International finance corporation country partnership strategy

Executive Summary

1. 
   Background. Progress in the former Yugoslav Republic of Macedonia (fYR Macedonia) over the past few years has been impressive. In 2001, the country was an IDA borrower and recovering from the economic, political and social fallout of an internal conflict. Today (2007), fYR Macedonia is an IBRD borrower and enjoys EU candidate status. On the economic front, macroeconomic stability and predictability have steadily increased, inflation has remained under control, and barriers to market entry and exit have been reduced by simplifying and accelerating registration and bankruptcy procedures. Meanwhile, though, economic growth and formal sector job creation have been disappointing. Growth has averaged only 3.5 percent over the 2003-2006 period. Such growth rates place fYR Macedonia among the slowest growing economies in ECA in this period. Also, the recovery remains narrowly based on a few key sectors and unemployment remains high. While official data have consistently overstated unemployment, at over 30 percent, fYR Macedonia’s official unemployment rate is among the highest in the region.
   

2. 
   Since 1990, the Bank has actively supported the country’s transition. During the 1990s, Bank support was focused on building the foundations of a market economy and a stable macroeconomic framework. Bank assistance was primarily focused on reform of the financial and enterprise sector, agriculture, human development public sector reform, infrastructure and energy, through a series of sector adjustment loans accompanied by investment lending. Since fYR Macedonia joined the World Bank Group in 1993, IDA and IBRD commitments to the country through 38 operations total approximately US$ 780 million and IFC commitments total over $93 million in IFC funds and more than $25 million in syndications.
   

3. 
   Performance during the FY04-06 CAS picked up following concerted efforts to address key issues and accelerate implementation. During the FY04-06 CAS period, the Bank worked with the government to deliver a high case lending program of $166 million, including $60 million for adjustment. The Bank’s program gradually shifted from a public sector to a private sector focus. The Bank also delivered a program of Economic and Sector Work (ESW) and technical assistance that contributed to policy dialogue during the CAS period. The quality of portfolio performance significantly improved since 2003. In 2005, fYR Macedonia gained direct access to foreign capital markets; it has received a credit rating just below investment rate and successfully issued its first Euro bond in December 2005 on relatively favorable terms.
   

4. 
   EU accession. On December 16, 2005 the European Council granted candidate country status to fYR Macedonia. The Council made this decision on the basis of the substantial progress made in completing the legislative framework related to the Ohrid Framework Agreement, as well as fYR Macedonia's track record in implementing the Stabilization and Association Agreement (SAA). While no date to open actual negotiations is specified, the EU perspective is a very positive element in reaching consensus across ethnic lines, crucial against the backdrop of the Kosovo discussions.
   

5. 
   A new government took office with great ambitions. After four years of opposition, a new coalition was elected to office in July 2006 on a very concrete election manifesto entitled "Rebirth in 100 Steps." Building on progress made over the last few years, and in the context of overarching goals of EU accession and NATO membership, these 100 steps focus predominantly on reforms to accelerate economic growth from its current level of 3.5-4 percent to 6-8 percent in the next few years. The manifesto was endorsed by all coalition partners, and, in July 2006, the government presented their new program for the period 2006-2010 to the Parliament. The program aims to improve the living standards of all citizens, increase employment, strengthen the fight against corruption, develop the democracy, and improve inter-ethnic relations political stability.
   

6. 
   The WBG will support fYR Macedonia in its efforts to join the European Union. Overall, the proposed Country Partnership Strategy aims to accelerate fYR Macedonia’s perspective to join the European Union. The proposed program is well grounded in the policy priorities of the government and takes full account of the priorities as defined in the Stability and Association program (SAp), and results from consultations with the government and other stakeholders. In the next four years, fYR Macedonia needs significant investments in its institutional capacity. The road to Europe will not only require the country to design and adopt EU-compatible standards and regulations, it also requires building the capacity to implement them. The WBG program over the next four years expects to play an important role in this process, including by providing “bridge” financing to allow fYR Macedonia to benefit faster from EU pre- accession funds.
   

7. 
   The CPS aims to support the government’s program around two core pillars: i) fostering economic growth, job creation, and increasing the living standards of all; and (ii) improving the governance and transparency of public service delivery to support the market economy.
   

8. 
   Pillar 1: Foster Growth and Job Creation, Increase Living Standards for All. The WBG will support the governments’ ambitious goals on accelerated growth and job creation through an integrated and multi faceted program. Under this pillar, the WBG will aim to (i) maintain macro economic stability, while ensuring proper integration of EU priorities into the budget; (ii) improve business environment, including regulatory reform and proper enforcement of contract and creditor rights; (iii) reduce the costs of capital; (iv) improve the enterprise sector’s competitiveness, (v) improve agricultural competitiveness; (vi) establish a functioning land market and institutions; (vii) improve infrastructure for growth by strengthening the framework for public-private partnerships and invest selectively in energy and transport; (viii) remove rigidities in labor market regulations and reduce the labor tax wedge; (ix) develop a productive and appropriately skilled labor force; and (x) use cash transfer systems to encourage school enrolment and preventive health.
   

9. 
   Pillar 2: Public Service Delivery and Supporting Good Governance. Under this pillar, the CPS aims to support fYR Macedonia in continuing the progress made in improving governance and reducing corruption, while deepening reforms in key sectors where governance weaknesses continue to undermine progress in the economic reforms necessary to strengthen the economy and create jobs. Improved transparency and accountability in service delivery is critical to meet the government program on growth, foster human capital, and meet EU standards. The WBG will support fYR Macedonia in its efforts to (i) continue its efforts to improve the environment of legal uncertainty and lack of confidence in the judicial system; (ii) apply proper public finance principles and governance standards at the municipal level, including to municipal public enterprises and utility companies; (iii) continue improving the efficient use of public resources and performance monitoring in the provision of affordable and quality health services, and (iv) make cash transfer systems more targeted and introduce incentives to encourage school enrolment and preventive health.
   

10. 
    The need for Bank lending is significant over the next four years but is subsequently likely to wind down as fYR Macedonia moves toward EU Accession and eventual graduation. The volume of the proposed lending envelope under the CPS is significant. The proposed base case lending envelope equals the high case lending envelope of the 2003-2006 CAS. This level accommodates the government’s intention to work closely with the WBG on key areas of their reform agenda in order to accelerate conversion towards EU levels and to help build the capacity to access and implement EU pre-accession funds. At the end of the CPS period, however, it is expected that the country will have gained access to significant EU pre-accession funds, reducing subsequent borrowing significantly.
    

11. 
    Actual lending will be determined by the pace of reforms in key sectors. The pace of reforms thus far, combined with fYR Macedonia’s creditworthiness and low, but stable growth, warrant a program of lending support that would encourage progress under the two main pillars of the CPS. The base case includes both investment and adjustment lending, and envisages two or three new loans per year, for a total of US$220 million over the four years. Under the high case scenario, this lending program could be augmented by two more investment loans, for a total of an additional US$60 million over the four years. Triggers for the base case require continued satisfactory macroeconomic performance, and proposes selected indicators to make continued progress on the business climate, while maintaining stability and a continuation of satisfactory portfolio performance. The triggers for the high case require meeting all fiscal targets included in the IMF program as well meeting specific triggers on the energy sector and on the competition agenda. Developments in fYR Macedonia are changing rapidly; the lending program will be reviewed during the planned CPS Progress Report (FY09), to ensure that WBG support remains fully responsive to evolving needs in the country.
    

12. 
    Risks. Regional instability, especially against the backdrop of the Kosovo discussions, could greatly influence the sustainability of the economic reform efforts. It could also have a negative impact on fYR Macedonia’s ability to attract much needed new investments. Domestic political tensions pose a risk to the implementation of the government’s reform program as well. Finally, lack of progress in the EU accession process could weaken the consensus on the direction of the reforms, and could consequently result in a slow down of reforms. However, successful implementation of the program as supported by this CPS, would strengthen fYR Macedonia’s economy, raise living standards of its citizens, and would help fYR Macedonia to continue to play its model role as a functioning multi-ethnic state in the Balkans.