Document of The World Bank FOR OFFICIAL USE ONLY Public Disclosure Authorized Report No. 41 209 -XK INTERNATIONAL DEVELOPMENT ASSOCIATION INTERIM STRATEGY NOTE Public Disclosure Authorized FOR KOSOVO FOR THE PERIOD FYOS November 9,2007 Public Disclosure Authorized South East Europe Country Unit Europe and Central Asia Region Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be disclosed without World Bank Authorization The date of the last Interim Strategy Note: March 30,2006 CURRENCY EQUIVALENTS (Exchange Rate Effective November 9,2007) Currency Unit = Euro €1 = 1.45US$ US$1 =€0.68 GOVERNMENT’S FISCAL YEAR January 1 - December 3 1 ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Assistance ADA Austrian Development Agency AMIK Association of Microfinance Institutions in Kosovo BEEPS Business Environment and Enterprise Performance Survey BETA Business Environment Technical Assistance CBAK Central Banking Authority of Kosovo CRLP Clean-up and Land Reclamation Project DCC Donor Coordination Center DFID Department for International Development DP Development Partners EAR European Agency for Reconstruction EC European Commission ECA Europe and Central Asia EFSE European Fund for South-East Europe EPIP Education Participation Improvement Project ESTAP Energy Sector Technical Assistance Project EU European Union FDI Foreign Direct Investment FPSG Fiscal Policy Support Grant FSFA Financial Sector Fiduciary Assessment GDP Gross Domestic Product GTZ German Technical Co-operation HPD Housing Property Directorate IDA International Development Association IFC International Finance Corporation ILO International Labor Organization IMF International Monetary Fund ISN Interim Strategy Note IPA Instrument for Pre-accession KBA Kosovo Bankers’ Association KCB Kosovo Consolidated Budget KDSP Kosovo Development Strategy and Plan KEK Energy Corporation of Kosovo KFOR Kosovo Force (NATO) KfW German Development Bank KPA Kosovo Poverty Assessment FOR OFFICIAL USE ONLY KTA Kosovo Trust Agency LPTAP Lignite Power Technical Assistance Project MEST Ministry of Education, Science and Technology MFI Micro-finance Institutions MIGA Multilateral Investment Guarantee Agency MTEF Medium-Term Expenditure Framework NATO North Atlantic Treaty Organization NBFI Non-Banking Financial lnstitutions NGO Non-Governmental Organization OSCE Organization for Security and Cooperation in Europe PEMTAG Public Expenditure Management Technical Assistance Grant PEFA Public Expenditure and Financial Accountability PFM Public Financial Management PISG Provisional Institutions of Self-Government POE Publicly Owned Enterprises PTK Post and Telecommunication Company RTK Radio Television of Kosovo SAP Stabilization and Association Process SESA Strategic Environmental and Social Assessment SFRYPAYG Socialist Federal Republic of Yugoslavia Pay-As-You-Go STM Stabilization and Association Process Tracking Mechanism SRSG Special Representative of the Secretary-General SWAP Sector Wide Approach TSS Transitional Support Strategy UN UnitedNations UNMIK United Nations Interim Administration Mission in Kosovo UNSG United Nations Secretary General UNSC United Nations Security Council USAID United States Agency for International Development VAT Value Added Tax Vice President: Shigeo Katsu Country Director: Orsalia Kalantzopoulos Task Team Leader: Ranjit Nayak, Bruce Courtney Lead Economist: Ardo Hansson This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization. TABLE OF CONTENTS EXECUTIVE SUMMARY ..................................................................................................... i I. INTRODUCTION ............................................................................................................... 1 I1. POLITICAL. ECONOMIC AND SOCIAL CONTEXT ........................................................ 1 A . Political Environment ............................................................................................................ 1 B. Economic Environment ......................................................................................................... 2 C . Socio-economic Environment................................................................................................ 4 D. Governance Issues ................................................................................................................. 5 E. Media and Civil Society ......................................................................................................... 6 I11. KOSOVO’S KEY DEVELOPMENT CHALLENGES ........................................................ 7 A . Fiscal Sustainability ............................................................................................................... 7 B. Structural Policies for Growth ............................................................................................... 7 C. Education ............................................................................................................................... 8 D. Financial Sector ..................................................................................................................... 9 IV. PROGRESS UNDER PREVIOUS PROGRAMS AND LESSONS LEARNED .................... 9 A . World Bank Support Since 1999 ........................................................................................... 9 B. Current Portfolio .................................................................................................................. 10 C . Other Donor Support ............................................................................................................ 11 D. Lessons Learned .................................................................................................................. 12 V . WORLD BANK ASSISTANCE STRATEGY ................................................................... 13 A . Education Innovation........................................................................................................... 13 B . Financial Sector Technical Assistance ................................................................................. 14 C. Risks..................................................................................................................................... 15 Tables Table 1: Main Economic Indicators. 2004-07 ................................................................................. 3 Table 2: Kosovo Proposed Grant Program (July 2007 .June 2008) ............................................ 15 Annexes Annex 1 .Implementation of FY06- FY07 ISN Results Matrix ................................................... 17 Annex 2 .Kosovo At A Glance ..................................................................................................... 19 Annex 3 - Selected Indicators of Bank Portfolio and Management............................................... 21 Annex 4 - Summary ofNonlending Services ................................................................................ 22 Annex 5 - IDA Operations Portfolio .............................................................................................. 23 EXECUTIVE SUMMARY 1. This Interim Strategy Note (ISN) covers the period of FY08. In the event that a change in the status of Kosovo takes place during this period, preparation of a successor strategy would begin depending on the clarity of the relationship between a post-status Kosovo and the World Bank Group.’ This ISN builds on the previous ISN (FY06 - FY07) and the Transitional Support Strategy (FY04 - FY05). Both of these strategies shifted focus from post-conflict reconstruction towards ensuring KOSOVO’Slong-term economic development. This ISN is also compatible with the Draft 2007 Kosovo Development Strategy and Plan (KDSP) and the 2008-10 Medium Term Expenditure Framework (MTEF) prepared by the Kosovo Authorities*. ii. Parliamentary and municipal elections have been called for November 17, 2007. Should these elections take place, a government is expected to be formed following a period of coalition negotiations. Meanwhile, discussions on KOSOVO’Sstatus continue under the auspices of the Contact Group, with a troika of mediators from the European Union, the United States, and the Russian Federation. The troika is expected to report by December 10, 2007 to the United Nations Secretary General (UNSG). There are widespread concerns in the international and regional circles that an uncoordinated settlement of KOSOVO’Sstatus would potentially have political and security implications in the Western Balkan countries. The evolving political climate is likely to have impacts on the sustainability of the reform agenda of Kosovo. The current ISN, therefore, remains limited in its scope and strategically targeted until there is greater political clarity. iii. This ISN continues to be founded on the two pillars of the previous ISN: (i)developing new sources and a higher quality of economic growth; and (ii)ensuring macroeconomic stability through sound fiscal policy and public finance management. The effective management of ongoing operations in education, energy, environment, public expenditure management, and business and cadastre development will be critical for achieving results in both these pillars. iv. Two new projects are envisaged in this