. Many activities currently sub-optimally performed by the government can and should be transferred to the private sector. The remaining public sector activities need to be strengthened and re-oriented.
D. PRIORITIES AND INVESTMENTS FOR RECOVERY AND TRANSITION
11.71 Following is a discussion of key priorities for recovery in the agricultural sector, with suggested supporting activities for donor financing. The external financing requirements, on a commitments basis, identified are presented in Table 11.2 at the end of the chapter.
11.72 Three broad sets of constraints must be addressed if the agriculture sector is to recover, begin the process of economic transition and realize its potential. A highly distorted incentive structure inhibits agricultural production and market activity; the private sector lacks both the capital resources to re-build its depleted resource base and the capacity to establish more efficient production and marketing systems; and public institutions are ill-suited and ill-equipped to support the agricultural sector in a market economy. These constraints are largely the result of structural problems within the sector, rather than sanctions and war or the recent floods and drought and should be addressed as soon as possible.
11.73 In response to these constraints, the government, supported by the international community in some cases,6 should focus its attention in three areas: • Measures to improve the incentive structure for agricultural production, marketing and trade, • Measures to promote private sector activity and investment in agricultural production, processing and marketing,
6 The EC, for instance, will address the following issues in its assistance program to Serbia (private communication to the Bank 4/10/2001): strengthen Ministry of Agriculture for policy analysis and design, strengthen institutional framework of the agriculture sector, improve coherence of agriculture and agro-industrial policies, and analyze market infrastructure and services.
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• Measures to modernize and strengthen the public institutions responsible for agriculture sector development.
11.74 Short and medium-term priorities associated with each of these themes are outlined below. Short-term refers to the period until the end of 2002, and medium-term to the period to 2003 and beyond.
11.75 Montenegro is more advanced than Serbia in measures to improve the agriculture incentive structure, since it started the reform process before 2000. Montenegro should therefore concentrate on: • Measures to promote private sector investment, to revitalize the tourist industry and strengthen public institutions.
Improving the Incentive Structure for Production, Marketing and Trade 11.76 Trade Policy. In a small country such as FRY, an open, liberal trade policy is the optimal basis for an incentive system for agriculture (in addition to its broader benefits for all sectors of the economy). With moderate import protection, farmers using existing technology will have adequate incentives to produce and invest. Given a simple system of tariffs, price signals will be readily transmitted from international to domestic markets (albeit with the add on of tariffs) and producers will be able to allocate their resources more rationally. A trade-based incentive system also reduces the need for direct support in the form of subsidies, or floor prices backed by public purchases, and so is more consistent with the limited budgetary resources of the Federation and Republican governments.
11.77 Short-Term Measures. With the leadership of the Federal Government, the republic governments should continue to carry out and, in the case of Montenegro, deepen general reform and liberalization of trade. With respect to agricultural commodities, this will involve abolishing quotas and licenses; terminating variable levies and establishing a tariff regime that provides moderate protection to agricultural commodities.7 • Because of the unique relationship between agricultural support programs in FRY and the EU and trade policy, donor technical assistance from agriculturally attuned experts will be needed to support trade liberalization in agriculture and assist the government in developing a position on agricultural commodities for WTO and other trade negotiations.
11.78 Medium-Term Measures. The Republican governments should continue agricultural trade reform backed up by continued liberalization of internal agricultural markets. • Donors should continue the technical assistance program to agriculture ministries on agricultural trade reform and trade negotiations.
11.79 Price and Subsidy Policy and Public Expenditure. Direct public support for production, processing and agricultural institutions, and government intervention in agricultural markets is likely to continue in some form. As severe budget restrictions currently limit the capacity of government to influence production and agricultural markets, the immediate aim should be to
7 The trade reform process in Montenegro has been and continues to be assisted by technical assistance from the EC.
251 Chapter 11. Agriculture target this intervention more effectively. Floor prices should be applied to a much smaller group of key commodities, and controls on consumer prices should be phased out. Once public expenditure begins to increase, the challenge will be to discern more appropriate, fiscally sustainable levels and forms of public support for both public institutions and producers and processors and ones that least distort producer incentives.
11.80 Short-Term Measures. The Serbian government should carry out liberalization of price policy, including measures such as: the removal of floor prices on most commodities, once an acceptable new tariff structure is in place; termination of the parity system, other than its transitional role as the basis for barter trade; the removal of margin controls on wholesale and retail prices; and the progressive relaxation and eventual removal of the price controls on bread and milk. • Donor technical assistance is needed to give analytical support to this reform of price and subsidy policy. With assistance of the European Commission, programs on liberalization of prices of flour, bread, milk and fuel are actively being pursued in Montenegro. During the transition to liberalized food prices, donor programs should avoid creating market distortions and, in particular, food aid, if monetized, should respect the principle of import parity price.
11.81 Medium-Term Measures. The Republican governments should broaden the focus of reform of the agricultural incentive system to cover issues such as termination of soft-budget support for socially-owned enterprises, reallocation of the agricultural budget to better serve the emerging market economy, and the transition path for each commodity to reduced or no subsidization. • Donor technical assistance to this process will need to continue in the medium term.
11.82 Commodity Reserve. It is important to include the Directorate for Commodity Reserves (DCR) and State Commodity Reserve Institution (SCRI) in the ambit of measures to improve the incentive structure. The agency has wide-ranging powers to intervene in agricultural markets and to influence producer and consumer prices. Due to the traditional secrecy surrounding its operations, these powers are typically exercised in a highly non-transparent manner. This combination of pervasive power and non-transparent action creates considerable uncertainty and instability in agricultural markets.
11.83 Short-Term Measures. The Federal and Republican governments should make the DCR’s and SCRI’s activities more consistent with the operation of a market economy, including: a reduction of the number of commodities under its mandate for food security, a phasing out of its involvement in short-term price stabilization, reduction and then termination of its involvement in barter transactions, and improvements in the transparency of its funding and operations. • Donor technical assistance will be needed to help design the reforms and their implementation, with attention to designing alternative mechanisms to replace the in-kind working capital now provided to some farmers.
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11.84 Medium-Term Measures. The government should gradually reduce the public commodity reserves and redefine the role and activities of DCR and SCRI in line with the recommendations of the EC technical assistance mission..
11.85 Donor technical assistance in helping to design the Serbian DCR’s evolution will be valuable. Under the support of the EC, a policy on redefinition of the role and activities of the State Commodity Reserve Institution in Montenegro has been already proposed and agreed by the Government. The process is due to begin from August 2000 with the eventual commercialization and privatization of any residual functions to be completed during the course of 2002.
Promoting Private Sector Activity and Investment in Production, Processing and Marketing 11.86 An appropriate incentive system is a necessary but not sufficient condition for sector recovery and transition. In the short run, agricultural and livestock production needs to be supported by an infusion of critical inputs. Farmers and processors must also have access to credit to reconstitute their capital base and introduce modern technology. Structural problems involving privatization of the agro-kombinats and the development of small and medium-sized processors, suppliers and traders should be tackled to achieve sustained growth and lay the basis for quality improvements and exports. Longstanding neglect of the irrigation system reduces production and is a major impediment to improvements in quality. Finally, private producer organizations need to serve and educate their members and place their concerns effectively before government are a key element of an agricultural growth strategy.
11.87 Input Supply for Farmers. Immediate actions are needed to support agricultural production, especially in view of another possible drought season. Last year’s drought has put severe stress on livestock production. The dairy sub-sector is most affected by poor nutrition, as dairy cows need concentrate for milk production. The average age of tractors and combine harvesters is about 15 years and half are estimated to be non-functional, due to lack of spare- parts, tires and fuel. There is a short-term need to have the combine harvesters and tractors functional to harvest wheat and prepare land for corn and other summer crops. Direct donor provision of farm inputs should be temporary, and where possible they should be sold or auctioned off to as a means to stimulate private sector activity in farm input markets. 11.88 Short-Term Measures. The Serbian government has indicated that there is a need for fertilizer, pesticides, herbicides, feed, fuel and spare parts for this year’s growing season in order to maintain food production. • Donors have already pledged assistance of 70,000t of fertilizer (as of February 2001).8 The Serbian government has decided to allocate DN920 million (US$15.33 million) for a fuel subsidy for the spring sowing season; the subsidized fuel will be DN10 per liter
8 The Japanese Government is now providing US$4.3 million for fertilizer for wheat, equivalent to about 21,500 tons of urea. Supplies have just arrived in country. European Reconstruction Agency (ERA) will supply 40,000t of fertilizer (25 percent urea and 75 percent NPK 15:15;15); delivery time is still unknown. The Agency is providing Euro 8 million for animal feed (maize and soybean meal). The Norwegian Government has pledged DM 3.5 million for inputs (gas and ingredients) for the Pancevo Fertilizer Plant. The plant is expected to produce 8,910t of nitrogen monthly (30,000t of KAN [20.6 percent nitrogen] and 6,000t of urea [46 percent nitrogen]).
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cheaper than the market price. Thus far, ERA is committed to provide Euro 8 million for animal feed aimed at dairy cattle9 and USDA 15,000t of soybeans. The government has received additional donor pledges of feed. The cost of equipping shops with spare-parts is estimated at US$ 5 million.
11.89 Medium-Term Measures. Beyond the need to provide input supply in the short-run, it will be necessary to set the conditions for sustained development in the private input supply sector. • Most important will be the removal of state enterprise monopolies and tax and other advantages not available to private firms. • Facilitate the establishment and growth of private agricultural firms through, for example, reduction of the regulatory burden and improvement of access to credit.
11.90 Rural and Agricultural Credit. Short-Term Measures. The Federal and Republican governments should support a viable system of financial institutions including commercial banks, savings and loan associations and micro-credit institutions which will adequately serve the rural and agricultural sector. Loan guarantee schemes could also be introduced initially in support of this process. • Donor technical assistance will be needed because of the complexity of the issues and the institutional development. • Donors may finance credit lines for farmers for working capital (so they can purchase fertilizer, seed, feed, spare parts for farm machinery). This would be the preferred mode of assistance rather than direct distribution of commodities, because it would support the development of private commercial supply.
11.91 Medium-Term Measures. The governments should continue to develop and strengthen financial institutions serving rural communities and agriculture-related customers. Medium-term credit lines to finance investment in farms, processors, suppliers and rural infrastructure should be introduced and extended to qualified borrowers. It should be understood that working capital borrowed by suppliers and processors would need to be adequate for them to further extend in- kind credit to farmers for such items as seed and equipment. In parallel, micro-credit schemes designed along lines that have worked in Montenegro and other Balkan countries should be piloted. The USAID Land O’Lakes credit program for livestock, for example, has worked well in Montenegro and should be expanded. The incentives for banks to extend rural credit should also be improved. A more streamlined process of foreclosure (which currently takes 3-5 years) should be introduced to this end, together with a more rational use of land as collateral (lenders currently require land assets worth twice the value of the loan). More importantly, the ability of bank staff to assess risk and manage loans will be improved through further training. • Donors should provide financial assistance to a range of financial initiatives and continue technical assistance and training to support the development of effective rural and agricultural finance.
9 Information as of late April 2001 is that the total ERA commitment will be Euro 18 million for fertilizer and animal feed.
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11.92 Privatization and SME Development. Short-Term Measures. The Republican governments should continue their efforts to accelerate and rationalize the privatization process. Agriculture constitutes a special case of privatization with unique problems that have not been optimally addressed in the privatization efforts in other countries. For example, special attention needs to be paid to agro-processing and agricultural supply enterprises owned by agro-kombinats (AKs), because of the key role of dynamic agri-business firms (but not monopoly-positioned, stagnant ex-agro-kombinat enterprises) in inducing farmers to develop demand-led, competitive agriculture and in financing inputs.
11.93 The governments should also start to grapple with the unique problems of privatization of AK-held farmland. To prevent low-productivity use of this land, the government should not make public land available to AKs or ex-AKs on a soft, long-term lease basis but, rather, provide for transition to market lease rates and eventual sale with significant land taxation. • Donors should provide technical assistance to: (1) assess on a case-by case basis the viability of individual agro-processing and agri-business enterprises, analyze their privatization and business plans, and determine how their corporate governance and social obligations should be structured so as to maximize the chances that they could become dynamic private firms rather than value-subtracting entities, (2) assess the state of wholesale agricultural markets; and (3) assess the state of SME agricultural processors and suppliers, determine their needs and constraints, and develop proactive proposals to assist them.
11.94 Medium-Term Measures. The Republican governments need to develop and implement programs to support SME agricultural firms. Depending on the success of the privatization and restructuring of ex-AK processors and suppliers, governments should very selectively assist these firms to gain access to private capital markets and provide other assistance as warranted. Legislation associated with the use and ownership of state owned land will need to be reviewed and amended, and the privatization of the agro-kombinat farming enterprises completed. Once the legal problems associated with land ownership are resolved, support for privatization of the farming agro-kombinats should be implemented on a similar basis as for the ex-AK agro- processors and agri-businesses. As for the sale of AK-land to private farmers, land should be made available in small parcels so that small farmers are able to augment the size of small farms with ex-AK land. • Because of the uniqueness and complexity of privatization and SME development in agriculture, donors should provide technical assistance targeted at these issues. • When there is full government commitment to take necessary measures, donors may also consider financial support for aspects of privatization, SME development and market infrastructure identified by the analysis.
11.95 Irrigation and Drainage. The most urgent tasks for the Serbian government is to rehabilitate drainage canals to reduce water-logging and provide supplementary water supplies for crops during the summer. The area that needs drainage is an area of 2 million ha, of which only 22,000 ha is protected. The rest is prone to water-logging. The existing drainage canals do not work well, due to lack of maintenance, fuel and spare parts for pumps.
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11.96 Short-Term Measures. The Serbian government should initiate planning for irrigation and drainage rehabilitation as soon as possible. Some drainage rehabilitation can be carried out on an expedited basis with major productivity impact. • Donors should consider providing technical assistance on irrigation and drainage issues, which will also demonstrate the necessary linkages among irrigation, better seeds, appropriate fertilizer, cultivation practices and cropping patterns. • As part of credit assistance to small farmers, particularly small vegetable and fruit (e.g., berry) farmers, donors could develop a program to enable farmers to finance well-based irrigation.
11.97 Medium-Term Measures. Because of the potentially large amounts of investment involved, the government needs to further develop its capability to plan for the long-term need for irrigation in FRY agriculture, both for major rehabilitation of the existing system and potential expansion of the system.10 • Donors should consider supporting this long-term process by providing technical assistance to the relevant government agencies and to producer organizations. • Donors should consider financial assistance to rehabilitate selected irrigation and drainage canals to reduce water-logging and facilitate irrigation, and in the long-run to consider extension of the system.
11.98 Private Sector Agricultural Organizations. The Federal and Republican governments should review the legislative basis for the business activity of organizations and that of cooperatives and other NGOs. Active, viable organizations will be essential in the development of a competitive agriculture sector. Viability of organizations, in turn, depends on their being able to make profits on services provided so as to sustain professional activity, but current law does not allow them to engage in commercial activity. Organization can also allow small agricultural traders and processors in commodities to increase their access to credit. The law on cooperatives needs to be revised to provide for members’ democratic rights, the financial and organizational sustainability of cooperatives and compatibility with EU standards. • Donors should consider providing technical assistance to the governments in developing legislative proposals. • Technical and financial assistance to establish associations of small producers, processors and traders and to improve their business management should be considered. • In conjunction with the private chambers, donors may want to finance activities such as trade fairs and exchange visits by businessmen from Western and Eastern Europe, as a means to promote agricultural exports.
10 The Minister of Agriculture, Forestry and Water Economy of Serbia announced in March 2001 that an Israel investment group (Marhaav Investment Group) was prepared to invest US$ 350 million in new irrigation construction for 200,000 ha. in Vojvodina, Central Serbia and the Velika Morava River valley. Additional information and technical and economic evaluation will be needed to assess this proposal.
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Modernizing and Strengthening Public Agricultural Institutions 11.99 The ministries of agriculture, the separate institutions responsible for education, research and agricultural extension, and the agencies responsible for the quality standards of food and agricultural products are ill-equipped and organizationally ill-suited for operation in a market- oriented economy. These institutions will need a wide-ranging restructuring to redefine their roles, reorganize their structures and acquire new skills and technology and transfer many of their traditional roles to the private sector.
11.100 Ministries of Agriculture. Short-Term Measures. The Federal and Republican governments need to (i) analyze their new roles and responsibilities and make a clear delineation of the roles and responsibilities of the respective ministries of agriculture; (ii) reorganize these ministries to be consistent with these roles and responsibilities; and (iii) begin a process to strengthen their capacity for policy analysis, policy formulation and regulation appropriate to a market economy. A start should also be made in the privatization of such activities as the veterinary service. • Donors could provide technical assistance to support the institutional strengthening process and to assist in the design of privatization of functions. The EC in Montenegro is examining the reorganization of the Ministry of Agriculture. Additional technical assistance will nevertheless be required in the technical aspects of regulation of agriculture, livestock, fisheries and forestry in a market economy.
11.101 Medium-Term Measures. The respective ministries should prepare a well coordinated medium-term strategy for agricultural sector development. • Donors should consider providing technical assistance to complete the reorganization and strengthening of the ministries and to support the medium-term strategy. • In particular, donors could provide assistance to the ministries in expanding, improving and restructuring their policy analysis and statistics units.
11.102 Plant and Animal Health. Short- and Medium-Term Measures. The Federal government needs to introduce legislation on protection of plant and animal health that it is consistent with EU standards, modernize the laboratories and facilities that perform this role, and train staff to use upgraded equipment. It should vigorously apply the new legislation and establish an appropriate institutional framework to monitor and enforce the revised standards. • Donors would have an important role in technical assistance in plant and animal health and disease control.
11.103 Agricultural Research, Education and Extension. The institutions responsible for agricultural research, extension and education are fragmented, over-scaled and involved in too many activities that could be performed by the private sector. While public research institutes should continue to conduct basic research and breeding of new varieties, activities such as field testing, seed multiplication, quality control and certification of agricultural commodities could be transferred to the private extension services and to certified private commercial laboratories. A wide-ranging reform of research objectives, university curricula and extension systems is also needed if these institutions are to provide strong support to the small-scale, private farms that
257 Chapter 11. Agriculture dominate agricultural production. In the future the emphasis should be on training people to understand and improve the mixed farming systems of small and medium-sized farmers, rather than concentrating as at present on the specialized farming systems of large farms. In both types of farming systems, training should emphasize the need to maximize profits rather than output.
11.104 Short-Term Measures. The Republican governments should establish links between universities and research institutes in FRY and Western institutions, as the basis for modernising curricula and research programs, and develop a more appropriate institutional framework for research, education and extension institutions. The governments should train extension staff in the areas of farm business management, and the use of modern farm technology, especially as it applies to small farms. Donors should consider: • Providing technical assistance and assist in the reestablishment of links with Western universities and research institutes • Financial assistance to update libraries and research equipment
11.105 Medium-Term Measures. The governments should adapt research and teaching agendas to reflect policy priorities and continue to upgrade research equipment and facilities. They should introduce fees/cost recovery to the extension activities of the Institute for Applied Science. The governments should also promote the establishment of additional private sector extension services in agri-business enterprises, agro-processing firms and co-operatives. • Donors should continue to provide technical assistance to the governments. They should also give support the private sector agencies that will assume responsibility for agricultural extension.
11.106 Quality Standards for Agricultural Commodities. FRY exporters will experience difficulty in expanding their exports of fresh and processed food to international markets unless the quality of these exports is markedly improved. Improved quality will depend on cost- efficient improvements in production, processing, grading, logistics and other fundamental aspects of agriculture and trade. Customer perceptions of quality will also depend on the marketing effectiveness of FRY exporters, the product characteristics currently being demanded in export markets, and the goods offered by competitors.
11.107 Short-Term Measures. As part of the drive to improve export quality, the governments need to bring quality standards up to and consistent with EU standards. To do so, it will among other things need to develop a more appropriate institutional framework for monitoring and enforcing food quality standards, to privatize appropriate laboratories, and to provide its agencies with modern laboratory equipment and retrained staff. Donors should consider: • Providing technical assistance to review and adjust food quality standards to the levels required for entry into EU markets, to develop the institutional framework for monitoring and enforcing these standards, including privatized laboratories and agencies where appropriate. • Providing financial assistance to modernize laboratory equipment and train staff. The EC is providing financial support to purchase laboratories equipment for milk quality control.
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• Providing parallel support to the private-sector agencies that will assume responsibility for activities such as quality testing.
Table 11.2: Agricultural Sector: Proposed Investment Program (US$ million) CY01 CY02-04 Program Total Recurrent Costs Critical Fertilizer/Other inputs 15.0 10.0 Total Recurrent Costs 15.0 10.0 25.0
Investments Water Resource Management/Rehabilitation 12.0 15.5 Total Investments 12.0 15.5 27.5
Credit/Equity Investments Working Capital for Farm Inputs1 27.0 24.0 Medium-Term Credit for Investment 0 60.0 Total Credit/Equity Investments 27.0 84.0 111.0
Technical Assistance Improving the Incentive Structure Reform of the Incentive Structure 1.0 2.0 Trade Policy 1.0 2.0
Promoting Private Sector Activity Strengthen financial institutions lending for 1.0 3.0 agriculture Agro-Processors & SMEs 2.0 6.0 Reform legislation for state owned land 1.0 0 Agro-kombinats 2.0 4.0 Support to farmer and trader associations 2.0 2.0 Reform the legislative basis for small business 1.0 0
Modernizing and Strengthening Institutions Strengthen ministry capacity for policy analysis 1.5 1.0 and formulation Prepare a medium-term strategy for agriculture 0 1.5 sector development Strengthen phyto-sanitary and veterinary systems 1.5 3.5 for pest and disease control Review and reform quality standards 1.0 0.5 Strengthen the institutions for research, education 2.0 12.0 and extension Total Technical Assistance 17.0 37.5 54.5
TOTAL 71.0 147.0 218.0 1/ Including Euro 18 million, which the EU has pledged for fertilizer and feed, and Euro 2 million allocated for capacity building including TA.
259 CHAPTER 12. ENVIRONMENT
A. INTRODUCTION
12.1 The Federal Republic of Yugoslavia (FRY) has a diverse landscape and rich biodiversity, and has developed a legal framework for environmental management and protection. The Federal Government is committed to pursue a path of sustainable development. There is awareness for environmental protection and improvement. Montenegro, for example, has declared itself to be the world’s first “ecological state,” and has pledged to live in harmony with nature1. The past conflicts and economic hardships have resulted in negative impacts on the environment, and have disrupted environmental management systems. As a result, the overall capacity to address environmental problems has been weakened.
12.2 In general, there seems to exist awareness for environmental protection, and people of Yugoslavia recognize the need to improve the environment. But given the current economic situation, neither the people nor the Government may be in the position to devote significant domestic resources to improve the quality of the environment2. Under these conditions, there is a high risk that the economic recovery and transition program would focus on short-term policy and investment solutions and ignore their environmental impacts. Another risk is that decision- makers would perceive due diligence for environmental concerns as an impediment to economic growth.
12.3 The draft note has been prepared on a basis of a desk review3. There are difficulties with the data since estimates differ widely between reports. Although the state of the environment has been monitored during the past years, the lack of harmonized methods prevents of getting a full insight into the current status of the environment. Problems also exist in assessing the impacts of the war on the environment. Although the Yugoslavian officials and researchers have shared the findings and results of the UNEP team as reported in the UNEP/Balkans Task Force Report and the FRY Report, the interpretation of some of the findings is different. The lack of reliable baseline data does not allow reaching a definitive conclusion on whether the impacts were the results of neglected measures to deal with pollution or were the result of the Kosovo conflict.
12.4 This note aims to present the current baseline for assessing environmental conditions and identifies the key environmental issues and concerns both green and brown4 that must be
1 In 1991, a Declaration was passed which asserts that the Republic of Montenegro is an “Ecological State,” the first in the world. The Declaration focuses on creating sustainable development in the Republic of Montenegro. 2 Environmental improvements at the margin will come from policy-based reforms on trade, privatization, economic and energy/water price reforms, foreign direct investment, addressing non-payment problems in utilities. 3 References consulted to prepare this section are listed in the reference section of the report. The key references are: Consequences of NATO Bombing for the Environment in FRY (2000) by the Environmental Department, Former Federal Ministry for Development, Sciences and the Environment; State of the Environment (1996) by Simic Jadranko; and State of the Environment and Environmental Policy (1989) by Sofija Borovnica 4 Green issues deal with more efficient use and conservation of natural resources and brown issues deal with reducing pollution pressure on the population and natural resources. Chapter 12. Environment properly integrated into other sectoral strategies to ensure that the economic recovery and transition program is carried under a framework of long-term sustainable development. A number of recommendations for an environmental agenda in the near-term and medium-term are outlined, and an indicative donor program is presented in Table 12.3 at the end of the chapter. External financing requirements identified for the environment total US$95 million over three to four years. Identified needs, on a commitment basis, for the first year of the program total US$38.5 million.
B. ENVIRONMENTAL SITUATION Geography and Natural Resources
12.5 The FRY has a total area of 10.2 million hectares (ha), Serbia 8.8 million ha and Montenegro 1.4 million ha, with a diverse topography and high biodiversity. The country’s terrain ranges from a flat and rich fertile plains in the north, to hill and high mountains in central and southern Serbia, to a section of the western Balkan Peninsula’s Karst region in Montenegro, and to a narrow coastal plain southwest bordering the Adriatic Sea. The climate conditions also vary from one part of the country to another. While the northern part is characterized by having continental climate with cold winters and hot, humid and rainy summers, the southern coast has a Mediterranean climate with hot, dry summers and relatively cold winters with heavy snowfall inland. The varied terrain, climate and hydrology have lead to the creation of rich ecosystem diversity within the territory of the two republics. The ecosystems of FRY encompass most of the major European habitats or 7 out of total of 12 terrestrial biomes on earth.
12.6 Overall average annual water resources in Yugoslavia are estimated at about 1,500 cubic meter (m3) per capita. The country is poor in terms of internally renewable water resources, since about 84 percent of the available resource originates abroad. The most important river in the FRY is the Danube, which enters the country from Hungary and flows through the northern plains to Romania and then to the Black Sea. The Morava, Sava and Tisa rivers, which flow through the territory of Serbia, are tributaries to the Danube. More than 90 percent of the Serbia territory drains into the Danube River, while the remaining of the country drains into the Metohija Basin within the Adriatic drainage basin.
12.7 Forest resources in Yugoslavia are considered of national and international significance on the basis of the number of tree species, their diversity and primary gene center. Forestland covers about 3.3 million ha (in 1995), of which 2.93 million ha are under forest cover. Forests cover 28 percent of the territory5. Forestry represents one of the most important natural resources for Montenegro, where forests cover 680,000 ha or 39 percent of its territory. Although the share of the forest sector in the national income is small, about 0.5 percent of Gross Social Product6 (GSP) in Serbia and 1.0 percent in Montenegro, forests provide important environmental, biodiversity and recreational benefits. The total economic value of forest resources is however much higher. The analysis in neighboring Romania estimated the total
5 Yugoslavia Survey (2000) and Statistical Yearbook of Yugoslavia (1999). 6 GSP is about 15-20 percent smaller than the GDP as it excludes public and other services. The size of the forestry sector in the overall national income is low because forestry products’ price was kept under government control – the price of most type of timber has been 2-4 times lower than international prices.
261 Chapter 12. Environment economic value as high as US$3.3 billion per year or three times the timber value. The current protected areas legislation designates about 400,000 ha or 4 percent of the territory as protected natural areas. Valuable objects of environment and biodiversity protection include 7 internationally protected areas, 9 national parks, 16 regional natural parks, 26 splendid areas and 89 nature reserves, representing 3 percent of the territory. The target under the current Spatial Plan of the Republic of Serbia is to protect 10 percent of the country by year 2010.
Environmental Situation Prior to Break-up of Former Yugoslavia
12.8 Prior to the war and sanctions, Yugoslavia was considered relatively progressive in terms of addressing environmental issues compared to other eastern European countries. The Federal and the Republic governments were aware of the need to protect the environment. Although the overall state of the environment was better than in most Eastern European countries, Yugoslavia was still facing high level of air pollution in industrial towns, emission of harmful gases from power generation and industrial plants, pollution of rivers, unsatisfactory disposal of solid waste, and complete absence of safe disposal options for hazardous waste (particularly in open cast mining and mining operations). Between 1989 and 1991, concerted efforts were made to draft environmental policy statements and pieces of legislation, and to develop an environmental strategy with the aim to reverse negative trends. Up until 1988, Yugoslavia was investing about 1 percent of the GSP for the protection of the environment.
Developments During Period 1992-1999
12.9 The break-up of the Former Yugoslavia was accompanied by an increased environmental awareness among the Yugoslavian population, which promoted positive changes in environmental legislation. Several laws and regulations covering the protection of the environment were enacted at the federal and republic levels. The most important ones include: the Law on the Basic Principles of Environment Protection (BPEP) in Yugoslavia (1998), the Law on the Environment Protection of the Republic of Serbia (1991); and the Law on the Environment Protection of the Republic of Montenegro (1996). The FYR has also appropriate legislation and mechanisms regarding environment impacts assessment (EIA) at the federal and republic levels. Separate regulations on EIA exist in the Republic of Serbia, enacted in 1992, and the Republic of Montenegro, issued in 1997. The EIA procedure is responsibility of each Republic. At the federal level, the BPEP regulates the EIA of activities with transboundary implications.
12.10 However, as shown in Table 12.1, with the break-up of the Former Yugoslavia environmental trends deteriorated and pressures on the environment and natural resources increased. After the introduction of international sanctions in May 1992, the conditions for the implementation of the environmental legislation changed for the worse: delays in investments in cleaner technologies, equipment for environmentally-friendly technology was not available, funds for environmental activities declined, monitoring of the environment was impaired, enforcement and control were weaken, inefficient energy/water use, and exploitation of natural resources was intensified. These resulted in the degradation of the natural eco-system and some deterioration of the health of the population.
262 Table 12.1: Pressures on the Environment and Natural Resources During the 1990s
INDICATOR UNIT 1991 1992 1993 1994 1995 1996 1997 1998 1999 COMPARABLE TREND Sulfur dioxide emission Index (1990=100) 88 69 79 83 91 85 103 103 n.a. n.a. kg per capita 43 33 38 40 44 41 49 49 n.a. 39 OECD kg per 1,000 US$ GDP 15 16 27 28 28 25 27 26 n.a. 2.1 OECD Nitrogen oxide emission Index (1990=100) 86 76 82 79 89 86 100 100 n.a. n.a. kg per capita 5.5 4.8 5.2 4.9 5.6 5.4 6.2 6.2 n.a. 40 OECD kg per 1,000 US$ GDP 1.9 2.3 3.6 3.4 3.6 3.2 3.4 3.3 n.a. 2.2 OECD Carbon dioxide tons per capita 3.6 3.2 2.9 2.7 2.9 3.4 0.0 0.0 n.a. 0.58 OECD Average sulphur dioxides - In Belgrade-Vracar microgram per cub met n.a. n.a. n.a. 44 63 74 80 79 n.a. 40-60 EU Directive - In Belgrade-Kosutnjak microgram per cub met n.a. n.a. n.a. 23 32 39 41 35 n.a. 40-60 EU Directive - In Niš microgram per cub met n.a. n.a. n.a. 20 25 28 25 29 n.a. 40-60 EU Directive - In Podgorica microgram per cub met n.a. n.a. n.a. n.a. 5 n.a. 5 4 n.a. 40-60 EU Directive Average particular matters - In Belgrade-Vracar microgram per cub met n.a. n.a. n.a. 39 44 31 55 69 n.a. 40-60 EU Directive - In Veljevo microgram per cub met n.a. n.a. n.a. n.a. n.a. n.a. 45 47 n.a. 40-60 EU Directive - In Podgorica microgram per cub met n.a. n.a. n.a. n.a. 13 n.a. 17 17 n.a. 40-60 EU Directive Industrial water use cub met per US$ GDP 11.9 12.8 12.0 20.9 35.0 38.6 30.8 n.a. n.a. n.a. Irrigation water use m3 per ha 4,235 3,105 2,905 2,951 2,892 2,758 4,408 n.a. n.a. n.a. Municipal water/wastewater - Water supply liter per capita per day 190* n.a. 186 n.a. n.a. 190 n.a. n.a. n.a. 166 Bulgaria - Wastewater collected As % supplied 76%* n.a. 89% n.a. n.a. 90% n.a. n.a. n.a. 67% Bulgaria - Wastewater treated As % of collected 8%* n.a. 11% n.a. n.a. 11% n.a. n.a. n.a. 64% Bulgaria Municipal waste - Belgrade kg per capita per day n.a. n.a. 0.7 n.a. n.a. 0.7 n.a. n.a. n.a. 1.4 OECD - Novi Sad kg per capita per day n.a. n.a. 1.0 n.a. n.a. 1.6 n.a. n.a. n.a. 1.4 OECD - Podgarica kg per capita per day n.a. n.a. 2.6 n.a. n.a. 2.7 n.a. n.a. n.a. 1.4 OECD Organic water pollution tons BOD per day 138 133 128 124 124 123 n.a. n.a. n.a. n.a. Energy use intensity koe per unit of GDP 0.56 0.66 0.74 0.79 0.78 0.84 0.85 0.85 0.78 0.26 OECD Min Disolved Oxigen - Danube River mg per liter n.a. n.a. n.a. 7.0 7.3 8.7 8.7 8.7 7.1 4-6** EU Directive (A2) - Tisa River mg per liter n.a. n.a. n.a. 5.3 6.6 7.7 6.4 6.5 4.7 4-6** EU Directive (A2) - Sava River mg per liter n.a. n.a. n.a. 7.5 7.4 7.6 7.3 7.9 7.2 4-6** EU Directive (A2) Chapter 12. Environment
Table 12.1: Pressures on the Environment and Natural Resources During the 1990s (Continued)
INDICATOR UNIT 1991 1992 1993 1994 1995 1996 1997 1998 1999 COMPARABLE TREND Max Nitrates concentration
- Danube River mg per liter (N-NO3) n.a. n.a. n.a. 10.5 2.6 4.3 2.9 3.7 3.3 5.6 EU Directive (A2)
- Tisa River mg per liter (N-NO3) n.a. n.a. n.a. 2.3 2.0 2.7 2.3 2.0 2.2 5.6 EU Directive (A2)
- Sava River mg per liter (N-NO3) n.a. n.a. n.a. 3.2 3.4 3.3 6.6 3.4 7.5 5.6 EU Directive (A2) Maximum BOD - Danube River mg per liter n.a. n.a. n.a. 5.6 5.2 6.3 4.9 7.8 20.0 < 5 EU Directive (A2) - Tisa River mg per liter n.a. n.a. n.a. 5.3 6.2 6.2 4.2 3.6 24.0 < 5 EU Directive (A2) - Sava River mg per liter n.a. n.a. n.a. 4.0 5.2 3.2 4.2 3.6 21.1 < 5 EU Directive (A2) Max Phenol concentration - Danube River mg per liter n.a. n.a. n.a. n.a. 0.005 0.004 0.004 0.004 0.006 0.001 EU Directive (A2) - Tisa River mg per liter n.a. n.a. n.a. n.a. 0.007 0.003 0.005 0.004 0.006 0.001 EU Directive (A2) Illegal cutting of forest Index (1975 = 100) 324 399 380 237 144 143 143 158 n.a. n.a. Fresh Fish Caches tons 8,004 7,410 6,169 6,229 6,166 7,078 8,408 9,938 9,507 n.a. Afforestation/regeneration1000 ha of forest984554333n.a. Forest damage by fire 1000 cub meters 7 74 46 6 4 11 7 22 n.a. n.a. Land erosion 100 ha 1,113* n.a. 1,009 n.a. n.a. 623 n.a. n.a. 3,486 n.a. Notes: n.a. means not available; * refers to 1990; koe refers to kilogram of oil equivalent; ** equivalent on the basis of 70% saturation rate. GDP refers to Gross Domestic. Product except for years 1990-94, where it refers to Gross Social Produt estimated to be 15-20% smaller than GDP. Sources: Prepared with information published in the Statistical Yearbook of Yugoslavia from 1995-2000, the Statistical Pocket Book 2000, World Development Indicators, UN database. Chapter 12. Environment
12.11 Air pollution emissions experienced a slightly declined between 1990 and 1992. Much of this decline was the result of the contraction of Gross Domestic Product (GDP), including industrial output, and Figure 12.1: Trends in Air Pollution the slight decrease in transport. As shown in Figure 12.1, the 120 decline in carbon dioxide, sulfur
100 dioxide and nitrogen oxides emissions were smaller than the 80 decline in GDP. In the 1990s the
60 level of emissions has been kept steady, while GDP plummeted 40
Index (1990 100) = by almost 40 percent partially
20 due to the previous high energy intensive development of the 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 economy, the low price of Carbon dioxide Sulfur dioxide energy products and subsequent Nitrogen oxides GDP Energy consumption inefficient use of resources in the industry and transport sectors. As shown in Figure 12.1 and Chapter 6, the decline in GDP has not been accompanied by a decline in energy consumption. Energy use intensity per unit of GDP increased by 60 percent during the 1990s from 0.54 kg of oil equivalent per unit of GDP (koe/GDP) in 1990 to 0.78 koe/GDP in 1999.
12.12 Despite the decline in air emissions, ambient air pollution concentrations still exceed World Heath Organization (WHO) and Table 12.2: Air Quality Trends for Selected Cities 3 EU Directive guidelines. (Maximum Concentrations in microgram per m per 24-hour) Up until 1998 and similar 1994 1995 1996 1997 1998 to the experience of other Sulfur Dioxide Belgrade-Vracar 146 132 204 264 522 South Eastern European Belgrade-Kosutnjak 78 110 122 142 278 Countries, air pollution Niš 71 97 108 110 124 was considered the most Veljevo n.a. n.a. n.a. 97 274 serious pollution problem Loznica n.a. 80 110 100 139 in cities of Yugoslavia as Podgorica n.a. 21 n.a 12 22 Particulate Matters a result of the out of date Belgrade-Vracar 317 174 219 415 1,575 and obsolete industrial Belgrade-Kosutnjak 81 74 79 174 258 technology, technical Niš 157 142 98 137 373 deficiencies and mis- Veljevo n.a. n.a. n.a. 295 320 management, the heavy Loznica n.a. 130 181 201 248 reliance on coal, and the Podgorica n.a. 138 n.a. 21 41 Source: Statistical Yearbook of Yugoslavia, several years. increased use of burning trees for fuel. The 1991- 1998 trends in sulfur dioxide and particulate matter for average annual and maximum concentrations shown in Tables 12.1 and 12.2 indicate that Belgrade and other cities were experiencing air pollution levels which exceeded EU Directive guidelines7. With the
7 EU Directive’s guidelines recommend 40-60 micrograms per cubic meter for mean annual values of sulfur dioxide and for particulate matter concentrations; and 100 and 150 micrograms per cubic 265 Chapter 12. Environment exception of Podgorica, no major improvements in air quality were registered during the 1990s.
12.13 Intervention are needed to reduce atmospheric emissions and improve urban air quality management in cities that currently fail to meet air ambient standards, otherwise the level of air pollution may surpass the end-1980s levels after the economy recovery. Possible interventions that could help reduce emissions (some at the margin) include the following: (i) reducing energy subsidies, (ii) switching to lower emission fuels, (iii) improving transport system efficiency, and (iv) investing in power and heat production sources within clear emission regulations.
12.14 Air pollution has important effects on human health. (For a more detailed treatment of the health sector refer to Chapter 14). High concentration of particulate matters and sulfur dioxide is linked to respiratory illness and premature mortality. Infant mortality trends during the Figure 12.2: Trends in Infant Mortality 1990s presented in Figure 12.2 120% suggest that between 1990 and Overall infant mortality 1998 the number of infant 100% Infant mortality respiratory deaths caused by respiratory
80% anomalies (diseases of respiratory system, respiratory 60% distress and other respiratory
40% conditions) declined at a slower Index (1990=100) rate than overall infant 20% mortality. While infant mortality
0% rate declined from 29/1000 in 8 1990 1991 1992 1993 1994 1995 1996 1997 1998 1990 to 14/1000 in 1998 , infant Source: Statistical Yearbook, various years. mortality rate caused by respiratory anomalies only declined from 6/1000 to 4/1000 during the same period. A marked difference can also be noted in the number of respiratory diseases registered in Montenegro and Serbia. In 1998, the incidence of respiratory illness reported in Montenegro was half of that of Serbia. On reason for this is that the inhabitants of Montenegro enjoy relatively cleaner air9.
12.15 In general, the status of the public health of the population is closely linked to the conditions of the environment. While the life expectancy in Montenegro in 76 years, the life expectancy in the rest of Yugoslavia is less than 72 years. The 1998 State of the Health of the Population Report also concludes that: “the chief strategy of health care and improvement of the state of health of the population should be geared to the improvement of the quality of living and hygienic and epidemiological conditions, application of effective environmental protection measures (particularly in the districts
meter for the maximum concentration (over a 24 hour period) of sulfur dioxide and for particulate matter, respectively. 8 Comparative infant mortality rates in South Eastern Europe countries range from 8/1000 in Croatia to 26/1000 in Albania. Average in EU countries is 6.4/1000. 9 Montenegro doesn’t suffer of large-scale environmental problems. Pollution is largely contained in the industrial cities of Podgorica, where aluminum is processed, and Nikšić, which is an iron and steel center. 266 Chapter 12. Environment where the dirty technologies are used), improvement of nutrition and protection of the national treasure: the waters.”
12.16 The quality of water resources, both surface and groundwater has experienced a continuous decline and is considered unsatisfactory. Just from 1994 through end-1990s, most of the rivers have deteriorated from second class (suitable for bathing and drinking purpose only after treatment) to third class quality (suitable for irrigation and industry). Some of the decline is attributed to the higher level of pollution in those water sources entering the territory of Yugoslavia. High level of pollution of surface sources threatens drinking water sources, fishery, and aquatic life. The latter two are also hazards to human health. Analyses have shown that groundwater cannot be used for drinking purpose without being processed. In certain areas close by to the Morava and Danube rivers, groundwater cannot be used for drinking purpose. Shallow groundwater wells are most vulnerable to surface water pollution than deep wells. The protection of groundwater sources is of paramount importance since about round 70 percent of the drinking water in Yugoslavia comes from groundwater sources10. (For more details about the drinking water supply sector refers to Chapter 8).
12.17 Coastal resources in Montenegro are threatened by untreated sewage and solid waste and oil spills, especially in tourist-related areas such as Kotor. The early efforts of the 1990s towards the protection of the Gulf of Kotor were hampered by the lack of funds. Preliminary investigations reveal that water, sediments, flora and fauna of the Adriatic Sea are severely polluted. Given that tourism is considered to have the greatest potential in the economy of Montenegro, there is a need to reduce pollution in the coastline11.
12.18 Access to good quality water supply is limited. Despite the efforts to extend coverage of drinking water supply (about 85 percent in 2000), the quality of the water does not meet hygienic standards. In 1996, out of the 200 water supply systems that were inspected, 20-25 percent were found to be hygienically inadequate in Serbia and 30-34 percent in Montenegro, and 31 percent of the systems did not meet physical/chemical and microbiological standards. The situation has deteriorated during the last years. The test results from the 100 water supply systems carried out in 1998/99 reveal that 66 percent do not meet the microbiological WHO/FRY standard and 48 percent did not meet the chemical and physical standards12. The lack of residual chlorine, extensive use of asbestos-concrete water pipes, the high levels of nitrate, manganese, iron and organic matter, and the excessive presence of Enterobacteria, Escherichia coli and Cytobacteria, have been reported as the most frequent causes for the inadequacies. The root of the problem is the financial unsustainability of the water supply services organization.
12.19 The quantity of municipal and industrial waste has experienced an increasing trend during the 1990s. Municipal waste production in Novi Sad, Niš and Podgorica increased from 1.0, 1.7 and 2.6 kg/capita/day in 1993 to 1.6, 2.0, 2.7 kg/capita/day in
10 It is interesting to note that about 84-90 percent of water supplied by municipalities to households and industry comes from groundwater. 11 In 1998, tourism contributed about 6 percent of Gross National Product in Montenegro, 2 points lower than the 1990 level. 12 EU guidelines on drinking water are compatible with WHO standards. 267 Chapter 12. Environment
1996, respectively. Up until 1996, only 50 percent of the waste in Yugoslavia was disposed of in an organized manner. Problems with collection and treatment of solid waste seem to be more severe in coastal and larger cities. The municipal waste, which many times contain hazardous material, has threaten the quality of groundwater sources. A large volume of waste has been disposed in open and uncontrolled dumps. Up until 1995, less than 20 percent of the dumps were topped with layers of soil and dumpsites were not provided with systems for the protection of groundwater. Incineration of municipal waste is currently banned. Waste deposits formed on or around roads as a result of the lack of suitable waste collection vehicles have caused blockage of sewer, canals and rivers.
12.20 A large share of enterprises’ generating hazardous waste has also ended up on town waste dumps or has been kept within the premises of the enterprise, in numerous cases without proper storage or control13. Most likely, these conditions have caused waste contaminants to leach into the soil resulting in contamination of groundwater supplies. According to the 1994 waste inventory, hazardous waste in FRY was about 250 tones/year, unclassified waste was also reported to be about 250 tons/year. Hazardous waste streams from hospital, expired medicines (many of them received as humanitarian aid), stockpiled hazardous wastes within industrial facilities, used fuel, and others are sources of great concern. The environmental legislation bans import of hazardous waste into FRY.
12.21 Another environmental problem relates to the management of radioactive waste material, particularly in the Republic of Serbia. At present, the radioactive waste material is temporary stored at the Institute of Nuclear Sciences, "Vinca" site, in two temporary storage facilities. The safety parameters of the stored radioactive waste materials seem to satisfy the requirements under the Ionising Radiation regulations. FYR needs to adapt its radioactive waste management regulations to bring them into line with EU requirements, and to develop a radioactive waste management strategy.
12.22 During the period 1990-1997, forest cover experienced a average annual reduction of 9,000 ha or 0.4 percent per year14. The overall wood volume has been estimated at 307 million m3 (235 million m3 in Serbia and 72 million m3 in Montenegro) or 107 m3 per ha (similar to the average standing volume in EU countries, 115 m3 per ha). The existing wood volume per ha represents about 50 percent of the volume necessary for optimum use of the stand production capacity. Average annual increment during the past years has been estimated at of 7.6 million m3 or 2.5 m3 per ha per year, which is lower than average incremental rates in European countries (e.g., comparable trends in Bulgaria, Croatia, Romania, EU countries are 3.8, 3.9, 4.1, and 3.7 m3 per ha per year, respectively).
13 The country needs to update its waste management strategy. The current strategy is based on the safely temporary storage of hazardous waste on generating site, until a hazardous waste management system, i.e., licensed treatment facilities and other disposal sites, is implemented in country. 14 Although this is not a high rate, it is a sign of worry, particularly when one takes into account that long rotation period of forest, sometimes exceeding 110 years, and the age of trees, sometimes beyond 75 years. 268 Chapter 12. Environment
12.23 High forests represent 44 percent of the total forest area, while the remainder is composed by low or sucker forests. According to the 1979 census, forests comprise pure broad-leaved stands (1.58 million ha, mostly beech and oak), pure conifers (148,000 ha, mostly fir-spruce), mixed broad-leaved stands (895,000 ha), mixed coniferous (64,000 ha) and mix coniferous/broad-leaved (171,000 ha). Available data on the health status of forest indicates that Yugoslavia’s forests have not suffered from trans-frontier and domestic air pollution. In 1998, about 8.4 percent of the all species were moderately or severely damaged.
12.24 Average annual harvesting is about 3.1 million m3 (which represents about 1 percent of standing volume), of which 0.6 million m3 is from thinning. The low utilization of forest resources (about 40 percent of the increment) reflects a weakened and overexploited growing stock. This poses serious threats to the quality and value of the forest, the creation of phytosanitary problems, and the increase of forest fire. In general, forests are managed as short-term commodities or cash crops rather than as depletable natural resources. During the past years, very little efforts were made to reverse the negative trend and to re-invest in rehabilitation of the resource. Over the last 10 years, there has been a sharp decrease in silvicultural operations and in regenerating forest activities (i.e., tending, cleaning, thinning, etc.).
Figure 12.3: Trends in Artificial Afforestation 12.25 As shown in Figure 12.3, the area under artificial 25000 afforestation has declined from about 20,000 ha in 1980 to less 20000 than 3,000 ha in 1999. Over
15000 the period 1980-1999, the decline in the scale of
10000 afforestation has been more Hectares severe in Montenegro than in 5000 Serbia. During the mentioned period about 2.1 percent of 0 Montenegro’s area was 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 afforested, while in Serbia the share was 7.6 percent. Source: Statistical Yearbook various years. However, there are serious doubts about the sustainability of the afforestation program as it was mainly in favor of locally non-adopted coniferous tree species.
12.26 Depleted stocks and lack of investments reflects substantial structural problems in the legal, policy, and administrative and entrepreneurial framework of the forestry sector. This has led to a low profitability of forest operations and availability to finance investments, and the limited contribution of the forest sector to the overall economic development of the country. Without substantial investments and structural reforms, forest in Yugoslavia will not be able to provide economic, environmental and social functions to the society.
269 Chapter 12. Environment
12.27 In contrast to the trends in Central and Eastern Europe countries, the state’s share of the total forest stock or fund has grown during the 1990s. About 44 percent of the growing forest stock in Serbia is in the hands of the private sector, while in Montenegro the share is only 26 percent. According to recent statistics, the state of the private sector growing stock is such that is hardly ever used by the woodworking industries. Most is used to satisfy the firewood’s needs of the owners. It seems that due to the lack of professional forestry practices within the private sector, private forest are neither cultivated, protected nor used properly. There are no incentives to encourage private owners to introduce the application of appropriate management methods in their forests.
12.28 Prices of energy and utilities (e.g., electricity, drinking water and sanitation, solid waste, district heating) were held down during the 1990s. Households, industrial and commercial users have been paying far below cost-recovery levels. Low energy and utilities prices have induced inefficient use of resources. As shown in Chapter 6, per capita consumption of primary energy in 2000 was about 39 percent higher than it would have been in a market economy with the same level of income per capita. Low electricity prices have also led to a rapid growth in electricity demand during the 1990s. The increase in household electricity demand was due partially to the low tariff (about US$0.009 per kWh or 20 percent of the average economic cost) and to the limited availability of district heat supply. A similar situation is encountered in the water supply sector. As shown in Chapter 8, average water consumption of households in Belgrade is about 400 lcd, which is several times higher than average consumption levels encountered in other European cities, and losses range between 5-50 percent. Low prices have not provided incentive to abate pollution, improve efficiency or reduce waste. Although the environmental laws call for the application of the “user-polluter-pay” principle, in practice the principle is hardly implemented.
12.29 Serbia and Montenegro are severely exposed to earthquakes and floods risks. They are seismically active and have proven to produce devastating earthquakes. There have been more than 230 earthquakes with magnitudes of 6 to 8 in the Mercalli-Cancani- Sieberg scale in FRY since 1973. The most severe earthquake was in Montenegro in 1979 (131 persons were killed, 1,000 persons injured, 100,000 homes destroyed), which damage was estimated at US$ 2.7 billion. The country lacks of a comprehensive strategy, which includes preparedness, mitigation, recovery and reconstruction. During the 1990s, more than 200,000 ha were affected by floods, which resulted in significant economic, social and environmental losses15. So far, the country has tried to mitigate flood risks by building infrastructure such as embankments and drainage facilities. This strategy needs to be combined with long-term flood management efforts and broadened to include both structural and non-structural measures.
Environmental Impacts of the Kosovo Crisis
12.30 This section presents the environmental impacts of the Kosovo crisis and economic sanctions, with particular attention to the local impacts on water and soil
15 Environmental impacts associated with floods include: pollution of surface waters as a result of insufficient environmental protection at the level of river basins, pollution of shallow groundwater wells used for drinking purpose, and frequent industry-related and mining-tailing accidents. 270 Chapter 12. Environment pollution that occurred around the main military targeted facilities, the impacts of energy pricing and destruction of heating infrastructure on the utilization of forestry resources and air pollution.
12.31 The Joint UNEP/UNCHS Balkans Task Force (BTF) concluded in September 1999, that the 1999 war did not cause an environmental catastrophe in the whole Balkans region. The report identifies four environmental “hot spots” in the FYR, namely Pančevo, Kragujevac, Novi Sad and Bor. These “hot spots” are industrial sites that were severely damage during the war. At present they pose serious threats to human health and ecological systems, and require urgent attention16.
• The industrial complex at Pančevo, with approximately 75,000 inhabitants and located 15 km northeast of Belgrade, includes the Pančevo Nitrogen Processing Plant, the Pančevo Refinery and the Pančevo Petrochemical Plant. The bomb damage of the industrial complex caused the release into the water and soil of 2.1 tons of 1,2-dichloroethane (EDC). EDC is toxic to both terrestrial and aquatic life. Very high concentrations of EDC have been detected in the soil and groundwater. However, the extend of the contamination is unknown. The report recommends undertaking urgent remedial action at the wastewater canal, which is seriously contaminated with EDC, mercury and petroleum products. This canal currently flows into the Danube River. The report also recommends immediate clean up of the mercury spill at the petrochemical factory.
• At the Zastava car plant in Kragujevac, an industrial city with about 150,000 inhabitants, the report recommends immediate steps to clean up high levels of PCBs, nickel, chromium and dioxins contamination, which are threatening groundwater, and improve storage of significant hazardous waste. This factory is located in the banks of the Lepenica river, a small tributary of the Morava, which is used for irrigation and discharges into the Danube. PCB contamination of the sediment and water of the Lepenica river represents a risk to the aquatic life and possible groundwater resources in the area.
• The Novi Sad oil refinery, located next to the Danube River with about 190,000 inhabitants, poses a severe threat to the environment. Large quantities of crude oil and petroleum products leaked into the soil and groundwater, and the Danube. The major concerns with this refinery are that the water polluted with petrochemicals from oil refinery could enter into the infiltration galleries of the Novi Sad Waterworks, and that siting of the wells close to the refinery. The report recommends carrying out detailed studies to determine whether oil product pollution has contaminated the groundwater, main drinking water supply for the region.
• At Bor (ore smelting complex), the report recommends as immediate action to prevent further releases of large amount of sulfur dioxin gas in the atmosphere, and to remove and securely store damaged equipment containing PCB oils.
16 For more information refers to the UNEP/BTF Feasibility Studies, which could be found at their website: http://www.grid.unep.ch/btf/reports/feasibility/index.html 271 Chapter 12. Environment
12.32 The first environmental clean-up projects in FRY were implemented in 1999, as part of the FOCUS initiative established by Switzerland, Russia, Greece and Austria. Additional clean-up projects have been financed and implemented by Swiss Disaster Relief Unit/Swiss Agency for Development and Cooperation (SDR/SDC). The SDC/SDR has realized the following environmental projects in FRY: initial phase for the protection of the wastewater canal in Pančevo; initial phase for mercury decontamination in HIP Petrohemija Pančevo; soil decontamination in Beopetrol fuel storage in Bogutovac; HIP Azotara fuel storage decontamination in Pančevo; groundwater monitoring in Novi Sad, Pančevo, Kraljevo, Nis and Smederevo.
12.33 The Kosovo conflict caused physical destruction of natural habits and precluded the use of medium- to high quality of petrol and fuel, which when compound by the aging of the vehicle fleet in FRY, further deteriorated air quality in urban areas. Evidence indicates that forests around urban and rural centers have been destroyed for firewood during the winter because of the lack of heating systems. The cutting of trees has caused a devastation of the forest ecosystems, and increased risk of extinction of many rare and endangered forest species.
12.34 During the Kosovo war NATO used ammunition with depleted uranium (DU) in the Kosovo region and at seven locations in Southern Serbia and one location in Montenegro. The DU Assessment Mission by UNEP was carried out in 2000, and a report was issued on the DU situation in the Kosovo region. The Federal Government of the Yugoslavia has set up a Council for monitoring the impact of the conflict on the environmental and human health in Yugoslavia dealing, among other things, with the depleted uranium issue. The Council will study the most recent report of the UNEP on Depleted Uranium, and suggest follow-up activities regarding this complex problem.
C. ENVIRONMENTAL INSTITUTIONAL FRAMEWORK AND THE ROLE OF CIVIL SOCIETY
12.35 The institutional administration for natural resources management and environmental protection is organized at the three levels: Federal, Republic and Sub- National. Environmental institutions also exist in large communes. At the federal level, the Department of Environment of the Federal Ministry for Health and Social Policy is responsible for the protection of ozone layer, monitoring of transboundary air pollution, monitoring of transboundary pollution of water and sea, transboundary waste movement permitting process, and takes the lead in international matters such as the negotiation and ratification of conventions and agreements. It is not clear whether this Federal institution is responsible for defining environmental strategy, drafting of federal legislation, and coordinating activities of other federal institutions.
12.36 Other federal agencies responsible for environmental activities are: (i) the Federal Ministry for the Economy, responsible of energy sources; use of mineral resources; and groundwater resources; (ii) the Health Department of the Federal Ministry for Health and Social Policy and the Federal Ministry for the Economy, responsible for the production and utilization of radioactive materials and its storage (under the Federal law of Ionized Radiation Protection); (iii) Federal Ministry of Agriculture, responsible for the protection and prevention of forests and agriculture land; and (iv) the Federal
272 Chapter 12. Environment
Ministry of Interior, responsible for transportation of dangerous goods, including hazardous waste.
12.37 In the Republic of Serbia, the Directorate for Environmental Protection within Ministry of Health and Environment Protection is responsible for environmental protection system (policy making, air pollution abatement, noise and vibration control and abatement, protection from dangerous substances in production, transport and disposal, nature conservation, landscape protection including the management of the five national parks, environmental impact assessment, environmental inspection, and international cooperation). The main operational responsibility for forest and water management is with the Ministry of Agriculture, Forestry and Water Management. The Institute of Nature Protection of Serbia is responsible for environmental management in protected areas together with directorates of national parks and local authorities.
12.38 In the Republic of Montenegro, the Ministry of Environmental Protection is responsible for environmental protection systems, nature conservation and natural resources protection, establishing and implementing environmental protection measures for protected natural resources and objects of nature, and protection from hazardous substances in their production, trade and disposal, oversee of the management of the four national parks, which are under the direct responsibility of the National Parks enterprises (sub-national structures). Other Republic institutes with responsibility for environmental management and protection are: the Ministry of Agriculture, Hydrology and Forestry, responsible for management of water resources, water pollution and protection, protection of agriculture land and soil pollution prevention, management of forest, hunting and fishery resources; the Ministry of Health, responsible for health and effects of noise, vibration and ionizing radiation; and the Ministry of Urban Planning is responsible for exploitation of mineral resources, power supply and geological research. The Institute of Nature Protection of Montenegro is responsible for environmental management in protected areas together with directorates of national parks and local authorities.
12.39 Local communities have responsibility to enforce environmental management protection activities and to manage their companies for providing environmental services (i.e., drinking water, sewerage, wastewater treatment and solid waste).
12.40 Non-Government Organizations (NGOs) are playing an important role in fostering the value for a clean environment, protection of natural resources. According to available statistics, in 1998 there were about 110 NGOs in Serbia (about 25 percent of the total number of NGOs) operating in the environment field. Some local NGOs have established good international cooperation. In some localities, NGOs have representation on municipal councils, and as a result they are influencing the environmental decision- making process at the local level.
12.41 Environmental protection is being regulated by a number of laws (more than 50) and regulations (more than 100) enacted at the federal, republic and municipal levels. There are special laws that regulate certain areas of environment protection, e.g., law on water resources management, law on the protection and use of agricultural land, law on
273 Chapter 12. Environment forest management, law on fishing, law on regional planning, and law on spatial planning.
12.42 Some of the major weaknesses with the existing institutional framework are the lack of appropriate monitoring equipment and laboratory facilities, the lack of vertical and/or horizontal harmonization of laws and regulations, the overlapping of responsibilities at the federal and republic levels, the existence of gaps in the regulation of certain parts of the environment, the lack of consistent approach for environmental protection countrywide, the heavy reliance on command and control instruments instead of market-based mechanisms17, and most importantly, the lack of implementation and enforcement of environmental legislation.
D. THE REGIONAL DIMENSION
12.43 The European Union has confirmed that its overall objective is the fullest integration of the countries in the region into the political and economic mainstream of Europe and that the Stabilization and Association process was the centerpiece of its policy in the Balkans, in particular in the area of environment. At present, several activities have been launched at the regional level. The most relevant one is the Regional Environmental Reconstruction Program (REReP), which is being carried out under the framework of the Stability Pact. This program provides a framework for the institutional and civil society reforms aiming to promote development in the region that is both environmentally and economically sustainable. The REReP is strongly supported by the international community. The FRY became a participant in the REReP in November 2000.
12.44 Regional aspects of the assistance in the area of environment could be split into two groups. The first group includes those issues that are essentially of national priority but have a regional dimension. Some examples are a source of pollution that threatens a river, factories located near borders that pollute the air. These issues are mostly addressed using national assistance with limited or nil co-operations with neighboring countries.
12.45 The second group includes those issues that require genuine cross border cooperation and dialogue particularly in the areas of protection of biodiversity on cross- border national parks, natural reserves, conservation of Balkans mountain ecosystems and protection of shared water bodies. Often activities in these areas do not receive high priority, which in many cases lead to lose of opportunities. If implemented, they could result in genuine regional cooperation and fulfillment of the main requirements of the Stability and Association Process. The political neutrality of environmental activities allows reaching agreements in a much easier manner than agreements in other development areas. There are a number of potential regional projects that would involve FRY. Pollution of the Danube has been a potential source of regional tension, and FRY
17 The use of effluent standards is not enough to prevent industrial pollution. Because of the low price of industrial water, industrial enterprises seem to have opted to use additional water to reduce concentration and meet the standards. Higher water prices would provide the right incentives to invest in water savings and reuse. 274 Chapter 12. Environment should be encouraged to become a full party to the Convention for the Protection of the Danube River.
E. TOWARDS AN ENVIRONMENTAL AGENDA
12.46 Serbia and Montenegro face daunting environmental challenges: inadequate water supply and solid waste services, inadequate hazardous waste management facilities and services, urban air pollution, deforestation, soil erosion, pollution of water resources, degradation of protected areas and coastal areas, and natural hazards. This section outlines the general objective and some recommendations for addressing these challenges during the transition and recovery program. The proposed environmental agenda, which aims to promote sustainable environmental improvements, could bring substantial benefits in terms of reduce risk to human health, improve well being of the population, and prevent irreversible loses on natural resources, which are key in resuming economic growth.
12.47 The proposed environment reform agenda for the FRY, and for the international donor community to support, is based on the harmonization of environmental protection institutional framework with that of the European Union. The environmental acquis provide a clear set of guidelines, which would help prioritize the reform agenda. In addressing the specific environmental challenges it is proposed to focus on the following specific objectives: (i) creation of functioning institutions and the development of a sound and effectively enforced environmental legal and policy framework; (ii) measurably reduced levels of environmental pollution, including the monitoring of the current situation and ensuring that the improvements and new investments to be made in the future contribute to reduce negative impacts on the environment; (iii) strengthened civil society, in which the public has access to environmental information, participates in environmental decision-making, and environmental awareness is enhanced; and (iv) integration of environmental protection within the regional dimension, in light that the environmental regional cooperation is not a simple political desire, but it can genuinely and substantially contribute to peace and stability in the region.
Near-Term Priorities
12.48 Because limited resources will be available for environmental improvements during the transition period, efforts will have to focus on top priorities. In the short-term and in line with the specific objectives outlined above, environmental measures and assistance should focus on: (i) strengthening environmental management systems; (ii) developing a national strategy and action plan for environmental priorities and natural resources management; (iii) addressing critical hot spots caused by damage to infrastructure and industry; (iv) restoring and addressing adequacy of municipal services of solid and hazardous waste collection and disposal as well as for sewerage and water supply; (v) protecting coastal line and sensitive groundwater sources; and (vi) building on synergies between environmental objectives and the economic reforms, including privatization, in the industrial/enterprise, energy, water supply and agriculture sectors.
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12.49 In the area of environmental management systems, there are at least three sets of key actions to be taken in the near term. The first set of actions is strengthening capacity for enforcement of environmental impact assessments and pollution permits. This is particularly important for ensuring that new investments incorporate environmental concerns, and will have a bearing on the ability of the government to clear new private sector investment and to assess pollution and environmental liabilities and their barriers to new investments or privatization. Environmental audits should be carried out to determine the environmental liabilities and to assess the cost of compliance. The government in turn will have to define cost-sharing arrangements to deal with clean up. The second set concerns with the restoration and strengthening of the environmental monitoring and information system. Having a reliable system for monitoring environment conditions (including effects of pollution on human health and biodiversity changes in protected areas) and compliance is essential for making sound policy decisions and enforcing standards. External support through concessional funding is needed to improve environmental management systems over the near term. The third set consists of the harmonization of environmental laws and regulations and of environmental impact assessment with those of the European Union and the ratification of priority international agreements in the field of environmental protection.
12.50 A number of incremental measures are needed in order to help develop a more positive attitude towards environmental laws and regulations and at the same time build public trust and credibility for government action. Individuals need to be empowered with information about the cause and effect between public health (in particular about children’s health) and environmental degradation. This will motive individuals and communities to act in support of targeted environmental programs.
12.51 Strengthening the NGO community, which currently plays an important role in the environmental field, is also necessary. Local NGOs could be more active in nature conservation and environmental awareness if they were provided with financial means. Communication skills of NGOs need also to be improved in order for them to increase their influence in environmental decision-making process.
12.52 There is significant scope for achieving environmental outcomes in the short- term, provided environmental considerations are built into the initial phase of the economic reform programs. Significant opportunities to reduce pressure on the environment and promote sustainable natural resources management exist on projects/reform programs related to energy, agriculture, and infrastructure sectors. Macroeconomic reforms and trade liberalization may have negative impacts if attention in not given to mitigation measures. Some recommendations to be taken into account when defining the reform programs are presented in Box 12.1.
12.53 Interest seems to exist for providing assistance for the preparation of environmental action plans at the Republic and local levels. The Government of Finland has offered financial support and technical assistance for the preparation of these environmental actions plans during 2001-03. The cost of the technical assistance has been estimated at US$ 1-2 millions per year.
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Box 12.1 Mainstreaming Environmental Concerns in the Sectoral Reform Programs • Restructuring, privatization and liberalized trade relations may lead to increase investment in cleaner technologies and processes provided effective environmental regulation and enforcement are in place. Ensure that trade liberalization and export promotion is not based on increased natural resources exploitation (e.g., forest, fishery, etc.). • Reducing fuel, electricity and municipal water supply subsidies (provided proper attention is given to sequencing and packaging of prices adjustments and availability of substitutes, e.g., fuelwood) will promote a more efficient use of resources yielding environmental benefits in terms of natural resources conservation and less pollution. The affordability of tariff for environmental services is likely to be a constraint on the speed at which Yugoslavia remove subsidies and introduce full cost recovery policies. Currently a large share of household budget goes for food expenditure – about 48 percent in 1999. • Removing of fuel subsidies may lead to increase air pollution as a result of substitution by dirtier and cheaper fuels or increase pressure on fuelwood, therefore the need to address the impacts on the environment and the poor segments of the population of price reforms. • Achieving sustainable development of the tourism sector requires sound management of the coastal line and natural landscape. Environmental considerations and integrated coastal zone management must become an integral component of tourism planning. • Improving management of forest, grazing and agricultural lands and irrigation water will result in increased productivity and farms income yielding environmental benefits in terms of reduce pressure on natural resources.
12.54 Efforts to clean-up identified hot spots should continue and concentrate on those locations where the risk of adverse public health effects, soil pollution and groundwater contamination are the highest. Total cost of the immediate action clean-up program (environmental humanitarian assistance) has been estimated at US$20 million, but so far, only 35 percent or US$7.0 million has been secured. Work has been initiated in three out of the four identified hot spots. Additional financial support and technical assistance of the international community is needed to carry out the immediate action clean-up and remediation activities. In addition, in order to implement other proposed measures, not covered by the immediate action clean-up program, additional financial resources are needed.
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Medium-Term Priorities
12.55 In line with the specific objectives outlined earlier, medium-term priorities should concentrate on introducing effective management of air and soil pollution in the energy sector (i.e., implementation of emission reduction programs and disposal of hazardous waste), supporting energy efficiency programs, piloting clean air programs in critical hot spots cities/towns, strengthening forest management and protected areas management, piloting activities on sustainable tourism/biodiversity protection in protected areas of national and regional significance, expanding solid waste collection/disposal systems, expanding drinking water supply and sanitation systems, reducing of pollution loads to the Danube River and Adriatic Sea, balancing development, landscape and conservation in the coastline through integrated coastal zone management, and addressing prevention and mitigation of natural disasters.
12.56 During the medium-term, efforts should continue in strengthening the institutional framework for environmental management. This will involve: (i) enact environmental regulations, (ii) encouraging the use of economic instruments, (iii) increasing awareness of environmental issues, (iv) developing environmental management capacity at the municipality level, (v) promoting public participation in the decision-making process, and (vi) ensuring dissemination of information on environment. Efforts will also have to be devoted to mobilize private investments through the establishment of financial mechanisms such as guarantees and revolving funds.
278 Table 12.3: List of Environmental Priorities and Funding requirements
Priority Financing US$ m Notes CY01 CY02-04 Total Investments Immediate clean-up identified hot-spots 15.0 16.0 UNEP already provided TA to identify work needed in each hot- spot. Grant financing is needed in the amount of US$30.0 million for immediate action Strengthening forest management and protected 7.0 8.0 Grant financing to cover incremental costs for global benefits areas management Piloting activities on sustainable tourism on 2.5 5.0 Grant financing to cover incremental cost for global benefits protected areas including wetlands restoration Restoring/strengthening monitoring and 3.0 2.0 Grant funding for equipment information system
Subtotal 27.5 31.0 58.5
Technical Assistance Developing/implementing integrated coastal zone 3.5 3.0 TA for preparing ICZM program management program Piloting urban clear air initiatives 0 4.5 TA to design an integrated approach to urban air quality management Restoring/strengthening monitoring and 1.0 3.0 TA to examine needs at the Federal, Republic and local levels. information system Transboundary Environmental Initiatives 1.5 2.5 TA to upgrade EIA legislation to meet EU standards identifies staffing and training needs and to develop policy, harmonize with EU environmental directives. Strengthening local environmental NGOs 1.5 5.5 TA to build capacity of local NGOs. Strengthening institutional framework 1.5 5.5 TA to assess role and potential of economic instruments and to carry out training and capacity building. Grant funds are needed. Assessing past liabilities industrial sector 2.0 3.0 TA for carrying out assessments Subtotal 11.0 25.5 36.5
Total 38.5 56.5 95.0 CHAPTER 13. SOCIAL PROTECTION
13.1 This chapter focuses on the social protection system in FRY. The chapter is divided into three sections covering Pensions, Unemployment Benefits and other Labor Market Programs, and Social Welfare. Each section begins with a description of the main features of the existing systems and is followed by a discussion of policy challenges. Reform priorities are then examined, followed by presentation of indicative donor programs to support reforms and maintain protection of the poor throughout the transition. The donor program is summarized in Table 13.11 at the end of the chapter. The external financing requirements identified over three to four years total US$ 365.4 million. The requirements for CY01, on a commitments basis, total US$ 170.5 million.
A. PENSIONS 13.2 FRY operates a mandatory, pay-as-you-go (PAYG) pension system. Generous benefits combined with a rapid fall in number of contributors per beneficiary has meant that spending is high and unsustainable. Table 13.1 charts the course of pension expenditure in recent years. Although the figures for 2000 are incomplete (as Montenegro is January-November only), it appears that at least 11.75 percent of GDP was spent on pensions, excluding arrears. Including arrears raises spending to nearly 13 percent of GDP. Spending has been compressed in recent years because pensions are wage indexed, and real wages have been falling. With positive real wage growth and unchanged entitlements, spending can be expected to expand beyond already high levels.
Table 13.1: Pensions as a proportion of GDP, Serbia and Montenegro, 1998-2000 FRY ECA Eastern (1996) Europe (1996) 2000 1999 1998 Pension spending (million dinars) 42, 469 26, 642 20,076 Of which: Serbia 37,653 24,270 18,524 Montenegro 4,815 2,373 1,552 Pensions as a percent of GDP 11.75 13.89 13.72 8 10 Arrears (million dinars) 4,444 3,838 3,313 Of which: Serbia 2,888 3,015 3,312 Montenegro 1,556 213 1 Pension spending + arrears as a percent of 12.98 15.58 15.99 GDP Source: World Bank and IMF Staff Estimates. Notes:1. For 2000, Montenegro covers January to November only. 2. Figures exclude Kosovo. 3. Figures exclude military pensions. 4. Eastern Europe includes EU accession countries, Baltic republics, and the states of former Yugoslavia. 5. ECA is Eastern Europe, the former Soviet Union and Albania.
13.3 To meet obligations on pensions, taxes on labor have remained high. In Montenegro, the contribution rate for employees is 24 percent of gross wages. In Serbia, the contribution rate was 25-30 percent in the mid-1990s, and now stands at 32 percent. In addition to labor taxes, pension funds in both republics receive revenues from special taxes on goods and services (including alcohol, tobacco, petroleum, telecommunications, and financial services), as well as a share of Chapter 13. Social Protection excise duties, turnover tax, and customs.1 High social security contributions and taxes have contributed to high labor costs, hurting competitiveness and encouraging migration of economic activity to the informal sector.
Background 13.4 Serious problems with the pension system emerged in the late 1980s when entitlements were made more generous, e.g. full wage indexation was introduced , valorization was made more generous, and farmer’s pensions (with low eligibility requirements) were introduced. Early retirement was also encouraged to "make way" for new labor market entrants. In the 1990s, pension fund finances deteriorated further, due to contraction in economic activity and growing informalization of the economy. The practice of granting contribution exemptions to particular firms added further unpredictability to revenues.
13.5 In recognition of growing problems, the 1997 Pension Law limited early retirement and buybacks, and made disability pensions more restrictive. The law also specified that the wage base for contributions be set in terms of a minimum salary per education level. While these changes contributed to an improvement in the financial position of the pension funds, the structure of entitlements was left largely unchanged. War and sanctions, which contributed to deteriorating pension finances, also made it easier to ignore systemic failures.
The present system: 13.6 Beneficiaries: There are about 1.6 million pensioners in FRY and about 2 million beneficiaries in total of the pension system (Table 13.2). Although there are no firm population numbers, it would appear that nearly one in five persons is a pensioner and one in four a beneficiary of the pension system. Pensioners in Serbia fall under three separate pension funds (PFs): for employees, for the self-employed, and for farmers, while Montenegro has one fund for all the insured. The majority of pensioners in Serbia are covered by the PF for the Employed, with the Farmers’ PF the second largest, and the Self-employed PF being relatively small. The Montenegrin PF falls between the smaller Serbian PFs (Table 13.2). Also notable is that the number of pensioners increased by over 47 percent during the 1990s (see Table 13.3).
13.7 The insured qualify for three types of pensions: old-age, disability and survivors. Old- age pensions are the most common (48 percent), but disability (29 percent) and survivors’ (23 percent) are also significant. The fastest increase in the period was among old-age pensioners, whose share increased from 35 percent in 1990 to 48 percent in 1999. In contrast, the share of disability pensioners fell from 40 percent to 29 percent. The changing proportions are largely due to the fall in share of disability pensioners in the Employed PF, but also to the large increase in beneficiaries in the Farmers’ PF which is dominated by old-age pensioners.
13.8 One group of pensioners not covered above are military pensioners, who come under the Ministry of Defense. Unfortunately, there is little information on these pensions, so the discussion here is confined to civilian pensions. There are believed to be around 50,000 military pensioners in FRY, with pensions on average about 1.5-2 times civilian levels.
1 Serbia has abolished these surcharges and replaced them by budgetary transfers in the 2001 budget.
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Table 13.2: Pension fund beneficiaries and average pensions Month No. of Total no. of Average pension pensioners beneficiaries LCU USD (DEM) Serbia: Pension fund for the October 2000 1,259,886 1,512,152 2,695 39 employed (90) Pension fund for the self- October 2000 39,179 43,794 2,152 32 employed (72) Pension fund for farmers October 1998 183,396 N/a 384 < 5 (13) Montenegro November 84,970 103,283 188 82 2000 (188) Source: PFs. Notes: 1. For the self-employed, number of pensioners and total number of beneficiaries for September 2000; 2. Dollar values are computed at the unofficial exchange rate. 3. Total beneficiaries includes pensioners and recipients of non- pension allowances, such as the allowance for assistance and care, physical disability allowance etc.
Table 13.3: Share of old-age, disability and survivor pensions FRY Serbia Montenegro Employed Self-employed Farmers’ 1990 No. of pensioners 1,078,732 971,462 24,280 18,848 64,142 Old-age (%) 35.4 34.8 38.4 87.8 28.1 Disability (%) 40.0 40.7 31.8 6.0 42.2 Survivors’ (%) 24.6 24.5 29.8 6.2 29.5
1999 No. of pensioners 1,587,588 1,263,315 38,462 202,121 83,690 Old-age (%) 48.1 42.8 35.3 88.1 38.0 Disability (%) 29.1 32.6 36.1 3.9 33.3 Survivors’ (%) 22.8 24.6 28.6 8.0 28.7 Source: Federal Bureau of Social Insurance
13.9 Benefits: As can be seen in Table 13.2, average pensions are low in absolute terms, and are considerably smaller in Serbia than in Montenegro. Entitlements are however generous and individual and average replacement rates are high.
13.10 Old-age pensions: It is worth noting a few key features of the system: • The statutory retirement age is 55 years for women and 60 years for men under the condition that they have a minimum of 20 years of service, and 60 years for women and 65 years for men under the condition that they have 15 years; no one can begin drawing a pension before 50 years of age. • Accrual factors (the rate at which an individual earns a replacement of his or her wage) are generous: at least 2 percent per annum. As a result, individual replacement rates are extremely high e.g. a woman with 35 years of contributions can expect a replacement rate of 85 percent. In Czech Republic, Poland or Hungary, the equivalent figure would be in the low 50s (in 1995). One factor that complicates comparisons with other countries is
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that net wages in FRY exclude a number of personal allowances (e.g. hot lunch allowance; holiday allowance) which would be counted as wage income in other countries and subject to taxation. Estimates of the degree to which wages are paid in these non-taxable forms vary, and range from 16 percent of net wages (Jovicic et. al., 2000) to 40 percent (Posarac 1996). The Serbian Government’s own estimate of the wedge is 35 percent. If we assume that other personal income amounts to an additional 25 percent of net wages, then replacement rates would be lower, but still high in international terms, e.g. the replacement rate for a woman with 35 years contributions would fall to 68 percent. However, in examining long run viability, net wages are the appropriate denominator. • The system sets a floor to pension income through minimum pensions (40-80 percent of average wage in Serbia and 55-90 percent of average wages in Montenegro depending on work history). In Serbia, over 18 percent of pensioners in the PF for the Employed and over a third in the Self-Employed PF benefit from minimum pensions. While some pensioners on low pensions are close to poverty (see chapter 16 on poverty), minimum pensions are by and large extremely generous (especially the higher ones) and do not encourage individuals to stay in work beyond the point they can start drawing a pension, particularly in sectors where the minimum pension is close to the sector average wage. Minimum pension schemes in other parts of the region use more modest proportions of the average wage – 15-35 percent is typical.2 • Another feature is early retirement: in Serbia, the average pensioner in the PF for the Employed has a contribution history of 33 years, which is about 5 years less than a full work history.3 Although early retirement was restricted in 1997, a significant proportion of the insured draw old-age pensions before the statutory retirement age -- in 2000, 14.7 percent of new male retirees and 16.8 percent of new female retirees were below 60 and 55 years respectively. The situation appears slightly different in Montenegro, where early retirement is less common among women than men.4
13.11 Disability pensions: The key features are noted below: • Disability rights are awarded to individuals whose capacity for work is impaired owing to illness or injury. Under the 1997 Law, disability benefits are no longer based on classification of disability (full, half etc.) but on the basis of work capacity. These changes, along with stricter enforcement of qualification criteria, probably explain slow growth in beneficiaries.5 Despite these efforts, access to disability pensions remains elevated. The bunching of disability pensions between 40-50 years for women, and 50- 60 years for men also suggests that they are a substitute for early retirement. This is an issue that requires closer investigation in both republics.
2 As in the case of individual replacement rates, international comparisons of minimum pensions bear the caveat that wages are measured differently in FRY relative to other countries. See earlier bullet. 3 Early retirees often benefit from special provisions for accelerated accrual rates. 4 See Montenegro Pension System, Prepared for USAID and KPMG Consulting (Lewarne, ed.). 5 Criteria are not consistently employed. During 1990-99 when the number of disability pensioners grew by 7 percent in FRY as a whole, disability pensioners in the PF for Self-Employed grew by 80 percent.
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• On average, pension levels are lower for disability retirees than old-age retirees. However benefits can be quite generous for disability pensioners as they are eligible for the same minimum pensions as old age retirees. • For those who remain in work there are a number of rights and allowances associated with disability, though these do not add greatly to costs (Table 13.3).
13.12 Survivor pensions: Survivor pensions are paid to the immediate family of the insured person or pensioner, and cover the spouse, children, and parents who have been supported by the deceased. The share of survivors’ pensions has remained stable between 22-25 percent of all pensions over the last decade. In value, these pensions are smaller than old-age or disability pensions.
13.13 Special rights (also called merit pensions): A number of pensioners benefit from special pension rights granted under Federal and Republican Laws, which are paid out of the relevant budget. Groups covered under these laws include partisans, employees of the Ministries of Foreign Affairs and Interior, war veterans, politicians and academicians, and miners. Around 10 percent of pensioners in Serbia and 12 percent of pensioners in Montenegro benefit from these special provisions. Owing to the breakdown in financial arrangements with the Federal authorities, the Montenegrin system has had disruptions in payments on Federal account since 1997.
13.14 Other benefits and allowances: In addition to pensions, the PFs pay a number of other benefits which are best described as social benefits.6 Although information is patchy, it appears that the number of beneficiaries has reached a plateau, and may even be declining for some individual benefits, at least in Serbia. Overall, these benefits represent a small proportion of total PF spending (Table 13.3).
Table 13.4: Ratio of average pension to average wage (percent)
2000 1999 1998 1996 FRY 78 89 101 Serbia: PF of the Employed:897889 PF of the Self Employed 89 104 105 PF of Farmers’ 33 Montenegro 89 82 87 (Jan-March 2000) Czech Republic 49 Hungary 58 Poland* 55 Slovenia 69 Source: FRY: for 2000, PFs; for 1998-99: Federal Social Insurance Bureau; for 1996: Posarac. Other countries: Palacios and Pallares-Miralles, World Bank, April 2000. * Figures for Poland are for 1995.
6 The most important of these are the allowance for assistance and care paid to the long-term sick and invalid, physical disability allowances, funeral expenses, and (in Montenegro) assistance with housing.
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13.15 Replacement rate: The average replacement rate (the ratio of average pension to average net wage) in FRY varies between 80-100 percent. Replacement rates for old-age pensioners are typically even higher e.g. in September 2000 in the PF for the Employed, the average replacement rate for old-age pensioners was 98 percent compared to an average of 82 percent. These are the highest rates in Eastern Europe – where in the mid 1990s, replacement rates were in the range of 50-60 percent, with Slovenia representing the high end with an average replacement of 69 percent.7
13.16 Dependency ratios: While benefits are generous, the number of people contributing to the system has been falling steadily since the late 1980s. Given the rise in beneficiaries, this has meant a sharp fall in the number of contributors per beneficiary (Figure 13.1). In the PF for the Employed, the ratio of contributors to beneficiaries fell from 2.6 in 1990 to 1.4 in 2000. The sharpest rise in system dependency has been in the Farmers’ Fund where, as a result of low eligibility thresholds, the number of contributors per beneficiary fell ten fold between 1990 and 1996.8 In contrast to the other PFs, the fund for Self Employed has a healthy dependency ratio, though this too has fallen since 1996. Although trends on Montenegro are not available, there were around 1.4 contributors per beneficiary in 2000.
Figure 13.1: System Dependency in Serbian PFs
40 37 35 30
25 1999 20 1996 15 1990
10 6.5 4.9 4.5 3.7 Contributor per beneficiary 5 1.4 1.8 2.6 0 Employed Self-empl Farmers
Source: Federal Bureau of Social Insurance, PFs
13.17 Contribution rates: Table 13.5 sets out the contribution rates in Serbia and Montenegro in 2000. One curious feature in Serbia is that the largest PF sets its contribution rate in agreement with the Government (not the Parliament). The contribution rate is the subject of year to year negotiation, in which the other variables are the share of other tax revenues to be earmarked to the PF, the level of contribution exemptions, the Government’s payment of its own arrears to the PF, and the level of anticipated borrowing from the banking sector. This makes the process of rate setting unpredictable and ad hoc, and militates against sound financial planning and management.
7 Similar issues apply to international comparisons as in the discussion on individual replacement rates. 8 Until 1997 a farmer needed to contribute for 5 years in order to be entitled to a pension.
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Table 13.5: Contribution rates in 2000 Fund Rate Basis Serbia: PF of the 32 percent Gross wage, shared equally between employer and Employed: employee PF of the Self 18 percent Insurance base, individual can choose from different Employed levels of coverage but it cannot be less than Republican average gross wage PF of Farmers’ 12 percent 50 percent of Republican average gross wage Montenegro: Employed 24 percent Gross wage, shared equally between employer and employee Self-Employed 20 percent Insurance base Farmers’ 20 percent Cadastral income
13.18 Financial solvency: The combination of generous benefits, falling contributors per beneficiary, and a shrinking contribution base has meant that the system is generating arrears. It is difficult to estimate the exact discrepancy between revenues and obligations because PF accounts are largely maintained on a cash basis9. Although the PFs are allowed to borrow, their accounts do not reveal the extent of current borrowing. However, information on the total stock of outstanding debt is available separately.
13.19 The PFs measure their financial health in terms of number of months of pensions due. At the end of 2000, pensions outstanding were: PF for the Employed, 1.5 months, PF for the Self-Employed, 1 month, PF for Farmers’, over 24 months, Montenegrin PF, 2 months. The Farmer’ PF thus appears easily the weakest in terms of financial viability.
13.20 However, the prospects for the other PFs is not as sanguine as these figures might suggest. All PFs have benefited from running arrears, as delays in payment with no indexation have meant an effective reduction in benefits. The PFs are also vulnerable to loss of special earmarked taxes which contribute between 7 and 20 percent of revenues.10 The Montenegrin PF position has been helped greatly by earmarked donor support of around 24 million DEM in 2000, a level of assistance which it cannot rely upon indefinitely. The PF for the Employed has used barter to pay arrears, , including the payment of pensions in the form of electricity vouchers in 1999. Despite this, its stock of outstanding debt at the end of 2000 was nearly 39 billion dinars (about USD 0.6 billion). A large part consists of borrowing from the Government (16.5 billion dinars), and is owed to the Development Fund and the Republican budget. Around 2.6 billion is short-term debt to the banking system. A further 10 billion dinars is debt arising from a Constitutional Court decision that ruled that lowering the replacement rate in 1994-95 was unlawful. There is also debt to citizens who did not want to take electricity coupons or were not able to use them.
9 In certain formulations, the expenditure side shows the addition to the stock of arrears on pensions and other allowances, but revenues are almost always shown on a cash basis. 10 In Serbia, the elimination of all special surcharges in the 2001 budget has meant a substantial compensating transfer of budgetary funds.
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13.21 Administration: In terms of administrative size, the PF for the Employed is the largest with over 2,800 staff in 34 subsidiaries and 120 branch offices. However, as it handles the largest number of beneficiaries, costs are a small proportion (2 percent) of expenditures, and close to international norms. The other PFs have higher costs ranging from 3 percent of expenditures in Montenegro to 4 percent in the Farmer’s PF and 8 percent in the PF for the Self- Employed. In addition to the Republican PFs, there is a Federal Bureau of Social Insurance which collates information from the two Republics.
Key Challenges and Options for Reform 13.22 As the previous discussion suggests, the pension system is unable to meet its legal obligations out of contribution revenues. The trend in dependency ratios, and the experience of other transition economies, suggests this situation is unlikely to improve in future. Given its share in public spending, pensions are a very important source of fiscal pressure. Putting the pensions system on a secure financial footing is thus essential for lower budget deficits, reduced tax rates, macroeconomic stabilization, and growth.
13.23 It is important to distinguish between reforms which are essential to restoring structural balance to the system (crucial reforms), and those which, while important, play more of a supplementary role (supporting reforms). As pension systems have a lot of momentum (due to existing retirees), crucial reforms which affect the long-term viability of the pension system do not necessarily have an immediate fiscal impact. On the other hand, supporting reforms often bring immediate fiscal returns without ensuring long term sustainability. It is therefore important to conceive of pension reforms in FRY as a package of measures that both bring immediate fiscal relief, and reduce structural imbalances. Table 13.7 lists reforms in both dimensions: crucial versus supporting nature, and immediate versus long-term fiscal impact. Under crucial and supporting reforms, the measures are arranged in decreasing order of fiscal impact. Making progress is likely to require concerted effort on a number of different fronts. Both Serbia and Montenegro have working groups developing reform options. The Serbian group is expected to present its recommendations by the middle of 2001, while the Montenegrin group will consider reforms during the course of 2001 for possible introduction in 2002. More immediately, Serbia has submitted for Parliamentary approval changes under which other personal income would be included in the calculation of wages so that wages reflect full labor income.
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Table 13.6: Pension reforms and their likely fiscal impact in FRY Measure Near-term Long term Comments fiscal impact fiscal impact (end-2002) (2003 onwards) Crucial reforms: Raising the statutory L H More of an impact in the long-run, retirement age although the Government could consider a one-shot rather than a phased increase. Equalizing the retirement age LH between men and women Changes to benefit formula L H Changes to valorization rules L H Supporting reforms: Changes to indexation -- H H Exact impact will depend on the raising the indexation trigger trigger level. Government may want to revisit this decision as finances permit. Changes to indexation – price M M Price indexation may aggravate indexation or Swiss financial imbalances in the short run indexation (half wage growth if real wages continue to fall. Swiss and half price growth) indexation allows for this uncertainty. Making minimum pensions H/M H/M less generous Raising effective retirement M M Early retirement not as widespread as age in other countries. Measure is most effective when accompanied by a rise in statutory retirement age. Reauthorizing disability M M Especially important for certain pensions pensions, e.g. Category II and Category III Limiting spending on merit M/L M/L pensions Reducing non-pension social LL benefits Changes to farmer’s pensions L L Simplifying social insurance L L Pension and health contributions taxation adjusted so as to eliminate health contributions being paid by the PFs. In Serbia, merging the three L L Subject to an assessment of costs and separate PFs benefits of a separate PF for the self- employed. L: low, M: medium, H: high
13.24 Crucial reforms • Raising the statutory retirement age: Increasing the statutory retirement age from 60 years to 65 years for men and from 55 to 60 years for women irrespective of length of service would be desirable. Numerous countries in the region have initiated this reform,
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which has an impact on long-run costs by reducing the length of time for which people draw benefits. Raising the initial age also allows for higher benefits at older ages. • Equalizing retirement ages for men and women: There are good reasons for considering this measure, including the greater longevity of women and the likelihood that their contribution history has been broken by child-bearing. However, few transition economies have gone down this route. • Changes to the benefit formula (to lower individual replacement rates): Current accrual rates are overly generous and need revision. This is just one of a number of changes in the benefit formula that would lower individual replacement rates. In Serbia the move to full labor income should provide a basis for making these changes. • Changes in valorization rules: This would also contribute to reducing individual replacement rates to sustainable levels. Possible changes are moving towards full life- time wage history or, at least a longer wage history than the current 10 best years.11 This change is more equitable than the present system and is also likely to prove acceptable to contributors. Instead of using nominal wage growth as currently, wage history could be valorized using a fraction of wage growth (as e.g. Poland) or half wage growth/half price- growth (as e.g. Croatia).
13.25 Supporting reforms • Changes in indexation: Changes to indexation rules are critical. One way would be to raise the trigger for indexation (currently 5 percent). Another would be to move from wage indexation to price indexation, or half wage/half price indexation, or indexation to whichever is the lower of wage growth and price growth. Price indexation has the advantage that pensions are preserved in real terms. However, if real wages continue to fall in the short run, price indexation may aggravate financial imbalances. Wage/price indexation or indexation to the minimum of wage and price growth allows for cost containment in a context where the real wage growth is uncertain. The Serbian government has indicated that changes to the indexation regime are likely to occur by mid-year. • Making minimum pensions less generous: Minimum pensions benefit a large number of pensioners and the higher minimum pensions are well above international standards. These higher minimum pensions should be eliminated, possibly in combination with simplification of the structure of minimum pensions. The regional standard is one minimum pension of 25 to 35 percent of average wage for a worker with 30 or more years of contributions. Alternatively, one could think of a two-tiered structure where the first tier has a lower benefit (say 10-15 percent of average wages) for lower contributions (15-30 years). In Serbia, the move to full wage income should facilitate changes to the minimum pension. Given the evidence on poverty among low-income pensioners (see chapter 16 on Poverty), it will be important when setting the minimum to examine the tradeoffs between lower pension spending and higher social assistance payments.
11 Wage records are available from 1970 onwards.
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• Raising effective retirement: The retirement age that matters in practice is not the statutory but the effective retirement age, and in FRY, despite the 1997 changes, a fair proportion of individuals retire early. One of the factors that encourages early retirement is accelerated accrual rates in some sectors. These should be reduced.12 To further discourage individuals from retiring early, their pensions should be reduced by a factor that provides compensation to the PFs for smaller contributions and for the likelihood of having to pay the retiree’s pension for a longer period. The use of actuarially neutral factors for early and late retirement would be most effective in combination with a rise in statutory retirement age. • Re-authorising disability pensions (particularly Category 2 and Category 3): One positive trend has been the slow-down in growth of disability pensioners. Despite this, the incidence of disability retirement remains high, notably in the years preceding statutory retirement age. There is a case for a careful re-evaluation of these pensions. Disability pensioners, especially those not completely incapable of work, are periodically reviewed, providing an opportunity for re-authorization. • Limiting merit pensions: Merit pensioners receive higher than average pensions and are responsible for a disproportionate share of spending. Spending on merit pensions could be limited by reducing the number of new retirees who qualify, or making these pensions less generous (e.g. reducing rates of accelerated accruals). • Reducing non-pension social benefits: The PFs also pay a number of other social benefits. These should be rationalized, ideally in a context that looks across the range of social benefits, not only those which are paid out of the PF. • Changes to farmers’ pensions: The Farmers’ PF is in serious financial problems, and there is a compelling need to review the structure of benefits in this fund. The best option may be for the Farmers’ PF to evolve a flat rate benefit (set at the level of contributions divided by the number of beneficiaries) with graduated pensions emerging only when financial circumstances permit. • Simplifying social insurance taxation: A reform worth considering is eliminating the responsibility for paying health contributions from PFs. The contribution rates for the Health Fund and PFs could be adjusted so that their financial position is left unchanged. This would help to make pension and health benefits more transparent, reduce opportunities for shifting arrears, and increase revenue predictability. Similar reforms have been undertaken in the region, including Hungary and Croatia. • In Serbia, merging the three PFs: A further administrative simplification would be a merger of the three PFs, particularly as the costs of the smaller funds are well above international norms. This should be considered a medium term objective and be based on an assessment of the benefits of separate funds versus the costs to the system (in terms of loss of scale economies and administrative fragmentation).
13.26 It will be important to avoid any immediate steps towards setting up a second pillar (mandatory private insurance) or third pillar (voluntary private insurance). With regards to the
12 The Serbian government is planning a reduction in the 12/18 month accelerated accrual rate for those in the military and certain other professions.
290 Chapter 13. Social Protection second pillar, the fiscal space to begin diverting payroll contributions simply does not exist. Even if it did exist, the regulatory capacity to oversee private funds does not. The best way to lay the groundwork for multi-pillar reforms would be to concentrate on bringing obligations of the first pillar in line with payroll contributions, and laying the foundations for open, transparent, and viable banking and financial institutions.
13.27 A further consideration in the first pillar is the degree to which PFs should be involved in the management of private companies. One of the legacies of privatization in the successor states of former Yugoslavia is that PFs have become significant shareholders in privatized companies. In FRY, this is more the case in Montenegro than in Serbia. Managing assets in private companies distracts from the main purpose of the PFs, which is to collect contributions and pay pensions. It is therefore important that a suitable model be devised under which the functioning of the PFs is not compromised, while at the same pensioners are allowed to benefit from assets which they contributed towards.
Donor Program 13.28 Unlike other sectors where there are identifiable investment and maintenance needs, the need in pensions is to put the system on sounder financial footing and to create the opportunity for more moderate levels of labor taxation and lower budget deficits. Donors can assist by helping the Governments and the PFs plan and execute reforms. They may also wish to provide budgetary support to the Republican governments. However, to avoid compromising incentives for reform, such support should be conditional on changes that would make the system more sustainable. Potential areas for donor support for technical assistance are discussed below, followed by a discussion of budgetary assistance. For each technical assistance activity, a cost estimate till end 2002 is given.
13.29 Assistance with planning reforms: This set of activities would consist of: • Supporting development of pension reform policy: This would support MOSA and MOLSW/PIO in design of pension reform options, and would include seminars, resident advisor(s), and resource materials. • Supporting development of a pension forecasting model: This would support MOSA and MOLSW/PIO in investigating the viability of their PAYG systems, including the short- and long-term impact of reforms. It would include building a forecasting model, filling data gaps, and developing forecasting tools for key variables. A limited amount of hardware and software may also be needed. • Support for public information: This would provide training and assistance to MOSA and MOLSW/PIO to explain the need for and the nature of reforms to the public. • Supporting introduction of an actuarial science program at a university in FRY: Unlike the activities discussed above, it is envisaged that one university program in FRY will represent a sufficient start.
13.30 Strengthening management of the PFs: This activity would strengthen the PFs which are the key implementing agency for the reforms. The types of activities envisaged are:
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• Strengthening financial management and accounting: This would include upgrading standards for the reporting of revenues and expenditures, strengthening financial controls, and internal auditing. • Strengthening contribution compliance functions: This is intended to strengthen the PFs’ role in increasing contribution compliance. This would require building and maintaining a database of contributors, developing the ability to make reasonable revenue forecasts etc. • Strengthening the organizational structure: In Serbia, this would include advisory services to evaluate the structure of three distinct pension funds. Advice would also be provided on how best to manage PF assets. • Developing a staffing and human resources policy: There would need to be development of a human resources policy for PFs.
13.31 Conditional budget support: Ideally, any budgetary support should be conditional on reforms of the type outlined. In cases where funds have already been committed, these should be linked where feasible to a program of reform. Conditional budgetary support should be tapered down over a period of time so as to provide incentives for systemic reform.
13.32 One approach would be for donors to meet a declining fraction of the current deficit in the PFs. In 2000, the PFs added arrears of around 1.75 percent of GDP, or US$100 million. With economic growth and improvements in compliance, this deficit can be expected to fall, provided entitlements do not grow disproportionately. Donors could agree to meet a declining share of this deficit provided reforms are introduced that would eliminate it over 3-4 years. Assistance could be front-loaded. Table 13.11 provides indicative totals for budgetary support for pensions.
B. UNEMPLOYMENT BENEFITS AND OTHER LABOR MARKET PROGRAMS
13.33 This section focuses on unemployment insurance and other services provided by the Labor Market Bureaus (LMBs). Unemployment compensation in FRY is generous, however spending is not high. This is because benefits are confined to those who have contributed for a minimum period, and to date there is little open unemployment amongst this group due to limited restructuring. This in turn reflects a very rigid labor relations framework, which discourages job turnover (see Box 13.1 for summary of current labor codes). The LMBs also engage in a number of active programs, including provision of information on vacancies, job search assistance, training, wage subsidies for first-time entrants, self-employment programs, and job ‘creation’ programs for the unemployed, the invalid, and those made redundant.
Background 13.34 Contribution rates and benefits: Employment programs are based on insurance which is mandatory for employed and self-employed but not farmers. Key features are: • Contribution rates are not high by international standards but benefits are generous. In Serbia, contributions are paid by employees and employers at equal rates (0.9 percent each), while UB is 50-100 percent of average net wage depending on work history. In
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Montenegro, the contribution rate is lower (1 percent) and is used to fund a number of LMB activities, but not the payment of UB, which is paid from the Republican budget. UB is a flat benefit of 65 percent of the minimum wage, which in October 2000 was 26 percent of average net wages. • In both republics, the duration of UB can be long: 3-24 months depending on length of service. For those with more than 30 years of service, UB can be paid until reemployment or qualification for pension. • Those who qualify for UB have pension and health contributions paid on their behalf. For those who are registered but do not qualify for UB, health contributions are paid by the budget.
13.35 Beneficiaries: A very small proportion of the unemployed receive UB. In Serbia registered unemployment at the end of 2000 was around 731,000 of which only 6.5 percent were receiving UB. In Montenegro of the 84,000 registered unemployed in January 2001, only 4 percent were receiving UB.13 The small proportion receiving UB reflects in part the age composition of the registered unemployed,14 and in part laxity in registration procedures (e.g. in Montenegro, surveys estimate nearly 40 percent of the registered unemployed are working). Despite the small numbers of recipients the system is generating arrears. Early in 2001, the Serbian authorities were 3.5 months behind in payment of UB, and in Montenegro, there have been arrears in UB since June 1997. Table 13.7: Spending on Labor Market Programs in FRY in 2000 Million dinars % of GDP All labor market programs 2,146 0.6 Serbia 1,724 Montenegro 422
Unemployment benefits 1,238 0.3 Serbia 1,204 Montenegro 34 Source: LMBs 13.36 Other labor market programs: Spending on active labor programs is relatively low, though more so in Serbia than in Montenegro. In Serbia, UB consumes the largest share of LMB resources (44 percent), followed by wage subsidies (23 percent) and administrative costs (20 percent). The LMB spends around 8 percent on investments in upgrading facilities and networks, while only a total of 4 percent is spent on labor market intermediation and training.15 In Montenegro, the largest item is administrative costs (30 percent) followed by the LMB’s self- employment program (26 percent). The remaining shares are: wage subsidies (11 percent), UB (8 percent), investment (4 percent), labor market intermediation (2 percent), and training (1 percent). All figures are for 2000.
13 This pattern is typical of the successor states of former Yugoslavia. 14 At the end of 2000, nearly 47 percent of all registered unemployed in Serbia were below 30 years of age, and nearly 25 percent were below 25 years. Over 60 percent had no labor market experience. 15 During 2000, there were 29,000 wage subsidies for first time entrants, 10,000 people used job creation programs co-financed by LMB, and 2,000 people were provided with computer training.
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13.37 Organizational structure: Administrative costs are extremely high. This is owing to the fact that in Serbia, the LMB has 1,400 staff, 24 subsidiary offices, and 125 local branches. In Montenegro, there are 200 staff and 80 first time labor market entrants employed on a temporary basis, and 21 municipal offices. Staffing and organizational structure seem extremely well- developed relative to available resources. Key Challenges 13.38 The authorities will face a number of challenges to reorient unemployment insurance and active labor market policy to the needs of an emerging market economy where greater demands will be placed on the system, particularly during restructuring. In particular, the authorities will need to address the following key challenges: • Making the system of unemployment insurance more affordable and incentive compatible: In Serbia, UB replacement rates are extremely generous, and in both republics benefits can be drawn for periods of time which are long by international standards. These provisions need to be scaled back to ensure the financial viability of the system as restructuring quickens, and to provide incentives for the unemployed to go back to work. Reforms also need to be accompanied by amendments in severance pay entitlements, so that the combined effect of enterprise-financed severance payments and unemployment compensation are addressed in a coherent manner; • Moving away from cost-ineffective active labor market programs: Both Republics expend a fair amount on active programs intended to provide the unemployed with skills, or experience, or the means (e.g. through small business loans) to ease re-entry into employment. However, experience from other transition economies suggests that active programs are more likely to be effective when economies are growing, and if the measures are targeted at groups -- such as the low-skilled or the long term unemployed -- who face particular disadvantages in the job market (Dar and Tsannatos, 1998). Neither of these conditions are being met in FRY at the moment. Moreover, the most cost-effective of all programs is job search assistance, something on which LMBs spend very little. It is also poor practice for the LMB to be providing small loans, a task which is better left to banks and other institutions. • Lowering the administrative costs of LMBs, which currently spend disproportionate amounts on maintaining staff and offices. Options for reform 13.39 Near term: • Reforming UB: Given the importance of well-functioning unemployment insurance for enterprise restructuring, the authorities should address this challenge as a matter of priority. One of the first reforms in Serbia would be to lower the income replacement provided by UB. Replacement rates of 30 to 50 percent are more in line with regional standards. A second reform would be lowering the maximum benefit period. A maximum of 12 months for those with extended service is not uncommon in the region.16
16 Unfortunately, some changes being proposed in the draft Law on Employment in Montenegro would raise the eligibility for extended UB.
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Box 13.1 FRY Labor Relations Framework FRY has both federal and republican labor laws. In addition to the labor laws, there is a range of legislation relevant to employment relations, as well as collective agreements. This box focuses on the core labor laws, which provide the broad framework for labor relations. As with many sectors, the FRY law is intended as an overall framework law, with more detailed elaboration at the republican level. However, the FRY law is in fact relatively detailed on a number of areas, so that there is substantial repetition between federal and republican laws.
The labor laws reflect the policy and institutional framework of a socialist economy in which enterprises perform a significant social welfare function. As such, there are serious concerns about their appropriateness for a market economy, as they prescribe an overly rigid labor relations regime. In addition, the laws neglect some core labor standards which one would expect to be included in European labor law. Apart from specific shortcomings, the overall level of detail goes beyond what would be considered appropriate for core labor legislation, and covers matters typically regulated by either collective agreements or employment contracts in market economies.
There are several key areas of concern with current labor legislation, which are acknowledged by the authorities in Serbia, and are to be addressed by them in amendments during 2001. This is not intended as an exhaustive list: • The laws omit explicit guarantees of several core labor standards, including freedom of association for employees and employers, freedom to negotiate and bargain collectively, and prohibitions on discrimination recognized in international treaties. Although some of these are in the Constitution or elsewhere, their explicit inclusion in the labor law is desirable; • The laws have heavy restrictions on employers wishing to terminate employment of workers. This includes very long severance payments (24-36 months), and outright prohibitions on laying off certain categories of workers (e.g. veterans). Such provisions act as deterrents to employers to hire additional labor, have not been able to be financed by many firms for some time (particularly state and socially-owned enterprises most in need of restructuring), and will be factored in by private domestic and foreign investors in valuing enterprises; • Hiring procedures are unnecessarily cumbersome, with mandatory advertisement through the public employment service, assessments of workers' fitness for employment, etc.; • Restrictive provisions on use of fixed term contracts. The underlying assumption of the laws is that full time permanent employment is the norm, and other forms of employment relations are exceptional. This is inconsistent with a typical market economy, which relies on more diversity and flexibility in employment relationships. While fixed term contracts may be increasing in practice, the legislation does not reflect this; • Provisions on collective agreements. The current laws automatically include all employers and employees under collective agreements, whether or not they have been represented in the bargaining process. This is not consistent with freedom of wage bargaining, nor with an economy where private sector employment is likely to be expanding. While there is provision in several European countries for extension of collective agreements to those who were not represented in the bargaining process, this is an exception to the basic freedom not to be bound by agreements without consent, and should be avoided if possible; • Wage determination. The current provisions prescribe wage determinants for all sectors and levels of employment. While the state may wish to regulate minimum wages, setting detailed coefficients on price of labor does not occur in the non-state sector of market economies; • Provisions on vacation and benefits. While the minimum vacation length is not overly generous (18 days), many provisions for extra paid vacations reflect the welfare functions of enterprises, and need to be reviewed. In addition, entitlements to other benefits such as paid maternity leave are very generous by the standards of most market economies. 295 Chapter 13. Social Protection
• Focusing spending on cost-effective active-programs: There is a need to reorient the activities of the LMBs away from wage subsidies, self-employment programs, and job "creation", towards activities such as providing information on vacancies, and job-search assistance. To the extent possible, groups who face particular disadvantages in the labor market should be the target of active programs.17 There is also a case for shifting expenditure towards monitoring and evaluation of on-going programs and activities. • Simplifying social insurance taxation: A further reform would be a simplification of the social insurance taxation structure. As with the other social funds, there is a case for pensions and health contributions for those drawing UB to be passed directly to these funds, with an accompanying adjustment in contribution rates; • Undertaking complementary reforms in labor legislation: This would be to make labor markets more flexible, thereby increasing incentives to hire new workers, and accelerating return to work for those dismissed. In Serbia, a new labor code is planned for 2001, while in Montenegro labor code reform has been under discussion for several years.
13.40 Medium term: • Over the medium term, the authorities should focus on addressing the excessive administrative costs within the LMBs. This should be done within the overall context of streamlining social protection delivery infrastructure (reference to Social Assistance section under Social Welfare).
13.41 Finally, it is worth noting one point on the overall level of contributions. Although the payroll tax for unemployment compensation and other labor market services is at the low end of the range by regional standards, it would be hard to justify any increase in payroll contributions in the near term without exploring the scope for cost savings through re-orientation of active- programs and reductions in administrative costs.
C. SOCIAL WELFARE
Background: 13.42 Both Serbia and Montenegro retain the key features of the former Yugoslav social welfare system, though in Serbia in particular cash transfers became increasingly dysfunctional during the 1990s. The system is characterized by a wide range of cash benefits and social welfare services, delivered through a comprehensive national network.
Principal social welfare programs 13.43 Social Assistance, both on a regular and a one-time basis, administered through Centers for Social Work (CSW). This is the benefit of last resort, available to households whose incomes fall below a specified "social security level". Social assistance is means-tested in both republics,
17 This suggests that the 0.3 percent of GDP set aside by the Serbian Government in the 2001 budget for the retraining of laid-off workers should focus on those whose re-employment chances are the lowest (e.g. low-skilled).
296 Chapter 13. Social Protection based on formal incomes and other screens, including asset tests. Low beneficiary numbers suggest that non-income screening has played a very important role. The "social security level" is linked to the average wage, and varies by household size 18. In Serbia, thresholds are based on the average municipal wage in the productive sector, unless it exceeds the republican average.
13.44 Benefits levels are calculated as a "top-up" to the household social security level. Benefit levels are low in absolute terms, ranging from 6 DM-82 DM in Serbia, and up to 165 DM in Montenegro in December 2000. In recent years, Serbia built up payment arrears of 26 months by end 2000. Montenegro had lower arrears of around two months. In both cases, regular benefits are financed from the general budget, while most one-time help comes from local budgets. 19 The relatively high level of local social welfare spending in Serbia suggests that spending on pre-schools programs and one-time help is significant, in recent years more than total republican spending on social assistance.
13.45 Other cash payments delivered through the social welfare network. These include carers' allowances for the immobilized; accommodation payments; job training benefit; redundancy payments in Montenegro and several programs supporting nursery and pre-school attendance. Most of these were in significant arrears at end 2000 in Serbia, though to a much lesser extent in Montenegro. While the total number of beneficiaries of these programs is significant (e.g. around 190,000 in Serbia in first half of 2000), the extent of double counting with social assistance and child allowances is substantial.
13.46 Child Allowances. Child allowances (CAs) are means-tested in Serbia for the first two children, and universal for the third. In Montenegro in contrast, there has been universal entitlement since 1993, though each household can only receive a maximum of three allowances. In Serbia, benefits vary by the number of children, and in Montenegro by age and level of education 20. In both republics, benefits are higher for categories such as children in single parent households or with disabilities. The program also has a strong pro-natalist objective, reflected in differences in benefit structure between high and low birth rate areas, and benefit levels per child in Serbia 21. Administration is done separately from social assistance in Serbia, with a distinct office network, though the function is merged in Montenegro.
13.47 The eligibility threshold for CA in Serbia is related to the average municipal wage, with households entitled to benefits if per capita household income falls below 50 percent of the average wage. Given the profile of wages and total beneficiaries, it is assumed that there has been strong self-targeting due to low benefit levels and payment arrears. Serbia had arrears of two and a half years, which the Government attempted to settle with "bonds" in September 2000.
18 The social security level by household size is: in Serbia: (i) 5 or more members of household = 100 percent of average wage in the previous quarter; (ii) 4 members = 90 percent; (iii) 3 members = 75 percent; (iv) 2 members = 70 percent; (v) 1 member = 50 percent. In Montenegro, the range is from 40 percent of republican average wage for one member households to 80 percent for a household of five or more. 19 In Montenegro there is a substantial discretionary fund at local level financed by the central budget for one-off payments. 20 In Serbia, benefit is 20 percent of AW for the first child, 25 percent for the second child and 30 percent for the third. Entitlements beyond that vary according to the local birth rate. In Montenegro, benefits range from 10-40 percent of minimum wage per child, dependent on child's age, and other factors. 21 In Serbia, in high birth rate areas, households with more than 3 children are entitled to only one more child allowance, whereas in low birth rate areas, benefits are provided for each child without limit.
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The obligations have now been financed by donors. In Montenegro, the situation was better due to donor support, with arrears of three months in January 2001. Financing for CAs comes from republican budgets.
13.48 Maternity Benefits and Allowances. There are maternity benefits for working mothers, and maternity allowances for unemployed mothers. There are also universal one-time birth allowances. Working mothers in both republics are entitled to one year paid leave for the first child on 100 percent of their wage, with up to two paid years for the third child. Non-working women receive an allowance for up to one year, with level related to the minimum wage 22. All benefits are paid from republican budgets.
13.49 Social welfare services. These are administered through CSW, and include family counseling and support services (e.g. related to divorce, fostering, domestic violence); services for the elderly; youth services (e.g. related to delinquency); and institutionalization. Given that the services are staff-intensive, they continued to operate in both republics in recent years, financed from the republican level.
13.50 In addition to programs in the social welfare system proper, both republics have retained to date significant consumer subsidies, notably on utilities and basic food stuffs, which have acted in effect as social welfare benefits. The universal nature of such subsidies has been a very inefficient way of achieving social welfare objectives.
Administration and delivery of social welfare 13.51 Responsibility for social welfare rests with the republics, which operate autonomously, with the exception of placement of clients in special institutions. Until end 2000 in Serbia, there were separate ministries responsible for social assistance and child/maternity programs, but these have now been merged under the Ministry of Social Affairs. In Montenegro, they are covered by the Minister of Labor and Social Welfare.
13.52 Social welfare administration is well-developed, with a network of CSW throughout FRY of 143 centers in Serbia and 10 in Montenegro (with sub-branches). There are also municipal and city social welfare departments managing the local system. There are around 2,400 employees in Serbia and 320 in Montenegro in the CSW network, and in separate CA offices in Serbia a total of 158 offices and 681 employees. Until end 2000, there were persistent wage arrears problems in the sector in Serbia. As of end-2000, the monthly cost in Serbia of CSW staff salaries was around 1.1 million. DM, and in Montenegro during 2000, average monthly wage payments in the sector overall were just over 320,000 DM.
Social welfare expenditures 13.53 Table 13.8 gives summary data on social welfare programs for 1998-2000 for both republics, not including salary and administrative costs. Given the massive arrears, execution data is a poor reflection of benefit commitments in recent years. The position for end 2000 is also complicated by the arrears clearance initiated by donors in late 2000 on cash benefits.
22 In Serbia, all non-working women are entitled. In Montenegro, women must be registered unemployed.
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Table 13.8: Social welfare spending in FRY as share of GDP, 1998-2000 Spending category 1998 1999 2000 Serbia Montenegro Serbia Montenegro Serbia Montenegro.
Social assistance/ 0.28% 0.05% 0.19% 0.07% 0.26% 0.13% Welfare (a) Children/family (b) 0.96% 0.1% 0.42% 0.13% 0.73% 0.24%
Local SW spending (C) 0.5% N/A 0.43% N/A 0.39% N/A
TOTAL 1.74% 0.15% 1.04% 0.2% 1.38% 0.37%
Source: Serbian MOSA/MOF. Notes: (a) includes social assistance, carers' allowance, accommodation, training, and staff; (b) includes child allowances, maternity allowances and benefits, pre-school allowances, and administrative costs. (c) Local spending for 2000 is estimated.
Table 13.9: Comparative social welfare spending Country Share of GDP on social assistance plus child allowances FRY (2000) 1.8% Slovenia 1.1% Macedonia 1.6% Croatia (1999) 1.9% Bulgaria (1997) 1.4% Latvia 2.4% Estonia 2.1% Note: 1996 unless indicated. Source: World Bank ECA Social Protection Strategy Paper, 2000; Croatia: Social Expenditures (WB mimeo, 2000)
13.54 Noting the caveats above, the recent range for social welfare spending in Serbia has been around 1 percent to over 1.7 percent of GDP, with a FRY aggregate for social welfare of around 1.2 percent to 1.9 percent of GDP. Of particular note is the volatility of spending in Serbia, and the dramatic increase in recent years in Montenegro, largely driven by donor funding. It is also worth noting that Montenegrin executed budgets substantially exceeded planned budgets in 1999 and 2000. Social welfare spending is compared to neighboring countries in Table 13.9. Overall, FRY spending in the period ranged from the low end of SEE comparators in 1999 to the high end in 1998. For Serbia, spending as a share republican GDP is in a mid-range, whereas for Montenegro, spending relative to republican GDP had reached a high level by 2000 relative to the region 23.
13.55 A more detailed picture for both republics at the end of 2000 is presented in Table 13.10. Beneficiary data for both republics vary monthly, and have significant double counting. The expenditure data should be treated with caution, but seems broadly consistent with MOF data. In particular, spending on salaries and administrative costs seems low by regional standards, even allowing for low wages. In Montenegro, there were significant arrears on benefits, as well as on contributions and non-wage compensation to employees, and payments for Montenegrin residents in Serbian institutions. In beneficiary and expenditure terms, CAs dominate, with an
23 In 1999 and 2000, Serbian GDP was over 90 percent of FRY GDP.
299 Chapter 13. Social Protection estimated 620,000 beneficiaries in Serbia, and 148,218 beneficiaries in Montenegro. Social assistance cover a smaller share of population - around 30,000 households, or a little over one percent in Serbia, and 8,108 households, or just over 2 percent in Montenegro. It is also worth noting that beneficiary numbers for both CAs and maternity benefits have declined significantly in recent years, the former for a variety of reasons including payment arrears, the latter reflecting the lower birth rate.
Table 13.10: Republican social welfare programs, Serbia and Montenegro, end 2000. Program Serbia Montenegro Beneficiaries 2000 estimate Beneficiaries 2000 (a) (YUD million) (DM million) Regular social assistance 30,000 270 8,108 households 10.5 households (16,347 people) (90,000 cap.) Carers' Allowance 17,000 225 4,720 2.8 Accommodation (institutions + 17,399 306 1,095 3.1 foster care) Child allowances 620,000 1,324 148,218 24.6 Maternity benefits (leave and 55,342 841 7096 9.1 allowances) Other maternity/child/preschool 186,150 402 N/a N/a allowances Other (admin./invests/ N/a 494 N/a 6.37 (b) other programs) Local level spending on social N/A 1,416 N/A N/A protection TOTAL N/A 5,278 N/A 56.5
As share of FRY GDP 1.46% 0.4% Sources: MOSA Serbia, checked against MOF data; MLSW Montenegro; (a) Beneficiary data for December 2000, except Serbia CAs, January 2001. (b) For salaries, from EU Inception Report, Social Security Advisor (2001, draft).
13.56 On the expenditure side, two notable features are: (i) the dominance of child/maternity spending over social assistance programs. Given the weaker targeting of these programs, this suggests a sub-optimal benefit incidence in poverty alleviation terms; and (ii) the high share of Serbian social welfare spending happening at the local level, with over 40 percent of social welfare spending at local level in 1999, and still over one quarter in 2000 estimates. Both observations have important policy implications.
Key challenges 13.57 The social welfare system will be presented with great challenges in coming years, given the need to address significant exclusion errors in targeting of social welfare, the likely short term negative social impact of economic restructuring, new demands for targeted transfers generated by price liberalization, and the possible beneficiary inflow due to refugees becoming citizens. The key issues include:
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(i) Structure of benefits and fiscal issues: • the structure of social welfare benefits is overly complex. There is a case for rationalizing the number of benefits, and in particular simplifying eligibility thresholds and entitlement structures for some benefits. At the same time, there will be new demands on the social welfare system which may require new benefits as universal price subsidies are phased out, at least on an interim basis (see below on energy and food price liberalization and social welfare); • the coverage of social assistance is low (particularly in Serbia), as is the adequacy of the benefits provided. Exclusion errors of the present system are therefore a cause for concern; • The linkage of social welfare eligibility thresholds and benefit levels to wages is undesirable. It complicates wage determination and fiscal policy, and only indirectly links social welfare benefits to the preferred benchmark - trends in the cost of living.
(ii) Enhancing equity and dealing with refugees: • in Serbia, the use of localized eligibility thresholds is an equity and a fiscal issue. In equity terms, a poor household in a poor area is significantly less likely to qualify for benefits, and to have a lower benefit level if they do qualify. From the fiscal angle, moving towards a standard eligibility threshold could have a significant cost, as more beneficiaries became eligible and average social assistance benefits increase;24 • in Montenegro, there is significant scope for improved targeting of social welfare by removing universal child allowance eligibility. The MLSW has set up a social welfare working group, with this as a key issue; • for all programs, there is an urgent issue with respect to refugees, in light of expected granting of FRY citizenship 25. At present refugees are not eligible to participate in statutory cash assistance schemes. There are around 400,000 refugees in FRY, most of whom would presumably apply for citizenship. Estimates of those in most need range from around 100,000 to around 300,000, creating a high likelihood of substantially increased demands on the social welfare system from early as 2001.
(iii) Streamlining and strengthening social welfare delivery: • the split delivery of social welfare programs into CSWs and child allowance offices in Serbia needs review. Such rationalization of the delivery network has already occurred in a number of former Yugoslav countries - e.g. child allowances delivered from pension offices in Croatia, and through CSWs in Bosnia and Herzegovina; • the neglect of social welfare infrastructure over the past decade has left an under- equipped delivery network and in some areas inadequate physical infrastructure.
24 The Government proposes to standardize the threshold at the republican average wage and anticipates that an additional 20,000 families will become eligible for assistance. Donor assistance for this revamped scheme is sought – see section on donor assistance below. 25 In February 2001, the Lower House of the FRY Parliament approved dual citizenship, which would open the way for most refugees to become FRY citizens, and so eligible for social welfare programs.
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Preliminary work indicates significant investment needs in IT and database, and in some regions in physical structures; • the lack of community care structures and alternatives to institutional care results in an excessive number of institutionalized clients.
(iv) Upgrading staff skills and engaging the third sector: • staff in the social welfare system have had limited professional development in the past decade. While there has been selective exposure to international practice, this has not been systematic. In addition, CSWs in SFRY had limited engagement with civil society organizations. The situation has changed somewhat in recent years, due to humanitarian programs. Nonetheless, social welfare policy will need to increase the incentives for partnership with the non-government sector in regular activities.
Policy Priorities 13.58 The authorities in both republics have been working on improved social welfare systems, with key agreements reflected in the recent IMF agreement. Serbia has a series of working groups under the MOSA and in Montenegro - where work is more advanced with support of the EC- a similar group has designed an overhaul of social welfare that would increase coverage among the poorest, while excluding the non-poor from child allowances and food subsidies. The reforms in both republics are intended to support long-run fiscal sustainability by ensuring that increased future demands can be managed with available resources. When implemented, they should enhance the equity and coverage of social welfare, and also contribute to poverty reduction.
13.59 Measures for initiation in 2001: • De-linking eligibility thresholds from wages. At the first stage, the threshold level need not change. Revised procedures for adjustments to the threshold could be made as part of policy amendments during 2001-2002, though the current "minimum" consumption basket would not be an appropriate level. • MOSA and MLSW to review analysis of recent HBS data on poverty profile and trends to inform policy development 26. The HBS should be used to get information on poverty profiles relative to current beneficiary groups and non-income eligibility screens, in order to assess inclusion and exclusion errors in targeting. • complete reviews of social welfare policy and programs. Given the linkages to broader social protection policy in pensions, employment programs etc., strategy development will need to be integrated to ensure coherence between social welfare and social insurance programs. The outcome of the review in each republic would be Government approval of a Social Protection Strategy, which would guide legal amendments to be drafted during 2001 27. The strategies would need to include costing of reform options in consultation with MOF and local authorities. In Montenegro, this has already been done
26 Though HBS needs amendment to improve its reliability and policy usefulness (see poverty discussion). 27 Key laws in Serbia are the Law on Welfare and Providing Social Security to Citizens, and Law on Social Care of Children, and in Montenegro, the Law on Social Protection and Child Care, and Law on Families.
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to a significant extent, with savings from phasing out of universal food subsidies planned to be used for supplementing existing social benefits, and increased social assistance spending being offset in part by targeting child allowances. Key policy issues to be addressed in any overhaul of social welfare policy are: (i) consistent with decisions on the overall structure of benefits, reforms of specific aspects of benefit design. This would include - assuming CAs remain as a stand- alone benefit in the short term - eliminating or adjusting localized eligibility thresholds for social assistance and CA, and lowering the eligibility threshold level for CA in Serbia;28 introducing targeting of CAs in Montenegro (a measure already agreed with the IMF); revision of the CA structure to remove differentials for regional birth rates and caps on total number of eligible children; and review of targeting criteria in light of poverty profile. Reforms need to take account of labor market incentive issues and effective marginal tax rates implied by threshold design. Despite the political sensitivities, maternity benefits would also probably need to be reduced to levels comparable to most of Europe29; (ii) assessment of new demands on the social welfare system and proposals on how the benefit structure could respond. This relates in particular to the social impact of energy price increases in Serbia, and food liberalization in Montenegro, the latter expected to be complete by August 2001. Chapter 7 on Energy provides discussion on the expected effect of energy price increases on the poorest. The Government of Serbia is considering a scheme of one-off payments to assist families deal with price shocks, based on eligibility for existing social assistance and child allowance. Montenegro plans to supplement existing social assistance payments to compensate poor households for the negative effects of price liberalization of basic food stuffs. Proposals will need to be consistent with the fiscal and administrative capacity of the system, suggesting that "piggy-backing" on existing programs is the preferred option, a route that would also allow for easier phase-out in the medium term; (iii) review income assessment mechanisms for benefit eligibility. An increased reliance on income rather than categorical assessment will necessitate further refinement of income and asset assessment mechanisms; (iv) stronger provisions on collaboration between the public and non-government social welfare sectors. The immediate priority will be removing any constraints on such partnerships; (v) a clearer assessment of social welfare functions being financed at the local level, and directions for a clearer assignment of roles and responsibilities by level of government; (vi) new policies need to encourage further family-based alternatives to institutional care; and (vii) rationalization of social welfare programs. While the political reality suggests that current range of benefits are likely to remain in the short term, the Strategies need to
28 The Government has indicated that it intends to move towards a unification of criteria for both social assistance and child allowances. 29 See EU Directive 92/85/EEC, Article 8, setting a standard of 14 weeks paid maternity leave.
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provide a framework for taking such decisions on possible rationalization or merging of benefits in the medium term.
• the policy work would feed into redrafting of key social welfare legislation. In Serbia, the new laws are expected to be prepared by the second half of 2001, though the Government may wish to introduce some changes sooner (e.g. adjustments in eligibility thresholds). Despite the desire to move quickly, it is not clear that a thorough reconsideration of social welfare legislation can be done much before fall 2001, for submission to Parliament by end 2001. In Montenegro, legislative changes can be quicker, and are planned for the second half of 2001. Projected donor budgetary support targeted to the social welfare sector may create the fiscal "breathing space" needed. In Serbia, this is reflected in a substantial increase in social welfare spending in the 2001 budget, mainly on child allowances. • by end 2001, conduct an inventory of all social welfare facilities, including CSWs, CA offices, and special institutions. This would summarize key parameters for each facility, including staffing levels, size of population serviced, the state of repair and equipping, as well as mapping their locations. The information would help to develop options on the future size and configuration of the social welfare network.30
13.60 Measures for 2002-2004: • based on SP strategies, develop more detailed policies on issues identified in 2001 policy work, including: (i) based on more detailed analysis of the poverty profile and current programs, assessment of the appropriateness of the current range of benefits. In spending terms, a key question is whether the continued separation of social assistance and child allowance makes sense, or whether a merged "poverty benefit" is preferable, in terms of streamlining, equity, and administrative efficiency. In addition, there are questions as to whether some programs should sit under social welfare or elsewhere (e.g. training benefit; untargeted financing of final year of pre-school); (ii) designing and piloting mechanisms for partnerships between the public and non-government sectors in social welfare, e.g. development of more detailed provisions for contracting relationships 31; and (iii) methods for promoting community-based care where appropriate. • in 2002 develop the basic software/database for CSWs and/or other social welfare facilities to report on main program indicators, particularly financial and beneficiary data. The software must allow local and republican policy makers to know the total number of discrete beneficiaries of social welfare programs, by providing reliable information on beneficiaries of multiple programs, as well as a more disaggregated and timely picture of local social welfare activities. • develop operational manuals for CSWs for basic client and case management. Existing materials and instructions could be further developed into operational manuals. Staff would then need to receive training in the procedures in the manuals.
30 The Government of Serbia has indicated that it is thinking of merging the CA and CSW offices, as a part of a longer run consolidation of both social welfare offices and labor market bureaus. 31 In both Serbia and Montenegro, there are interesting proposals for an “innovation fund” approach to piloting such partnerships.
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• MOSA and MLSW should elaborate a strategy and identify financing implications for professional development in social welfare. This will depend on local and foreign resources, but should at a minimum include an effort to restock resource materials and design a rolling training program for CSW staff, including Directors. The focus resource center would likely be the School of Social Work, though a more decentralized approach may need to complement this.
Donor program 13.61 The question of recurrent cost financing for social welfare is a complex issue. On one hand, republican governments welcome general budgetary support, targeted social welfare cost coverage, and assistance with unemployment benefit/severance. On the other hand, budgetary support without policy changes would provide only short term sustenance to a system that needs reform. The numbers on budgetary support in the table therefore present only (i) partial coverage of the social welfare system, and on a declining basis; (ii) One off payments through the child allowance system to mitigate effects of price liberalization, such as in energy, and ;(iii) assistance with severance payments. The latter is understood to be strictly conditional on making severance pay requirements substantially less generous than the present system of 24-36 months of net wages (see Box 13.1) and entitlements of one month per year. Existing commitments are not included.
13.62 There are considerable investment and technical assistance needs for the FRY social welfare and labor market systems, with particular focus on TA and budgetary support needs in 2001-2002, and increased emphasis on training and investments in upgrading the delivery system in 2002-2004. In some areas, Montenegro has already been receiving support, notably from the EC. The key needs are set out in Table 13.11. The major investment needs are as follows: • upgrading the social welfare information network. A considerable share of CSWs is without basic computer and software capacity, or with outdated equipment, and therefore investment needs for computers, software and database development, and networking of CSWs. • basic structural repairs to CSWs. • there is a need to restock the social welfare system with basic reference and resource material for upgrading of staff skills. Ideally, this should happen in the context of revitalizing the School for Social Work, probably with a policy and evaluation unit in the Ministry. • training needs in the sector will be substantial in coming years. Priorities include: (i) training for republican level managers and specialists, including study tours to relevant countries; and (ii) training for CSW managers and staff, and local level social welfare officials. • technical assistance needs include: (i) support on social welfare strategy development, including specific support in later years on targeting methodologies and testing of different mechanisms; (ii) support on improving social welfare administration; and (iii) technical support to develop and pilot community-based care initiatives to support de- institutionalization.
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• development of labor market policy, particularly for UB and active labor market programs, but also for the framework for labor relations (Box 13.1). This would require technical assistance to the Ministries of Labor and LMBs, including advisory services, study tours, and seminars. There will also be a need for training MOL/LMB staff in public relations and communications, and consultation and consensus building activities, particularly with trade unions. • An NGO/CSW partnership fund, which would finance innovative public/non-government sector collaborations in social welfare services provision. This would be done on a competitive basis, with clear selection and monitoring and evaluation criteria.
Table 13.11: External Financing Requirements for Pensions/Social Welfare and Labor Market Programs (US$ million) CY01 CY02-04 Total Recurrent Costs Pensions (a) 70.0 65.0 Republican Social assistance programs (b) 15.0 22.5 Child allowances (c) 60.0 20.0 Severance support 15.0 60.0 Subtotal 160.0 167.5 327.5
Investments Upgrading CSW IT/ databases 1.0 3.5 Infrastructure of CSWs 1.6 3.0 CSW equipment/staff skills training 2.0 5.0 Subtotal 4.6 11.5 16.1
Technical Assistance Pensions reform planning/Pension fund 0.9 1.0 management Social welfare strategy 2.0 6.0 development/administration/community based care pilots Social Welfare/Labor market (d) 1.5 2.9 NGO/CSW partnership innovations, community 1.5 6.0 based care pilots Subtotal 5.9 15.9 21.8
TOTAL 170.5 194.9 365.4 (a) The United States had pledged budget support for pensions of US$12 million for Serbia and US$33 million for Montenegro for CY01, which is included in these projections. (b) Social assistance needs include a share of estimated needs in Serbia arising from the use of uniform standards of eligibility throughout the republic. (c) Child allowance needs include a share of the cost in Serbia of supplementary one-off payment program targeted at families with children intended to mitigate effects of price liberalization in energy etc.. (d) Montenegro already receiving EU-financed TA on social welfare policy.
306 CHAPTER 14. HEALTH
INTRODUCTION 14.1 The main concern in the health sector today is fiscal imbalance, caused primarily by inefficiency in the delivery system. This chronic problem affects not only the functioning of the health system, but also has a major impact on the overall economy of FRY. Chronic fiscal pressures have left priority public health and disease prevention programs under-funded, allowed equipment and buildings to become dilapidated, and resulted in a crisis in the supply of pharmaceuticals, all of which have negative effects on the quality of health service provision. Another consequence of the fiscal crisis in public sector health spending is it simultaneously places an increasing burden on patients and raises significant equity concerns.
14.2 On a more macro level, the deficit in the Serbian Health Insurance Fund (SHIF) in 2000 accounted for one third of the total Serbian deficit and 0.75 percent of GDP. In Montenegro the fiscal situation is less severe but there too the system is also “sick” and a potential time bomb. Health is a major part of the economy, comprising an estimated 13-15 percent of GDP (including private and military health expenditures) and approximately six percent of the workforce in FRY today.
14.3 Surprisingly, health status indicators remain strong relative to other countries in the region, but small cracks are appearing as the first unofficial reports of increases in the infant mortality rate and other key indicators are appearing. Unless major structural reforms are undertaken, the health sector will be unable to meet the needs of the population and continue to have a negative effect on the overall economy of the two republics.
14.4 This chapter first examines the health sector in detail and outlines key challenges faced by the sector. This is followed by a discussion of priorities for transition and recovery, and an indicative donor program, which is presented in Table 14.5 at the end of the chapter. The identified external financing requirements for a three to four year program are US$ 205.6 million. Identified needs for CY01, on a commitments basis, are US$ 65.3 million.
A. BACKGROUND 14.5 Health services in Yugoslavia have historically been the responsibility of the Republican Governments. Montenegro and Serbia have always had separate health insurance funds and the freedom to finance and govern their own health systems. While their current systems are quite similar, there are important differences in population, geography, infrastructure, and financial resources that will be taken into consideration as each republic moves forward with their own health sector reform program.
14.6 The Federal Ministry of Labor, Health and Social Policy is responsible for relations with international agencies, drug registration, surveillance and control of some infectious diseases such as TB and HIV/AIDS. The Federal Government also finances the military health insurance system that has its own network of providers. Chapter 14. Health
Health Outcomes 14.3 FRY is barely maintaining what were amongst the best health indicators in Eastern Europe ten years ago. Some minor declines in health status have been reported recently, and although these are not well documented they are of concern given other conditions in the health sector and experiences in other countries in the region where health status has deteriorated significantly. 14.4 When looking at causes of death, the picture is clearly one of a developed and transitional country with high levels of heart disease, strokes, and cancer. Smoking is estimated to cause 30 percent of the mortality in Serbia. Poor nutrition is another major risk factor. A high annual incidence of tuberculosis (39 per 100,000 population) indicates a need to continue to be vigilant about infectious diseases as well, particularly given the living situation of the most vulnerable population and the affordability of drugs. A widespread outbreak of HIV infection and AIDS is also a risk. Surveys also indicate a growing dissatisfaction with the quality of services delivered.1
Table 14.1: Basic Health Indicators, FRY (Including Kosovo) 1990 1995 1996 1997 Infant Mortality Rate 22.8 16.8 15.0 12.7 Maternal Mortality Rate 16.8* 13.7 Male Life Expectancy 68.96 69.88 Female Life Expectancy 74.61 74.67 Life Expectancy 71.3* 72.8 Number of Hospital Discharges per 100 15.8 13.8 15.11 14.3 Outpatient visits per person 4.4** 4.5 4.6 4.1 *data from 1989 **data from 1991
Health Care Financing 14.5 The Yugoslav health care system was unique in Eastern Europe because it was financed by social insurance and not directly from the budget. This provides the country with an advantage in terms of experience with provider contracting, collection of revenues and some of the basic functions of insurance that other countries in the region have had to learn from scratch. Today there are three health insurance funds in FRY, two Republican funds and one Federal level military fund. The Republican funds have regional branches that are not independent units and essentially perform administrative functions for the central funds. Over the past ten years the Republican funds have become increasingly centralized, receiving criticism that operations have become more administratively complex and less responsive to local conditions. On the other hand, centralization has helped to solve, but not eliminate, some of the system’s earlier regional distributional problems.
14.6 Historically, health has been a priority for public financing, receiving approximately 10 percent of GDP in the 1990s. The real amount of public sector money (excluding military health expenditures) that is spent per capita on health care fell from US$240 in 1989 to US$59 in 2000 in FRY2. Part of the decrease in public sector spending on health has been picked up by patients
1 UNICEF, 10 Year Update 2 Excluding Kosovo and Montenegro. With Kosovo the corresponding figure would be US$46. 308 Chapter 14. Health and total health spending is likely to be significantly higher than official data show. Patients pay for services in the private sector as well as making ‘under the table’ payments to health professionals employed in state institutions. They also pay the cost of linens, food and drugs brought to hospital, and over the counter drugs. Household survey data are scarce, but anecdotal evidence and small scale studies confirm the growing burden of health expenditures on the poor.3
14.7 Despite this fall in expenditure, public sector expenditures as a percentage of GDP remain relatively high in FRY, particularly given the current economic situation of the country. In 1999 almost 7 percent of GDP went to health care, although in 2000 this declined to approximately 6.6 percent.4
14.8 The financial performance of the funds over the past five years has been poor. The accumulated arrears of the Serbian HIF by the end of 2000 were 5.9 billion dinars (0.3 percent of GDP). Out of this amount, approximately 1.2 billion dinars in arrears were incurred in 2000. The Serbian HIF has met its deficit by (i) taking out commercial loans; (ii) delaying payments to suppliers, especially pharmaceutical companies; (iii) delaying payments to providers; and (iv) artificially maintaining low reimbursement prices. Similar tactics have been used in Montenegro. Unfortunately there are no data on how much debt has been accumulated by the providers, but it is clear that addressing the fiscal imbalance of the Insurance Funds alone would not solve the problems of the Serbian and Montenegrin health care systems. It is very probable that reduced spending from the HIF induced higher indebtedness in the hospitals in addition to higher levels of out of pocket spending by patients.5
Sources of Revenue 14.9 Nearly all of the public sector revenue for health comes to the health insurance funds in the form of contributions paid by employees and their employers, the self employed, farmers, the pension fund, and the unemployment fund. The remaining revenues come from the budgets of both Republics. Combined, the health insurance funds cover approximately 94 percent of the population with 6 percent remaining uninsured.
14.10 Several points are worth noting about contributions and other revenue flows into the Health Insurance Funds:
• Wage contributions, the largest source of revenue, are split evenly between employer and employee and are set at 19.5 percent in Serbia and 15 percent in Montenegro.6 Compared to other countries in the region, the contribution rate for Serbia is high, particularly given the current income levels.7
3 UNICEF Mobile Teams assessment missions estimate that the public has to cover 40 percent of health care services by covering the price of examinations, prescriptions, and hospital care (p 11, October 2000) 4 World Bank staff calculations using data from the Serbian HIF includes arrears incurred during 2000. While adding arrears to public health expenditures is legitimate, the amount of arrears directly attributable to health care is probably less, as this figure includes interest payments and exchange rate losses as well. 5 Available data do not indicate any change of patterns in utilization, employment and infrastructure. 6 Serbia reduced the tax in 1997 from 18.62 percent to 16.2 percent in an attempt to reduce the burden on labor, but raised it again when the HIF ran into financial difficulties. 7 In 1999 the rates were 13.5 percent in the Czech Republic, 14 percent in Hungary, 13.25 percent in Slovenia, 13.7 percent in Slovakia and 16 percent in Croatia. 309 Chapter 14. Health
• Salaried employees – who represent less than 30 percent of the population -- provide approximately three quarters of the revenues to the HIFs. This level of solidarity, though the hallmark of a social insurance system, imposes a heavy burden on labor and encourages informal employment, under reporting of earnings, non-payment of assessed contributions, and overall acts as a disincentive to formal employment creation. • Pension fund contributions are 8 percent of pensions, recently reduced from 10 percent when the pension fund faced its own financial difficulties • The Republican budget is supposed to cover the cost of health care for certain groups of citizens (children and youth, pregnant women and mothers, recipients of social aid and patients with specific diseases) directly. These are in effect contributions, and it is clear that while the governments are legally obligated to cover these groups, the contribution has been merely symbolic. • Health care services for IDPs and refugees are supposed to be covered by funding transferred from the federal government, based on a 1994 agreement that sets aside US$170 million per year for this purpose. However, in mid-1999, the Serbian health fund received approximately 10 percent of the promised funds per month. Despite the lack of funding, both the Serbian and Montenegrin Health Insurance Fund continue to provide these services with some assistance from NGOs and aid agencies.8
Table 14.2: Revenue to the Health Insurance Funds according to sources in 2000 Serbia Montenegro Revenues Share in in '000 dinars % of total Share in in '000 % of total pop* % contr. pop*% dinars** contr. Contributions by employees 53.8 16,452,944 80.8 44.9 2,458,227 75.7 Contributions by self-employed 686,615 3.4 97,417 3.0 Contributions by farmers 18.2 258,235 1.3 14.3 5,053 0.2 Contributions of Pension Fund 19.4 2,705,631 13.3 25.8 540,023 16.6 Contributions by Employment 6.8 34,484 0.2 13.8 86,966 2.7 Bureau Other 1.8 82,073 0.4 1.2 0.0 All Contributions 20,219,982 99.3 3,187,686 98.1 Revenue from the budget 130 0.0 Other 148,694 0.7 60,711 1.9 All Other 148,824 0.7 60,711 1.9 TOTAL 20,368,806 100.0 3,248,398 100.0 *based on 1999 data **based on 1 DM~30 dinar exchange rate Source: Federal Social Security Bureau, 'Economic Aspects of Implementation of Health Insurance in 1999',(2000) based on Data from the Serbian and Montenegrin Health Insurance Funds.
8In addition, hospitals devote part of their resources – separate from those transferred by the Funds – to provide services to refugees.
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14.11 Other Public Sector Revenues: In addition to the public sector financing that flows through the health insurance funds, a very small portion of the state budget covers the administrative costs of the Ministry of Health and the Institute of Public Health. Military spending on health is likely to be much higher. Another small, unquantifiable amount is spent on health services by line ministries that are not accounted for in the budget of the HIF.
14.12 Private. Out-of-pocket purchase of drugs, surgical materials and food by the patients, both legal and illegal, are most probably a significant portion of total health care spending. These cannot be reliably estimated without a household survey. A widely shared opinion among health professionals is that the gray economy takes a significant proportion of total spending for health and that, effectively, privatization of the health care services is already under way even if the number of officially registered providers is small. A private health insurance system is developing but is unregulated and the amount paid in premia is unknown.
Health Expenditures 14.13 Table 14.3 shows the profile of expenditures of the two health insurance funds. A significant portion of the expenditures (3.5 percent) are not paid directly to health care institutions, but are instead compensations to individuals for some of the expenses associated with being sick. These include compensation for sick leave benefits after 60 days, reimbursement of travel costs, and in the case of Serbia, compensation of funeral costs. Administrative costs of the health insurance funds are included in the “other” category.
14.14 A relatively small portion of funding goes to hospitals, according to these data. However, these data do not break down outpatient services into primary and secondary care and much of the secondary care is likely to also be provided at hospitals. Nonetheless, a fairly large portion of funding went to out-patient clinic services. These tables also do not include all drug expenditures. Sources in the Serbian HIF state that approximately the same amount goes both for prescription and in-patient drug costs. When estimated from the industry data, drugs equal approximately 3 percent of GDP. This is a very high percentage and calls for a close look at existing procurement practices and pharmaceutical policy.
14.15 The breakdown by expense category in 2000 (according to estimates by the Serbian HIF) was: 57 percent for salaries, 15 percent for prescription drugs, 10 percent for medical consumables and equipment maintenance, and 18 percent for food and utilities.9 Today, salaries are uniform, negotiated and covered under a contract signed between the Ministry of Health and the trade unions. In the current fiscal situation, the Health Insurance Fund pays only for salaries of employees plus some drug costs. Employment in the public sector’s health system (like in all other state enterprises during the past decade) has partly assumed the nature of a social protection service delivering welfare payments (minimal salaries) to employees irrespective of the work they do.
14.16 The current official reimbursement system is complex with 7,500 relative prices for different procedures. Prices include a component of salaries, medication, emergency equipment, management, and materials.10 The input prices used to estimate the reimbursement price for each
9 While the data were not available for Montenegro, we can assume that salaries were higher. 10 Capital investment is funded through the Republican budget. 311 Chapter 14. Health procedure are kept artificially low – most notably for salaries and drugs.11 But there is also a problem with the relative weight given to each input, so that even increasing wages and prices of drugs will not solve the problem entirely. Until accurate data are available on the real cost of service provision, it is difficult to estimate the gap between revenues and expenditures.
Table 14.3: Structure of Health Expenditures in the Health Insurance Funds, 1999 (for Serbia 2000)
Type of Expenditures Montenegro Serbia Amount % Amount % Health Care - Total 918,822 90,06 18,838,219 92.48 Out-patient clinic services 364,256 35.70 6.921,375 33.98 In-patient hospital treatment 280,870 27.53 6,453,128 31.68 Prescription drugs 209,843 20.57 2,702,233 13.27 Dental health care 47,249 4/63 617,879 3.03 Orthopedic devices and aids 5,502 0.54 125,777 0.62 Other health care 11,102 1.09 2,143,604 10.52 Compensation - Total 37,169 3.64 660,000 3.24 Compensation during sick leave 15,684 1.54 440,064 2.16 Compensation of travel costs 21,485 2.10 113,696 0.56 Compensation of funeral costs - - 106,240 0.60 Other compensations - - - - Other expenditures 64,266 6.30 870,587 4.27 TOTAL EXPENDITURES 1,020,257 100.00 20,368,806 100.00
Source: Federal Social Security Bureau, 'Economic Aspects of Implementation of Health Insurance in 1999',(2000) based on Data from the Serbian and Montenegrin Health Insurance Funds.
14.17 More inefficiency comes from the fact that the funds currently enter into contracts with all public sector providers in addition to some private providers and the military hospitals. This results in higher administrative costs for the funds and dilutes their negotiating power with the providers. At the provider level, it is difficult to reach a sufficient level of volume necessary for reasonable efficiency. Quality suffers because unless a critical mass of services is performed, skills will be lost and equipment not maintained.
Performance of the Delivery System 14.18 Health services provision in FRY is characterized by an extensive network of public facilities, from the ambulantas – the health stations that are scattered throughout the country – to the Clinical Centers – tertiary university hospitals located in Belgrade, Podgorica, Nis, and Novi Sad. Overall, there are approximately 58,500 beds, or an average of 5.9 beds per 1000 population (6.5 per 1000 in Montenegro). The level of service inputs is almost identical to that which was operating in 1990, but the financial resources flowing into the sector have significantly declined. Consequently, with no capital investment, buildings are deteriorating and some are now beyond repair. A recent survey of medical equipment found that a third did not work, a third could work provided maintenance/repairs were carried out, and a third were working but were already beyond their life span.
11 The price of drugs was recently increased. 312 Chapter 14. Health
14.19 While the supply of infrastructure did not contract with the fiscal crisis in the health sector, there was a slight decrease in demand. However, utilization rates remain high relative to other countries. Hospital admissions are 11.5 per 1000 population, average length of stay is twelve days, and occupancy rates are around 70 percent. As table 14.4 indicates, in some areas FRY is doing better than its neighbors, but in most it is doing worse.
Table 14.4: Comparison of Health Service Delivery Indicators, 1999
Hospital beds Admissions Average Occupancy Number of per 1000 per 100 Length of rate (%) Doctors Stay FRY Serbia 5.9 11.5 12 70.4 2.1 Montenegro 6.5 11.5 11.2 1.7 Croatia 4 13.4 9.6 88.2 2.3 Slovenia 4.6 15.9 7.9 75.4 2.3 Macedonia 3.5 8.1 8.9 66.5 2 Bosnia and H. 3.4 7.4 9.7 70.9 1.6 Hungary 5.8 21.7 8.5 75.8 3.6 Netherlands 3.4 9.2 8.3 61.3 2.5 UK 2 21.4 4.8 n/a 1.6
14.20 It is important to understand why there has not been a greater response in the system to the significant decline in public financing for health. The implication is either that the decline has been substituted with private financing, or that the system was able to survive due to an extremely high level of inefficiency. The answer is most likely somewhere in between.
14.21 Private sector: A rudimentary framework seems to be in place to allow private practice, and some parts of the system such as dentistry are rapidly moving in that direction. There are, reportedly 3,000 registered private institutions, doctors and services, employing over 6,000 workers full time with 12,000 part time consultants. It is a parallel system that is serving a small portion of the population, those that can pay for services in cash. Many doctors from public services work within the private sector as consultants , with potential conflicts of interest between their two professional engagements.
14.22 Human resources: Approximately 165,000 people worked in the health sector in 1999.12 Physicians have dominated the system, with less emphasis on nursing and other paramedical specialties. Training and exchange of updated professional information were particularly difficult during the sanctions. Today, 6000 doctors are reported to be unemployed in Serbia alone and the remaining are reportedly underemployed. This appears counter-intuitive given that the number per 1,000 population – 2.1 – is lower than both the EU average (3.5) and the CEE average (2.5). However, one of the problems may be the distribution by specialty or region. More study is required to determine the extent and nature of the problem. In the short term, no plans have been made to cut enrollment in medical school and the annual graduating class is around 1000.
12 The exact number is 165,401. Health care and Social Work, FRY excluding Kosovo, data are for 1999, source is Statistical Yearbook of Yugoslavia, 2000. 313 Chapter 14. Health
14.23 An excess supply of health care providers exacerbates the fiscal problem because providers will, out of their own interest, generate demand for their services that is unnecessary, but the necessity of which the patient is unable to discern. This might include extra laboratory tests, operations, referral to specialists, or return visits. The excess supply of providers results in lower publicly paid salaries for all, which perpetuates the demand for under the table payments. Not only does this have negative consequences on the patient who must pay, but it also represents a significant amount of loss income on tax revenue to the Government.
14.24 As wages have fallen in real terms and basic means for delivering health services have deteriorated, the morale and motivation of the workforce has deteriorated. The average net wage of health workers was 1,493 YUD in 1999.13 Based on studies in other countries, this is likely to have had an additional negative impact on quality of care.14
14.25 Pharmaceuticals: Prior to 1990 Yugoslav pharmaceutical companies exported a great share of the locally produced drugs to the Soviet Union. After the imposition of sanctions, however, they lost their traditional export markets to other countries. As a result current production capacity significantly exceeds local needs or present production levels. There are 15 pharmaceutical companies in FRY, five of which are large and comply with GMP standards for a number of their products.15 The companies import most of their raw materials and process the drugs (mostly generics) in their plants for local sale, where they have approximately 70 percent of the market.
14.26 The local pharmaceutical industry has also suffered from the financial crisis of the health insurance funds. In order to keep costs down, the health insurance funds refused to increase reimbursement prices to the drug companies over a five-year period, during which time the companies were not able to cover production costs and shortages of drugs resulted. Due to this shortage, a large gray market developed for pharmaceuticals (mainly in the form of smuggled products from the neighboring countries) that local experts estimate to be around 25-30 percent of total pharmaceutical expenditures.
14.27 In March 2001, an agreement was reached between the drug companies and the Serbian HIF to increase drug prices by an average of 84 percent. This was calculated by taking Slovenia as a comparator and agreeing that the Serbian price level should be at least 47 percent that of Slovenia. In order to cover the increased costs generated by the higher prices, the Government intends to reduce the number of drugs reimbursed by the HIF from 400 to 100, along the lines of WHO’s essential drug list.
B. KEY CHALLENGES
14.28 Many of the issues facing the health sector in FRY are the same as those facing other countries in the region. Collapse of the economy has depleted the main source of financing for the sector – in FRY’s case, contributions from wages – and resulted in the patients themselves becoming the key source, causing increasing inequities and the loss of the benefits of risk
13 Statistical Yearbook of Yugoslavia, 2000. 14 See Case studies on Work Force Motivation, PSR Project/USAID, Abt Associates. 15 In addition, the public Institute, “Torlak” Institute of Virology and Immunology is a major produce of vaccines (BCG, DPT, OPV, TT, DT, and Influenza). 314 Chapter 14. Health pooling that come with a predominately publicly financed system. Despite the weakening economy, few efforts were taken to improve the efficiency of a system that was bloated and overspecialized. Rather than limiting the benefits provided or reducing the number of staff, reimbursement prices were reduced to a point that was well below actual cost.
14.29 The situation in FRY has some distinct differences as well. Armed conflicts within and surrounding the country have resulted in refugees and IDPs that have placed an extra burden on the health system. The sanctions resulted in a prolonged period with no access to many critical drugs or supplies and spare parts. A long period of isolation has left practitioners behind in introducing new technologies, especially in regard to health promotion and management. Finally, the uncertainty of the political environment regarding Kosovo and Montenegro makes health planning particularly challenging. Some of the main challenges FRY faces today in the health sector include:
Achieving fiscal balance in the health insurance funds while protecting the poor
14.30 For both Serbia and Montenegro, finding and maintaining a balance of what is affordable for public financing via the health insurance funds presents a key challenge. The budget for the Serbian health insurance funds is projected to be 38.5 billion dinars or 5.6 percent of projected GDP for 2001. On the expenditure side, the noted 84 percent increase in the price of drugs will increase significantly the cost of services. Serbia is taking steps to close the financing gap by introducing new co-payments. Nonetheless, a small financing gap remains. The Serbian budget will also compensate the HIF for lost revenue due to changes in tax regulations. The level of financing under the 2001 budget is, however, well below what many in FRY consider minimally necessary to run the existing system. Consequently, until major structural reform, patients will continue to pay for a part of health care services – in particular, for drugs - out of pocket.
14.31 A longer term strategy is clearly going to have to find a way to eliminate the chronic inefficiency in the system and bring spending to a level that will be affordable and equitable for the two republics. Regardless of the strategy adopted, the level of public financing for health care will be less in real terms than it was in 1989 when it reached US$240 and total public health sector spending was more than 10 percent of GDP. Part of the challenge in balancing the health insurance funds will then also be to control these out-of-pocket expenditures on health – particularly the informal payments - before they become too large. While there is nothing wrong per se with private participation in the costs of health care, there should be transparent regulation, so that the government can manage the content and quality of care provided and discourage the growth of an underground medical economy. Large levels of out-of-pocket payments, even when officially charged, pose equity and efficiency issues and should not be relied upon to fill the growing financing gap of the health insurance funds.
Restructuring the delivery system and orienting it more towards primary health care 14.32 Ten years without capital investment and limited maintenance has left most of the infrastructure in ruins. With excess capacity in the system, it will be too be expensive to upgrade, repair and/or replace everything. The challenge will be to reach consensus with Government, health care providers, and the public on the need for a smaller but more efficient health delivery system and to rebuild and equip this system based on a new model of health care, rather than attempting to repair the old.
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14.33 Experience from the region has shown that these reforms are extremely challenging given the lobbying power of the medical profession and other affected interest groups. But there will be no way to increase salaries, improve efficiency, or afford the necessary longer term quality enhancements unless these reforms are implemented.
14.34 Many of the reforms that will have the biggest impact on health require changing behavior, and therefore should not be expected to happen overnight. Ultimately, it will not be until patients begin to accept primary health care and practice healthier lifestyles that improvements in health will be seen, regardless of investment in developing protocols, training personnel to use them, and putting the right financial incentives in place.
Managing the reform process with limited data and human resources. 14.35 Reaching consensus on a health policy and developing an implementation strategy is going to be particularly challenging as it is in every country. Accurate data for decision making are scarce. Management capacity in key implementing institutions such as the Ministries of Health, Health Insurance Funds, and health care providers is weak. Managing expectations of the public, who have memories of the previous overly generous system and look to Western Europe for models for health care, will make the task more difficult.
14.36 Managing donors is also critical as an influx of donated pharmaceuticals, medical equipment, and supplies arrives. Some donated drugs and equipment may actually end up causing harm rather than helping. Croatia and other countries are now borrowing money that could be better spent on other investments to destroy unusable donated drugs and supplies.
C. PRIORITIES FOR TRANSITION AND RECOVERY
14.37 Both republics have begun to work on reforming their health sectors, with key agreements regarding Serbia reflected in the recent IMF agreement. Montenegro’s reform program is currently more advanced. The highest priority must be to get the fiscal situation in the health sector under control through a combination of improved efficiency and increased revenues. After that, the priority will be to develop a new health care financing strategy, as part of the development of a broader new health policy. This would include recommendations for changes in the tax system, transfers from other funds or the budget. It could also address a series of other important issues such as private participation, decentralization, and provider payment. Ultimately, however, a major restructuring of the system will be required before financial stability can be achieved.
14.38 Several lessons in health financing reform from the region are worth noting: • Payroll taxes have proven to be the most reliable source of financing for the health sector because they have been relatively protected at times of fiscal crisis. Therefore, ideally any reduction in the part of the contribution would be replaced with another earmarked tax for health. One possible replacement for the wage contribution to health would be an earmarked tobacco tax. This would have added public health benefits. Studies have shown that contrary to the fear of many governments, higher tobacco taxes and prices reduce consumption and also raise revenues.
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• While immediate prioritization of a basic package of services and discontinuing payments for some treatments sounds appealing as a means to control expenditures, in reality this is very difficult to do both politically and administratively. It is important to remember that in the case of Eastern Europe, moving to a basic package approach almost always entails taking benefits away rather than adding to what is already provided. • The Health Insurance Funds in FRY – like many countries - have also suffered from their reliance on other government funds and the budget for contributions for large, expensive group such as pensioners, disabled, unemployed, and children who typically consume more services. More detailed costing and actuarial studies can be undertaken in 2001 in preparation for the 2002 budget. • New contracting arrangements with providers have the potential to introduce better resource management of health institutions and to increase efficiency. However, experience in other countries has shown that rushing to contracts – even of the most straightforward kind - has been a major weakness, given the overall lack of management skill and transparency in the system. • When it comes to optimizing capacity in the sector, the market approach has not proven to be particularly effective. Furthermore, countries that have left reform in this area until later have been more likely to see financial failure in their health insurance systems, as they have often proven unable to control expenditures.
14.39 Achieving fiscal stability in the sector. In the near-term, this would combine measures to improve revenues and decrease expenditures. Measures to improve revenues would include: • Budgetary support for pharmaceuticals: Fiscal balance will not be achieved immediately, therefore donor support to the health budget will be important in the short term. This support, however, should be conditional upon structural reform of the system. • Improving collections and working with other social funds in expanding definition of tax base. • Introducing co-payments. Co-payments have recently been introduced in Serbia and are expected to raise YUD 1.0 billion (0.15 percent of GDP) annually. Exemptions for vulnerable groups have been established and it will be important to study the impact of these fees – as well as other out of pocket health spending – on equity before settling on an overall health care financing policy. However, given the dearth of resources and the knowledge that people are already paying for health services, co-payments seem to be one of the most sensible short-term solutions for mobilizing revenue. Use fees also have a role in controlling demand, although this needs to be weighed against the marginal cost of collecting such fees. Measures to decrease expenditures include: • Shifting sickness and transport payments to the Ministry of Labor which is responsible for benefit management and safety nets. While only comprising 4 percent of HIF expenditures, there is no reason these items should be covered under the health insurance funds.
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• Merging laboratories, departments, and facilities or extending working hours. The most significant efficiency gains will come with actual facility closures and personnel lay-offs, but initially even these smaller, less painful steps accumulated together can be quite significant. • Introducing new drug procurement procedures and other incentives to decrease pharmaceutical expenditures • Improving data and information on system performance and financial flows to allow monitoring and assessment of the system and its finances. This will require development of a set of national health accounts and collection of other data necessary for developing health care financing strategy.
14.40 Following collection of more accurate data and completion of analytical studies, a new health financing strategy for both Serbia and Montenegro will be prepared. An important part of implementation will be to ensure that adequate accounting and information systems are in place prior to introducing any sophisticated contracting arrangements.
Restructuring the delivery system in order to improve the quality and accessibility of health care services 14.41 In the near-term, this would begin with the equipment and repair of priority health care facilities. Evaluations by WHO and the Ministries of Health have confirmed that the lack of functioning medical equipment and need for some essential maintenance of heating, water, and electrical systems at health facilities. While reluctant to invest significant amounts of money in facilities whose future is uncertain, it is possible to identify some facilities that have a high probability of remaining in the future system. Serbia has decided to concentrate resources initially in one hospital in each region, on the rationale that most people will be able to reach one of the regional hospitals, and that each of the regions is likely to be able to supporting a hospital in the future. Other priorities are equipment for emergency care units and maternities.
14.42 In parallel, there is a need to develop a plan for restructuring the delivery system. Both Serbia and Montenegro have indicated their intentions to place more emphasis on prevention and primary health care, acknowledging the overspecialization and inefficiency of the existing system. Given the current excess supply of staff and facilities, these changes and others make it necessary to optimize the system and will result in various restructuring, mergers, and closure of facilities. Controversial political issues and important decisions such as ownership, governance structure, and staffing will have to be made. While really part of a single integrated system, the plan can be divided into three components: hospitals (and health centers), primary health care (including public health), and human resources. • Hospital Restructuring: Tentative proposals and ideas to restructure the system exist. It is quite common to assume that some of the excess beds can be used for long term care or nursing homes, but this approach risks creation of a system of delivery to that which other countries are now trying to dismantle. Many agree that the place to begin will be the large cities, especially the Clinical Centers – or large University Teaching Hospitals. Restructuring the Clinical Centers will pose an enormous challenge, but is also where the biggest gains will be found. None of these decisions can be made, however, until a hospital master plan is developed. Once a master plan is prepared, it can be implemented
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gradually – perhaps supported initially by targeted investments from donors and selective contracting from the insurance funds. Such a plan should not be limited to hospitals, but include all types of health facilities. • Primary Health Care Development. Primary health care exists in theory and even in legislation, but does not function effectively. A program to pilot several different models of delivery and financing prior to wide implementation would seem most desirable. Medical education in FRY is not set up to train primary care physicians – or family doctors - and to do so will be a long term process that requires reforms in undergraduate and post graduate education system. Transitional models tried in other countries have included teams of physicians from the specialties of general medicine, pediatrics, and gynecology. • Human resources: There is first a need to understand whether excess capacity is a real problem or not. An overall human resources plan will answer that question as well as identify priority training needs. Both Ministries of Health have identified health management and public health to be a high priority among training needs (including at the post-graduate level). Finding ways to deal with redundant health personnel poses another set of challenges. Moving to private practice is one alternative, as is retraining in one of the underserved specialties. Attractive severance packages will also be needed and should be considered in the cost of future restructuring options. Consideration also needs to be given to how reforms in health will link to overall civil service reform.
Medium term: 2002-2004:
14.43 In the medium-term there will be a need to further develop the restructuring plan. This will extend well into 2002, and implementation beyond 2004. In an ideal world, development of such a plan would be preceded by an extensive data collection exercise and a long, thoughtful process of reaching consensus. There are several reasons to accelerate this process in FRY: the urgent need for the efficiency gains restructuring can bring; acting before too much resistance from interests groups can be built up; and eliminating duplication and/or misallocation of scare donor investments. Therefore, it may not be possible to have detailed implementation plans for the entire system before beginning structural reforms. In the case of FRY, reform of the hospital sector is particularly urgent. Government will want to monitor donor investments in order to ensure consistency with their overall master plan and as well as future cost implications to the system. Hospitals are also the most expensive component of the health system and where the biggest cost savings will be seen in the short term.
Creating the capacity to develop, communicate, and effectively implement a preliminary Health Policy 14.44 In the near-term, this will require support to the high level Task Forces in Serbia and Montenegro to facilitate the preparation of a blueprint for reforms that can be used to build consensus as well as the needed steps to restructure the health system that raises efficiency, quality and access.
14.45 The medium-term agenda will have three key elements:
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• Development and implementation of a communications strategy. Developing a communications strategy and managing expectations is a priority that should not be delayed until finalization of a new health policy. It will be important to be proactive on this issue. New policies such as co-payments and increases in drug prices are important to put in the context of the overall goals the Serbian and Montenegrin governments have in health. Communication with the public, patients, elected officials, and health care providers are all equally important. • Providing support to build capacity in major institutions that will be involved in health sector reform: the Ministries of Health, Health Insurance Funds, and Institutes of Public Health. The major institutions involved in the health reforms in Serbia and Montenegro will benefit significantly from clear definition of their roles and responsibilities in the reform process and additional training. Support can be provided to defining and developing the functions of these key institutions in the health sector in order to strengthen overall governance and to improve transparency. Training in management has been identified as a priority by both the Serbian and Montenegrin Ministries. • Developing health information systems and collecting essential data for policy making. Accurate information is a prerequisite for decision making and strategic planning. Many of the first tasks to be undertaken, such as developing a new health policy, estimating future revenue and expenditures for the health insurance funds, and preparing a facilities restructuring plan require collection of accurate data. The collection of data for development of the national health policy provides an opportunity to begin to design a new health information system.
D. PROPOSED DONOR PROGRAM
14.46 Recurrent cost financing: Financial assistance to complete HIF transition and cease their being a drain on the two respective republican budgets. While recurrent cost financing needs are expected to be relatively small, as much of the gap will be filled by direct transfers from the republican budget (at least in Serbia) and planned revenue from co-payments, an increase in drug prices for 2001 will place extra pressure on the funds. Of particular concern are the more vulnerable groups. Therefore, earmarked budgetary support for pharmaceuticals is suggested, beginning in 2001 and steadily decreasing through 2004. This would help compensate for the increase in pharmaceutical prices and allow time for the health insurance funds to go through the necessary structural adjustments.
14.47 Health IT Systems: Computer hardware and software to support the development of health information systems, particularly in the health insurance funds.
14.48 Medical equipment and civil works: (i) initial repairs and equipment for 25-30 hospitals; (ii) priority equipment for primary health care facilities and therapists; (iii) larger scale investments, particularly linked to some structural reforms.
14.49 Technical Assistance and training needs include: (i) Support for Policy Development and Capacity Building to support a task force in Serbia and in Montenegro to develop a National Health Policy; (ii) preparation of a plan for a health information system for the health insurance funds and design of an integrated health information system; (iii) preparation of a health
320 Chapter 14. Health financing plan; (iv) developing a health system delivery restructuring plan including a hospital restructuring plan, human resources strategy, and primary health care strategy; and (v) support to priority health promotion and disease prevention programs.
Table 14.5: Estimates of external financing requirements for the Recovery Program in the Health Sector
Priority Estimated Financing Total Program Requirement US$ m CY01 CY02-04 Recurrent Expenditures Pharmaceutical Support 30.0 25.0 Subtotal 30.0 25.0 55.0 Investments Health IT systems 0 25.0 Medical equipment and civil works 25.0 58.0 Subtotal 25.0 83.0 107.5 Technical Assistance Needs Policy Development and Capacity Building 4.0 7.0 Health Information system design 2.0 3.0 Health Financing Strategy 1.3 7.3 Health service delivery and system 1.7 7.0 restructuring planning, HR development Priority Health promotion and disease 1.3 8.0 programs Subtotal 10.3 32.3 42.6
Totals 65.3 140.3 205.6
321 CHAPTER 15. EDUCATION
INTRODUCTION
15.1 This chapter summarizes the current situation of the education sector in Serbia and Montenegro at all levels: preschool, primary, secondary and higher education. It recommends a number of priority actions for the short-term and medium-term to begin to make the educational system functional and sustainable, to raise labor-force productivity and flexibility, and to promote peace in the region. Unless specifically mentioned, all references to the Federal Republic of Yugoslavia (FRY) and the Republic of Serbia in the text and figures exclude Kosovo. The chapter begins with a description of the legacy of the recent past in the education sector, then describes the key features of the current education system, and finally presents the sectoral priorities for transition and recovery.
15.2 Quantifying recent education developments presents serious difficulties. Part of the problem results from the legacy of firstly decentralization under the former SFRY, then of de- professionalization of the Ministries of Education that occurred under the previous government. Although data on enrollments are available, it is difficult to infer from those data what proportion of the school-age population this represents because of the population movements – affecting the denominator of the education coverage estimate -- since the last population census in 1991. This situation will improve when the results of the next population census become available. In the meantime, indirect estimates of education coverage have been made.
15.3 This chapter presents background information on the education sector and identifies key priorities for transition and recovery. This analysis is followed by a proposed reform program and an indicative donor investment program, summarized in Table 15.9 at the end of the chapter. The external financing requirements in the education sector are estimated to be US$247.5 million over three to four years. The financing requirement for 2001, on a commitment basis, is estimated at US$83.5 million.
A. BACKGROUND
The Socialist Legacy 15.3 Education Management. Education in Serbia and Montenegro under the Socialist Federal Republic of Yugoslavia (SFRY) was quite well developed, although with important regional differences. Average coverage of education in SFRY in 1989 was 95 percent for the eight-year primary cycle, 80 percent for the (mostly) four-year secondary cycle, and 19 percent for higher education.1 Responsibility for education management under the SFRY was legally decentralized, but management of key aspects of education effectively remained centralized. The six republics of the Federation and the two autonomous provinces of Serbia (Vojvodina and Kosovo) were responsible for education management at all levels, including establishing curricula and educational standards. Actual responsibilities for hiring teachers, building and maintaining schools, and purchasing educational materials were devolved to self-management
1 World Development Report, 1992 Chapter 15. Education committees at the municipal level, or even at the school level. In general, municipal revenues and local contributions met over 99 percent of the financing needs for education.2 The poorer republics – Montenegro and Bosnia -- received transfers from the Federation and the autonomous province of Kosovo received transfers from the Serb Republic budget to enable them to maintain minimally acceptable standards in education. The more prosperous parts of the Federation were free to maintain higher standards, and did so. In spite of the appearance of decentralization, however, party discipline led to broad uniformity of professional content and political orientation of education at all levels.
15.4 As the SFRY began to come apart in 1990, the Republics of Serbia and Montenegro moved to formally centralize education management. In part, this policy was designed to resist further fragmentation of the Federation. The Republic of Serbia suspended the autonomy of Kosovo and Vojvodina provinces in 1991 and imposed a Serbian-language curriculum.
15.5 In 1992, Serbia and Montenegro adopted legislation that further centralized education management. This legislation moved most of the financial resources for education from the municipal level to the Republic level. At the same time, it suspended the authority of self- management committees to select their own school principals, and gave this responsibility to the respective Ministers of Education. School principals were often appointed on the basis of political orientation. Directives of the Ministries of Education effectively changed the role of the principal from management of the education process within the school to prevention of strikes and political opposition by teachers. The centralization of education budgets provided another tool for enforcing political loyalty. Opposition municipalities were punished by receiving smaller education budgets. Meanwhile, the trade embargo and the financing requirements of the wars in the neighboring republics meant that there were fewer resources for education even in politically loyal municipalities. Universities in Serbia at first remained autonomous, but in 1998, they, too, were brought under strict political control by new legislation which made the Minister of Education personally responsible for all appointments of deans and rectors. The reaction of university faculty and the public to this change provided impetus to the political opposition, and contributed to the fall of the Socialist government in October 2000.
15.6 A Rigid Labor-Market Interface. The rigidities of the transition countries prior to the start of the transition have been aptly characterized in the following terms: Education was directed toward the productive and ideological goals of the socialist regimes, and thus has been limited in its ability to respond to the changing economic structures and employment patterns essential for the success of a market economy. Under the previous regime, school systems and curricula were subject to rigid control by central governments. Curricula and teaching styles reflected socialist values, emphasizing conformity, the acquisition of fact and political loyalty over critical thinking and analysis. Enrollment targets were set by planners to serve the needs of industry. Secondary and tertiary education, especially, were strongly influenced by industrial ministries, which determined enrollments and designed curricula. Vocational and technical programs were emphasized at the expense of more academic, flexible programs, and certain disciplines, particularly in the social sciences, were neglected or ideologically biased. Employment was virtually guaranteed for virtually all recent
2 Education, a background paper for the Educational Forum prepared by Mirosinka Dinkić.
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graduates, with Party affiliation more important than academic achievement for preferred jobs.3 Under its system of self management, SFRY embodied some of these features less than the other socialist economies in the region. There was, for example, open unemployment in SFRY from the mid 1960s. But education in SFRY nonetheless remained focused on narrow professional or occupational specializations, and pedagogy emphasized mastery of facts over application and critical thinking.
Table 15.1: Total Enrollments by Level in 1990/1991 and 1999/2000
1990/1991 1999/2000 Serbia (excluding Kosovo) Preschool 169,686 164,749 Primary 749,975 731,427 Secondary 294,320 332,559 higher (full-time) 89,000 107,693 Montenegro Preschool n.a. 12,500 Primary 81,547 78,037 Secondary 26,572 31,817 higher (full-time) 4,084 4,688
15.7 A Decade of Isolation and Neglect. The education sector in Serbia and Montenegro suffered heavily under the disruption and economic deprivation of the past decade. The influx of as many as 690,000 refugees – mostly from Bosnia & Herzegovina -- early in the past decade, and another 250,000 from Kosovo4 has seriously strained education capacity. Most schools have had almost no new educational materials for the past ten years. Schools have not been maintained; teachers have been demoralized by political interference and by the sharp decline in their real earnings; curricula and teaching methods at all levels have stagnated as fresh professional inputs of all kinds have been choked off by the embargo, by political interference, and by budgetary deprivation. The Kosovo conflict in March, 1999 created additional problems, destroying four primary schools, damaging 238 others,5 suspending classes in much of Serbia, and causing further dislocation of population in the areas affected. More than 28,000 students were displaced at the primary level alone.6
3 Trends in Education Access and Financing During the Transition in Central and Eastern Europe, Bruno Laporte and Dena Ringold, World Bank Technical Paper No. 361, Social Challenges of Transition Series, 1997. 4 The earlier figure is from the Statistical Yearbook of Serbia, 2000, cited in Statistical Data for Background Purposes of OECD Review: Serbia, University of Ljubljana Faculty of Education, Center for Educational Policy Studies, January, 2001. The latter figure is from Education in Serbia 1999/2000, a working paper prepared by Professor Ivan Ivić for the Educational Forum. 5 The damage to most schools was minor. Total war damages have been estimated at US$1.3 million for civil works and US$0.6 million for materials and equipment. (Economic Effects of NATO Intervention on Primary Education: Assessment of Damages and the Necessary Resources for Reconstruction. Mirosinka Dinkić et al., Belgrade Economic Institute, 1999.) 6 Ibid.
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15.8 Enrollments in both Serbia and Montenegro declined slightly during the past decade at the primary level, but increased for secondary and higher education (Table 15.1). Preschool participation declined slightly in Serbia; time-series data are not available to record preschool trends in Montenegro.
15.9 Although some of the decline in primary enrollments may reflect the decline in the natural growth rate of population in Serbia during the decade,7 the large influx of refugees and IDPs implies that education coverage – expressed as a percentage of the population in the relevant age group -- declined significantly for the primary age group. Coverage may have increased slightly for secondary and higher education, but cannot have increased significantly. Whatever the actual changes in coverage, they clearly were accompanied by a steady degradation of the teaching and learning environment, including the loss of large parts of the last two school years due to the Kosovo conflict and other disruptions. Assessment results are not available to document the impact on learning achievement, but it is highly unlikely that learning achievement did not suffer.
15.10 One of the troubling implications of the stagnation of education coverage is that it means that the labor force of Serbia and Montenegro have fallen further behind the labor force of the OECD countries in terms of educational qualifications. For the former SFRY and a number of European countries, Table 15.2 shows the percentage of the adult population with at least a secondary education in 1990:8
15.11 The figures for Yugoslavia reveal a conspicuous age gap in educational attainment of the adult population, and imply very significant improvement in education coverage since World War II. Whereas the youngest age group in the adult population in 1990 had a level of secondary education attainment as high as the OECD average, older age groups had progressively lower secondary education attainment. Slovenia and Croatia had the highest educational coverage of the former SFRY Republics. Coverage in parts of Serbia, especially Vojvodina, was also above average. Coverage in Montenegro and, especially, Kosovo was considerably below the SFRY average. In the meantime, average participation in secondary education in the OECD has risen to 76.3 percent,9 but in Serbia and Montenegro it has stagnated at roughly the same level as it was 10 years ago. This comparison understates actual educational differences, since education quality in Serbia and Montenegro has fallen sharply in relation to the OECD average.
7 In 1991 the census population of Serbia was 7,759,571 and of Montenegro was 615,035. According to sample- survey-based estimates of the Federal Institute of Statistics, the total population of Serbia declined slightly to 7,747,389 in 1998, but increased to 647,118 in Montenegro. Over the same period, the rate of growth of population from natural increase declined from +0.9 percent per year to –2.9 percent per year in Serbia. Population growth from natural increase (births minus deaths) remains positive in Montenegro (+0.6 percent). (Figures for Serbia are from Statistical Data for Background Purposes of OECD Review: Serbia, University of Ljubljana Faculty of Education, Center for Educational Policy Studies, January, 2001. Figures for Montenegro are from Republic of Montenegro Statistics, 1998, cited in Statistical Data for Background Purposes of the OECD Review, December, 2000.) 8 I.e., attended secondary school. Figures from D. Perazić, Obrazovanje u SRJ , cited in Transformation of Education: Education and the Transformation of Yugoslav Society, Professor Ivan Ivić. 9 Education at a Glance, 2000, OECD
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Table 15.2: Percentage of 1990 Population in Various Age Groups with at least a Secondary Education
Age Group 25-34 35-44 45-54 55-64 France 66 56 45 27 Germany 88 86 79 67 Switzerland 88 84 77 69 Austria 79 70 63 49 OECD Average 66 59 49 38 Yugoslavia 66 54 37 25
Features of the Current Education System in Serbia and Montenegro 15.12 Minority-Language Education. An important feature of education in the FRY is minority language education. Under the Federal constitution, all linguistic minority groups have the right to mother-tongue education at all levels of education. There are 284 primary and secondary schools in Serbia which deliver the full curriculum to 46,500 students in the Hungarian, Albanian, Romanian, Ruthenian, Slovak, and Bulgarian languages, with Serb as a second language.10 In terms of the proportion of students affected, this is one of the most diverse programs of minority-language instruction offered by any national education system. In Montenegro, where the principal minority is Albanian, minority-language instruction is offered to 3,200 Albanian-language students in 40 primary schools.
15.13 Minority-language education is a positive feature of education in Serbia and Montenegro, but it may be appropriate to consider eventual refinements which would provide better sustainability and strengthen the benefits of the program. Provision of minority-language instruction goes well beyond the requirements of the European Charter for Regional and Minority Languages, which calls for provision of initial minority-language instruction in any region where the minority constitutes at least 20 percent of the population. The constitution of the Serbian Republic calls for minority-language education to be provided whenever the population of any particular class exceeds 15 students. The application is even more generous. Minority-language education is offered in many classes numbering only 4 or 5 students. Some classes have only 3 students. The relatively high cost if such a program should be recognized. Given financing constraints, focus should be placed on improving efficiency in the delivery of minority language education, but all efficiency objectives must be balanced by the legitimate desire of local stakeholders to maintain their linguistic and cultural heritage.
15.14 Low Roma School Attendance. There is a serious problem of education coverage for the one linguistic minority which does not benefit from the minority-language program – the Roma. It would not be practical to try to offer the primary-school curriculum in the Romany language, because there is no consensus on the appropriate version of the Romany language.
10 Figures from Statistical Data for Background Purposes of OECD Review: Serbia, University of Ljubljana Faculty of Education, Center for Educational Policy Studies, January, 2001, and Evaluation of Elementary Education in the Federal Republic of Yugoslavia, Svetlana Marojević, draft working paper, 2000.
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Only one third of Roma children complete primary school.11 Most do not start school at all, or drop out in the initial two or three years. In 1981, only 34.8 percent of the Roma population of Serbia were literate, versus an average literacy rate of 78.7 percent for the population of Serbia as a whole.12 There are many reasons for this dismal performance. Parents are often illiterate and do not appreciate the importance of education. Low income makes it difficult for most Roma households to purchase the textbooks and other school supplies that parents are expected to provide. Roma children often work in the informal sector to supplement meager family income. Many Roma children do not have a reasonable command of any of the languages of instruction in schools. Many Roma families lack legal status and are therefore denied access to schools, health care, and other services. Romas often marry and start childbearing at a very early age – as early as age 12. Of those Roma children who do complete primary school, few attend secondary school or go on to university education. This pattern of school participation, combined with the fact that a relatively high proportion of the population is in the primary- school age group13, suggests that there are roughly 75,000 Roma children of primary-school age in Serbia who are not attending school. This constitutes a serious gap in school coverage at the compulsory level, amounting to about 10 percent of total enrollments. Another problem is that the few Roma children who do attend primary school are often stigmatized by being assigned to schools for the handicapped, because of their lack of command of the Serbian language and other educational handicaps resulting from their environment, rather than from innate limitations.
15.15 There are a number of NGO-supported programs in Serbia and Montenegro which offer a range of interventions to help overcome these educational handicaps and to prepare Roma children for successful school participation. These include preschool education in the Romany language or in a multi-lingual environment, parental education, legal registry, and other interventions. The experience with Roma-targeted programs in other countries in the region shows that this holistic approach offers the best prospects of raising school participation and school performance among the Roma population, especially when it involves child-centered learning methodologies and the commitment of the Roma community.14 Other successful measures to improve Roma school attendance and educational performance include (a) the provision of financial incentives to schools which attract and retain Roma students; (b) the provision of catch-up classes for Roma drop-outs and tutoring for Roma students: (c) special training for teachers of Roma children; (d) the provision of linguistic and cultural mediators in schools with Roma students; and (e) offering of optional Romany language and culture classes. In Montenegro, there is less of a problem with Roma children not attending primary school than there is with children of Kosovar refugee families who have settled in Southeast Montenegro during the past two years. Here, a similar, broad approach is needed to raise attendance levels and school performance.
15.16 Education Efficiency. School facilities are used quite intensively in Serbia and Montenegro. In Serbia, 36 percent of primary schools operate on double or triple shifts, and 40 percent of primary students attend such schools. In Montenegro, all urban schools, and 33
11 Aleksandra Mitrović and Gradimir Zajić, op cit. 12 Early Childhood Development in the Former Republic of Yugoslavia: Suggested Strategies for UNICEF, Cassie Landers, 2001. 13 A total of 40.7 percent are 14 years old or less, ibid. 14 See Early Childhood Development in the Former Republic of Yugoslavia: Suggested Strategies for UNICEF, Cassie Landers, 2001.
327 Chapter 15. Education percent of all schools operate on double or triple shifts, and 40 percent of primary students attend such schools.15 But school staffing is relatively generous, and offers significant scope for economies. Most importantly, class sizes and student/teacher ratios are relatively low for primary education by comparison to many other countries (Table 15.3).16 In addition, the ratio of non-teaching staff to teaching staff appears to be significantly higher in both Serbia and Montenegro than in most OECD countries.
Table 15.3: Student/Teacher Ratios in Serbia, Montenegro, and Selected Comparators Student/Teacher Ratio Primary Secondary Higher Serbia 16.8 16.3 9.6 Montenegro 16.0 13.7 7.0 United Kingdom 22.0 16.7 17.7 Greece 13.6 11.5 26.3 Czech Republic 19.2 15.4 13.5 Germany 21.6 15.5 12.4 Ireland 22.6 16.3 16.6 Spain 16.0 12.1 17.2
15.17 In fact, class sizes for many schools in Serbia and Montenegro are much smaller than these figures indicate because of the bimodal size distribution of schools. In Serbia, there are 2,008 primary schools with fewer than 50 students.17 Most of these are small rural branch schools which provide the first four years of primary education. Often, these schools operate with multi-grade teaching, but without adequate teacher training or educational materials to make it effective.18 There are, for example, 491 four-year primary schools with a single teacher for all four grades, and an average of 11 students per school. In Central Serbia, there are there are 59 eight-year primary schools with fewer than 50 students in all eight grades.19 More than 65,000 students in Serbia are enrolled in schools which do not offer the complete 8-year primary curriculum.
15.18 In addition to the dispersion of population and the small sizes of primary schools, one reason for low teacher/student ratios in primary is single-subject teaching starting in grade five. Although some subject teachers teach in (and travel among) several primary schools, average actual teaching hours for subject-specialist teachers are still lower than the average for classroom teachers. Another important factor contributing to low efficiency is the much smaller class sizes in the minority-language classes. Class sizes in minority-language primary-school classes
15 Evaluation of Elementary Education in the Federal Republic of Yugoslavia, Svetlana Marojević, draft working paper, 2000. 16 Figures for Serbia and Montenegro are government estimates. Figures for other countries are from Education at a Glance: 2000. OECD 17 Statistical Data for Background Purposes of OECD Review: Serbia, University of Ljubljana Faculty of Education, Center for Educational Policy Studies, January, 2001. 18 In Serbia, 10.3 percent of primary classes and 60.3 percent of primary schools operate with multi-grade teaching. In Montenegro, 13.0 percent of primary classes and 67.2 percent of primary schools operate with multi-grade teaching. (Evaluation of Elementary Education in the Federal Republic of Yugoslavia, Svetlana Marojević, draft working paper, 2000.) 19 Figures provided by Svetlana Marojević, of the Belgrade UNICEF office.
328 Chapter 15. Education average 4 students in Montenegro and 5 in Serbia, versus 15 and 17, respectively, in majority- language classes.20 The small print runs for minority-language textbooks – as few as 300 copies for some Albanian-language topics in Montenegro -- also lead to high unit costs. There is significant scope for improving the efficiency of education provision through school consolidation. Plans for school consolidation need to be carried out with care, to establish that the gains from more efficient teacher deployment would more than offset the additional costs, including student transport, that it would entail, and to ensure that it would not have negative developmental consequences for students in the initial grades of primary school. Efforts to rationalize school facilities through consolidation should also, particularly in rural areas, take into account the potential consequences of closing rural schools on increased urban migration. Achieving efficiency gains through raising student/teacher ratios would require, over time, some slimming of the teaching force and non-teaching staff at all levels. This would need to be carried out judiciously so as not to further jeopardize the quality of education. Staff reductions could help to raise the quality of education if they are carried out on the basis of qualifications, rather than seniority.
15.19 One of the least costly measures to improve quality and efficiency in schools is to extend the duration of the school day – providing more instructional time with no additional requirements in facilities or teaching staff, and little increment in educational materials. This could significantly raise learning achievement without significantly raising costs. Instructional time in primary and secondary education is well below international standards in Serbia and Montenegro, particularly in the initial grades. Instructional time in the first two grades in Serbia and Montenegro is just 14.5 hours per week (or 464 hours per school year) and some experimental schools offer just 11.5 hours per week (368 hours). This is far below the OECD average of 788 hours,21 and should be significantly increased. There is major scope for improved efficiency through raising class sizes and student/teacher ratios in primary education. Capturing these gains will often require decisions on school consolidation and rationalization. Further efficiency gains could be achieved through reducing the number of non-teaching staff in schools, although these staff are among the lowest paid and savings would be less than a reduction in the teaching force.
15.20 Higher education offers particularly good prospects for improved efficiency. It is at this level that student/teacher ratios, when counting only full time equivalent students, are most out of alignment with comparator countries. There is, in addition, a serious problem of internal inefficiency. On average, university students in Serbia take eight years to complete a four-year undergraduate degree. In part, this tendency of students to prolong their studies reflects the lack of opportunities in the job market. Raising university student fees and related fees for student board, accommodation and transport would help strengthen students’ incentive to use their time effectively, and would also help generate resources to improve teaching conditions in universities. Currently, higher education is free for students who score above a stipulated threshold in the university entrance examination. Students with lower scores pay fees. Since university students are disproportionately from relatively affluent families, raising tuition and related fees in higher education would improve cost recovery from the groups who are most able to bear those costs, and would reduce cross-subsidies to this group.
20 Evaluation of Elementary Education in the Federal Republic of Yugoslavia, Svetlana Marojević, draft working paper, 2000. 21 Education at a Glance: 2000. OECD
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15.21 Employment and Earnings in the Education Sector. The salaries of teachers and other education sector staff in Serbia and Montenegro are extremely low in absolute terms. Average annual salaries for primary and secondary teachers in the OECD countries is US$28,519.22 In contrast, the average net salary of employees of the education sector in Serbia was just DM 66 in October, 2000, or US$365 per year. Education sector salaries in Montenegro are about twice that level – but still very low. Education sector salaries are also low in relation to other public-sector employees in Serbia and Montenegro. These salaries are very low by comparison to teachers’ salaries elsewhere in the region. Net teacher salaries in Kosovo, for example, range from DM 245 in primary school to DM 275 in secondary and DM 367 in higher education. In Bosnia, teacher salaries vary by canton and by level of education, ranging from DM 376 per month to DM 790 per month. As shown in Table 15.4, average net salaries of teachers and other workers in the education sector in Serbia were slightly below the public-sector average in 1999, and fell further below the average in 2000:
Table 15.4: Serbia Average Net Salaries by Sector, 1999 and 2000 (in current YUD) 199923 200024 Education Sector 1,630 2,033 Public Sector 1,675 2,483
15.22 In view of the relatively high educational qualifications of teachers, the relative salaries of education staff of equivalent educational qualifications are probably even lower than these figures indicate. Low teachers’ salaries are widely seen as a source of low morale among teachers. Low teachers’ salaries encourage some teachers to seek supplementary income through other work – often, in the informal sector. They also contribute to the occasional practice of charging illicit fees for education or for unearned grades. An important goal of the new Ministry of Education is to increase teachers’ salaries in order to reduce the economic hardship of teachers, to improve morale, to reduce the need for teachers to engage in other activities, and to prevent teachers’ strikes. The 2001 Serbian budget provides for an increase in teachers’ salaries of 14 percent in real terms, which will go some way to alleviating the salary problem. However while increases in teachers’ salaries are needed, they should be made in the context of more efficient deployment of teaching and non-teaching staff, and increases in the duration of teaching hours (and the school day).
15.23 Education Finance. Currently, the financing formula introduced under the former Government remains in force, although both Republics propose some decentralization of financing in the future. The Serbian budget for education declined sharply during the decade of the 1990s. The decline is especially pronounced in comparing republican expenditures on education in 1998 (when there was a temporary increase in social expenditures) and 2000. The republican budget for education declined from US$621 million or about 3.8 percent of GDP 25 in 1998 to US$209 million, or 2.3 percent of GDP in 2000. There has been a similar decline in the
22 Education at a Glance, 2000. OECD 23 Statistical Yearbook of Yugoslavia, 2000 24 Figures provided by Mirosinka Dinkić. 25 Statistical Data for Background Purposes of OECD Review: Serbia, University of Ljubljana Faculty of Education, Center for Educational Policy Studies, January, 2001.
330 Chapter 15. Education absolute level of education expenditures in Montenegro, where budgeted expenditures on education totaled US$66 million in 2000. But in relative terms, Montenegro devotes a higher share of GDP – about 7.1 percent -- to education.26 The republican budgets predominately finance the salaries and social benefits of teachers and other school staff (Table 15.5). The republican budgets are also responsible for financing facilities construction and maintenance, educational equipment and materials, and operations and maintenance for university faculties. In principle, the municipalities are responsible for financing all school construction, school maintenance, utilities and heating, and provision of furniture, educational equipment and educational materials for primary and secondary schools, but they lack the resources to do so. In some cases, the republican budgets also help finance these expenditures, although the procedure for selecting schools and municipalities to receive this financing has lacked transparency and objectivity. For higher education in Serbia, there are major expenditures in several poorly defined categories of “special expenditures”, which together account for almost as much as total salaries of higher education staff.
15.24 The sources of financing for all levels of education in Serbia, and the change in financing shares for these sources between 1989 and 1998 (Table 15.6)27. Households finance 7.3 percent of the costs of education in the form of textbooks, school supplies, school meals and student transport, and fees for university students below the entry score threshold for free education. The proportion of household expenditures spent on education increases with the level of household income, and are estimated to range from 1.0 percent of household expenditures for the lowest expenditure quintile, and increasing to 1.5 percent for the second quintile, 1.9 percent for the third quintile, and 2.3 percent for the highest quintile. This progressivity in household education expenditures appears to result largely from differences in fees paid for higher education, reflecting the inaccessibility of fee-paid higher education for the poorest households.
Table 15.5: Republican Expenditures on Education by Level (US$ millions) Primary Secondary Higher Total Serbia28 salaries 80.8 37.4 34.7 152.9 educational materials 6.8 3.9 4.7 15.4 Administration 0.7 0.1 0.8 Stipends and other 0.0 6.2 34.1 40.3 Total Serbia 135.8 73.6 209.4 Montenegro29 salaries and benefits 31.5 12.3 7.5 51.3 civil works 2.0 0.5 2.5 educational equipment 0.5 0.3 0.8 Total Montenegro 34.0 12.3 8.3 54.6
26 Republic of Montenegro Statistics, cited in Statistical Data for Background Purposes of the OECD Review, December, 2000. 27 Figures from Education, a background paper for the Educational Forum prepared by Mirosinka Dinkić. 28 Realized Republic Expenditures for 2000, Republic of Serbia 29 Republic of Montenegro Statistics, 1998, cited in Statistical Data for Background Purposes of the OECD Review, December, 2000.
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Table 15.6: Shares of Financing Sources for Education in Serbia, 1989 and 1998 Source of Financing (percent) 1989 1998 Republican budget 0.2 76.4 Local communities of interest 84.3 2.0 Parents’ contributions & purchases 5.8 7.3 Contributions of enterprises 4.9 3.0 Contributions of social services 2.7 2.9 Other 2.1 8.4 TOTAL 100.0 100.0
15.25 Municipalities are responsible for financing the “material costs” of primary and secondary schools, comprising construction, furniture, educational equipment and materials, maintenance, heat, water, and electricity. The expenditures of the municipalities on education vary by needs in each local area, but are estimated to account for a surprisingly small share of municipality expenditures (Table 15.7). The amount spent on education is just 10 percent of total municipal expenditures. This is a much lower share of local government expenditures than in many of the OECD countries.
Table 15.7: Local Government Expenditures in Serbia by Sector, 2000 (in billions of current YUD) Sector of Expenditure Expenditures Education 1,416 Social assistance 1,439 Housing and community affairs 6,241 Recreation, culture, and religion 964 General public services 3,530 Other 67 Total 13,658
15.26 The actual expenditures on education in 2000 by the Belgrade City Assembly, covering 16 municipalities, and 277 primary and secondary schools (Table 15.8). This reflects the local expenditure priorities of the largest and one of the best endowed cluster of municipalities. But even here, resources fall well short of needs.
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Table 15.8: Education Expenditures of the Belgrade City Assembly, 2000 (in thousands of current YUD) Expenditure Item Amount regular material expenses 29,260 heating 13,858 water 1,737 garbage disposal 1,527 public utilities for suburban municipalities 428 Land for new construction 4 cleaning 657 specialist examinations 406 student competitions 71 gymnasium rental 1,412 health examination for employees 2,461 transportation for employees 12,568 insurance 712 rodent extermination 177 chimney cleaning 11 practical training 155 accommodation and meals 297 practical training out of school 75 other 290 repairs and maintenance 14,070 investments and equipment 60,003 Total, of which 86,182 financed from the budget 86,170 financed from other income 12
B. PRIORITIES FOR TRANSITION AND RECOVERY
Government Programs 15.27 The Ministries of Education in Serbia and Montenegro are developing a recovery and reform program for the education sector that aims to raise the quality, relevance, and efficiency of education programs. Teams are at work in both Ministries to identify specific priorities for the short and medium term. In Serbia the Ministry has developed a Program of Strategic Priorities, which are: a) reorganization of the Ministry as an efficient and functional structure, modeled on Western European Ministries of Education, b) establishing democratic school management, c) changing pedagogy to encourage critical thinking, team-work, and creative application of knowledge, d) aligning secondary vocational education with the future needs of the economy, and e) devolving education management to local governments, including development of accreditation criteria through a participatory process and development of quality assurance mechanisms at the local level.
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15.28 In Montenegro, the Ministry of Education is developing its recovery and reform program in close collaboration with advisors who developed the recent education reform in Slovenia. The program will include measures to: a) improve teaching and learning conditions in schools through improved educational materials, strengthened in-service and pre-service teacher training, and improved textbooks, b) decentralize education management, c) streamline curriculum and make it more student centered, d) expand preschool education to make it available to all children, and e) institute effective monitoring and evaluation, including participation in international assessment studies.
A Proposed Donor Program for Recovery and Reform 15.29 Based on the issues identified in the preceding sections, a reform program is proposed below for the education sector in FRY, with a corresponding donor investment program (Table 15.9). The program is designed to address the most important issues that are described in the preceding sections, both by providing needed inputs and by supporting policy reform. Some of the actions can be taken by the Ministries of Education in Serbia and Montenegro. Others, notably the decentralization of responsibilities for education management, will need to be taken in concert with other partners because they involve government decisions concerning the collection and allocation of tax revenues, agreement with trade unions, or consensus on other issues. In some cases, specific roles are suggested for particular agencies, based on their comparative advantages.
15.30 The intention of the proposed assistance program is not to remake the education system as it was before the breakup of the SFRY. It is instead to build on the positive features of the current system and to reform others in order to develop a functional education system which is inclusive of all groups, which responds to the new needs of the global economy, which promotes peace in the region, and which is fiscally sustainable. To the greatest extent possible, the proposed assistance should help support the needed policy reforms, and should help to mobilize other support. Several specific examples of such conditionality or linkage are proposed.
15.31 The proposed recovery and reform program is intended to be a logically complete set of activities. These actions are intended to complement each other, rather than providing an opportunity for ranking of priorities among more urgent and less urgent tasks. Thus, the investments to re-equip and re-build damaged and neglected schools are proposed only in the context of system rationalization and tighter deployment of existing resources. The commitment to these reforms should come before the investments to rebuild and re-equip, although the implementation would proceed in parallel. In each of the proposed areas of intervention, the proposed short-term actions will need to be followed up with medium-term actions to deepen the reforms and the investments initiated in this first phase of recovery.
Recurrent Costs 15.32 Provision of Educational Materials. Reviving of the educational system will require some external financing of recurrent costs through the transition period, due to multiple competing demands on government fiscal resources through the transition to a market economy. This financing would provide educational materials to students and teachers, and would be phased out over a three to four year period.
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Investments in Education 15.33 Re-equipping primary and secondary schools with essential educational materials. This activity would raise teaching and learning effectiveness by providing a very basic set of educational equipment and materials to primary and secondary schools in Serbia and Montenegro, based on norms established by the Serbia Ministry of Education and Sports. No specialized equipment would be provided to secondary vocational schools at this initial stage. Re-equipping of vocational secondary schools would not be undertaken until the Ministries complete a reform plan to make secondary vocational education more responsive to evolving labor-market needs.
15.34 School Rehabilitation/Civil Works. This component will look to rehabilitate school infrastructure, including that damaged during the Kosovo conflict, throughout FRY. The EC is supporting rehabilitation of primary and secondary schools throughout Serbia under its Schools for Democratic Serbia Program. The initial phase of this program of around US$3.4 million, now nearing completion, is supporting the equipping and rehabilitation of primary and secondary schools in municipalities run, under the former government, by opposition mayors. The average cost of school rehabilitation under this first phase was about US$22,500. About 80 percent of this was spent for civil works, and the balance for educational materials and other inputs. Because there is in most schools a more conspicuous need for educational materials and equipment than for physical refurbishment, it may be that this emphasis on civil works contracts results from the fact that municipalities both identified priorities and carried out procurement. Making school principals responsible for identification of needs and having other entities, such as the republican Ministries of Education, carry out procurement might lead to a more balanced identification of priorities, and might lead to economies of scale in procurement. The EC plans to support a second stage totaling around US$13.5 million, to be based on criteria of need rather than political orientation. In order to get maximum benefit from this important EC assistance, it is recommended that schools demonstrate some local commitment and cost sharing – even in the form of labor provided by parents – in order to qualify for this assistance. Research findings from many countries also documents that parental contributions to school improvements tends to promote better ownership and, in many cases leads to better learning achievement. Involving parents in these school improvement investments should also raise parents’ involvement in safeguarding the schools and providing school maintenance, thereby helping make these investments sustainable.
Technical Assistance 15.35 Filling the Gaps in Primary School Coverage. Special efforts need to be made to bring excluded groups into mainstream education. This activity would be targeted to groups with low primary-school attendance and performance, predominately, but not exclusively, concentrated in Roma communities. It comprises an integrated set of activities for school-aged children and parents, including assistance in establishing legal status, preschool education, after-school tutoring, literacy training and public awareness training for parents, maternal and child health care, support for educational materials, school lunches, clothing, school transport, and TA for monitoring and evaluation of results. Sub-project implementation would build on successful pilot programs for these groups which are being carried out in Serbia and Montenegro with UNICEF and NGO support. Donors who are currently active include UNICEF, the Open Society Institute, and the Netherlands Government
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15.36 Teacher Training. This activity would support the extension of successful models of in- service teacher training to make teachers more effective in teaching, and better able to deal with teaching challenges. Pre-service and in-service training content will have to be updated to include a focus on participative teaching methods, cooperative learning, critical thinking skills, information and communication technology, and effective teaching practices for multi-grade classes. In addition to a focus on new content and training methodologies, a new cost-effective delivery system will have to be developed. This could involve some private training provision with the center taking on a coordinating and funding role, and could include the establishment of teacher training centers at regional or local levels. Developing a new delivery system and training content should build on successful models of in-service training which the Ministries of Education in Serbia and Montenegro have developed in collaboration with a number of partners, including UNICEF and the Open Society Institute.
15.37 Updating Higher Education Content. It will take years to overcome the isolation and neglect of higher education during the recent past. This activity would make a highly selective start in this effort by beginning to develop functional university libraries, and by sending selected faculty on short fellowships and study visits to catch up on professional developments in their respective fields. It would provide journal subscriptions, IT hardware and software with internet connections, and photocopying machines to university libraries in Serbia and Montenegro. Providing these inputs is essential to making university libraries functional, and functional libraries are the most cost-effective means of starting to update the professional content of higher education courses. This activity will also support short fellowships and study visits for key faculty members. This support would be provided to universities which commit themselves to rationalize the deployment and use of teaching staff and to strengthen performance incentives for students and faculty in order to improve the efficiency of resource use in higher education.
15.38 Decentralizing Education Management and Improving Efficiency of Education Resource Use. The objective of this activity, decentralized education management, is an instrument of improved efficiency in use of education resources, and of improved responsiveness of education programs to the needs of the global and local economy. Whatever form decentralization takes, it needs to align responsibilities and resources for management and financing of education at the republican, municipal, and local levels. A recommended model for doing so would be to combine a centrally-managed per student funding formula for each level of education with devolved financing in the form of per student block grants to municipalities and potentially even directly to schools. As was previously the case in Yugoslavia, local authorities would be responsible for budgeting, expenditure control and personnel management for teachers, school directors and non-teaching staff. However, unlike previously, education funding would be provided principally from republican revenue sources. This approach would provide several positive incentives in the system such as promoting broader coverage (per student budget allocations provide an incentive to increase enrollments), promoting a more efficient use of resources (per student-based funding provides an incentive for managers to use teachers and facilities more efficiently), and smoothing regional and local differences in revenue capacity. Rather than a central planning approach aimed at mandating efficient development and use of education resources, this decentralization model provides incentives for rationalizing the use of schools and more efficient deployment of teachers and non-teaching staff, while delegating decisions on these sensitive issues to local authorities. As noted above in the discussion on quality, decentralization in education implies a re-orientation at the center away from a culture of
336 Chapter 15. Education control over resources toward information-based activities such as policy analysis, monitoring and evaluation, and measuring student performance outcomes. A new model for textbook production and selection should be based on a framework to include central financing, private sector production and municipal/school choice. Technical assistance, training, networking opportunities and study visits would be provided to the Serbia and Montenegro Ministries of Education for help in planning the decentralization model with the participation of regional and local governments. A crucial focus would need to be given to developing accountability mechanisms (budget transparency, school boards, municipal education councils, etc). Assistance would also be provided for systems analysis and training, and minimal hardware and software to begin to establish a functional Education Management Information System which is crucial to the functioning of a new decentralized structure and information-based decision making.
15.39 Restructuring Secondary Education, Training, and Improving Labor-Market Links. Whereas other countries in the region have begun to reform and update their education systems to introduce flexibility and make them more responsive to the needs of the global economy, the education systems in Serbia and Montenegro have fallen behind. Some of the main features of the needed reform are the following: (a) secondary and higher education need to become more demand-driven rather than centrally directed; (b) vocational education at the secondary level needs to teach more generic skills for a few broad families of occupational specializations rather than highly specific skills for a large number of narrow occupations; (c) vocational education should give more emphasis to developing numeracy skills, problem-solving skills, communications skills (including foreign language proficiency) and teamwork skills; (d) primary, secondary, and higher education need to provide more opportunities for students and teachers to apply IT throughout the curriculum, including use of PCs to access and share information on the world-wide web; (e) career counseling needs to be developed to provide students, teachers and parents with up-to date information on the implications of education choices for employment opportunities and options for further education; (f) higher education needs to be more flexible at entry and to offer easier transfer opportunities across programs and faculties; (g) higher education needs to provide stronger performance incentives to students and faculty; and (h) the legal and fiscal environment needs to changed to encourage employers and local governments to develop life-long learning programs to meet local (and global) skill needs. This activity would support the development and initial implementation of a program to do the above. In particular, it would support the development of a streamlined curriculum for secondary education and training, of incentives and enabling measures to stimulate private provision of training, and of career guidance counseling and a modern data base to support it.
15.40 Creating a capacity for monitoring, evaluation and student performance assessments. Perhaps the most important step toward improving quality will be to establish a mandate and a capacity at the center to conduct qualitative assessments of educational outcomes. It is difficult to talk about improving the quality of education in Serbia or Montenegro without the most basic comparative information on learning standards and performance goals, and some basic indicators with which to monitor progress in quality enhancement. As control over education finance and personnel is delegated to localities (see paragraph 15.3), significant capacity building support will be needed to develop a culture of monitoring and evaluation in the central ministry, whose role will change from resource control to policy making and quality assurance. Building this capacity in the context of decentralization is closely related to the need to develop an education management information system. In addition, Serbia and Montenegro will need to make
337 Chapter 15. Education significant investments in creating a capacity, within or external to the central education ministries, for standardized student assessment at primary levels. In most OECD countries, monitoring student achievement outcomes and identifying learning problems through standardized assessments has become an essential element of quality assurance programs. A similar focus on measuring learning outcomes will be needed in Serbia and Montenegro.
15.41 Building Democratic School Management. This activity would complement and facilitate the Serbian Ministry of Education and Sports’ proposed replacement of unqualified school principals. Using the training materials developed by the Open Society Institute, it would train principals to manage their schools effectively, including the promotion of community involvement in school activities.
15.42 Promoting Tolerance. During the past decade, textbooks in Serbia and Montenegro were produced under a closed process that allowed political control of textbook content in all areas. Current textbooks include a number of that do not promote tolerance and reconciliation. There is great potential for education to serve as an instrument for promoting tolerance. This activity would support an analysis of existing primary and secondary school textbooks in Serbia and Montenegro - particularly, but not exclusively, in history and social studies subjects -- to identify content that is inconsistent with basic values of tolerance and peace, and to develop alternative content that is consistent with these values. In order to be effective in detecting subtle messages, this effort calls for a high degree of objectivity. For this reason, it should be carried out largely by international experts in content analysis for civic education. This analysis would be carried out under a task force comprising donor agencies and NGOs with experience and expertise in education for democracy.
Table 15.9: Estimated Donor Financing Requirements of the Recovery Program
Priority Estimated Financing Total Program Requirement US$ m CY01 CY02-04 Recurrent Expenditures Educational Materials 40.0 50.0 Subtotal 40.0 50.0 90.0 Investments Re-equipment of schools 15.0 30.0 School rehabilitation/civil works 19.0 65.0 Subtotal 34.0 95.0 129.0 Technical Assistance Needs Filling gaps in Primary/Secondary Coverage 1.0 2.0 Teacher training 3.0 6.0 Updating Higher Education Content 2.0 3.5 Decentralizing Education management 1.0 2.5 Restructuring Secondary Education 1.5 3.0 Other Technical Assistance 1.0 2.0 Subtotal 9.5 19.0 28.5
Totals 83.5 164.0 247.5
338 CHAPTER 16. LIVING STANDARDS, POVERTY AND INEQUALITY
A. INTRODUCTION
16.1 A decade of armed conflicts, international isolation, economic turmoil and instability has affected the living standards of the vast majority of the population in FRY. The impact of war, with a total of 720,000 refugees and IDPs to FRY, has been severe. Poor economic performance, and in particular reductions in real wages, have also been a key factor in the rise of poverty. Many workers have also been affected by delays in their wage payments.
16.2 While data are poor, this chapter shows that some preliminary conclusions are possible. Prior to the 1990s, living standards were relatively high, and inequality fairly low. Absolute poverty is now about twice as high as it was in 1990 - with roughly the same incidence in Serbia and Montenegro. In addition, about 20 per cent of the population are near-poor. Unemployment, when measured in a consistent and internationally comparable way, is not nearly as high as is reported by official statistics, although it is on a rising trend. The unemployed, the elderly, the disabled, and families with many children and/or single parents appear to have the highest risk of poverty, as do the refugees and IDPs who have arrived in the wake of conflict and economic crisis over the last decade. Regional differences are also important, with higher poverty rates in Southern Serbia and Northern Montenegro.
16.3 Public safety nets play a relatively minor role compared to informal coping mechanisms. These coping strategies prevented the worst cases of deprivation and no major signs of malnutrition are apparent (WHO). Nevertheless, some of the very poor have only limited access to both subsistence farming and informal employment activities.
16.4 For now, inequality remains moderate by regional standards and poverty remains relatively shallow - with incomes of the average poor 23 per cent below the poverty line. However, the clustering of households around the poverty line implies that even small changes in household income will directly affect the poverty status of a considerable number of people. With the liberalization of economic activities, inequality is likely to be pushed up. This increase in inequality could undermine the trickling down of growth benefits to the poor. As there are many working poor, improvements in the real wage and employment restructuring are prerequisites to rapidly lift them out of poverty.
16.5 This chapter starts with an overview of the basic characteristics of poverty in FRY. Section 2 explains the factors that underlie the increase in poverty over the past ten years. Finally, section 3 provides policy recommendations and identifies some areas of further need for donor assistance. Estimated external financing requirements of US$ 2.0 million over three to four years are presented in table 16.3. Requirements for CY01, on a commitments basis, are estimated as US$ 0.5 million. These requirements are included under Economic Management in the summary Tables 1.1 and 1.3. Chapter 16. Living Standards, Poverty and Inequality
B. POVERTY AND INEQUALITY: SNAPSHOT AND CHANGES
16.6 In the broadest definition, poverty is the status of a person who falls short of a level of economic welfare deemed to constitute a minimum, usually called the "poverty line". Analysis of poverty in a country depends on the accurate measurement of incomes or consumption levels through sample surveys. A representative household survey (HBS) has been conducted by the Federal Statistical Office (FSO) in FR Yugoslavia since 1984; there have also been a number of surveys by various other local and international agencies aimed at filling gaps in the HBS data.1 This chapter is based on published reports on living standards in FRY.
16.7 In FRY, there are two different measures of the poverty line which reflect the costs of meeting minimum nutritional requirements: the FSO minimum food basket and the World Food Program (WFP) minimum subsistence basket.2 Their values are reported in Table 16.1 below together with the standards used in social policy.
Table 16.1: Poverty lines for FRY in April, 2000 (monthly values per capita) Serbia Montenegro YUD DEM USD DEM USD Poverty lines The cost of the minimum WFP/OCHA 885 39 19 74 36 basket* The cost of the food basket by FSO** 1,114 49 24 100 48
Social minima Minimum wage 280 12 6 67 32 Minimum pension*** 861 38 18 102 49 Eligibility threshold for social 1,077 47 23 74 36 assistance**** * WFP basket for Serbia, UN OCHA shopping basket in market prices for Montenegro. ** Based on a published minimum for the family of four, YUD 4454; *** 40 percent the of average wage in Serbia, 55 percent in Montenegro **** 50 percent of municipality's average wage, here assumed mean national wage in Serbia; 40 percent of average net national wage in Montenegro; for 1-member family. Sources: WFP, UNOCHA, FSO, IPPS/CEPS, CPIJM.
16.8 For Serbia, the social minima are below absolute poverty lines, while in Montenegro they are dangerously close to the poverty line. The minimum wage in particular is significantly below the absolute poverty line in Serbia. Even small changes in policy variables will directly
1 Most notably - coverage of the IDPs and refugees. 2 FSO basket (65 items) was developed a decade ago based on the actual consumption at that time. Currently its allowances for food are regarded as too generous (as a consequence of a fall in living standards); the basket does not have allowances for non- food consumption. However, it is the only truly comparable standard for making comparisons over time. In 1999 WFP developed a basket based on the actual consumption patterns of the poorest. It is based on the minimum caloric intake and includes allowances for non-food items. Similar methodologies were used by UN OCHA to develop a shopping basket for Montenegro; however, the allowances are greater than those in the WFP basket.
340 Chapter 16. Living Standards, Poverty and Inequality affect the poverty status of a considerable number of people. For example, there are about 20 percent of Employees Pension Fund beneficiaries in Serbia receiving the minimum pension.
16.9 Poverty in FRY is widespread. About one-eighth of FRY residents are clearly in absolute poverty, with roughly the same incidence in Serbia and Montenegro. In addition, there is about twenty percent of the population who are near-poor. Using the WFP line in 1999 (1st half year), around 10 percent of the population in FRY (without IDPs and refugees) was classified as being in absolute poverty (CESMECON). In the first quarter of 2000, this proportion increased to 13 percent, i.e. close to 1.2 million people were poor in the first half of 2000 (Table 16.2).
Table 16.2: Poverty in FR Yugoslavia in the first half of 2000 (based on the WFP poverty line)
Total Percent Number of poor Population of Serbia 7,841,000 12 947,190 IDPs and Refugees 723,000 25 180,750 Population of Montenegro 654,000 11 72,380 Total FR Yugoslavia 9,222,000 13 1,200,320 Source: WFP (2000) using HBS for Serbia, UNOCHA for Montenegro3, IFRCRC for refugees and IDPs.
16.10 Using a higher poverty line (FSO food basket), CESMECON estimated that around 30 percent of the population (2.8 million) was poor in 1999. In the first quarter of 2000, even more people were reported poor (one third of the population, WFP). Thus, in addition to 13 percent poor there is about 20 percent near-poor.4 Other indirect indicators of poverty suggest similar orders of magnitude5.
16.11 In spite of poverty being widespread, it remains relatively shallow and thus highly responsive to economic fluctuations. The average shortfall for the poor in Serbia was 23 percent (income of an average poor was 23 percent below the poverty line) as reported by WFP, suggesting fairly shallow poverty and bunching of households around the poverty line. Therefore, changes in real household incomes (positive or negative) are likely to lead to sharp changes in the poverty rate. Based on the WFP line we could very roughly estimate the total poverty gap for the country as a whole at around US$65-70 million in 2000, i.e. less than 1 percent of GDP6.
3 The WFP estimates of poverty do not include data from Montenegro. Montenegro data in the table are based on scaling down the OCHA basket to WFP allowances and published information on the distribution of incomes. The estimate for IDPs and refugees is obtained using published distribution from the IFRCRC report and the cost of the WFP basket. 4 The total headcount of poverty will be refined once data from the HBS 2000 is analyzed with USAID support. 5 At the end of 1999 beneficiaries of humanitarian aid distributed through the Yugoslav Red Cross included 992,000 persons in 1 Serbia or 12 percent of the population; /3 of refugees and IDPs are receiving such aid. IFCRCR and WHO report that both in Serbia and Montenegro about 1/3 of households consider their food consumption as insufficient. 6 Such a measure is in no way an indicator of the total need, as no existing system can deliver assistance with perfect targeting and at a zero economic and administrative cost.
341 Chapter 16. Living Standards, Poverty and Inequality
16.12 Nevertheless, absolute poverty now is about twice as high as it was in 1990. Figure 16.1 shows a sharp increase in the number of poor and near-poor in 1999 as compared to 1990 or to 1997/8. Data from other sources suggest a rise in the number of deprived.7
16.13 A given level of poverty may be less of a problem now than a few years previous, as households have developed various coping mechanisms. Households are trying to minimize the consequences of poverty in many ways, largely through participation in informal economic activities. Between 15 and 20 percent of adults are engaged in some form of gainful activity that does not imply a regular employment contract or registration, and up to 40 percent of households receive income from such activities (CPIJM and UNOCHA). The second type of informal activity is subsistence farming. Over half of the households in Serbia are reported to produce at least part of their food supply themselves (26 percent in Montenegro, ibid.). These coping strategies have assisted the worst cases of deprivation and no major signs of malnutrition are apparent (WHO).
16.14 Nevertheless, among the extremely poor access to the opportunities offered by informal activities is very limited. The poor have only limited access to both subsistence farming and informal employment activities (data on income structure by deciles from Posarac). In a sense, poverty is an outcome of failing to find a place in the informal economy, currently the only reliable way to ensure economic success.
Figure 16.1: Poverty headcount 1990-1999 (FSO food basket) Note: without Kosovo, source: SMMRI based on FSO HBS primary data.
50%
40%
30%
20%
10%
0%
Percent population of below the poverty line 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
16.15 Poverty in FRY is concentrated in two main subgroups: “social cases” identifiable with some formal criteria, and the ‘new poor’ who are, to a large extent, difficult to distinguish from the non-poor. Although the most seriously affected population appears to consist of refugees and IDPs , these groups do not constitute a majority among the poor.
16.16 Data on the composition of poverty by groups of population and their relative poverty risks in FRY are incomplete or outdated. The latest year for which a detailed poverty profile is
7 HBS data suggests that absolute poverty has roughly doubled in 2000 compared to 1990 (using half of the FSO food basket, Posarac 1990-1996 for data).
342 Chapter 16. Living Standards, Poverty and Inequality available is 1996 (Posarac), which was limited by the nature of data generated by HBS. Based on the secondary sources of data, the following groups are consistently reported as having higher poverty risk in most of the studies on poverty in FR Yugoslavia:
• Families of the unemployed, underemployed or low paid workers (esp. industrial workers not receiving salaries). • Families with many children and single parents. • Families of the disabled. • Low income pensioners (esp. those on minimum pension), living alone or with dependants. • IDPs and refugees. • Certain regional pockets (Southern Serbia, Northern Montenegro).
The above illustrates that the poor in FR Yugoslavia are a highly heterogeneous group. The specific situation of refugees and IDPs is covered in Annex 1 to this chapter.
16.17 The composition of poverty resembles more the poverty profile of an economy in the CIS than that of an Eastern European transition country. For instance, the very fact that there is a group of "underemployed" among the poor indicates that the profile in FRY is closer to the situation in CIS than to that in Eastern Europe8. The high risk of poverty among pensioners is also atypical for the ECA region; it is a highly disturbing outcome especially considering the expensive pension system with high average replacement rates.
16.18 This high risk of poverty among pensioners is quite a recent phenomenon. Pensioners as a group fared relatively well both in 1990 and in 1996 (Posarac), with poverty risks significantly below the average. However, by 2000 their risk of poverty was double that of the population at large (WFP surveys), reflecting a fall in the real value of the minimum pension. There was a large variation in the position of pensioners, with single pensioners and pensioners living with dependants faring much worse than pensioners residing in extended families with working members.
16.19 One of the most controversial results of the poverty profile information available is the relatively low rural poverty risk. However, this result needs to be treated with caution as the definition of agricultural households in Yugoslav statistics does not fully match the definition of rural households (it is based on sources of income, not on location). There are important indications from other sources that living standards of the rural population are low compared to those in urban areas (CPA/CPS 2000 lists farmers as the group with the lowest material status among workers).
16.20 The level of inequality of total incomes in FRY is still moderate by regional standards, as Figure 16.2 suggests. However, inequality is higher than in 1990 (in 1990, 0.280 Gini per
8 The adjustment to fall in output in CIS was primarily through fall in wages, making employed vulnerable to poverty and to large adjustments in hours. In Eastern Europe there are relatively fewer employed, but those who are enjoy much higher living standards than other groups.
343 Chapter 16. Living Standards, Poverty and Inequality capita income, in 1999 it was estimated at 0.305 – CESMECON). So far the increase in inequality has been moderate, but it has been kept under control through the use of administrative non-market interventions.
Figure 16.2: Inequality in selected transition economies
0.5
0.45
0.4
0.35
0.3
0.25
0.2
Gini index (based on per capita values) values) capita per on (based index Gini Latvia Russia Poland Croatia Kyrgyz Georgia Bulgaria Slovenia Hungary Moldova Tajikistan Macedonia FRYugoslavia Income-based Consumption-based
Source: Making transition work for everyone, Yugoslavia – CESMECON
16.21 With the liberalization of economic activities, inequality can be expected to rise. The main driver of inequality is the change in the distribution of earnings. The level of inequality of earnings in FRY has remained low (Gini of 0.31 in 1998 - Krstic, only a small change compared to early 1990 data9). The lowest paid workers have lost in relative terms during the 1990s, a change that would result in much higher inequality if there were no compression of earnings in the middle range (Krstic), which is clearly an outcome of policies pursued. As a result, the wage premium for educated workers has been falling over time in FRY, while in CEE countries it has been rising strongly (ibid.). This suggests that market forces have been retreating in the determination of earnings and allocation of labor.
16.22 A likely increase in inequality could undermine the trickle down of growth benefits to the poor. Poverty and inequality are very closely linked: for a given mean income, the more unequal the income distribution, the larger the percentage of the population living in income- poverty. At least part of the increase in poverty over 1990-2000 can be associated with a rise in inequality. Empirical estimates for Yugoslavia show that poverty is highly responsive to changes in inequality (elasticity above 3, i.e. keeping the mean income constant and increasing inequality by one percent increases poverty by more than 3 percent - CESMECON).
9 Compare to a range of 0.35-0.40 for CEE countries.
344 Chapter 16. Living Standards, Poverty and Inequality
C. EXPLAINING POVERTY
16.23 A decade of armed conflicts, international isolation, economic turmoil and instability have affected the living standards of the vast majority of the population of FRY. Key events affecting living standards have been political, economic, (often related to political: macroeconomic crisis and hyperinflation following war, budget arrears on pensions, collapse of many industries closely integrated in the former Yugoslav market), and natural (severe drought in 2000) in nature. Among these events the impact of war, with a total of 720,000 refugees and IDPs in FRY, was particularly devastating. Nearly 90 percent of refugees were settled in private accommodation, putting additional pressure on a society already made vulnerable.
16.24 Poor economic performance has been a key factor in the rise in poverty. Growth is fundamental for poverty reduction, as changes in real household incomes are likely to have strong impacts on poverty. GDP per capita has declined by more than half over the past decade. There was a strong negative correlation between changes in GDP and poverty rates over the period 1990-2000. It is interesting to note that the elasticity of poverty with respect to changes in incomes is high: each 1 percent of growth in consumption reduces absolute poverty by about 3 percent10. This means that to reduce poverty in FRY by half from its present level in three years, the consumption of the population should grow at an annual rate of 5 percent.
16.25 Economic performance has affected poverty over the past decade primarily through a fall in real wages rather than an adjustment in employment levels. Although employment has been continuously falling since the mid 1980s, this has happened at a slow pace. It is estimated that employment has fallen by about 0.5 million workers between 1990-2000. Most of this reduction was through retirements and a freeze on hiring (Arandarenko and FSO). 16.26 The brunt of the adjustment of falling GDP was absorbed by the fall in earnings: the average real wage measured against the constant poverty basket lost 60 percent of its value in 1991-200011. As a result, an average wage in Serbia in 2000 was barely enough to keep the wage recipient and one dependant out of poverty. This explains an unusual situation in which poverty affects many working families. In addition, many workers have been subject to arrears. There is no systematic data on arrears, but it is believed that there is about 500,000 workers not receiving wages on time (or 25 percent of the workforce, information from Jovicic). In Montenegro over 40,000 workers (30 percent of employees) are owed back wages (MONET).
16.27 Unemployment, although on a rising trend, is not as high as is reported by official statistics. A common perception is that unemployment is extremely high (close to 1 million registered unemployed). Recorded unemployment, however, includes many who do have jobs in the informal sector (as a special survey of 1997 has revealed - Krstic). The official unemployment rate is further overestimated by using only non-farmer registered employment in the denominator. Using an ILO definition of unemployment and Labor Force Survey data the
10 Source: CESMECON for 1999: an estimate using POVCAL based on published data for 1st quarter of 2000 gives the same number. 11 This comparison is hampered by an implicit break in the series (average wage reported as wage bill divided by the number of workers who have actually received wages prior to January 1997, since January 1997 paid wages were related to total labor force on payroll in denominator). The widespread and increasing share of in-kind benefits for compensation makes comparisons of real wage problematic.
345 Chapter 16. Living Standards, Poverty and Inequality estimate of the unemployment rate is 15 percent of the country’s labor force (less than the registered rate of over 25 percent). This has been on a rising trend since 1998.
16.28 The key characteristics of unemployment in FRY are its long duration (half of LFS number unemployed for over 3 years); its stagnant character (Krstic – low probability of escape) and very high unemployment rates for new entrants (LFS unemployment rate for 17-24 is over 50 percent). All of these are symptoms of sclerosis in a labor market displaying allocative inefficiency. The potential increase in unemployment is worrying. In 1996 the estimate of excess labor based on detailed data of workers compensation by sector produced an estimate of 600,000 (30 percent of employed under consideration - Jovicic). Economic trends for Montenegro estimate excess labor in the range of 15,000 - 25,000 workers (10-15 percent of employees), of which half are on waiting lists, and another half are on forced unpaid leave.
16.29 Changes in relative prices have not been a major factor in poverty, but are likely to be in the near future unless specific mitigation mechanisms are put in place. High volatility of prices, the existence of multiple prices for the same good, and rationing have direct repercussions on living standards. Delayed liberalization is likely to backfire and cause a spike in the relative prices of necessities. However Serbia, as an agricultural producer, is likely to protect its consumers reasonably well against increases in food costs. The largest challenge will be adjusting to changes in the relative price of energy. The social costs, likely impact on households, and management of the transition to world prices are discussed in chapter 7 on Energy and in chapter 13 on Social Protection
16.30 Although it has played a relatively minor role compared to informal coping mechanisms, the public safety net has helped many of the poor. The size and coverage of various programs are described in detail in chapter 13 which highlights that pensions are the most important protection mechanism, and social assistance has a rather limited role. This conclusion is confirmed by the HBS data which shows that on average all of the social assistance accounts for less than 1 percent of total incomes of households in 2000, compared to pensions which accounted for at least 16 percent of household incomes. Roughly 25 percent of the population receives pensions and close to 40 percent of households have an income from pensions (Chapter 13 and IFRCRC); among the social assistance program child allowances exceed all others by far. However per beneficiary amounts are low and insufficient to make any significant dent in poverty. Given the weak targeting of these benefits (Chapter 13), such an allocation of social safety is clearly sub optimal from the point of view of poverty alleviation.
16.31 Among all sources of income, social assistance was the hardest hit over the period 1990- 2000, particularly in the last two years; by 2000 it had declined to 40 percent of its 1990 value in real terms. On the contrary, informal earnings and consumption in-kind have increased in real terms, replacing formal safety mechanisms. Public safety nets are less extended than networks of exchange and mutual support that households maintain. Close to a third of households in Serbia receive food from other households, as reported in CPA/CPS (only 11 percent in Montenegro, UNOCHA), roughly 10 percent of households receive some form of social assistance from the authorities in Serbia, and 25 percent receive formal social assistance in Montenegro (IFRCRC).
346 Chapter 16. Living Standards, Poverty and Inequality
16.32 Some groups among the poor are not covered by targeted programs, with unemployed workers in particular receiving little support. Unemployment benefits are received only by a small fraction of workers and are chronically in arrears (Chapter 13).
16.33 Efforts of donors providing humanitarian relief to the most vulnerable groups (especially refugees and IDPs) have played an important role in averting severe deprivation during the worst period of crisis. Programs of various donors and NGOs, both local and international, cover about 8 percent of the total population but are targeted mostly to refugees and IDPs (close to 90 percent of whom receive different forms of humanitarian assistance). In the local population the share of households receiving such assistance is much smaller (7 percent in Montenegro, UNOCHA, and around 1 percent in Serbia). Humanitarian relief played an important role in averting severe deprivation during the worst period of 1999 (there were more than 1 million applications for Red Cross food assistance), but have not significantly changed (and were not intended to change) the main factors determining the distribution of incomes. The real challenge in the future will be to devise proper procedures to identify beneficiaries among the ‘new’ poor, which are very different from the groups traditionally covered by humanitarian relief.
D. CONCLUSIONS AND RECOMMENDATIONS FOR POLICIES AND FOR THE DONOR COMMUNITY
16.34 The analysis above leads to the following main policy conclusions:
• Growth is fundamental for poverty reduction. However, the risk that robust growth and rapid reduction of poverty is compromised by an increase in inequality is high. • As there are many working poor, improvement in the real wage and employment restructuring are required to rapidly lift them out of poverty. • It is important to monitor changes in the real value of minimum pension and benefits, as deterioration of these will move many people into poverty. The lack of an official poverty line and poverty measurement methodology represent an obstacle to the use of available data for conducting such monitoring. • The high risk of poverty among the elderly has major implications for pension reform. The poverty situation of pensioners can be improved in the short to medium term by preserving the minimum pension while working to restore the solvency of the system through lowering the overly generous entitlements and flattening benefits. • Simple expansion of resources available for social assistance in the short term is insufficient to reduce poverty. In the context of a large informal economy, efficient targeting requires a new approach to the selection of beneficiaries. A group which is likely to grow over time, but is currently not covered by the existing safety nets is the ’new poor’ (underemployed, new unemployed) that are unidentifiable by formal criteria. • The concentration of the poor in certain regional pockets (e.g. Southern Serbia and Northern Montenegro) has serious implications for the design of social assistance, as it may require the introduction of geographic targeting.
347 Chapter 16. Living Standards, Poverty and Inequality
• The lack of an accurate, comprehensive and consistent profile of poverty is the key constraint on available information on poverty in Yugoslavia. It is also a key obstacle to reform of the existing system of social protection and to increasing targeting efficiency. 16.35 The main messages for the donor community are:
• More work needs to be done to monitor the social impact of reforms. The information gap is a key obstacle to reform of the existing system of social protection and improving its targeting. Donors are encouraged to support such efforts. • There is a need for technical assistance to forecast the impact of policies on the poor, to develop instruments that will mitigate the negative social consequences of reform, and to improve the targeting and efficiency of social programs. • To monitor the social impact of reforms, there is a need to create favorable conditions for the collection of accurate data on poverty, and for using such data in policy making and public debate. In the most immediate future this will consist of: (i) creating demand for data on poverty; (ii) building a capacity to produce better data on poverty and living standards. 16.36 There are two reasons to consider this area a priority. First, failing to deliver on living standards improvement is a clear risk to the reform agenda. As a byproduct of restructuring, poverty is likely to increase before it decreases. Better data are needed (a) to promote more balanced policy discussion less prone to speculation; (b) to design possible mitigation packages. Second, the current system of collecting data is obsolete, provides data with long delays, and does not cover the entire population.
16.37 The assistance needs described above are largely covered in the donor programs for fiscal management (including statistics) in chapter 2 and in social protection in chapter 13. However dedicated analytical technical assistance for poverty monitoring will also be an important component of the donor program. These needs are estimated in table 16.3 below.
Table 16.3: Technical Assistance requirements for Poverty (US$ millions) Priority Estimated Total Financing Program Requirement US$ m CY01 CY02-04 Poverty monitoring and analysis Technical 0.5 1.5 Assistance Totals 0.5 1.5 2.0
348 Chapter 16. Living Standards, Poverty and Inequality
References – Chapter 16 WFP: Food consumption of the low income population in Serbia, 2000; VAM bulletin No 1,2,3; Survey of pensioner households for nutrition and living conditions, November, 1999, Update March, 2000; Update November, 2000. IFRCRC: FRY: IDP’s and refugees living conditions. April/May 2000; UNHCR The assessment of collection centers in Serbia. 2000; UNDP: Human Development Report 1997; The Challenge of Social Cohesion. Early Warning Report, November, 2000; Suspended Transition, 2001 IRC Assessment of the health situation in the collective centers in Serbia. 2000. WHO "Health status, health needs and utilization of health services of the population of Serbia" 2000. UN OCHA: Humanitarian Risk Analysis, Issues 1-15; 1999-2000; UN OCHA: FRY: A survey of Conditions in the Municipalities, Belgrade, 2000; UN OCHA Sub-Office in Podgorica. Income and expenditures in Montenegro. Economics Institute, 2000. CESMECON. Petrovic P., Dragutonovic D. and Arsic M. The FRY economy: macroeconomic developments and main imbalances . 2000 CPA/CPS (Center for Policy Studies) Cvejic S. and Babovic M. The Survival strategies of households in Serbia in the year 2000. Belgrade, 2000. Making transition work for everyone. Poverty and inequality in Eastern Europe and Central Asia. World Bank 2000. Pošarac, A. Unemployment, Labor Market and Social Sector in FRY 1990-1996. World bank, 1997 Mimeo. Ravallion M. and Chen S. What Can New Survey Data Tell Us about Recent Changes in Distribution and Poverty? World Bank Economic Review, 1997, vol. 11, No.2 Arandarenko М. Unemployment and Labor Market Reform in FRY, 2000. Krstić G., Reilly B. Secondary Job Holding in Yugoslavia: Some Empirical Evidence, 2001. Krstić G., Reilly B. The Gender Pay Gap in the FRY, 2001. Jovičić М. , Nojcović А., Paranos А. Labor force survey data on wages and earnings in the private and social sectors in FR Yugoslavia, 2000. FSO: Statistical Yearbook of Yugoslavia 2000 Саопштење савезног завода за статистику, Анкета о потрошњи домаћинства, 1 полугодишту 2000. Београд, 2000; Савезни завод за статистику. Потрошачка корпа, цене и просечна нето зарада, Београд, 1999:2000. ISSP-CEPS: Montenegro Economic Trends, 2000- 2001.
349 Chapter 16. Living Standards, Poverty and Inequality
ANNEX 1: Refugee and IDP Populations in FRY
1. Displaced people represent a significant social welfare issue in FRY. Current official estimates put the number of refugees (400,000)12 and Internally Displaced Persons (IDPs) (200,000) at around 600,000, representing about 7 percent of the population of FRY. Most refugees originating from Croatia and Bosnia came to FRY in the early 1990s. IDPs from Kosovo arrived in the last three years. The majority of refugees have settled in northern areas of Serbia, especially in Vojvodina and the area around Belgrade. IDPs have mostly settled in Southeastern Serbia, south of Nis. While refugees and IDPs in Montenegro are a relatively smaller number than those in Serbia (14,000), as a percentage of the much smaller population of Montenegro, they represent a significant issue there as well. In contrast to the situation in Serbia where most displaced are refugees, currently, the majority of displaced in Montenegro are IDPs.
2. In most refugee crises, displaced populations are settled in temporary camps or collective centers and subsist on subsidies from government and international humanitarian aid. In FRY, while approximately 40,000 displaced are in collective centers, nearly 90 percent were settled in private accommodation. In the first few years, large numbers of displaced were taken in by relatives, friends and others in the population putting additional pressure on a society already made vulnerable with the impact of Balkan wars, sanctions and the collapse of the formal economy in Yugoslavia. Gradually, the displaced have moved into their own accommodation or contributed some rent money to host families. In Montenegro, the additional temporary pressure of 100,000 Albanian IDPs for a few months during the Kosovo crisis bears note, although this was offset somewhat by the massive influx of international humanitarian aid which flowed into the republic.
3. It is difficult to make accurate assessments of the vulnerability of displaced populations in FRY. Many displaced families, particularly refugees who have remained in FRY several years longer than the more recent IDP population from Kosovo, have found some sort of employment. Normally in refugee situations, the percentage of a displaced populations in collective centers represents a reasonable indication of those in real need. However, there is general agreement in FRY that many of those in private accommodation may be even more vulnerable than those few who have found a place in collective centers. But, at least 1/3 of the refugees and IDPs (230,000) receive food aid distributed mostly through the Yugoslav Red Cross. At present, this remains the best, albeit imperfect, proxy for vulnerability among the displaced populations. Preliminary indications from a re-registration of refugees in Serbia in March 2001 indicate the refugee population to be around 400,000. While this will not provide a definitive answer to vulnerability of refugees, it will hopefully provide more information than presently available including more precision on the exact numbers of refugees in the country.
4. Refugees and IDPs represent an additional burden on a country already burdened with a host of transitional vulnerability problems. The percentage of displaced within the overall population is significant. The problem is made more severe by the regional character of the settlement of displaced. Refugees make up more than 10 percent of the population of Vojvodina and potentially a higher proportion in Belgrade. IDPs make up a high percentage of the population in many municipalities in areas of Southern Serbia where vulnerability is already high
12 Based on preliminary indications from the UNHCR refugee survey of March 2001.
350 Chapter 16. Living Standards, Poverty and Inequality due to long-term chronic underdevelopment as well as the impact of the past ten years. Refugees do not, at present, have citizenship of FRY and are not eligible for access to the social welfare system of the country. However, IDPs, as citizens of FRY, do have access to social welfare benefits and represent an additional drain on an already strained safety net.
5. Sustainable solutions for displaced populations tend to fall into three categories; (i) return to their original homes; (ii) resettlement in a third country; (iii) integration in situ or resettlement elsewhere in areas of the country of asylum. The future of IDPs in FRY is tied to the eventual political outcome in Kosovo which, at the present time, remains uncertain. The continuing tension in Kosovo makes an immediate return home unlikely. In fact, it is not impossible that further flows of IDPs could take place. Their situation cannot be sustainably resolved in the near future other than through individual decisions by IDPs to permanently settle within FRY outside of Kosovo. The longer the displacement of IDPs lasts, the more likely that increasing numbers will, in all likelihood, gradually chose this option. In either case, the access of IDPs to their personal property within Kosovo is an important aspect of any durable solution.
6. Refugees face a somewhat different situation. Their longer stay in FRY makes it likely that more have gradually integrated into the country and made the decision to stay permanently. Repatriation is an option which is enshrined in the Dayton Accords. Any strategy for refugee support must support this component. The key issue is that refugees have a right, to the extent possible, to make their choices freely as to where they wish to live. At the same time, we must also carefully coordinate strategies of investment in areas of origin and assistance to refugees in their countries of asylum to minimize duplication and wasted effort. Investments to support repatriation need to be demand-driven to ensure that donor aid is effectively utilized to provide a positive outcome for refugees.
7. The results of various surveys have suggested that the majority of refugees, if given the choice, would stay in FRY and not return to their original homes in Croatia or Bosnia. While these results cannot be seen as conclusive, they do indicate that integration is a likely option for significant numbers of refugees and that donor support will be required for refugees who freely chose this option. The government of FRY is currently considering a citizenship law which would expedite the presently lengthy process of refugees acquiring FRY citizenship and permit dual citizenship, which would assuage concerns of refugees regarding continued legal access to their property and pensions in Croatia. If the law is passed, it is not possible to predict with certainty that the majority of refugees will avail themselves of this opportunity. However, if, as is expected by many, refugees do take FRY citizenship, they will be able to have the same access to social welfare benefits as the normal FRY population. Given the limited capacity of the social welfare system at present, this may not provide a high level of immediate benefits. But, as the system is rehabilitated, and the number of refugees receiving food aid is seen as some kind of proxy for the numbers of vulnerable refugees, perhaps as many as a quarter of a million people will be added to the ranks of those eligible to draw upon the system. Those refugees who accept citizenship will no longer legally be refugees.
8. Humanitarian and development aid frequently come from different channels in donor governments and are not always coordinated. In this case, however, it is important that donors recognize this situation and take the following actions: (i) reduce humanitarian aid based upon
351 Chapter 16. Living Standards, Poverty and Inequality refugee status but do so gradually and carefully to ensure that refugees do not decide on citizenship questions solely on the basis of continued receipt of humanitarian aid; (ii) allow for transitional support to the FRY social welfare system to adapt to this potential inflow and avoid a collapse of the system.
9. While there have been some pilot efforts by the international community to support the construction of housing for refugees, it may not be possible, in the context of the overall budgetary needs of transitional FRY, to make this option available for the majority of refugees. For specific populations, particularly in rural areas, this could remain an option if some donors wish to support such programs.
10. There appears to be broad consensus within FRY that the key problem for refugees who settle in the country (and for IDPs) is access to employment and income resulting from a successful economic transition in Yugoslavia. There are specific issues in regard to the situation of Roma refugees and IDPs but that these are similar to the issues raised in a section of this report devoted to the Roma. There are also certain specific blockages for employment of displaced populations such as the difficulty of non-citizens attaining public sector employment and the complication of acceptance of foreign educational certificates and degrees within FRY. However, fundamentally, the problem is the same as the problem of the FRY population in general - employment. There is perhaps some specific focus possible in that refugees and IDPs are settled in concentrations in particular regions of FRY and thus add to the overall vulnerability and unemployment situation in these areas. However, again this can be treated in regard to overall sub-regional targeting strategies of FRY investments which must balance vulnerability and sub-regional economic potential.
11. An additional important issue for sustainable solutions for refugees (as for IDPs) is the question of access to their property in their countries of origin. As with IDPs, this is partially a question of facilitating repatriation for those who chose this option and partially a question of providing access to productive assets which can be sold and contribute to the family incomes and investments of refugees who stay in FRY. While some refugees have been able to repossess their property to settle on or to sell, most have been unable to do so. The international community must continue its efforts to facilitate the conditions in Croatia and Bosnia for access to property. These efforts include regional development efforts such as those in Eastern Slavonia to rehabilitate areas of origin but also need to include efforts at confidence building, in both local municipal governments and populations in areas of origin, and with refugees themselves, to facilitate the creation of a de jure and de facto enabling environment which is secure and attractive to refugees who wish to return home temporarily or permanently.
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